In celebration of our upcoming 3rd anniversary, we would like to elaborate on our mission at Somar, which we have illustrated below (Fig. 1). We will use this, and the following two letters to delve deeper into our core pillars.
We believe that Somar offers a very compelling way for investors to share in the vast amount of consumer value being created by highly talented consumer-oriented entrepreneurs.
We are extremely excited about our current and future prospects due to the abundance of opportunity we see, our unique approach to identify and capture it, and the option to augment our returns with attractive short opportunities that also reduce the impact of the market fluctuations on our returns.
This month we focus on the attractive opportunity set that Somar targets and how we distinguish between future highly profitable leaders and fast-growing pioneers that may struggle to sustainably achieve an attractive return on capital.
At Somar we focus on providing early access to future leading consumer businesses. This is an attractive opportunity for two reasons:
- The ongoing broad and brisk pace of innovation is allowing entrepreneurs to offer significant improvements in their consumer offer, opening numerous attractive investment opportunities
- Somar’s capabilities position us well to identify, vet and monitor potential future consumer leaders
We believe that by sharing in the vast amount of value being created for consumers over the next few years, Somar investors can achieve a superior investment return.
Eyes of the Consumer
The first step in identifying future leading consumer businesses is taking the consumer perspective to assess what unique advantages the company provides and whether they are enough to make consumers switch providers. Somar looks for situations where this advantage is “game-changing”. Incremental improvements (e.g. 5% lower cost, 10% more choice) do not interest us. We look for the “wow factor” – companies and offerings that amaze and go above and beyond what consumers expect.
The search and vetting of these opportunities require strategic analysis and marketing research. Most Wall Street professionals typically don’t develop these skills. Somar’s professionals have experience in marketing, consumer field research and strategic analysis. This enables us to identify consumer leaders with direct observation, before their success is reflected in their reported financial performance.
We have found a growing proliferation of businesses with “step-change” improvements in the past few years (Fig. 2 offers an illustration of a few of these). You will continue to learn about several more in our weekly “Changing World” e-mails.
Defensible business models with expanding competitive advantage
There is a long list of innovative companies that were unable to hold to their lead of the markets they pioneered: Palm and Blackberry in smartphones, MySpace in social media, eBay in e-commerce, Yahoo in search and many others. Successful investing in future leaders requires parsing out the innovators that have a sustainable or even expanding superior consumer offer from the ones who are vulnerable to disruption from a competitor.
This topic alone could fill a full letter. We will limit ourselves to making two points here:
- Not all competitive advantages are created equally
- The same business skills are required to identify the sustainability of a competitive advantage as to identify step-change improvements in the consumer proposition. As mentioned previously, we believe this to be a Somar strength relative to typical institutional investors.
To illustrate the first point above, let’s look at two cases of network economies. In our August 2018 letter we showed that food delivery marketplaces benefit from powerful network effects. This leads to a winner-take-all, or at least winner-take-most long-term outcome. Said another way, the larger the lead, the stronger the network economies advantages (Fig. 3).
In ridesharing marketplaces, however, these network advantages tend to reduce as soon as the marketplace is large enough to offer their customers a 2 to 3-minute average wait time. At that point, additional scale will not provide additional consumer benefits over competitors. In fact, Lyft recently said that for average wait times of 1 minute, the conversion rate is actually lower as consumers feel they don’t have enough time to meet their driver and tend to cancel their request. This enables smaller growing competitors to close the gap on average wait time. While ridesharing benefits from some network economies, these don’t provide a defensible long-term competitive advantage. We believe this structural difference has a profound impact on the long-term economic prospects of these businesses.
Partner with entrepreneurs early in the opportunity
We believe the most attractive time to invest with these entrepreneurs is after their concept has been validated by the first customers, but before the company’s ultimate financial success is apparent and understood by mainstream equity investors. This usually means that Somar tends to invest in companies that don’t need additional venture capital support but are not yet included in major market indexes.
This focus offers Somar investors several advantages:
- Long runaway for value creation: these companies are usually less than 20% penetrated on their market opportunity providing several years of value creation ahead
- Strong alignment of interests: entrepreneurs tend to still hold a significant (10%+) share of the stock
- Attractive returns: the capital competing to invest in these opportunities is smaller than the capital available to invest in venture capital and in index / ETF funds
- Fit with Somar capabilities: successful identification of long-term winners requires the strategic, marketing and entrepreneurial analytical skills that the Somar team has acquired and continues to develop.
Next month we will dive deeper into Somar’s proprietary research process that enables us to successfully identify, vet and monitor both companies we believe are future leaders and companies that are in the early stages of significant disruption to their business model.
All the best,
Disclaimer: This website is for general information purposes only and is not intended to be, nor should it be construed as investment advice, nor a solicitation or offer to buy or sell any securities, related financial instruments, or interests in the Somar Master Fund, LP (the “Fund”) or its feeder funds. The information contained herein is not complete, and does not contain certain material information such as disclosures and risk factors about the Fund or its feeder funds. Opinions expressed are current opinions as of the date of this material only and are subject to change without notice. Hedge funds: (1) often engage in leveraging and other speculative investment practices that may increase the risk of investment loss; (2) can be highly illiquid; (3) are not required to provide periodic pricing or valuation information to investors; (4) may involve complex tax structures and delays in distributing important tax information; (5) are not subject to the same regulatory requirements as mutual funds; and (6) often charge high fees.