Dear Partners,

The Fund returned -3.10%* for Q3 and is up 10.02%* inception (3/1/2017) to date. The Fund’s performance was partially limited by a negative contribution from the short book as well as a negative contribution from the options book. The long positions contributed positively for the quarter. (*Returns are gross of any incentive allocation accrued to date if applicable but net of all other fees and expenses)

September was a particularly difficult month with the fund down 8.52%. All three components of the fund were down with the long contributing -0.73%, the short positions

-4.13%, and the options positions -3.39% to the total return. While it is frustrating to have a negative month, the heartening news is that in our view, very few of the price movements are attributable to long-term fundamentals in the underlying companies.

Some volatility is always to be expected while running a concentrated portfolio and with the significant price movements we have seen (in both our long and short positions), a little pullback can be viewed as a healthy market movement. Short-term notwithstanding, I couldn’t ask for a better market environment going into the 2020s—both long and short.

The options positions held by the fund are generally longer-term in nature, and will experience a higher degree of price volatility in the short-term. The options positions are currently spread out, weight wise, roughly 50/50 into puts and calls. One example of an options position on the call side are Jun 2019 AMZN 1200 calls that contributed -0.91% to the performance this quarter.

With the current price of Amazon at roughly $960, we feel confident—without anything guaranteed of course—that these calls offer us an attractive risk-reward proposition. On the put side, the positions are structured to have an outsized effect in the event of a dramatic market pullback, and we have timed them strategically around potential catalysts (i.e. earnings releases, product cycles, etc.). The strategy with regards to options is to focus on what we believe are attractive risk-reward opportunities that have the potential to pay off dramatically in either a market drawdown—or the culmination of our investment theses.

The potential for significant gains and multiple returns on fund capital allows us to stomach some volatility in the short-term. The idea of the fund is to offer protection in the event of a significant market correction, while simultaneously seeking to position ourselves for success in the event our investment theses play out successfully.

The fund attempts to have less correlation to the broader market, instead targeting industrial verticals that are currently in the throes of disruption. The idea (and goal) is to return multiples on the Fund’s capital—tax efficiently—over a long time-horizon. The verticals we are concentrated in are still in the process of undergoing very rapid disruption.

One of the areas where we have short positions is the retail auto parts sector, highlighted by our short positions in Advance Auto Parts (AAP), O’Reilly Automotive (ORLY) and Auto Zone (AZO). While these positions had a negative effect on the portfolio this quarter, going forward we believe these companies will continue to face massive headwinds. There are two catalysts working against these businesses: In the short-term, auto parts retailers will see pricing pressure from Amazon intensify. In the longer-term, however, the transition to electric cars will be transformative, choking demand for these company’s products altogether. (Traditional engines contain about 2,000 moving parts. Electric motors, on the other hand, contain roughly twenty.)

These companies have margins that are simply not sustainable in a competitive online market in our view.

Nor does it appear their distribution channels are developed enough to compete with Amazon. As we have seen with other incumbent companies whose businesses are being disrupted, they have focused their innovation efforts on balance sheet chicanery, instead of innovating their products. These efforts have a possibility to work temporarily, but ultimately there is only so many ways to rearrange a shrinking deck. The market ends up being mostly efficient over time.

If the transition to electric cars continues, and we believe it will in a dramatic fashion — see this article — these companies will not just suffer. Their entire business, as it currently stands, may cease to exist.

We believe the current market has not priced this scenario appropriately. So, if we must stomach some volatility in the short-term, that’s acceptable in our view over the long- term. This month we conducted an interview with Tony Seba, an expert on disruptive events who nicely highlighted the difficulties incumbents face while operating in the traditional ‘internal combustion engine’ ICE business:

  • “So the inability to transition does not lie in the technology itself, but in the fact that they’re addicted to the cash flow that they already have. Also, the internal combustion engine industry hasn’t changed, really, in a hundred years. They add one little thing at a time, but it hasn’t really changed substantially. On the other hand, electric vehicles are more like computers on wheels. Things change dramatically very quickly. So back to your question – how do I see the battle between EV companies and ICE vehicle companies? It’s more cultural than it is about their technology itself. That’s one. The next one they don’t understand, or at least have been denying, is the speed of the rate of change in electric vehicles. That has mostly to do with the drop in costs of Lithium ion batteries, which is more than anything what drives the cost of electric vehicles.”
    – Tony Seba

As the pace of disruption continues at increasingly rapid rates, these realities can play out far quicker than expected and the traditional incumbents will be left to suffer unless they can drastically pivot. I have been consistent for years in my view that the dramatic transition to cloud computing will continue. The old guard, however, is not correctly incentivized to compete. While the market has begun to realize the size and strength of AWS, we are still at only roughly 15% of the addressable market from our calculations.

And once data is sent to the cloud, companies loathe to switch cloud providers, ensuring a high probability of revenue streams for years to come.

That is why it is crucial to win the business on the front-end by focusing on competitive pricing and customer value proposition. Once the business has been acquired, revenue and earnings streams often become ‘utility-like’—something we are currently seeing in our positions in Netflix (NFLX) and Amazon (AMZN). The ecosystem creates a positive feedback loop wherein more revenue creates a better product, which attracts even more revenue.

It is a myth that Amazon doesn’t make money. By my calculations, Amazon will likely be the first tech company to reach $100 billion in gross profit (GP) by 2019. Apple might get there first (we’ll see how their new phones sell though) but to us Amazon is like a machine growing GP each year. Gross profit is cash earned through selling a product or service. As investors, we’re happy that Amazon deploys its cash into AWS and other ventures—as long as those ventures are growing in value more than cash would grow.

And although we have made multiples on our money, Amazon, by my valuation, is actually cheaper than it was five years ago.

Of course, increase in revenue comes at the expense of traditional market incumbents. Often in disruption cycles, the ultimate revenue pie distribution is smaller than previous cycles. We are fine with this dynamic. In the age of the Internet, market share is increasingly concentrated by a single company with a dominant value proposition— and these are the companies we want to own. For incumbents, however, this is a disastrous scenario which allows us to build short positions in companies we view as unable to adapt.

We have begun to see the market react on the short side to companies like IBM, whose entire business is disintegrating in our view. IBM executives know that you can’t manipulate quarterly earnings in perpetuity without eventually paying a price. Which goes back to another point I have argued for in the past: That companies should break out organic revenue vs. revenue acquired through acquisitions.

The companies we own are growing at impressive rates and will almost certainly be bigger in a year’s time barring some major unforeseen setback. This is the result of organic growth and tremendous opportunity and execution. As I alluded to earlier, this growth is coming at someone else’s expense, and when companies focus on per-share metrics and bolt-on revenue, it is almost always because their business can no longer compete effectively. When the “value-creation” of a CEO appears to be only accounting in nature, the business is already heavily in decline.

As I’ve said before, we’re living in an incredibly exciting time for investors. Technological disruption is creating a mind-blowing redistribution of wealth in the stock market. But at the same time, shareholders are too often getting kicked around in the corporate board room. That’s why I’m so vocal about shareholder advocacy—and fighting against wasteful stock buybacks, Wall Street corruption, and excessive CEO pay.

Below you’ll find a complete list of our recently published columns in Forbes, as well as a link to our first white paper on the “revolution” happening in the renewable energy market. Going forward we have created a newsletter which will be sending all of my writings upon publication.

•••••

Our renewable energy whitepaper

  • The Renewable Energy Revolution: A Longterm Outlook For Investors
    • Renewable energy is disrupting industries faster than you think. For investors, both the opportunity—and downside risk—is massive.

Forbes Columns:

Disclosures:
Quarterly, monthly, and since inception performance presented is gross of any performance allocation (if applicable) but net of all other fees and expenses. The attributions for each fund component are gross and do not reflect the deduction of any fees or expenses. Fees and expenses would be reflected as a negative return attributed to the cash position. Past performance is not indicative of future results.
The opinions expressed herein are those of Nightview Capital, LLC and are subject to change without notice. There is no guarantee that strategies, thesis, or investment ideas will play out or be
profitable. The company (or companies) identified or referenced herein is an example of a current or potential holding or investment target and is subject to change without notice. This information should not be considered a recommendation to purchase or sell any particular security. It should not be assumed that any of the investments or strategies referenced were or will be profitable, or that investment recommendations or decisions we make in the future will be profitable. Past performance is no guarantee of future results. Nightview Capital reserves the right to modify its current investment views, strategies, techniques, and market views based on changing market dynamics.

Nightview Capital, LLC does not accept any responsibility or liability arising from the use of this document. No document or warranty, express or implied, is being given or made that the information presented herein is accurate, current or complete, and such information is always subject to change without notice. Shareholders and other potential investors should conduct their own independent investigations of the relevant issues and companies involved in this article. This document may not be copied, reproduced or distributed without prior written consent of Nightview Capital.

Nightview Capital, LLC is an independent investment adviser registered in the Investment Advisers Act of 1940, as amended. Registration does not imply a certain level of skill or training. More information about Nightview Capital including our investment strategies, fees, and objectives can be found in our ADV Part 2, which is available upon request. WRC-17-25