Investment Memo recap and what triggers a reset

Late last year we started releasing something we called “Investment Memo’s” across all of the Investments we hold in our various different portfolios.

In this educational article we will look to summarise the following:

• What is an Investment Memo
• What we use our Investment Memos for
• When do we revise or re launch an Investment Memo

As we do every year, we closed out 2021 with a portfolio wide review of all of our investments and found that the review process was taking longer than it should have to answer the simple question of “has our investment delivered what we wanted it to deliver in 2021”.

Long time readers would be well aware of our approach to investing in small cap stocks. We like to back companies and management teams early and then hold patiently while they execute their business plan.

In the long run, we think that this business performance and execution on a day to day basis, will eventually translate into share price performance and as a result an “investment return” for us.

This means that we are less focused on the day to day movements of the companies share price and more focused on seeing our Investments execute their business plans.

This brings us back to the Investment Memo’s we started releasing.

Recap of what is in our Investment Memo’s:

Regular readers would now be well aware of the format we document these in, effectively with our Investment Memo we are doing a point in time evaluation of our Investment and writing down where the company is at and what we want to see over the course of the next 12 months.

Effectively these became our “2022 Investment Memo’s”, where we put together a short, digestible, high level summary of our reasons for investing in a particular company.

Our memos are split into six different sections:

1. What does the company do? - Here we have tried to succinctly summarise what our portfolio companies are doing/what they are trying to achieve.
   
   
2. What is the macro theme? - Here we tried to summarise the global trends (macro trends) that our Investments benefit from.
   
   
3. Why did we invest/Why do we continue to hold? - Here we establish the key reasons why we made an investment or why we continue to hold that particular company in our portfolio.
   
   
4. What do we want to see the company achieve in 2022? - Here we set some key objectives that we want to see achieved in that particular year so that we can evaluate how a company performed at the end of that particular year versus our expectations.
   
   
5. What are the risks to our Investment thesis? - Here we would ask ourselves what could go wrong with our investment by staying completely objective.
   
   
6. What is our Investment plan? - Here we detailed our holding/selling strategy, this helps us stay objective with our investment and free carry or take profit as the company achieves key milestones.

How do we use our Investment Memo’s:

Effectively, the ultimate purpose of our Investment Memo’s is to be able to track the progress of our portfolio companies using our Investment Memo as a benchmark throughout any particular year (2022 for our current memo’s).

As our portfolio companies execute on the key objectives we set for them, we will always look to go back and check to see how the company is doing versus the objectives we first set in our Investment Memo.

Depending on the number of objectives delivered and the results from these objectives we will assess how our portfolio company has performed for the year.

Our approach goes a little bit like this:

1. A company has outperformed our Investment Memo expectations - This would be where our portfolio company has delivered everything that we wanted to see them achieve in any given year or has exceeded our expectations.
2. The company has passed the expectations we set in our Investment Memo - Here a company would have met some of our objectives but not all of them. In this case we would consider the significance of the objectives missed and evaluate the company’s performance accordingly.
3. The company has failed against our Investment Memo - here the company would either have failed to deliver on any of the objectives, or missed the most significant ones. This could also be triggered by one of the key risks we mentioned materialising.

Generally we will look to do this review at the end of each calendar year but sometimes our portfolio company’s will fall into one of these categories well ahead of time.

Given our long term focus the more that our portfolio companies deliver against our expectations and further develop their business’ we expect to see the market reward this progress with higher valuations.

As a result we expect to see our portfolio companies that sit in the “Outperformed” and “Passed” categories to see their share prices move higher. Consequently any companies that sit in the “failed” category are likely to have share prices that move lower.

When do we do a memo revision?

Our Investment memos are effectively a timestamped snapshot detailing our Investment thesis for our portfolio companies.

This inherently makes them rigid by nature.

Listed companies are the complete opposite and companies can make developments that sit outside of our Investment Memo’s or the market conditions could quickly change and force our portfolio companies to adapt.

As a result there are specific conditions that trigger a re-think of our Investment Memo for a particular portfolio company.

Below are those conditions:

MEMO REVISION CONDITION 1: Times up. Our review process is completed

Every investment memo will be revised at the start of the calendar year, with an assessment of performance from the past 12 months, and a new set of memo items to track for the next 12 months.

Our review process and the particular company's performance can be categorised into one of the three categories we mentioned earlier. “Outperformed”, “Passed” or “Failed”.

After this review process, we will re-evaluate our investment and determine how and where the company fits in our portfolio, documented via a new Investment Memo.

MEMO REVISION CONDITION 2: highly material announcement:

This is self explanatory. Companies are operating 24/7 and unpredictable catalysts can materialise at any particular time.

These type events can be at the company level where maybe a company looking to make a gold discovery, all of a sudden makes a new and completely unexpected lithium discovery. ASX listed Kidman Resources’ comes to mind when we think of this, where they made a $800M lithium discovery right next to an old gold deposit in 2018.

These type events can also happen at a macro level, maybe the Australian Government decides to commit capital to a particular industry (Iluka Resources recent $1.2 billion loan from the AUS government comes to mind) OR a ban on exploration for a particular commodity is overturned and all of a sudden a project comes into play (the recent lifting of the ban on fracking in the Northern Territory comes to mind).

These type shifts can be unpredictable and depending on our assessment of the impacts of this style announcement on our portfolio company could be the trigger for a complete revision of our Investment Memo.

MEMO REVISION CONDITION 3: Large capital raise is completed:

Again this is a clear trigger for an Investment Memo revision.

Generally when we write up our Investment Memo’s we take into consideration the financial capacity of our portfolio companies and set expectations based on these resources.

For example a junior explorer with $3M in cash can only run one or two small scale drilling programs, whereas an explorer with $30M in cash can run several rounds of larger, more expensive exploration programs.

Generally these transformative capital raises will happen after a company makes what looks like a new discovery, new investors will pile into the company’s stock and trigger a re-rate which then increases a company's ability to raise larger amounts of capital.

A recent example from our portfolio is Latin Resources’ (ASX: LRS) which made a new lithium discovery in Brazil and went from ~3.5c to a high of ~23c, after which the company raised $35M @16c per share.

These large scale capital raises transform the company's ability to develop its business and will almost always trigger a revision of our Investment Memo where we will take into consideration the increased financial firepower the company has.

MEMO REVISION CONDITION 4: Management/Board of directors change:

This one can be a little less obvious and will depend mostly on the nature of change.

Sometimes as company’s make progress they will look to bring in new expertise, whether that is through a new management team or through new directors.

Our investment universe is mostly focused on companies that are valued at <$100M market caps which naturally means they are generally being built up from the ground.

This can mean that oftentimes founders or the dealmakers who put together the projects or built an idea from scratch are the managers/CEO’s of these companies.

As these ideas progress and companies get into execution mode these founders will often look to recruit talent who have been there and done it all. New people can often be an addition to the existing teams our portfolio companies have and in those cases an Investment Memo revision would not be triggered.

In the event that the changes are more structural, i.e an entire management team/board of directors are replaced we will look to meet these teams as part of our due diligence process before rewriting our Investment Memo’s.

This is the least clear of the triggers as it will almost always depend on the significance of the change.

Given these people are the stewards of our capital and are a large part of the focus during the due diligence process we think these type changes cant be dismissed.

MEMO REVISION CONDITION 5: Acquisition of new projects:

Another circumstance which may warrant a relaunching of our Investment Memo is when one of our portfolio companies makes an entirely new acquisition.

Market conditions can change and our portfolio companies will look to capitalise on these changes by bringing in new projects where they think they might have found value.

When this happens, we like to review the acquisition before determining whether or not it warrants an updating of our Investment Memo.

Sometimes these acquisitions can be small, an addition to existing assets or simply the buying out of rights over existing assets.

The only times we will consider a full revision of an Investment Memo is when we think the acquisition is material enough to change our Investment thesis.