Our Letters

The Year so Far

Dear Investor,

The year so far

The year is off to a strong start for Somar. We are encouraged by our performance both on the long and short sides. After years of macro-driven capital markets, we have found 2024 to be more discriminatory in company performance. This dispersion of returns bodes well for active management going forward.

The last few weeks have been busy with multiple earnings releases. We have seen an unusual, but welcome, symmetry in outcomes. Companies doing well both on reported earnings and strategic investments are being rewarded, while companies falling behind on either earnings or strategic investments are being punished. This has benefitted fundamental investors. At Somar we have benefited both from our long and short investments and are having a strong February so far.

It is also confirmation of the emergence of the age of Artificial Intelligence (AI). Most large companies are investing billions of USD in building both the infrastructure and capabilities to take advantage of this emerging technology. It is still unclear how consequential it will be. Most pessimists equate it to a nice add-on feature with some micro-impact on a few industries, while optimists expect strong macro-economic impact with acceleration of productivity and economic growth for the next couple of decades. At Somar we will be driven by the data we see in real time and currently are somewhere in the middle of those two positions. There are industries where the impact is already large and expanding: cloud infrastructure, semi-conductors, software coding productivity. While others are still in testing mode: customer service, media production, education among others.

Discontinuous change is good for active investors that can anticipate opportunities early and position their portfolios to take advantage of them. We have already benefitted from this in both our long and short investments. We expect much more in the future.

In the next few months, we will write to you about recent investments we harvested to illustrate the opportunities we see.

Somar team

I would like to take this opportunity to thank the Somar team for the wonderful work they do on behalf of the Somar investors. We have a deep bench of talent, and I don’t anticipate adding to our team even if we were to double our current assets.

The investment team is composed of João Delgado, Carlos Silva, and Tiago Rodrigues. One is focused exclusively on shorts. The other two are tasked with deeply researching new clusters adjacent to our historical focus area where we believe there are attractive opportunities. Both these efforts have produced quality ideas that have already produced attractive returns. However, we believe most of the return is still ahead.

Will Bruce and Dhwani Vahia lead our operations and we have no hiccups, problems, or surprises. Issues are quickly flagged and addressed, and our external interlocutors frequently praise the professionalism of our operations team.

Dhwani also leads our client service area, and I will let you tell me where we can improve. So far, I haven’t yet received any complaints. That said, suggestions are always welcome as we want to continue to grow and improve over time.

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The team always enjoys hearing from you and updating you on our progress. Don’t hesitate to contact us to learn more about our approach.

Sincerely,

Pedro Ramos

Year in Review

Dear Investor,

Year in Review

2022 brought strong economic headwinds. Persistent inflation pressures around the world led central banks to sharply raise interest rates. Global economic growth slowed down and is currently expected to create recessions in some geographies. Stock markets sold off. The growth-oriented Nasdaq index is down 33.0% as of this writing, approaching the 41.5% decline in 2008.

Amidst this backdrop, Somar’s performance has been resilient but not stellar. We outperformed the benchmark and other leading investors in secular growers, but we had hoped to do better. Our security selection considers the inevitability of years like 2022, and even longer periods of recession. Our short book was a strong performer. Our portfolio construction improved throughout the year. We found attractive long opportunities. We end 2022 in a stronger position than we started it: we are looking at valuations close to decade lows and are confident of strong performance ahead through the cycle.

2022 was our most successful short year since inception based on the large number of frauds, stock promotions, and strategically challenged businesses we found. We booked strong profits. More encouragingly, we had a strong pace of diverse idea generation. While future years may not be as favorable to shorts as 2022, we look to them with confidence. Our process was upgraded throughout the year, and we allocated dedicated team members to this effort with great results. Our short practice ends 2022 in its best shape yet and we hope to continue improving throughout 2023.

Our portfolio management improved significantly during 2022. The strong underperformance of market share growers in the year highlighted the importance of a diversified portfolio of extremely compelling long ideas during economic dislocations. We worked proactively on this and since June have enjoyed from a wider breadth of opportunities. This will provide us the option to lean into the opportunities that recover faster. We do not make macro calls. The operational data and valuations will continue to direct our capital allocation amidst economic volatility.

We were also opportunistic in adding to our favorite market share growth ideas after large selloffs during 2022. When the data gave us comfort in the ability of some to continue to delight customers for years to come (compared to alternative options) and the valuations reflected a worst-case scenario (or worse) we didn’t hesitate in buying more in the comfort that the cash-flows over time would reward our investors with a very attractive return.

Highly volatile years like 2022 create strong valuation discrepancies. Investors sour on certain industries and/or geographies and sell all their holdings “throwing the baby out with the bath water”. The recent growth of ETFs and other passive investment vehicles further exacerbate this trend. This is good news for Somar. It offers us ample opportunities to pick out the winners from the losers and, valuation permitting, buy the former and short the latter.

We look forward to 2023 with confidence.

Valuations have come down sharply and, in some cases, price very draconian scenarios.
Our short book, process and dedicated team are the best we have ever had.
We have a wide breadth of long opportunities that will allow us to lean into the ones that sprout first.
Most of the financial tightening in the US should be behind us while other geographies are still well behind. This provides a diverse environment with opportunities both for longs and shorts.
The significant valuation moves during 2022 created large market inefficiencies, providing a more fertile field for active investors like Somar to outperform.

Sincerely,

Pedro Ramos

Perspectives for 2023

Dear Investor,

Perspectives for 2023

2023 has started strong for both the capital markets and Somar. While the market tailwind is helpful, we believe 2023 faces a wide dispersion of outcomes both for the global economy and for different regions. In addition, we expect 2023 to impact different industries and business models differently, given differentiated stages of monetary and fiscal policies as well as adjustments to a post-covid world. This is a helpful environment for active management. Somar is well positioned to perform well both on the short and long sides of our investments in a wide range of scenarios.

The last few decades have witnessed supportive macro policy with interest rates in secular decline and supportive fiscal policy which minimized the magnitude of each economic bump. This liquidity and fiscal support led to risk-on rallies occasionally interrupted by occasional bear markets in response to some external events (like the mortgage crisis in 2008, European sovereign crisis in the early 2010s and the pandemic in 2020). In this environment, the dramatic injections of liquidity (and related pauses) were the main drivers of capital market performance, with broad participation of different industries and companies in both bull and bear markets.

The 2021 emergence of inflationary pressures, high levels of sovereign debt as a % of GDP, slow down of the globalization process and deceleration of China’s economic dynamism means that the macro tailwind will materially weaken in the next few years. Outperformance will accrue to businesses that can offer materially better value to their customers while generating high and growing free cash flow. Their competitors will lose market share and struggle financially. This opens good opportunities both for long and short investments. At Somar we are focused on both and expect to generate returns from each.

The risk-off macro environment of the last 18 months, driven by the Fed liquidity tightening cycle, has led to a strong sell-off of fast-growing innovative companies. This was evident from the 2022 performance of the Nasdaq of -33%, materially worse than the performance of both the S&P 500 and the Dow Industrials. However, in the rush for the exit, investors sold many great businesses down to extremely cheap valuations, even considering the material economic deterioration. Somar closely tracks these companies: based on what we see, we start 2023 with a better than average opportunity set for our long investments. In the first few weeks of January, we already had 4 of our long investments pre-announce profits ahead of guidance (and others reporting profits ahead of expectation). We expect to see more of this in the rest of the year.

The euphoria around SPACs, cash-burning unicorns, and crypto companies has created a big gap between these companies’ valuation and their cash-generating ability. The level of venture capital and growth capital raised eclipsed previous records in the last couple of years. It is reported by Bloomberg that up to $300 bn of venture capital funds are available to be deployed. This creates an unprecedented demand for narrativedriven businesses with high cash requirements that need to eventually make their way into the public markets to provide liquidity for the venture capital and growth equity investors. A lot of these companies are already listed and offer great opportunities for short opportunities. Many more will list in the next few months. Somar expects this flow of new listed companies to provide a good short environment: the profligacy of cash-burning private investments eventually will meet the cash-weighing mechanism of the public markets. In addition, many of these narrative-driven companies not only are based on faulty businesses models but are also riddled with fraud (as the recent FTX episode illustrates). We have resources specialized in these opportunities and we continue to examine a strong weekly flow of new short opportunities as I write these lines.

In summary, we expect 2023 to be marked by cross-winds among different macro regions and industries; we have a better than average opportunity set for our long investments and a steady flow of short opportunities; we have the best team in our history to execute on these; and we have the portfolio and risk management capabilities to capture these opportunities. We look forward to reporting our accomplishments on your behalf 12 months from now.

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I generally abstain from giving investment recommendations for Somar in these letters. However, given the attractive opportunity set I see and described in this letter, I would like to emphasize this is a good time to invest in Somar. Please give me a call to discuss this further.

Sincerely,

Pedro Ramos

Short Illustration: C3.ai

Dear Investor,

Short Illustration: C3.ai

When a former successful founder gets back in business we get interested. In fact, it is a well-known fact that previous founders tend to have success in future ventures. Steve Jobs and Elon Musk are prime illustrations of this. Thomas Siebel founded and sold Siebel Systems to Oracle for $5.85 billion. Coming out of retirement he founded C3 and brought it public. Our due diligence however, made us suspicious of the motives, strategy, and prospects of this new venture. Instead of buying it we ended up shorting and returning a profit of 30% to Somar Investors. We found a company with no clear vision, lack of competitive advantage, problems with their main customer and shareholder, lack of management depth and continuity, including having four different CFOs in the past three years.

C3.ai (NYSE:AI), founded in 2009 as C3. The product roadmap focused on developing industry vertical applications of software products and tools that could be deployed by customers with limited or even no additional coding needed.

In 2016, C3 jumped on the Internet of Things (IoT) bandwagon and rebranded to C3 IoT. Similarly, in 2019, when ‘Artificial Intelligence’ (AI) became the buzzword of the moment, C3 changed its name again, this time to the current C3.ai (continued as “C3”). On June 2019, 6 months before its IPO, C3 signed a contract with Baker Hughes (BH) and sold 15% of its stock to them. The goal was to build a proof of concept for the Oil and Gas Industry and have BH be the exclusive re-seller in that industry.

While the branding and vision are attractive, the product doesn’t seem to live up to it. Former employees said that they could not find an AI platform at C3 and that, if there were no advertisements, C3 would be invisible. Customers and financial analysts contacted have also had trouble understanding where C3 fits in the AI ecosystem.

The rebranding did, however, achieve an important goal. It allowed the company to IPO in December of 2020 at $42 and together with multiple TV and media appearances by Tom Siebel, stirred retail investor enthusiasm driving the stock to a peak above $175 within a month.

More worrying has been the worsening relationship between C3 and its most prominent stakeholder – Baker Hughes (BH). BH is a technology provider for the oil and natural gas industry and C3’s largest client. After getting 15% of C3’s stock, BH’s CEO was elected to C3’s board. The two companies signed a contract, making BH C3’s exclusive reseller to the natural gas and oil industries. Initially, this contract had a 3-year duration, with non-cancelable minimal financial commitments. However, three months later, the contract was amended to postpone some of the payments. In June 2020, there was a second amendment to the contract (under the guise of Covid-19), with a significant reduction in the annual commitments and a further postponement of the payments. A few months after C3’s IPO, BH sold 20% of its stake at $67. After this, the companies signed a third contract amendment, with another decline in the annual commitments and with the payments postponed one more year.

In December 2021, BH’s CEO stepped down from C3.ai board. At the same time, BH announced a partnership with another artificial intelligence company (Augury), with BH becoming one of its main shareholders and a board member.

This hints at poor product performance leading to lack of commercial success of C3’s offer. In an interview, a former sales executive, said C3 and BH’s partnership was not working, because C3’s product was a ‘nightmare to sell’ and the companies’ cultures were so different, they couldn’t work together. According to public filings, BH still owns about 8.2% of C3’s shares.

Equally worrying is C3’s lack of strength in the C-suite. Since May 2019, C3 had four different Chief Financial Officers.

The first CFO, Marc Levine (05.2019-09.2020), left the company during the IPO process.
His replacement, David Barter (10.2020-12.2021), left the company in December 2021 for ‘personal reasons’
Adeel Manzoor (12.2021-02.2022), which had been involved in accounting irregularities at his former company due to revenue recognition issues, lasted less than 3 months and left also for ‘personal reasons’. On a personal side, he was also accused of domestic violence.
The current CFO, Juho Parkkinen (02.2022-Present), was promoted internally. Since assuming the new functions, he has been selling C3.ai shares almost every month.

To compound the product, commercial and management team issues, C3 hasn’t yet settled on the adequate business model. While it started as a traditional subscription (Software as a Service) offering, the company has recently shifted into a utility-type consumption-based model. This change was accompanied by a material (16% at the midpoint) cut in sales guidance.

While multiple-time founder and CEOs have been among the most successful entrepreneurs of all time, this is not an iron law of physics. C3 on the surface seemed to tick all the boxes for a successful venture (successful founder, emerging artificial intelligence technology, key customer, and shareholder). A deeper analysis showed that while the house was beautiful from the outside, the inside was rotten and the foundations shaky. We shorted and returned 30% on invested capital in this position to Somar shareholders

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We continue to find ample opportunities in the highly volatile markets. We will continue to update you on our progress both through these letters and our individual calls. The team and I are energized and excited by the opportunities ahead.

Sincerely,

Pedro Ramos

Short Illustration: Cazoo

Dear Investor,

Short Illustration: Cazoo

On the heels of the successful monetization of two previous copycat ventures, Alex Chesterman took advantage of both the 2021 Special Purpose Acquisition Company (SPAC) boom and the once in a generation cyclical-peak in used-car prices to bring Cazoo public at a $7bn valuation. Cazoo is a European online used-car dealer operating mostly in the UK with expansion projects in France, Germany, Italy, and Spain. They operate two segments: B2C – selling vehicles to end customers on their website; and B2B – auctioning used cars to other dealers. Cazoo sold an exciting story to investors with no support from field reality. We shorted the company and achieved a 65% return. Subsequently, the stock rallied, we shorted Cazoo a second time gathering a return of over 30%. This was a case of being able to leverage our work for two profitable trades, something that doesn’t happen often but that we constantly look for opportunities to do.

What first attracted our attention to Cazoo was management’s extremely optimistic projections provided as part of the SPAC acquisition process. The Company projected 100%+ compound annual growth rate until 2025, while improving the margins by over 60 percentage points. This would be striking for a company with incremental margins close to 100% like some software companies. But for a retailer, this heroic performance on both sales and margin defies economic logic. To grow, the company needs to continually spend marketing dollars to acquire new customers (cars are not a monthly purchase for most consumers) as well as hire and invest in personal in the UK and in their new geographic markets.

Customers could be acquired cheaply if the product was superior to its competitors and word of mouth from satisfied customers helped bring free traffic to Cazoo’s websites. However, our due diligence showed this not to be the case. We priced several models on Cazoo and its competitors and Cazoo came out more expensive both in the price of the car and in the financing options provided.

Cazoo’s choice for marketing channels was also odd and unconventional. Cazoo spends a significant part of its marketing on brand (rather than customer acquisition). They even sponsored the shirt of a couple of English Premier League soccer clubs. Somar’s contact with a Cazoo peer confirmed our suspicions: investing more in marketing ‘does not move the needle’ because consumers are always looking for the best price.

Cazoo’s founder and CEO, Alex Chesterman, has a good track record – he founded LoveFilm (movie rental business, which was acquired by Amazon) and a real estate platform called Zoopla which was listed in the UK in 2014. Both ventures were small competitors to larger and more established leaders: Netflix and Rightmove respectively.

The timing for Cazoo’s listing was opportunistic. As we know, the Covid pandemic led to disruptions in the auto semiconductor supply chain. This meant that new cars were hard to come by. Therefore, most customers that needed a car immediately resorted to the used-car market. Unsurprisingly, the average selling price for comparable used cars rose roughly 30% between 2019 and 2021. Such was the dearth of supply that some used models sold close to parity to prices of new ones. This price spike led to extraordinary gains for Cazoo’s inventory that was not sustainable and risked being unwound when the market normalized.

The tailwinds turned into headwinds during 2022. The auto-chip supply chains normalized, and higher interest rates (in response to higher inflation) reduced the affordability of auto-loans for used-car buyers. This led to strong misses from Cazoo on both their sales and margin guidance and the stock price reacted accordingly. Given the market volatility, we were able to short the company profitably twice since its IPO.

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Sincerely,

Pedro Ramos

Short Illustration: Astra Space

Dear Investor,

Short Illustration: Astra Space

Astra Space is an early-stage company aiming to design and build small rockets to transport small satellites to the Low Earth Orbit (LEO). Having secured a deal with NASA, the company went public through a Special Purpose Acquisition Company (SPAC) during the first quarter of 2021. After researching the company, Somar concluded it has the wrong strategy, poor execution capabilities, unrealistic financial projections, and a promotional management team. We shorted its stock and achieved a profit over 80% for Somar investors.

Wrong Strategy

Astra Space’s strategy is to build smaller rockets to deliver each satellite to the exact orbit their customers require. This reduces the time needed for the satellite to be operating in the customers’ specified orbit than traditional methods. To deliver this the company radically increases the number of launches while decreasing the size and payload capacity of each rocket.

Somar found two problems with this strategy:

Industry demand is moving towards larger satellite constellation deployments that require higher payloads. In addition, satellites themselves are getting larger: for example, Elon Musk’s Starlink’s Gen 1 satellites weigh 260 kg while Gen 2 weigh about 1,000 kg. Upon IPO, Astra offered a 300 kg payload, that has since been increased to 500 kg. This is still insufficient to accommodate the growing demand for larger satellites. Meanwhile, SpaceX is now capable of delivering up to 130 satellites with a single rocket and can accommodate not only large satellites, but also large constellations with each launch.
The limitation above could work if there was a cost advantage in the smaller satellite niche. But while Astra is projected to be cheaper than current sub-scale operators, Astra’s cost per payload weight is currently estimated at double that of SpaceX’s Falcon 9. Astra’s strategy of eschewing reusable rockets leads to higher costs.

Poor execution

Assuming that somehow, the strategy was made to work, Astra’s team hasn’t shown the capability to execute and deliver on its promises:

Of the 7 launches the company conducted between 2018 and 2021, 6 failed within the first seconds of the flight.
To reduce costs, Astra has chosen to build its rockets with off-the-shelf parts and cheaper materials, such as aluminum (instead of fiber) leading to lower reliability.
The company seems to accept, with management stating publicly, that failed launches are an acceptable trade-off for lower costs of doing business. The CEO has stated they are not aiming for perfect reliability. This of course disregards the costs of lost client satellites in crash launches, which will increase the total cost to its customers along with insurance costs to the company.

At the Q2 2022 earnings call, management announced that the company would not conduct any more launches during 2022 and was uncertain whether the company would conduct paid commercial launches in 2023. They also announced an increase in payloads to 600kg per rocket, and a further decrease in their CAPEX estimates. Given the speed at which the industry is evolving it is unclear whether Astra will ever be able to successfully build a competitive and reliable launch system.

Unrealistic financial projections

Taking advantage of SPAC’s regulations that permit companies going public through SPACs to present financial projections under Safe Harbor, Astra Space stirred up enthusiasm with wildly optimistic projections. Not only are margins highly questionable given the comments above on strategy and execution, but their sales projections also defy common sense.

For example, for 2025 Astra projected it would launch 300 satellites. Not only is this number significantly higher than the total industry size in 2020, but it would also represent more than a 50% market share in 2025 based on the most optimistic industry projections (After accounting for the commitments already taken by SpaceX, China and Russia.).

Promotional management

Management has been quite promotional. It has focused more on presenting a good investor story than on serving their clients and improving the product. A few examples illustrate the tone:

Management claims Astra to be the fastest to send a rocket into space based on a December 2020 test. Two problems with this assertion: 1) the rocket failed to reach orbit; 2) it failed to mention that most of Astra’s team had previously worked for 10 years at NASA-backed Ventions, which failed to design a working rocket.
Management claimed to be funded through 2025 even though they are on track to run out of funds in 2023.
Management claimed to be funded through 2025 even though they are on track to run out of funds in 2023.
The CEO makes a big deal of having previously worked as CTO at NASA. A closer look shows that he was leading only the corporate IT department and not involved with flight and space operations.

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Sincerely,

Pedro Ramos

Short Illustration: Porch Group

Dear Investor,

Short Illustration: Porch Group

It is no secret that the US housing market is slowing down. If you add a cash burning company with promotional management, accounting tricks enabled by lax internal controls and which was built through M&A driven growth executed at the top of the market multiples, you have a very attractive short opportunity. At Somar we took advantage of this and made a return of about 70% on this short.

We found Porch in a long list of recently listed companies through SPACs (Special Purpose Acquisition Company). It had several bear reports on it that piqued our interest. Our research confirmed these and other concerns. Below, we summarize our thesis.

Porch Group provides software and services to home services companies such as home inspectors, mortgage companies, loan officers, title companies, moving companies, real estate agencies, utility companies and roofers. The software helps with scheduling appointments, document sharing and communication. Porch leverages this information to sell insurance products to home buyers.

Porch Group monetizes through two revenue sources:

Software [64% of Revenue]: consists of a vertical software platform for the home service companies mostly booked on subscriptions. Additionally, Porch also earns per-lead and per-quote based fees from insurance companies.
Insurance [36% of Revenue]: homeowner insurance and warranty policies earned through its own insurance carrier and certain homeowner and auto insurance policies fees through its licensed insurance agency.

Porch Group went public in 2020 through a SPAC (PropTech Acquisition Corporation) merger. Its growth has been mostly driven through acquisitions. Porch reported $192 million revenue in 2021 after spending more than $250 million in acquisitions. When questioned about organic contribution to their growth, management provides broad and evasive qualitative comments which lead us to believe it is very low if at all positive.

On top of the strong acquisition spend, these revenues have come with high operating losses. In 2021Porch lost 45 cents pre-tax for each dollar of revenue. This puts the company in permanent need of capital injections, of which the SPAC transaction was only a partial and temporary solution.

Porch has been under financial distress. Their auditor is sufficiently concerned about the cash burn that it issued a going concern opinion in their 2019 audit report. Additionally, according to the company’s filling in 2020, after the announcement of the SPAC deal, several of the company’s loans were in technical default. Finally, they reported a material weakness on its internal controls over financial reporting that stated the company did not have “sufficient, qualified personnel to prepare and review complex technical accounting issues and effectively design and implement systems and processes that allow for the timely production of accurate financial information in accordance with internal financial reporting timelines to support the current size and complexity (e.g., acquisitions, divestitures, and financings) of the Company”.

Also worrisome is the company’s inflation of its revenue. Porch used the same practice that Groupon used prior to publishing its IPO prospectus, which the SEC opposed. Specifically, Porch reports “Managed Services Revenues” on a Gross basis. Here is an illustration: after connecting a homeowner and a contractor, Porch reports as revenue all the contractor’s invoice. It then reports this amount (net of Porch’s commission) as a Cost of Services. All companies we know of (including Groupon) report as revenue only the net fee charged to make the transaction. While this has no net impact on operating profit, the revenue boost on questionable accounting grounds is a sign of aggressive accounting choices. We wonder what other accounting tricks are also being perpetrated. Porch likely aims to present their valuation at lower revenue multiples, which is a common valuation gauge used by growth equity investors.

Another example of management exaggeration bordering on deception is their claim of near $0 Customer Acquisition Cost on their insurance business. Their logic is these contacts are obtained through their software business (internal database). This claim has two problems: first, their conversion rate is low and hence the cost of the phone calls to obtain these customers is significantly higher than $0. Second, most customers are startled to be called by a company they don’t know. Many have presented complaints. There is a material chance that regulation and or litigation around privacy may close this acquisition channel altogether in the near term.

Porch has badly missed their SPAC projections on the operating profit line. While they guided for significant double digit percentage profit in 2021, they reported a loss. We believe this is due to the focus on adding revenue at any cost. When we asked the company details about the incentive plans, the answers were evasive and claimed they were tied to performance. SPACs have unaligned incentives. The SPAC sponsor usually gets 20% of shares in the newly formed company for a token monetary investment (basically for free). They are then incented to tell an exciting growth story to keep the stock high until the lockup period expires and they can sell their shares. It is not unreasonable to expect them to incent management along the same lines.

Management track record is not stellar. The CEO and Chairman of the Board, Mr. Matt Ehrlichman was previously the Chief Strategy Officer of a company (Active Networks) in an unrelated industry. During his tenure, Active Networks never turned a profit and was later sold to a Private Equity at a price lower than its IPO price. According to his Bio, he was responsible for 85% of Active’s P&L. If that is correct, he has a poor track record of shareholder value creation.

We hope this illustration gives you a good appreciation of the type of short opportunities we have been finding. We continue to find more every week and will update you on other cases in future letters.

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We recognize volatile years can be distressing. But they open a wide array of extremely attractive opportunities. We are seeing plenty of them both on the long and short sides of the book. Our patience will be rewarded with above average returns by the time this cycle is over.

Sincerely,

Pedro Ramos

Short Illustration: Mullen Automotive

Dear Investor,

Short Illustration: Mullen Automotive

Industries of the future, like Electric Vehicles (EV) are fertile soil for future bankruptcies, including from pump and dump schemes. We saw this two decades ago with multiple e-commerce and internet companies. We also saw it last century with the advent of the auto industry and aerospace travel. These spawned hundreds of companies of which only a handful survived a few years later.

This cycle is capital destructive for shareholders. This doesn’t stop entrepreneurs from partnering with promotional management teams to seize the opportunity to tell a good story, raise capital, pump up the stock price so they can cash in their shares. In the EV space, these schemes seem to follow the following steps:

Choose a catchy name that calls people’s attention and build a futuristic website.
Secure a charismatic CEO, build a fun culture, and poach some engineers from competitors.
Build at least one prototype to showcase your vision, even if it is not 100% functional at the time (Famously Nikola produced a video with their electric truck prototype in movement. What it didn’t disclose was that it was powered by gravity, having gathered speed on a road descent prior to the start of the video).
Use this prototype to extract the most cash possible by taking pre-reservations on your site.
Foster a steady stream of positive announcements of future projects to keep the share price high.

Somar has been active in the space and successfully profited from shorts in several would-be EV companies. Mullen Automotive is a good case study here. Founded in 2014, Mullen Automotive (MULN) went public on the Nasdaq in November of 2021 through a reverse merger with a company called Net Element, Inc. It describes itself as development stage EV manufacturer.

Mr. David Michery, Mullen’s CEO, has a background in the entertainment industry. He was the CEO of several companies in the music industry, including AMC American Music Corporation. He was involved in a case of fraud in the U.S. as CEO of American Southwest Music Distribution, Inc. (ASWD). Finally, Mr. Michery was also involved with several failed companies whose securities registrations were revoked by the SEC.

Additionally, some of Mullen’s largest shareholders also have a poor track record, with some associated with shareholder value destruction value and financial crimes. For examples, Acuitas Holdings LLC, controlled by Mr. Terren Peizer. suffered tremendous shareholder value destruction in companies such as TOP SHIPS Inc. (NASDAQ: TOPS), Precipio Inc. (NASDAQ: PRPO) and MusclePharm Corp. (OTCMKTS: MSLP). Esousa Holdings, LLC, is controlled by Mr. Michael Wachs. who pled guilty to defrauding Chase Manhattan Bank for $20 million in 1997.

Mullen followed the script outlined above. Throughout, Mr Michery has been active making several positive announcements that upon closer inspection are not supported by the facts. We will detail 5 examples here.

Solid-State Battery

Mullen claims to be on the brink of commercializing a Solid-State Battery. If true, this will be a major step change in state-of-the-art technology more than doubling the mileage range while significantly reducing the weight required and time to charge. We find two issues with this claim:

Mullen has invested $3 million per year on R&D to get here. Experts believe the most advanced company and team in the field is Quantumscape which after investing $1 billion is only targeting 2024-2025 to commercialize its technology.
Mullen claims to use technology from Chinese company Linghang Bao. This company looks fake. Their listed phone number is shared by hundreds of other Chinese companies. Their business address is an office not a factory. Its website is down. The agreement called for $2 million to be paid by Mullen. However, in 2020 Mullen revoked the agreement invoking “force majeure” after paying only $390k.

Sports Car

In December 2018, Mullen announced an agreement with Qiantu to assemble and distribute the Qiantu K50 in North America. This car had already been introduced in China in 2015. Mullen would change the logo and name of the car to “DragonFly” (You can see the unveiling of the car at the 2019 New York International Auto Show here: https://www.youtube.com/watch?v=pnaKZ9b2H38). Three years later, Mullen has not sold a single car. It also failed to pay the first installment to Qiantu which led to a contract breach at the end of 2019. This process is still in court. However, Mullen continues to accept pre-orders of $1,000 for the DragonFly on its website, which has “Coming Soon” in the DragonFly’s webpage.

Electric Fleet Vans

In August 2021 Mullen announced an agreement with a cannabis retailer to buy 1,200 EV vans for a total of $60 million. However, this retailer only has a warehouse in Texas and on its website, they state clearly that they distribute their products exclusively through USPS (To distribute cannabis in the U.S., one needs a manifest to show the authorities the cannabis is being distributed for commercially approved uses and not illegally. This manifest is not cheap and is burdensome. Therefore, the company prefers to distribute the cannabis through USPS that do not require the manifest for the distribution of cannabis). It defies imagination what use would this retailer have for 1,200 EV vans.

In September 2021, the company announced an agreement with Chinese company Tenglong Automotive to build and sell Class 1 and Class 2 EV Cargo Vans in the U.S. and Mexico. Mullen would assemble these vans in its factory in Tunica, Mississippi, and distribute them in the two countries. In March 2022, the company upped the ante stating its EV vans were actually “designed, manufactured, and customized by Mullen. Its website shows two different EV Cargo vans. However, Mullen’s import registers show two vans exactly like the ones the company pictures on its website. No design and production has yet occurred in the US facilities.

In January 2022 Mr. Michery indicated that Mullen would start to commercialize its Electric Vans in the second quarter of 2022. This has not happened.

SUV – The Mullen FIVE

Mullen has also built a prototype of an SUV: The Mullen FIVE. This has been presented in several auto shows. The company expects to start shipping in 2024 and is taking orders, even though no manufacturing facility is in place (see below).

This has not prevented Mullen from announcing what seems to be fake orders. In December of 2020, Mullen announced a non-binding letter of intent with a company called Unlimited Electrical Contractors Corp. to buy at least 1,500 units of the Mullen FIVE, which could go up until 10,000 if the company wanted to buy more units. This order seems odd because Unlimited Electrical Contractors Corp. only has 30 employees listed on LinkedIn so why would this company need 1,500 EVs, let alone 10,000?

Tunica Manufacturing Facility

After jumping from facility to facility, Mullen settled on a manufacturing facility in Tunica, Mississippi that the company says will assemble EV vans. Mullen bought this factory in November 2021 for $12 million and initially called it a pilot facility. However, after abandoning its Memphis facility, Mullen now plans to upgrade Tunica from the current 125 thousand sq ft to 1.2 million sq ft.

Mullen states this factory is equipped with state-of-the-art equipment but the video on the company’s website, only reveals a simple elevator and the two EV vans imported from China. The website also has a picture with two advanced robot arms like those found in Tesla factories and other automakers. However, this picture is a public domain photo available for download on Adobe’s repository of images. Therefore, it is not a picture of the Tunica’s facility as Mullen would like us to believe.

With almost no revenues and liquidity left, Mullen has been funding itself mainly through new stock issuance driving a material dilution to existing shareholders. Somar has made a return north of 30% on this short

Sincerely,

Pedro Ramos

Somar turns 6

Dear Investor,

Somar turns 6

Six years into our journey offers a good time to pause and take stock of where we are and where we are going. The vision for Somar is an ambitious one, but one I have a high conviction for: to be one of the best returning financial investment enterprises through partnering with generational entrepreneurs who transform the markets they address, augmented by an insightful and profitable short investment operation.

Today we are in the best position yet to achieve this vision. Notwithstanding a difficult start to 2022, over the first six years of Somar we have built a team, processes, and culture that I believe will help us bring our vision to fruition for years to come. In this letter, I will touch on a few of these: idea generation, short book, risk management, portfolio management, culture, and team.

We have generated more short and long ideas than I expected. This has stemmed from our cluster approach to ideas (studying every public and private company in each sector when vetting an idea), from an increase in the number of innovative companies going public (helpful both for short and long ideas), and from the quality and work ethic of our team, allowing us to cover more industries than anticipated. This provides the portfolio manager with plenty of options to build a diversified and highly compelling portfolio.

Over the last two years we have achieved a step-up improvement in the performance of our short book, which has been profitable not only this year, but also last year despite the rally in the markets. This was achieved through better idea generation, faster rotation of the portfolio and a development and allocation of talent to the shorting discipline.

During our first six years, we were tested by very diverse environmental shocks: Brexit, Trade War, Pandemic, Inflation, and an ongoing European War. Our portfolio was not immune to this shock, nor should you expect it to be going forward. That said we were resilient, managed risk adequately and used these shocks to find opportunities that left our performance better off after the risks subsided. We track risks closely, and continuously. The abundance of ideas mentioned above, give us the tools to adjust our portfolio fast, if that is justified. We will continue to improve our risk management for many decades to come but given the diversity and sudden onset of the shocks we have faced, you should take comfort we believe we have the resilience and wherewithal to turn the initial impact into long-term opportunities.

When Somar started, I had already managed portions of a larger portfolio, but had never overseen a full marketed portfolio. There were no big surprises for me in assuming the Portfolio Management role. But Somar’s ambitious vision requires constant improvement in all areas. My daily push has yielded material improvements in portfolio management, and I will continue to work hard to maintain this pace of progress.

We have a strong culture, that allows us to attract the right talent to pursue our vision and creates an exciting work environment for highly talented investors that want to excel at the investment craft. You may remember our culture is summarized by 3 Hs:

Honest: we are stewards of your savings. Nothing but complete honesty with ourselves, our colleagues and our investors is tolerated at Somar.
Humble: we never forget that we live in a complex world and are called to make decisions with incomplete information. We always assume the person on the other side of the trade is smarter than we are. This forces us to think deeply about risks, multiple future scenarios and to demand an entry price that gives extremely high odds of a very positive return.
Hungry: a fact of life of the investment cycle is that in some years we will have outstanding returns just by reaping the hard work of previous years coupled with riding a more favorable cycle. It could be tempting to slack off if your year is showing 40%+ return. This is not acceptable at Somar. We are always sowing the seeds of future performance, knowing we must outwork the best investors. This high work ethic and focus on process rather than short term results allows us to do our best work both in exuberant and panic years in the markets.

Over the past year I have been very fortunate to identify, recruit and train highly talented investors in Portugal. I hope you get a chance to talk with Nuno, João, and Carlos in the future. Despite acing a grueling hiring process, they have performed at Somar well ahead of my expectations. I’m also excited that as we grow, we now have a good process to identify additional highly talented and motivated investors for Somar.

Finally, it’s been an absolute honor to work with you, our partners. I always enjoy our discussions and your thoughtful questions. I take the honor of managing your capital very seriously. Some of you know that my father is a doctor. For him the health of the patient is his alpha and omega. Growing up I saw how he spared no effort to take care of his patients. I feel the same calling to managing your capital. And your support is one of the most gratifying parts of Somar. I look forward to continuing our partnership for many decades to come.

Sincerely,

Pedro Ramos

A bedrock for prosperity

Dear Investor,

A bedrock for prosperity

During the depth of the 2008 financial crisis, I confirmed my calling to be an investor. The financial system was melting down. People were questioning whether Goldman Sachs or Morgan Stanley were going to make it. Some even questioned capitalism itself. Yet, despite all these sobering headlines, I loved getting up in the morning, going to work and researching each opportunity in-depth based on its merits and the evolving financial and macro-economic landscape. To succeed at that time, you needed to get into the weeds and understand what risks each business had, under scenarios they had not planned nor had faced before. Scenarios were adjusted and stress-tested frequently. It was a peak performance time. A few years later, I took inspiration from what Novak Djokovic said after winning the 2012 Australian Open final in the longest (almost 6 hours!) Grand Slam final on record: “We are professionals. We live for matches like this!” (Please check the video at https://www.youtube.com/watch?v=OyvOZbLi9ts). As professional investors, we live for times like this.

I am extremely energized by our current environment. It brings challenging, long working days, that feel like they last only minutes. While the scoreboard and the news might make most people want to focus on something other than the financial markets, I love these discontinuity moments. They stress test all market participants, open very attractive investment opportunities, and accelerate the pace of news and analysis that allows the prepared and industrious investor to profit. I believe Somar is going to thrive from the current environment and look forward to substitute results for words in the future.

The sharp reduction in equity valuations creates direct benefits for investment returns:

Improves the returns on capital available for our portfolio companies to invest the cash they generate both on acquisitions and share buybacks
Creates catalysts for profits and alpha generation on our short investments
Expands future returns by investing in attractive businesses at lower prices

Indirectly, the broad-based sell-off creates temporary market inefficiencies that reward the prepared investor who can recognize and act on them. These sharp sell-offs appear to surprise many, but they are part of the way financial markets work. The credit cycle inevitable tempts many to over borrow in good times to improve their returns. That strategy works in the beginning as good macro conditions prevail. Inevitably, one or more events trigger an economic slowdown, and many investors are forced to sell at the market price to meet margin calls. Leverage contracts, and the excesses of over-valuation are followed by the excesses of under-valuation. Somar is not levered and that affords us the opportunity to take advantage of these opportunities.

The current cycle has followed a similar pattern, accelerated, and exacerbated by the sharp rise in inflation:

High enthusiasm for high growth names – especially visible in pre-IPO funding rounds from growth equity funds
Higher nominal interest rates to combat higher inflation. This will continue for the foreseeable future, reducing liquidity from financial markets
Liquidity calls on levered investors, like what happened to Archegos last year
Liquidation of Investment Funds, such as Melvin capital recently

The rise in inflation is a new development for many investors. It hasn’t happened since the early 80’s. Unlike previous downturns, such as 2008, the Federal Reserve is in no position to lower interest rates to support financial markets and investment. In fact, it is forced to do the opposite. This will be a more persistent headwind to valuations than experienced in the past. It will also affect different businesses in different ways. Having grown up with inflation north of 20% in Portugal, I remember how different the economic life can be with high interest rates. This creates opportunities in the short but also in the long sides. We are pursuing both.

So far, Somar’s results have fallen short of what we were hoping. While there are reasons for this, I will not dwell on excuses. Clearly, I could have done better: I have been eager to take advantage of the lower valuations earlier than I should. That said I like where we are and believe we have not lost opportunities on the long side while we have taken several good opportunities on the short side. The time for long investments will come and we are ready for it.

Sincerely,

Pedro Ramos

An illustration of a recent short

Dear Investor,

An illustration of a recent short

Since our inception, our performance in the short book has steadily improved year after year. In fact, we have generated profits on our shorts both in 2021 and in 2022 so far. This reflects deep investment in our capabilities to improve an area of our book we believe can be highly accretive to our total profits.

Given the faster rotation of ideas on the short book we have harvested many ideas we can talk to you about. This month we would like to present our thought process shorting Ginkgo Bioworks, which we have done with the support of one of our new team members.

Gingko was presented to investors as a platform to develop and spawn novel cell programming businesses. Our investigation revealed an undifferentiated services company with questionable accounting practices, opaque related party dealings and highly promotional management. We have since covered our position for a profit of more than 50%.

* * *

Ginkgo Bioworks (NYSE: DNA), founded in 2009, went public on September 17, 2021 after completing a reverse merger with Soaring Eagle Acquisition Corp., a Special Purpose Acquisition Company (SPAC). The company conducts synthetic biology R&D services for its customers, using its horizontal platform for cell programming (Foundry). Customers use it to improve their manufacturing processes or develop new products.

Ginkgo receives cash payments on a cost-plus basis. In addition, the company retains what it calls “downstream value”, i.e. royalties from the sales of future products that the customer develops using the molecules developed by Ginkgo or even equity stakes in the customer. This “downstream value” is usually contingent on the achievement of specific milestones by Ginkgo.

We came across Ginkgo upon reviewing the public report of an activist short investor. We reproduced most of this investor’s analysis and conducted additional proprietary analysis ourselves.

Ginkgo’s value proposition is its ability to essentially brute force its research, running parallel liquid handling machines, as is common in the industry, to automize the yeast fermentation process until the desired result is achieved. This is an iterative process. We couldn’t identify any proprietary Gingko technology other than its database which includes physical (engineered cells and genetic parts) and digital (genetic sequences and performance data) biological assets. However, there are other similar databases elsewhere and other competitors also have their own databases not much different in size and scope than Gingko’s. So, this database is not a meaningful differentiator.

Ginkgo’s financials reveal an over-complicated business model. Ginkgo’s revenue recognition policy unusually suggests that the company could be recognizing as revenue non-cash considerations almost immediately, although the policy doesn’t specify in which cases and why. We found several clues that this is happening. For example, days receivables grew from 51 to 156 days between 2019 and 2021. Another example was $12m recognized as deferred revenue (but not collected) from a related-party formed just two weeks before the close of the quarter: Kalo Ingredients (now known as Arcaea). These sort of arrangements with relatedparties are frequent with Ginkgo. The company reported $25m of deferred revenue from another one: Allonnia at the end of 2019. Allonia had just completed a $33m financing-round one month before yearend (led by Ginkgo and its investors), and registered $25m in R&D expenses (matching Ginkgo’s reporting). However, its cash balance remained at $33m, suggesting that the deferred revenue reported by Ginkgo was 100% non-cash. We can find a similar deal with Synlogic, another related-party.

Related-parties account for a significant percentage of Ginkgo’s revenues (as high as 72% in 2020). While we are told that Ginkgo receives equity stakes in customers after being contracted and delivered its services, in fact often Ginkgo purchased equity stakes before being contracted. Conveniently, the company received suspiciously similar amounts of revenue from its related-parties to the amounts invested by Ginkgo in them. In other words, the company appears to be round-tripping revenue.

For example, just before going public, Ginkgo announced a series of deals with related-parties such as Kalo Ingredients (now known as Arcaea), Verb Biotics and Ayana Bio (in total Ginkgo announced 8 new partnerships in the month and a half preceding the SPAC merger: Verb Biotics, Ayana Bio, Bolt Threads, Arcaea, Huue, Cambium Biomaterials, Tantu and Africa CDC). Some of those were formed weeks before the deals were announced, many of them without key personnel such as a chief technology officer; some were headquartered in the same address as Ginkgo.

Ginkgo’s CEO and founder is Jason Kelly. Despite his technical education, after analyzing his interviews and presentations, we believe he sees his role mostly as promoting and selling the company instead of building an innovative and unique offering. For example, Jason Kelly loves to compare Ginkgo to Amazon, Apple, Microsoft, etc., claiming that biotech is as easy as programming a computer. It requires little common sense to understand this is not so. Besides, even IT programming is not entirely predictable (bugs are common in software). This comparison disappeared from the SEC filings in their latest 10-K.

Another instance of over-hyping is Gingko’s Biosecurity segment. Purportedly started in 2018 it only generated revenues starting in 2020. A closer look shows these revenues are mostly Covid-19 tests. After a boom during the peak of the pandemic, the segment is guided to decline revenues in 2022. Its future attractiveness and sustainability remain in question.

Management’s reaction to questions is also telling. For instance, Ginkgo’s CFO seems intent on obscuring the operating cash flow model of the company:

At Investor Day, after initially claiming Ginkgo received upfront cash and an equity stake in its customers, to be sold in the future, he claimed that liquidity “depends” because nobody wants to sell a successful investment. Immediately after, their chief accounting officer claimed that Ginkgo was going to sell that equity in an apparent correction of the previous claim.
In its first earnings call, the CFO said Ginkgo was not going to disclose the amount of non-cash vs cash revenue that it generated due to NDA agreements with its customers.

Gingko’s valuation peaked at almost 30 billion dollars despite generating only about 314 million dollars in revenue in 2021, with just 113 million dollars of which generated through Foundry, their supposedly high growth platform business line. Cash Flow is very negative: Gingko burned about 150 and 200 million dollars in 2019 and 2020 respectively. In 2021 it burned over 300 million dollars. At this pace, it could run out of cash in the next few quarters.

Ginkgo’s operating margins are also negative. So much so that we wonder if they are truly being paid upfront at cost-plus. The company does not disclose gross margins for the core Foundry business, which doesn’t give investors the tools to gain comfort on its future viability as it stands.

Our analysis of Gingko’s assets, strategy and investments didn’t reveal any platform or real optionality to launch additional sizeable businesses with their current capabilities that would materially impact their valuation in a blue-sky scenario.

We modelled Gingko’s inherent value and couldn’t get close to the market value under any realistic scenario. A “what do you have to believe” scenario to get to the public market value forced unrealistic assumptions both for market size, profitability and value realized through “downstream value” stake changes.

We were patient building a position to allow for the initial enthusiasm and short squeezes to play out and the first cracks to become more visible on their operating model. After making more than 50% on our short position we have now fully covered.

* * *

Sincerely,

Pedro Ramos

Discontinuities

Dear Investor,

Discontinuities

Vladimir Lenin is credited as saying: “There are decades where nothing happens; and there are weeks where decades happen.” This seems description of the recent weeks. The war in Ukraine came as a surprise to many and re-focused the priorities of western politicians and businesses. Energy security became a top priority. Supply resilience and redundancy have become paramount (as opposed to cost and just-in-time inventory) following disruptions from the pandemic, supply-chain constraints, and geopolitical threats. Across the board, CEOs are calling for onshoring and/or near shoring of manufacturing. Perhaps the most visible example is semi-conductors: most of their production is currently in Taiwan and Korea, and their recent shortage has closed factories across the US and Western Europe.

These changes are putting upward pressure on inflation and interest rates. They are also changing the medium-term prospects for different economies around the world. The situation is fluid, but Somar is prepared to adapt and thrive in the new environment.

Somar has always avoided high geo-political and macro-economic risky markets for its investments. We don’t claim to have better insight into macro-economic and geopolitical trends than the average investor and believe our core competency lies in identifying emerging superior customer offers designed and led by highly talented entrepreneurs and teams. Therefore, since our inception, we decided to focus on investing in North America and (mostly western) Europe. The qualities we look for in a market to consider investing are:

Strong Rule of Law – courts defend the rules-based system and promptly enforce contracts; low corruption; healthy open debate of pros and cons of policies and public choices.
Capitalist, market based economic system.
Open and liquid capital markets both domestically and internationally.
Stable, sensible and predictable regulatory environment.

Somar also has the tools to adapt and thrive in any changing environment:

Liquidity: our portfolio is highly liquid. Since our inception I can’t recall a time where it would take more than 2 days to orderly liquidate substantially all our portfolio.
Ability to use both long and short investments to take advantage of opportunities as they present themselves in the market. We also have the flexibility to adjust our net and gross exposures to changing circumstances.
Large, accumulated know-how of hundreds of companies and dozens of clusters that give us perspective of differentiated impact of changing environment as well as multiple pulse checks into how the economy and consumer are reacting to ongoing news.

At the onset of the war, we acted immediately to better position the portfolio to the new reality.

Ensured each of our long investments had non-material exposure to the most affected geographies.
Shorted companies with exposure to the affected geographies.
Re-assessed each of our long and short investment thesis for potential impact from the new events. To the extent the thesis was impacted we eliminated the position. To the extent the thesis was reenforced, we increased our position size.
Got in touch with management of our top positions to get their assessment of any changes to their prospects and strategies.

Given our above-mentioned market focus and the secular, customer-friendly, source of our long investments’ competitive advantage, almost all our long investment thesis was left intact. New opportunities presented themselves in our short book and we acted on them. We have also built and kept some dry powder to take advantage of additional opportunities that future market disruptions may present to us.

As the above Lenin quote says, the speed of change accelerates in these moments. We believe this is good news for Somar as our long investments offer more for less cost to their customers. Therefore, we are excited with the potential ahead. While the short-term situation remains fluid, we are managing risk well and have seen good risk protection throughout the recent volatile days. We believe our long positions will perform well as soon as a more constructive investment environment returns to global capital markets.

* * *

The team always enjoys hearing from you and updating you on our progress. Don’t hesitate to contact us to learn more about our approach.

Sincerely,

Pedro Ramos

Short Investing

Dear Investor,

Short investing

We have an opportunity to generate material profits from our short investments over the next few years. This should be additive to our long performance. Last year we generated profits on our short book, even in the face of rising markets. That has continued in 2022, although helped by more volatile markets.

This month we want to give you more detail about our short investment process. We focus mostly on four types of short opportunities:

Companies being disrupted: businesses whose value proposition ceases to be attractive to their clients due to the emergence of innovative alternatives
Stock promotions: companies sold to the public through IPOs, SPACs or direct listings with rosy projections backed by promotional management teams eager to cash-in on their holdings
Fads: businesses that benefit from exponential success and growth during a season but fail to sustain it once the novelty effect wears off
Frauds: accounting fraud, representation fraud and any other form of misrepresentation made by previous holders and management to inflate the company stock above its inherent value

The opportunity set today is larger than when Somar got started. Fig. 1 shows the acceleration in adoption of new technologies that reduces the runway for incumbents to defend their business.

Below, Figure 2 shows the increase in the number of listings recently, including SPACs.

Our method for identifying, conducting due diligence, and executing on these opportunities varies by type of short. In this letter we will give a summary overview of each. If you wish to discuss this in more detail, please reach out to us.

Companies being disrupted are normally identified through the course of our cluster analysis. We identify innovative companies that can offer a significant improvement in the customer value proposition and study whether the incumbent can close the gap. If not, the incumbent becomes a potential short candidate. We estimate what it would take for the incumbent to disrupt itself, and whether the board and management team have the track record necessary to conduct such a big pivot. We investigate channel partners and customers to gauge their satisfaction and willingness to change. If both the pivot strategy and the milking the status quo strategy leads to significantly (20%+) lower inherent value than the market is ascribing, we get interested in the short opportunity. This analysis considers the speed of decline and cash generation and capital deployment abilities of the management team to ensure the thesis plays out in the next 6 to 9 months.

Stock promotions like IPOs, SPACs and direct listings cross our desk when these sales are launched to the public. We study them with an open mind as some could be long opportunities, but most will turn out to either be a pass or a short opportunity. The starting point is the incentive structure of the management team and the stock sellers. We also investigate the business plan of the companies and through field work assess whether their promises are conservative or over ambitious. Importantly, we look for a long-term competitive advantage. Is this the first company of many that will claim to own a particular hot sector (AI, Blockchain, …)? Or is their position unique that they will have limited competition even when their sector matures? Interviews with venture-backed challengers are a very helpful tool here. Finally, we investigate management’s track record and motivations: are they missionaries, builders? Or are they salespeople mostly motivated to cash-in? The enthusiasm around these aspirations can lead to significant overpricing of mediocre assets opening good short opportunities.

Fad candidates are new products or services that surged into the mainstream zeitgeist in a short period of time. Some of these will turn out to be the next iPhones, Google or Instagram. Most will fade. To winnow the wheat from chaff, we investigate the market penetration and the difference between sell-in to the channel and sell-through to final customers to get early reads into sales inflections. Field observations and social media engagement are also good clues for potential fads. Once one has been identified, our valuation analysis will inform us whether there is still downside for the short investment or whether we were too late in spotting that particular opportunity. Timing and agility are of the essence in this type of opportunity.

Frauds may be the most exciting type of opportunity on the short side. We identify these based on exposés by either investigative journalists, former employees, or activist short sellers. We aim to duplicate their analysis to confirm the assertions and accusations. A careful analysis is made of the character of the management and employees involved in the fraud, including interviews with former colleagues. Finally, we estimate the inherent value of the company after accounting for the fraud impact. If the difference to the current price is material (20%+), we get interested.

* * *

There are strong connections between our short work and our long work. Many times, our work on one long opportunity leads us into a short opportunity and vice-versa. The short work also makes us better sellers in our long book. By forcing us to invert our mindset it allows us to see potential negative trends earlier than we otherwise would have. Most importantly, we believe our short investments can continue to be a source of positive profits for many years.

* * *

We hope you get in touch with us during the year. Volatile markets can lead to questions, and we will give you our perspective on what we see in the companies we follow closely. Volatile times are the most attractive to invest in but seem to be the opposite as you are going through them. This was true both in March 2009 and more recently in March 2020. We have experience investing through several different kinds of crisis during the last decades

Sincerely,

Pedro Ramos

The Long-Term and Return on Capital Employed [ROCE]

Dear Investor,

The Long-Term and Return on Capital Employed [ROCE]

I have yet to meet a fundamentals-based investor who doesn’t claim to be a “long-term investor”. It reminds me of the famous studies that reported around 80% of US drivers ranked themselves as above average. While not doubting the sincerity of the self-reporters, this fact sheds light on the difficulty of human beings in self-rating their own behaviors.

After starting Somar Capital, I provided advice to many other investors that were starting new funds. They all reported to be long-term investors, and that their backers were patient long-term financiers. Unfortunately, most of these funds ended up closing, with very few making it past the two-year mark.

Which begs the question: what is the long-term? At Somar we look for the timeline where a business fully replaces its invested capital. It varies by industry but in general it would be around 10 years. That is, after 10 years, close to 100% of the company’s capital employed in productive assets has been fully amortized and re-invested. Why is this important? Because in the period beyond 10 years, the major drivers of investment success are: a) the attractiveness of the business operations; and b) the ability of the management team to efficiently allocate the capital.

Somar measures the attractiveness of the business operations, through the business Return on Capital Employed [ROCE]. We calculate it as the ratio of operating profits after tax to the equity plus net debt invested in the business. A business is attractive if it can return 30% or more per year on its capital. Think of it as a machine that produces annual net cash flow equal to 30% of the cost of building it. These superior businesses tend to be rare. In addition, entrepreneurs and competitors see the opportunity and try to get a piece of these profits. Therefore, Somar spends a lot of time studying how sustainable these returns will be, and how can the company protect its franchise from existing and would-be competitors. Unique networks, brands, proprietary technology, scale economies, are a few of the ways companies use to protect their superior economics.

As importantly, Somar tracks the management team’s ability to deftly allocate capital at attractive returns. Our leading indicator here is the Return on Incremental Capital Invested. Somar estimates the returns obtained from the investment of additional capital over the previous 2 to 3 years by current management. There are three possible outcomes from this analysis:

Returns on incremental capital invested are similar to the average ROCE for the company as a whole. This means that management is keeping the business’ historical attractiveness. Normally a good sign, especially if management is careful to return the excess cash to shareholders through either dividends or stock buybacks (assuming the stock price is trading below inherent value).
Returns on incremental capital invested are higher than the historical ROCE. A very bullish sign, that management is finding superior ways of deploying capital than they have been historically. This may signal an improvement in the economics of the base business and / or the investment of attractive adjacent businesses.
Returns on incremental capital invested are below the historical ROCE. This raises alarm bells that either the company’s base business is losing to its competitors, or the management team allocation is careless and not focused on the shareholders’ interests. If sustained, this trend means that the business’ future will be less profitable than its past.

A quick example shows how useful this process is. While looking at clothing retailing, twenty years ago I found a man’s clothing company that had strong growth, a small footprint, and high (20%+) returns on invested capital. Their offer was branded, differentiated and very popular. The management team embarked on an aggressive expansion plan to open the stores throughout the whole country. However, my analysis showed that the new stores were coming with a lower (10%) return on incremental capital invested. I raised the issue with management who assured me their higher scale would provide procurement savings that would restore the return on capital to the historical 20%+ range.

However, the following year, the returns of the new stores came even lower at 3% to 5%. This showed that management had lost discipline in their capital allocation plans and were prioritizing empire building. I stepped aside. A few years later, during the Great Recession the company filed for bankruptcy.

Just like every great champion knows: you are only as good as in your last game. Management teams are only as good as their recent capital allocation decisions. Somar tracks these carefully and uses them to inform our investment, selling and short decisions.

* * *

We hope you are having a good return from Summer. We look forward to continuing to hear from you in the weeks and months ahead.

Sincerely,

Pedro Ramos

Numbers are hygiene, mission and values are destiny

Dear Investor,

Numbers are hygiene, mission and values are destiny

As investors, we have access to real-time earnings releases, conference calls and even trading data on stock exchanges all over the world. We also have high-powered computers that many investors use to trade algorithmically in fractions of a second. Does this mean that markets are extremely efficient? Does it mean that computers can identify superior investments better than humans? Somar’s answer to both questions is “No”.

In my years of investing, I've learned that while numbers are important, they aren't the be-all and end-all of successful investing. They're like good hygiene - necessary, but not sufficient. Numbers are helpful but have a few shortcomings:

They can be wrong: not only through fraud but also through accounting conventions. For example, Silicon Valley Bank Balance Sheet didn’t reflect the large mark-to-market losses on their hold to maturity bonds.
They provide limited information on the mission, values, and motivation of the management team. What will be their judgement in tough choices they face?

Running a business often requires difficult choices that may create significant value long-term while hurting the financials in the short term.

Netflix’s decision to disrupt their DVD by mail by launching streaming was poorly received by investors who rewarded the temporary hit to earnings power by selling off the shares more than 70%. A similar (albeit less dramatic) dynamic happened when Netflix started investing in its own original content.

When Amazon, an online retailer, invented and started to commercialize the public cloud model through Amazon Web Services, investors reacted poorly. Please see the cover of the business week in 2006, the time of AWS launch, that reflects the consensus view at the time (Fig. 1).

As we know, these CEO decisions led to significant value creation. In fact, they increased each company valuation by multiples.

The quality of management, its motivations and values are not included in the reported financial statements. They are not translatable into a set of numbers. Somar invests significant resources to ascertain them. Our main activities here include:

1. Evaluate the track record of the management team.

Have they shown vision and customer-centricity in difficult business decisions in the past? How have they dealt with and recovered from adversity?

2. Assess the management team's commitment to the company.

How much personal investment have they made in the business? More importantly: do they love the business, or do they love the money? Are their personal values and aspirations aligned with the company’s mission? Watch for signs that the management team is more focused on short-term gains than long-term success, as this can often lead to poor decision-making and ultimately undermine the company's potential.

3. Examine the team's depth and skill diversity.

A successful management team is like a well-rounded sports team - it requires individuals with different strengths and skills who align together effectively in the service of the business customers and mission.

Additionally, a management team with a strong bench of talent and proven ability to internally develop top talent can better withstand the inevitable departure of key personnel. If a company's success is too closely tied to a single individual, the risk of disruption is too high.

4. Assess the company's culture and values.

Look for evidence of a strong ethical foundation, a focus on long-term success, a commitment to talent development and a high energy work environment.

5. Look for a clear strategic vision.

Does it uniquely address a unique customer pain point that nobody else can address to the same degree? Does it contribute to the company’s success. Do management’s tough choices reflect that?

6. Monitor the team's adaptability and resilience.

The business world is constantly evolving, and a successful management team must be able to adapt and respond to changes in the market. Look for evidence of a management team's adaptability and resilience in the face of adversity. Have they demonstrated an ability to pivot when necessary, or are they resistant to change? A management team that can quickly adapt to new challenges and embrace innovation will be better positioned to capitalize on emerging opportunities and weather market disruptions.

7. Communication and transparency.

A great management team will prioritize open communication with shareholders, employees, and other stakeholders. Transparency in their decision-making process and a willingness to provide clear, honest explanations of their strategy and actions are signs of a trustworthy management team. This level of communication fosters trust, accountability, and credibility, all of which are critical for a company's long-term success.

8. Observe their industry reputation and relationships.

The reputation of a management team within their industry is an unbiased indicator of their competence and credibility. Ask suppliers, customers, competitors, and other industry players. Their views show management’s effectiveness and ethical standards “where the rubber meets the road”.

Recognizing exceptional management teams is a critical skill for successful multi-compounding, long-term investing. This requires careful long-term study of the character, skill, and motivations of flawed human beings. This is not expressed in a set of numbers. But in careful consideration and human interaction and inquiry. Somar develops this skill to find the next Reed Hastings (Netflix) and Jeff Bezos (Amazon).

New Administrator Introduction

Somar recently changed Fund Administrators. We found a reputable provider that will give us higher service while reducing the cost to our fund and investors. We thank SS&C for their support all these years. More on the change in this video: https://youtu.be/vfbAAtCB5OA

Sincerely,

Pedro Ramos

Innovation: land of opportunity

Dear Investor,

Innovation: land of opportunity

Trying ChatGPT brought me memories of the mid 1990’s when I sat down for the first time to “surf the web”. The power and novelty of the tool to reach human knowledge and information spawned a rush of ideas on the possibilities of new services and products to be created. A first glimpse into a more fruitful future. We all know that in the late 90’s the financial markets and the venture capital industry got carried away with these possibilities and many companies with poorly thought-out business models failed. But many like Amazon, eBay, PayPal, Google, … thrived.

It is unclear if a similar boom and bust wave will accompany the emergence of AI. What is true, though, is that these waves of innovation create discontinues of opportunities for fundamentals-based investors. Both on the long and short sides.

The long side is relatively self-explanatory. Most of the largest companies in the world by market capitalization are downstream from the information revolution. Additional innovation creates an opportunity for these companies to create more shareholder value and for new companies to join their ranks. This is core to Somar’s work: finding the emerging companies of the next decade. It’s very intensive and multidisciplinary (including field observations) work. But everyone at Somar loves doing it.

The short side is even more fertile. Not only will most companies fail to develop a profitable business that serves the need of their customers, but also the “gold rush” of new buzzwords and the eagerness of venture capitalists to not be left behind, funds a lot of frauds and promotion artists. The latter are especially good at marketing in a way that appeals to financial investors. Many have former Wall Street professionals as Clevel executives. And, given most of the value is in the future, the ability to tell a good story and make bold promises is a competitive advantage. This is music to our ears, as Somar actively looks for these types of shorts. We have written up about a few of them in the last 12 months and we will write more in the future.

Many will object that these boom-and-bust cycles have been fed by low interest rates. And rates are not historically low now. However, these cycles have been occurring for centuries now, and during the late 90’s rates weren’t low either. So, while low interest rates may help the process, they are not a necessary condition.

Regardless of whether the AI revolution ends up matching the impact of the internet or the transistor, we are amidst several innovation waves that alone provide plenty of opportunities for Somar: cloud, mobile, streaming, e-commerce, … We write about one of them twice every month. Please reach out to Dhwani at Dhwani.Vahia@somarcap.com if you are not receiving these e-mails.

Innovation and frontier exploration has been the land of opportunity for many centuries. For a big home-run we remember the colonization of the USA and its westward expansion. However, in the early 19th century, Gregor MacGregor enticed many European investors and prospective settlers to buy from him land, titles and bonds in a very promising American colony: “Colony of Poyais”. Not the first, nor the last time, that investors in innovation and exploration were defrauded of their funds.

Passive investing, high-speed trading, factor investing may have a role in financial markets. But a dynamic and innovative society provides the best long and short opportunities to fundamentals-based investors. Somar works hard every day to earn the spot of your preferred partner.

Sincerely,

Pedro Ramos

Active Investment

Dear Investor,

The year is off to a good start as investors have found some appetite for risk, after a relatively disorderly sale of growth and innovation-oriented companies during 2022. While unpleasant for our short-term results, these drawdowns are neutral to positive to your wealth creation in the fullness of time. It is well known that market participants (Mr. Market as described by Ben Graham) oscillate between periods of panic and periods of euphoria and optimism. Somar’s long investments’ stock prices get bid lower during transitions into panic periods. During 2022, our periodical checks with our long investments’ management teams found they:

continued to take market share.
continued to invest in widening their advantage in customer value proposition.
sharpened their focus on efficiency by reducing costs on tasks not valued by their customers.
raised the emphasis on short term cash generation.
found better environments to deploy capital either through acquisition of strategic assets at lower valuations or by buying back their own stock.

These good management practices, together with Somar’s active deployment of profits from our short investments and rotation of long investment capital into the opportunities with larger upside post the 2023 sell-off positions us well to capitalize on the recovery once the panic of the market sell-off subsides.

Active Investment

Active investment’s major benefit is adapting our investment portfolio to large changes in prospective investment returns. Massive market moves like those of 2022 can trigger these as mentioned in the paragraph above. Large discontinuities in fundamentals always trigger these.

Discontinuities in fundamentals happen every year to a few sectors, companies and sometimes to entire economies. The past months have been rich in these discontinuities. Let’s look at a few of them.

Last month, people around the world were introduced to a powerful all-purpose AI technology both through ChatGPT and Bing chat. These are the opening salvos of what industry insiders say will be a slew of impressive launches throughout 2023 and beyond.

From what we have seen so far, these technologies will create large new opportunities for many businesses both consumer and business to business. They will also significantly increase the consumption of computation and storage resources. Finally, a few existing businesses will be challenged by novel superior approaches to serving their customers. We are studying all these very closely and finding compelling new opportunities both on the long and short sides. We will update you about some of these in future letters.

About a year ago, the Russian invasion of Ukraine shocked the western world and led to a discontinuity of the geopolitical assumptions of its countries. That has profound implications for investments in defense companies, energy infrastructure and even supply chain security of critical inputs such as high-performing semi-conductor chips. In a few cases, the market lagged these transitions and opened a window of opportunity in the lag between the inherent value of the assets and their market price.

Finally, the Inflation Reduction Act in the US has relaunched Industrial Policy in the western world which is changing the rules and regulation in diverse sectors such as energy and infrastructure. These may lead to additional measures both in the US and in Europe. These changes create discontinuities and opportunities for Somar to take advantage of very attractive entry points in highly attractive businesses we want to own for the long term.

These discontinuities, together with the large macro-driven moves of 2022, provide Somar with the best long opportunity set we had since our founding. We are excited about our future. We are also cognizant the journey will not be a straight line. But Somar’s role is to use the volatility in our favor. With patience and fact-based analysis of our investments we look forward to 2023 and beyond with confidence.

* * *

The mark-to-market basis of our business creates the opportunity to add to our investments at better prospective returns that are available in less liquid markets such as housing. Human nature makes this difficult, as declining prices make most investors nervous and anxious to sell to ease the “pain”. Some investors don’t resist this temptation while others are even forced sellers to raise funds to attend to a liquidity crisis.

Our managers are focused on creating inherent value. Somar is focused on allocating your capital to the opportunities with the highest returns we can find. And you also have an opportunity to allocate capital to Somar at a time when the market is stressed and valuations are attractive.

Sincerely,

Pedro Ramos

Financial Turmoil

Dear Investor,

Financial Turmoil

This month we recorded a video that summarizes Somar’s views of the opportunities and risks the on-going financial crisis presents to Somar investors. We are confident on our ability to take advantage of the volatility ahead. Month to date, at the time of this writing, we have positive returns.

You can fund the video here: https://youtu.be/CFZV4l-3N5Q

Sincerely,

Pedro Ramos

Liquidity vs. Mark to Market

Dear Investor,

Liquidity vs. Mark to Market

While visiting prospective colleges for my oldest daughter, we had the company of Roger Federer, the tennis champion. Not in person. But in the voice of our directions app. Every time we found a hazard or detour on the road, Roger in a calm voice described our solution and encouraged us: “Let’s stick to the game plan”.

I couldn’t help but think of the parallels to investing in the public markets, where minimal hazards can lead to sudden 10%+ correction to the market indices. The availability of mark-to-market makes these oscillations quite noticeable to investors. What could be a source of additional profits (buying low and selling high) becomes a huge financial cost. One prominent study conducted by Dalbar, a financial services research firm, found that individual investors earned an average annual return of just 4.25% over a 20-year period, while the S&P 500 index returned 9.85% during the same timeframe (Dalbar, Inc. (2021). Quantitative Analysis of Investor Behavior).

This apparent small difference compounds overtime (Fig. 2). We can see that at the end of 30 years, the more disciplined investor has 4.8x more money than the average investor.

Emotions get into the mind of the investors, including long-term oriented ones that lead to this outcome. There are several reasons for this. Some of the most common are:

Loss Aversion: Investors often fear losses more than they value gains. This fear forces them to make hasty decisions, often resulting in selling positions after the market declines instead of holding for recovery. Nobel prize winners, Kahneman & Tversky estimated that the emotional pain of the loss of $1 is roughly double to the emotional joy of winning $1.
Herding Behavior: Many individual investors tend to follow the crowd. This can lead to purchasing securities at inflated prices during market booms or selling during panics, both of which adversely impact long-term performance. This effect is exacerbated by the wide media coverage in the press (and even in cab rides) of the market extremes, making it hard for long-term investors to “stick to the game plan”.
Overconfidence: Individual investors often overestimate their knowledge and abilities. This leads to excessive trading and suboptimal investment decisions, as noted by Barber and Odean2, who found that frequent trading resulted in lower returns for individual investors.

Mark-to-market trading is the “price” investors pay to assess daily (instantaneous) liquidity. Investing in public securities allows you to invest in the best companies in the world, the ones taking market share, while being able to get liquidity at a breadth’s notice. Perversely, this instant liquidity and news making index fluctuations become a large obstacle to investors’ success.

A different behavior occurs when investors buy houses or invest in private companies. When the market suffers a temporary downturn, most investors wait for a recovery before selling. If they do the same in the public markets, their success is virtually guaranteed (Fig. 2).

Despite that, in Europe, the most successful instruments are UCITS funds which offer daily liquidity. The same trend is spreading in the US with the emergence of ETFs that offer minute by minute liquidity. Experience, and the reliably unchanging human nature show that this will hurt the performance of investors.

A few years ago, I got emergency surgery for appendicitis. While theoretically, it would probably be appealing for me to stay awake and give feedback and advice to the surgeon, the best outcome was achieved by selecting the right surgeon, the right hospital, getting an anesthesia and “stick[ing] to the game plan”.

Great Tennis champions know it. Great Surgeons know it. But somehow when it comes to investing in the stock market, investors tend to enjoy the gaming / gambling part of short-term noise at the cost of long-term success.

Better to partner with someone you trust, like Somar Capital, and “stick to the game plan”.

* * *

As always, we are eager to hear from you and to provide our latest thinking whenever you feel the need for it. We have excellent opportunities both on the long and short sides. We look forward to sharing our progress with you in future letters.

Sincerely,

Pedro Ramos

Fig. 2 - Source: Blackrock, Morningstar, Forbes

Fig. 1

Baltic Classifieds Group

Dear Investor,

Baltic Classifieds Group

Baltic Classifieds Group [BCG] is an under-monetized dominant online classifieds platform in the Baltics (Lithuania, Estonia and Latvia). It serves all the main verticals: auto, real estate, jobs and general classifieds (think craigslist). We believe BCG will be able to grow its Free Cash Flow at a high teens / low 20s% rate over the medium term by leveraging its dominant lead in the space to continue to take share from traditional media, raise prices and improve margins through operating leverage.

Reasons we have been drawn to BCG include:

Large and expanding lead with audience from 7x up to 36x larger than its closest competitor (depending on country and vertical). Each resident in the Baltics visits BCG sites 10 times per month on average.
Extremely resilient to macro and other shocks: auto and real estate re-sellers need to advertise with BCG to reach their target market. BCG continued to grow throughout Covid and the Russian invasion of Ukraine.
Still very under-monetized both compared with cost per lead on traditional media and on on-line peers in other European geographies. Pricing and upselling opportunities to drive sales for more than 10 years.
High and expanding margins with operational leverage driven by fixed costs and high incremental margins.
Strong cash generative business model with limited working capital and minimal capital expenditure needs. Capital employed is virtually nil, with most of deployed capital used in tuck-in acquisitions.
Strong management team, supported by supervision and mentoring from best-in-class operators of Rightmove (leading real estate classifieds in the UK) and Auto-Trader (leading auto classifieds in the UK) on its board of directors and shareholder registry.

The company trades at an attractive valuation compared to its peers. Its valuation doesn’t reflect its higher growth prospects driven by the earlier stage of market development in the Baltics:

Proprietary Due Diligence

We have been following the online classifieds industry closely for the past 17 years

Strategic and financial evolution has been consistent across geographies for each of the verticals
All case studies converged on a dominant leader with most of the market, accruing high margins and hard to contest market share
Still a growth business in the most advanced markets (UK, US)
Challenges from online aggregators such as Google have failed in the past

Field work including management and Board interviews

We have long known the Chairman and former Chairman of BCG
Meeting and calls with CEO and CFO
Track record analysis shows growing market share over the past 10 years
Online market checks

Risks

Data Protection and Cyber Security

Somar’s Views: The leak of confidential client information through cyber-attacks would hurt consumer and business confidence on the platform. Cyber attackers could take down the site, request ransom and hurt monetization. While this would delay growth and monetization it would not (absent a very draconian disaster) alter BCG’s lead and ultimate strategic and financial goals.

Geopolitics

Somar’s Views: Russia has ambitions to maintain the Baltics under its area of influence. It borders the region from both the mainland and the Kaliningrad enclave. If an invasion and war were to occur, it would lead to substantial losses of BCG’s business ranging from total loss to temporary suspension of operations. While it is hard to handicap this probability, it should be noted that the Baltics are both NATO and EU members and such an operation would be very unlikely to be only contained to that region. We believe the probability of such a move to be very low.

Management Attrition

Somar’s Views: While the business would not be unduly hit in the short and medium-term by a downgrade of management quality, the development of new products that allow continued monetization opportunity would start to suffer after 3 years. That said, management is highly incentivized with stock ownership and long-term bonus targets. There is also a deep bench of top management to tap into the leadership role. Successful transitions have been observed in other peers like Rightmove, Auto-trader and REA.

Macro

Somar’s Views: While BCG is recession resistant, it is not recession proof. A strong recession that would impact number of transactions and prices on either the auto or real estate verticals would lead to slower revenue growth for some time. While this would impact the stock price for a few quarters, BCG would resume shareholder value creation once a more stable macro returns.

Returns and Lessons learned

Somar has made substantial double digit returns so far.

Under-followed geographies present interesting opportunities. Particularly in the face of a selling institutional investor (Apax) that discouraged investors with shorter time frames from getting involved prior to full selldown of prior owner. In July 2024, Apax fully exited the position removing this risk going forward.

* * *

Sincerely,

Pedro Ramos

Quick Market Commentary

Dear Investor,

Quick market commentary

We refrain from dwelling on market commentary on these letters. We focus instead on the fundamentals of both our long and short investments. In the fullness of time, the measure of each business inherent capacity to generate excess cash flows will dictate its ultimate value for its shareholders.

That said, it is instructive and sometimes entertaining to observe some short-term trends the market exhibits that make the stock valuations detach wildly from each business’s inherent value. Just over the past few years we’ve had: SPAC mania, meme stocks, electric vehicle start-ups among others.

A wise scientist once pointed out to me that a perfect pendulum spends as much time moving away from equilibrium (when it rests inertly pointing downwards) as it does moving towards equilibrium. I think this physics observation also applies well to public financial markets.

In the first quarter earnings season that is ending, we mostly observed a move away from equilibrium. Most companies that beat (and sometimes raised guidance) sold off, sometimes dramatically (more than 10%) after reporting earnings. On the other hand, companies that have weak fundamentals and reported earnings at or sometimes slightly below expectations rallied strongly in relief.

I don’t have an explanation for this phenomenon that while not frequent does recur from time to time. What I do know is that it opens good opportunities for long-term shareholders that trust their work and are willing to keep emotions aside to take advantage of more attractive opportunities.

At Somar we strive to prepare ourselves to take advantage of these opportunities. Our fundamental work provides intellectual confirmation of our thesis, while our organizational setup (with long-term limited partners and with own funds sufficient to fund our operation for decades) provides the emotional stability to ride out these short-term performance swings.

We end this quarter with more confidence in most of our theses, larger position sizes at attractive prices in stocks that have moved against us and the tranquility of knowing that we have improved returns ahead from these trades that will pay off in the next few quarters.

* * *

We have excellent opportunities both on the long and short sides. Don’t hesitate to contact us to learn more about our approach.

Sincerely,

Pedro Ramos

Short Illustration: EBIX

Dear Investor,

Short Illustration: EBIX

The policy of low interest rates has spawned several poor capital allocation decisions. It has also enabled many fraudulent ventures to emerge. Steadily, these frauds are being uncovered. Debt maturity often provides a good catalyst for separating real cash generating ventures from narrative and obfuscation-driven frauds. Somar diligently looks for this. EBIX represents an instructive recent illustration.

Around the 2010s, EBIX was a highly profitable, mature software and services provider to the insurance industry. Led by CEO Robin Raina, it then embarked on a debt-financed acquisition expansion that boosted its revenue fivefold from about $200mn in 2012 to about $1,000mn in 2022. This expansion, however, added mostly a highly competitive unrelated business (prepaid gift cards), involved fraudulent clients and financial statements, yielded its CEO some nice compensation and led to the company’s bankruptcy 18 months later. Somar identified multiple early signs of EBIX’s demise: management character (or lack thereof), financial statement fraud, lies about customers, strategic mismatches, and upcoming debt maturities.

The character of CEO Robin Raina was the first thing that caught our attention. In 1998, after Raina was promoted to VP of Sales, EBIX overstated its revenues by 18%, later leading to a regulatory investigation and to the sanction of the auditor who allowed such manipulation. In the 2010s, as CEO of a mature business, Raina decided to embark on a debt-fueled M&A expansion into the low margin, highly competitive business of prepaid gift cards. This delivered growth, hid the ex-growth nature of the base business, and allowed the company to temporarily maintain a higher multiple. It also, however, steadily destroyed shareholder value. To underline its disregard for shareholders, in 2023, months before EBIX declared bankruptcy, Raina took an annual bonus equal to 3% of EBIX market capitalization.

A close analysis of EBIX’s financial controls also raised red flags. Between 2004 and 2022, EBIX was audited by 7 different firms. In 2021, one month before the 10-K filing, RSM resigned due to “unusual transactions related to EBIX’s gift card business in India”. After asking several times for additional audit evidence regarding suspect transactions, RSM didn’t receive them. EBIX replaced it with KG Somani, an Indian auditing firm with no experience auditing US-listed corporations.

EBIX also misrepresented its customer relationships. For example, it reported partnerships with Reliance Industries and Apollo Tires. When questioned, these two companies denied even knowing EBIX. Additionally, EBIX’s India regulatory filings reveal that two other enterprises alone accounted for more than 20% of its prepaid gift card revenue. One of these only reported $151 thousand total revenues and its corporate headquarters stood in an empty flat on a rundown building. The other, a purported e-commerce company, had a malfunctioning website, no employees on LinkedIn and no activity at all on social media. EBIX also reported more than 650k retail outlets in India, with more than 900 distributors in the country. However, an investigation contacted all distributors, and only 7% reported selling EBIX’s prepaid gift cards. Additionally, Google Maps’ Street view did not match the EBIX reported photos of these customers.

Even taking the financials and customer relationships at face value, it was clear the acquisitions were value destructive. Its gross margin declined from 80.9% in 2012 to 31.3% in 2022, and its operating margin declined from 38.6% in 2012 to 11.5% in 2022. Its ROCE declined from 18% in 2013 to 10.1% in 2022. It appears that to mask the maturity of a great business, EBIX management decided to acquire its way into an unrelated and inferior new core business. No longer a vertical software company, EBIX was now a commodity prepaid gift card provider. By 2022 this new segment represented 76% of total revenue. Clearly a financial engineering project rather than a sensible strategic long-term move.

All this value destruction piled up in the balance sheet in the form of debt. It reached $650mn maturing in February 2023, while EBIX had access to only $90mn of cash. With tightening credit conditions, the refinancing would either be extremely expensive or not possible at all. Equity issuance and sharp shareholder dilution was the only other option. EBIX’s chosen solution was to IPO its EBIX Cash business in India. However, this had been announced in August of 2019, and it was repeatedly delayed for unclear regulatory issues. In March of 2022 it was reported that the IPO was imminent. It never happened. EBIX defaulted in February 2023, but got successive extensions from its debtors until December 2023, when it finally filed for bankruptcy.

* * *

The team always enjoys hearing from you and updating you on our progress. We are finding excellent opportunities both on the long and short sides. Don’t hesitate to contact us to learn more about our approach.

Sincerely,

Pedro Ramos

Uncertainty and Scenario Planning

Dear Investor,

Uncertainty and Scenario Planning

The recent past has brought very large challenges: Covid pandemic, flare-up of inflation, sharp rise in interest rates, two large on-going wars, real estate / financial crisis in China, and simmering tensions in the South China Sea. Each of these has different implications for different industries and different geographies. Most of these came suddenly and mostly unexpectedly. How to position a portfolio of assets to not only survive but also thrive in this environment?

First, at the underwriting of any long or short investment we analyze its outcome under multiple scenarios. This ensures that we are aware of any scenario that could materially impair our returns and think through its probability and how we would manage if that risk were to manifest itself. Very rarely do we move forward with an investment where a low-probability scenario would lead to a very large impairment. Any potential impairment, even if small, is always weighed against the probability and magnitude of upside at the time of underwriting.

Second, after the investment is made, we constantly monitor the incoming data to reassess the probabilities of the scenarios contemplated and identify early signs that an adverse shock may be occurring. We proactively do additional field work / primary research to confirm the incoming adverse data.

Third, position sizing considers potential risks across positions. For example, if we found extremely attractive investments in different industries in Southeast Asia, we would be cognizant of their aggregate exposure to the region and cap it to limit the fund’s exposure to a regional geopolitical or macro-economic shock.

Fourth, we take advantage of both the liquidity of the markets and the large body of research on multiple industries and geographies we have done over the past seven years to quickly adjust our portfolio to any large, unexpected shock that occurs. Liquidity is an advantage that not only helps protect the downside but also enables us to position the portfolio to thrive in the new environment. Covid in 2020 was a good example of this.

Fifth, as a team we discuss weekly what we are hearing and learning from incoming data and challenge each other to think through the impact of potential future shocks on each of our positions. We push each other to consider the unthinkable and how we would thrive in that scenario. This increases the team preparedness for discontinuities in the macro and geopolitical scenario.

For each discontinuity we think of the range of outcomes and how they would impact each of our positions. For example, on the ongoing war in Gaza / Israel we consider the probability and impact from the most benevolent outcome to the most destructive. Although we assign low probabilities to each, they help us think through the evolution of risks and their impact as we move from one end of the continuum to the other. Based on this, we have a game plan of the ideal portfolio to protect and grow our investor’s capital.

This is a time where our work allows us to make a big difference. As opposed to an environment where all assets go up powered by low and declining interest rates, the years ahead should be volatile and impact industries and geographies differently. We are ready to use all our work to make sure your dollars are always allocated to the most attractive opportunities we can find.

* * *

We hope you and your families are healthy and safe. Don’t hesitate to contact us to learn more about our approach and thoughts during these more volatile times. We look forward to continuing to hear from you in the weeks and months ahead.

Sincerely,

Pedro Ramos

Short Case Study: Enviva

Dear Investor,

Short Case Study: Enviva

Enviva is a case of a wolf in sheep’s clothing. The company attracted investors by covering itself in ESG credentials. Our due diligence uncovered lies, environmentally damaging practices, an unprofitable business model, excessive financial leverage, and an unsustainable dividend. Our short yielded a higher than 50% ROI on the position.

Founded in 2004, Enviva (EVA) is one of the world’s largest producers of wood pellets, an important raw material to produce biomass and electricity from the burning of biomass. It has 10 operating plants in the US and exports to the UK, EU, and Japan.

Starting in 2020, the company took advantage of investors’ enthusiasm for ESG-friendly investments to label itself as an environmentally-friendly company. The company stressed that biomass-burning was a renewable source of energy. This led to a more than 60% growth of its share price.

This claim amounts to “greenwashing” as biomass burning is a step backwards for the global environment for three reasons: 1) the burning of biomass leads to high emissions of CO2; 2) Biomass burning is the most inefficient and dirty source of energy with higher emissions per unit of energy generated than other sources, including coal; 3) while in the long-run biomass is renewable, the aggressive logging of forests to produce biomass leads to deforestation a more serious problem for global warming and eco-system stability.

To prevent deforestation, regulators limit logging to 45% of a given area. Enviva claimed to follow this rule. However, based on GPS coordinates of their activities (according to their own websites) as well as comparative photographs from Google Earth and Google Maps, we estimated that Enviva was logging at clear-cut rates of between 65% to 90%, more than double of what Enviva reported their clear-cut rate to be (30%). This was confirmed by interviews with some former Enviva employees, which added that higher clear-cut rates lowered unit production costs. Unsurprisingly, Enviva lost its Chief Sustainability Officer, Dr. Jennifer Jenkins (a Nobel prize recipient) in 2021 and never replaced her. The company also lost its director of sustainability and climate initiatives after just 18 months on the job.

Additionally, Enviva has an unprofitable and cash-burning business model. In the last decade, Enviva turned a cumulative $6.2bn in revenue over a decade into just $218m of cashflow from operations and burned more than $1.1bn in free cashflow. Our forensic accounting analysis revealed some accounting shenanigans hid an additional half a billion dollars of cash burn during the period.

To further entice investors, Enviva offered a generous dividend. Given the absence of cash generation, the dividend was funded through debt, taking advantage of the low interest rates and lax debt underwriting standards during the period. Unsurprisingly, the leverage ratio (net debt / Adj. EBITDA) soared from 2.7x in 2015 to 10.5x in 2022. Correcting the accounting shenanigans, Somar estimates the leverage ratio was actually 22.6x in 2022, a clear case of financial distress. The sudden rise in interest rates put additional pressure on the company.

All of this came to roost during 2023. One month after its investor day when Enviva presented a cost-cutting and productivity improvement project, the company badly missed its earnings with a negative operating margin of more than 19%. More importantly, the company admitted it wouldn’t be able to meet its costcutting targets, cut guidance and suspended its dividend. The stock fell more than 50% and we covered our position.

Over the following months, the stock gradually retraced some of its losses, re-opening the opportunity for Somar to short again. During Q3 2023 the CFO was replaced. When the company reported its Q3 earnings the guidance was pulled, the company announced the CEOs resignation and that it was breaching its debt covenants. Our second short trade also yielded well over 50% of profit on our position.

In the age of index investing and thematic exposure, the opportunity for people with less scruples to tap into investors following the theme of the day (SPAC, ESG, Crypto, …) is high. These “entrepreneurs” cash in before the economic reality catches up with the story sold to investors. In addition, a lot of investors are getting exposure through ETFs and most of these perform very limited diligence on their portfolio components. This opens opportunities for investors that do in-depth due diligence to find great short opportunities like Enviva. Somar will continue working on it and will report back to you on additional cases in future letters.

* * *

We hope you and your families are healthy and safe. We wish you a happy Thanksgiving and Holiday period. Don’t hesitate to contact us to learn more about our approach and thoughts during these more volatile times. We look forward to continuing to hear from you in the weeks and months ahead.

Sincerely,

Pedro Ramos

A year of several cross-winds

Dear Investor,

2024: A year of several cross-winds

Since 2020, financial markets have been mainly driven by large macro-economic and geopolitical events: Covid in 2020, re-opening in 2021, inflation and interest rate hikes in 2022 and end of interest-rate hikes coupled with accelerated investment in AI infrastructure in 2023.

We can never preclude a major geo-political event being the major driver of financial markets during 2024. But assuming no major news on this front, several intriguing trends and imbalances pervade each industry that should color investment opportunities in the new year.

It takes no foresight to believe that high investment to train new AI models will continue during 2024. However, we will see the beginning of the second wave in the sector: the development of customized applications with significant value for either businesses or consumers. It is likely a new generation-defining company will come out of this emerging sector. Including, hopefully, one or two attractive opportunities for Somar.

On media we are already witnessing a new focus on cash generation rather than investment in stand-alone streaming ventures and large libraries of new content. This will lead to lower content spend, consolidation, stronger cash-flow generation, and margin accretion.

Social media should continue to outperform, especially the larger companies that have been better able to use AI to measure conversion in a post Apple privacy (ATT) initiative. They continue to show discipline in cost control and better capital allocation priorities.

Assuming no major consumer recession, consumer businesses should perform well with a return to channel shift from brick-and-mortar to online commerce. After explosive growth during the pandemic, online consumer retailers over-invested and faced new competition from a slew of richly venture-funded start-ups. New competitors have either closed or sold, costs have been cut over the last few quarters and the consumer spending that migrated to experiences and brick-and-mortar is showing signs of returning. We expect in 2024 these businesses will return to their more attractive pre-pandemic growth rates while delivering operating leverage and cash-flow generation. The best management teams here have a great opportunity to deliver high shareholder returns in 2024.

A similar trend of return to pre-pandemic growth with operating leverage should also be observed in the software and cloud-computing sectors. After being impacted by declining demand driven by cost-cutting / headcount reduction in its customers and lower startup job creation, the last couple of quarters have shown early green shoots of stabilization of demand.

The reduction in mortgage rates and strong investments spurred by both the CHIPs Act and the Inflation Reduction Act will lead to acceleration of construction activity and higher demand for related industrial suppliers. It could also put pressure on commodity prices, but these will ultimately be driven by Chinese demand which has been soft over the past year. That said, low inventories, brittle supply chains and low spare capacity could, in a positive macro scenario, lead to temporary spikes in commodity prices that would impact headline inflation rates and the interest rate trajectory.

The proliferation of wars and conflicts will lead to increased investment in defense around the world. That will be good for the companies that supply the armies but bad for the governments that need to fund them. We are particularly interested in seeing the choices made in the EU. Given slowing economies, high debt levels, high taxation, but low investment in defense, can they step up at this moment without creating credit fears in some countries by bond market vigilantes? In addition, higher interest rates are being passed onto consumers and businesses, which may pressure their ability to repay their loans. After the tailwind of higher interest margins in 2023, the financial sector faces the potential of higher credit losses.

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While these cross-winds create exciting opportunities for active investors, what most excites us is finding the gems that will prosper no matter what. The entrepreneurs whose life mission it is to create a much better solution for their customers and the passion to bring their solution to as many customers as possible. The “square pegs in round holes”. Our team studies the innovators closely and monitors their progress continuously. We find many good entrepreneurs that provide incremental improvements. Once in a while, we find odd thinkers that upend assumptions and offer unique value propositions. If customers start to flock to their company with enthusiasm, we know we have a gem on our hands. At a sensible price we are buying.

Human nature doesn’t change. We see this in the multiple cases of fraud, stock-promotions, and serial offenders we research on the short side. We have resources 100% dedicated to this and will continue to update you throughout the year of our investments there. I hope you find these insightful. Some of the stories seem eerily similar even though they come from different geographies and industries. The one thing we can bank on for 2024 is that more frauds and stock promotions will present themselves. Human nature will continue to tempt too many down that path.

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We wish you a prosperous 2024. We are energized for the new year and grateful for your trust in us on this journey. Don’t hesitate to contact us to learn more.

Sincerely,

Pedro Ramos

Cyxtera Technologies

Dear Investor,

We hope you are enjoying a good summer with time for rest, recovery and connection with family and friends. Despite the rally in the market this year, the Somar team has found good short opportunities. This month we bring you one example.

Cyxtera Technologies

Cyxtera Technologies operated as a global data center operator providing colocation and interconnectivity services to more than 2 800 companies worldwide across 61 different data centers in 28 countries. The company was acquired by private equity in 2017 and went public via reverse merger with the SPAC Starboard Value Acquisition Corp on July 21, 2021. We came across Cyxtera a year after it hit the public markets and found several red flags in its financials and its business model. We judged its excessive leverage put it at risk of bankruptcy. Somar covered the position after Cyxtera filed for bankruptcy.

Cyxtera business consisted of renting space in data centers and subleasing it to its customers. Additionally, the company offered interconnection services for its customers to establish fast, convenient, affordable, and highly reliable connections to their preferred network service providers.

The company was strategically trapped with no profitability nor growth at a sub-scale position. Its sales of $700mn paled in comparison to its peers’ $4bn and $6bn. To make matters worse, Cyxtera was losing market share: its sales stagnated between 2018 and 2021 in a sector growing high-single digit to mid-single digit. Cyxtera’s operations were subpar, and it consistently reported operating losses, vs. 20% margins for its peers. Naturally, the company struggled to generate cash to sustain such high debt levels.

Cyxtera was also vulnerable to its high customer concentration. Lumen, its top customer, represented 11% of revenue. The top 20 and 50 customers represented 42% and 55% of the company’s recurring revenue. Lumen had already indicated that it was not going to renew its contract in 2025. Comments gathered from customers and employees suggested Cyxtera was providing a deteriorating quality of service.

Rising energy costs pressured its margins as Cyxtera was only able to pass 90% of the extra expenditure to customers. Starting from a low level of cash generation, this hurt its finances. With most of its debt at variable interest rates, Cyxtera faced growing interest expenses which put further strain on liquidity.

The company’s high leverage limited management options. Interest paid consumed 80% to 85% of cashflow from operations. With debt to adjusted EBITDA at 14.6x, Cyxtera’s only source of extra funds would have to be dilutive equity issues.

Management’s resort to using creative metrics was a concerning sign. Cyxtera reported “transaction-adjusted EBITDA”, a made-up metric that excluded several cash expenses (for example around $75m excluded in 2021).

One of Cyxtera’s private equity owners, Medina Ventures, was involved in a similar underperforming deal in the sector. Manuel Medina, Medina Ventures General Partner, was the CEO of Terremark, another data center operator. Its stock price was flat from 2005 to 2010, and in 2010 generated negative free cashflow of $95M. In 2011, the company was sold to Verizon, which divested Terremark in 2016.

Our scenario analysis suggested the company had to accelerate its revenue growth (despite losing its largest client) over the next 10 years, ramp its operating margins to best-in-class for Cyxtera to even have a positive equity value. To reach the $6 dollar stock price that the market was attributing to Cyxtera, the company would need a revenue CAGR of 11% for the next decade, with unprecedented operating margins of about 40%.

We will spare you the details of the last few months which included desperate measures such as sale-and leasebacks of the last-owned assets, attempts to convert to REIT and to raise dilutive rounds of capital. Eventually, the creative destruction gale of capitalism took its path and Cyxtera was forced to close doors and let their more efficient and better managed competitors take their customers.

This case study illustrates a current source of good short ideas: zombie highly-levered companies that have been able to muddle along due to the prolonged period of zero-interest rates. As these debts come due and need to be refinanced at higher rates, creditors and shareholders are thinking hard of whether to double down or throw in the towel and close operations. While it is Somar’s practice to cover once most of the profit has been made, sometimes the deterioration is so fast that affords us the opportunity to hold the position until the filing.

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We hope you are having a restful break. We look forward to continuing to hear from you in the weeks and months ahead.

Sincerely,

Pedro Ramos

On Holding

Dear Investor,

On Holding

Hopefully by the time you read this letter you will either be on vacation or have one or more weeks penciled in for the near future. Let me suggest you add On shoes to your luggage. Please let me know your thoughts.

Started by professional athletes, some of them Olympic athletes, and with a differentiated shoe focused on performance, On is the fastest growing large sports shoe company in the world. It has two innovative patents that significantly improve their performance versus competitors: air pockets that reduce the impact while running and an inner metal plate that facilitates forward motion at the take-off phase of your running stride. Starting in track, On has expanded into hiking and tennis, after adding Roger Federer as an investor, consultant, and ambassador (amazingly Roger called them first).

Most businesses have demand as the bottleneck to growth. Not On. The company sells all the shoes it can manufacture and has been growing at more than 50% per year for the last 7 years. Mass consumer products like this are rare (Tesla and iPhone in the early days for example).

While not an athlete myself, I’ve participated in a few runs and triathlons over the years. With age and weight gain, I have come to appreciate the importance of a good shoe to prevent injuries and long recoveries. I found some improvements with quality running shoes, but nothing in the ballpark of the improvement I got after I tried my first On. I’m embarrassed to admit that I only tried them as part of Due Diligence on the company IPO. But that experience surprised me. It was the largest step up in performance compared to anything I had tried before. Additional calls to other consumers provided confirmation of my experience. Finally, a few friends of mine who had family members go through orthopedic procedures told me the surgeons suggested using On shoes during the recovery period. So Somar decided to do a deep diligence on the company

We found it was an early challenger in the $300 Bn Global Sports shoe market. This market is growing fast, in the high single digit range. With a little less than 1% market share, On has plenty of opportunity to grow.

On is an authentic performance brand. Designed and built by athletes for athletes. Nike challenged Adidas in its earlier days with the same strategy. However, both Nike and Adidas, along with Puma, Hoka, Veja and others are currently more focused in marketing to streetwear junkies and cultural influencers (for example, the Adidas collaboration with Kanye West) than to focus on improving product performance. This leaves a fantastic opportunity for On. They have extended from track into tennis through its investor and partner Roger Federer and recently by signing world number 1 female player: Iga Swiatek.

Other adjacent opportunities will follow as the company builds its capacity to serve them. Their patents have also provided them with a differentiated product since day one.

Modelling the company with similar margins to its peers and conservative expansion assumptions provided with an inherent value of multiples of what On was trading in the market for. It is worth noting that the company has been profitable almost from day one, despite its strong growth and expansion investments.

Our adverse scenario that led to less than 20% downside on the investment, involved a strong deceleration of growth and weaker margins than the competitor. A situation in which the current enthusiasm for the product would die off immediately and the company’s current premium pricing would not be sustainable.

Balancing the risk-reward, the investment was quite attractive, and we bought a medium position and added to it on weakness. Our on-going due diligence suggests the thesis is well on track with almost no shoes ever going on sale (and if they do, only very limited quantities and in odd sizes) and a noticeable expansion in the number of people wearing the shoes in NYC.

This year, the market started to recognize the value of the company and the stock has about doubled. We still see significant upside ahead and believe that if management continues to execute, On could be a powerful compounder of wealth for Somar investors for at least the next decade. We will keep updating you on it.

I hope you find the time to rest, recharge and enjoy the company of friends, family, and nature in the summer months. If you get bored, please give me a call. It’s always wonderful to talk to our investors about the opportunities we see.

Sincerely,

Pedro Ramos

Somar Anniversary

Dear Investor,

Somar Anniversary

Somar’s anniversary is a good time to take stock of what has been accomplished and what remains to accomplish in the years ahead. When I think back to our first day, I realize how much we have improved: we have a better team, a wider and more attractive opportunity set, a crisis-tested operational team, and more investors than when we started. Our alpha generation is improving, well-illustrated by last month’s production of alpha and positive returns in both our long and short books

As a Portfolio Manager I have grown a lot over the past few years. Having faced scenarios unanticipated by many, such as Brexit, Covid, Trade de-coupling and sharp interest rate increases, I have been able to keep our risk under control and in many cases add significant alpha with the dislocations available. I look to the future with open-eyes and confidence in turning so-called “unprecedented” scenarios into prosperity opportunities for Somar investors.

Over the past few years, I have trained our analyst team comprised of hungry, talent-heavy, and opportunity-starved rising stars from the elite universities of my native Portugal. They have proved very focused, hard-working, and insightful analysts. One specializes in short investments. Others specialize in focus industries for Somar.

The institutional setup of public equity investing has made the market more inefficient in the emerging entrepreneurial public companies. The rise of passive investment has drained active investment dollars into large cap stocks by design of market capitalization-weighed indexes. Most large active managers launched cross-over funds to invest in private fundraising rounds ahead of potential IPOs. We welcome the reduced competition on our opportunity set and believe will serve us well in the next few years.

Institutional investors love fresh-thinking, performance-focused and nimble emerging managers. But they worry about their firm’s risk and operational failure. The team at Somar has answered those concerns conclusively. We faced wide market swings, a pandemic and sharp interest rate swings without missing a beat. For an external observer, our operations could even be classified as “boring”. The trains run on time, the trades clear, the cash matches. Every day. Every year. Our risk controls identified all types of attacks: phishing, impersonation, over-charging. I couldn’t be prouder of our operation team.

There is not a single day of my work that I don’t think of our investors. I’m incredibly grateful for their trust and I will be forever loyal to them. We have the investors we need to get Somar to where we dream. We will continue to grow organically by compounding capital. While we are still accepting additional capital, we will stop accepting it far before the level we feel could in any way be detrimental to Somar’s returns. Our investors have been loyal throughout the years. I will not forget this.

A final confession I make with some hesitation. I like to under-promise and over-deliver. But I feel our performance so far doesn’t reflect the quality of our work and the opportunities we have. Some of you are familiar with the way public markets work and understand this. Last Christmas, I mentioned to some of you how Meta was selling for mid to high-single digit multiple of its earnings. A clear example of how low valuations can get in public markets. Since then, Meta’s stock has more than doubled. As a member of the socalled FANG group of stocks, Meta is widely followed by analysts. Our long portfolio includes names that we believe will be the Meta of 5 to 10 years from today. They have less coverage. They can be ignored and discounted even more than Meta. I see well more than 10 companies today in this situation. This gives me confidence that our returns will improve in the years ahead.

It has been a good journey so far. But I am confident the future will be even better. Nothing will make me happier than sharing those fruits with you

Sincerely,

Pedro Ramos

Somar Anniversary

Dear Investor,

Somar Anniversary

As I reflect on the Somar anniversary I look to the future of your investment in us with much confidence. We have a portfolio of very attractive and unrelated investments, a highly talented and committed team, an experienced and proven operational structure and most importantly a committed group of long-term minded investors like you allowing Somar to invest for the long-term providing you the highest probability of success. We have improved significantly since our inception and the seeds have been planted for much further improvement in the short and medium term.

Our investment ideas are diversified by geography, industry and type of thesis. In our opinion, what they share is a high probability of elevated returns and low probability of adverse outcomes, with care that adverse outcomes would not inflict high permanent losses. We have written about different opportunities such as emerging sporting shoe company On (who just signed Iga Swiatek and Zendaya), employee-owned & market share taker admin consolidator JTC, online classifieds leaders such as Rightmove and Baltic Classifieds and food delivery platforms such as DoorDash.

We have also written extensively about very diverse short investments in companies that came public through SPACs, multiple frauds, pump and dump schemes and copycat story stocks with limited traction in hot sectors such as electric vehicles. More to come.

Our team has been stable throughout Somar’s tenure providing depth of knowledge and investment acumen. We have a great investment team and a highly efficient and responsive operations team. Many, if not all of you, have had a chance to interact with them and I trust you were able to gauge for yourself the caliber of human capital that serves your investment. We will continue to invest time, resource and continuous learning in our human capital, starting with myself.

I would also like to thank our service providers, Goldman Sachs, NAV Consulting, Deloitte, Salus GRC, Seward and Kissel, Silver Fern Financial and Carne who promptly and professionally assist us in running a tight ship on the operations side.

At the end of the day, we exist to compound your wealth. To build a snowball that keeps growing throughout crisis like Brexit, Covid, sharp interest rates fluctuations, wars and other geopolitical tensions. While the track record is pleasing, we are not satisfied. The team and I believe we can do better and based on all the ingredients mentioned above you can see why we feel confident in our chances of delivering more in the next few years than we have in the past.

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Sincerely,

Pedro Ramos

Year in Review

Dear Investor,

Year in Review

With a few days left in the year, and a decent December so far, we feel comfortable to say that Somar had a good 2023 in both process and performance. Our team worked well to uncover attractive long and short opportunities, and we were able to offer double digit returns to our investors.

2023 was especially prolific in short idea generation. We were short a few banks that declared bankruptcy in the year. We also found a few new stock promotions and some stock frauds that allowed us to have a good year on the short side.

On the long side we came into the year with an attractive portfolio that performed well. Some beaten down names like On shoes, JTC, and DoorDash started to rally strongly off the lows. But we believe these companies’ potential is way above what they have so far achieved. We found a few additional new ideas that we may write to you about in 2024. Overall, this makes us pleased about 2023 but even more encouraged for 2024

I would like to thank the Somar team who worked tirelessly all year. We originated top ideas both long and short, managed risk well, served our partners promptly and kept our operations at the level of firms several times our size. We are in a good position, and we look forward to continuing this trajectory in 2024 and beyond.

2023: main trends by industry

In the financial markets, the year was marked by the so-called “Magnificent 7”. As of this writing, these 7 firms (Apple, Microsoft, Microsoft, Tesla, Meta, Alphabet and Nvidia) were up close to 50% for the year while the remaining 493 companies of the S&P 500 returned high-single digits. The Magnificent 7 rally was spurred by enthusiasm around AI, and the efforts of some to reduce costs and become more efficient. Surprisingly, the largest gain in market capitalization in the group (more than $1 trillion for Apple) was for the only company that neither announced AI projects nor reduced costs (and had declining sales). So thematic investing is still alive and well in financial markets.

Other industries also experienced major changes throughout 2023. We will give a one or two sentence description of most, to keep this letter short, but please reach out if you want to discuss further.

The banking sector was under pressure at the beginning of the year due to the impact of rising rates on their fixed rate, mostly public debt securities. A few banks went bust, most notably Silicon Valley Bank and Signature Bank. Credit growth slowed as mortgage demand collapsed with the sharp rise in rates. While non-performing loans steadily increased, no sharp increase in write-offs materialized as the US economy was able to avoid a recession. European banks fared better on the security side due to slightly lower rate raises and less exposure to fixed rate assets, and a little worse on non-performing loans due to the stagnation in Germany and other core EU economies.

The energy market went sideways. While demand grew at the top end of forecasts, supply also surprised on the upside as US production, augmented by growth in Brazil and Guyana, kept markets well supplied. Despite the geopolitical instability and China’s exit from Zero-Covid, we had relatively stable energy prices which helped keep a lid on inflation and consumer confidence in the western world.

Travel and other consumer services continued their post-Covid recovery. Retailers continued to benefit from the re-opening, while online retailers experienced better growth as secular trends reassert themselves.

Highly promotional and over-funded VC consumer companies either folded or significantly reduced their operations. This has allowed the leaders and incumbents to restore their margins and restore sales growth. This trend seems sustainable in the medium term, as fundraising from VCs and exits through IPOs hit multiyear lows.

The passage of the CHIPs Act, Inflation Reduction Act and the commitments to energy transition imply an investment in infrastructure that does not seem to be priced in, in the financial markets. Renewable forms of energy have lower density than fossil fuels and will require strong investments in grid and production infrastructure. This, together with the different bill of materials needed for electric vehicles, will require the usage of certain materials such as copper and lithium to grow by multiples. In addition, the strong investment in the training and development of new AI models will lead to a strong growth of the energy needs of data centers that some estimate will be equivalent in the US to the current annual consumption a middle-sized European country like the Netherlands. This is an ambitious, capital-intensive project. Not many of these are likely to yield attractive returns, and they are likely to be inflationary. That said, one of the privileges of being an investor is finding and partnering with those entrepreneurs that invent ways to do more with less, solve complex problems and deliver on societal aspirations with high returning private enterprises.

Ozempic and similar weight-loss GLP-1 drugs took the world by storm and crowned Novo Nordisk as the most valuable European company. While this is a sector we don’t invest in, we are inspired by the innovation and hope further advances in AI, CRISPR, and other biotechnologies will continue to improve the health and life quality of the world.

Great investment returns compounded over several decades create hard to fathom results. That is the mission of Somar. And while we devote wholeheartedly to the multi-decade return, the lifespan of all of us is beyond our control. So, we root that 2024 brings all of us health, and more novel cures and advances to extend the span of quality lives for all of us.

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We wish Happy Holidays and a healthy, happy, and prosperous 2024. Don’t hesitate to contact us to learn more about our approach.

Sincerely,

Pedro Ramos

Short Illustration: Fisker

Dear Investor,

Short Illustration: Fisker

Fisker was another electric car startup led by dishonest promoters, with the wrong strategy and limited execution capabilities challenging a highly competitive market. The company went bankrupt in 2024. Somar shorted the stock several times with the latest trade in 2024 when we delivered an almost 50% return to our investors.

Henrik Fisker is a car designer who made a name for himself while at BMW and later at Aston Martin. He later had a short stint at Tesla and left due to disagreements with CEO Elon Musk. He then decided to launch a competing company and this first venture offered a view into his character.

Fisker Automotive, Fisker’s first electric vehicle (EV) venture, was founded in 2007 and went bankrupt in 2013. During its life it produced only 2,400 cars. During this process, the company lied to the US government to get a half a billion dollar loan, outsourced its battery production to a failing Chinese company and failed to live up to Henrik Fisker’s commitments leading to multiple lawsuits, a judge claiming Mrs. Fisker was not a credible witness due to conflicting testimonies, Mr. Fisker claiming 10,000 firm orders when only 750 had been received, promising the state of Delaware to hire 2.5k employes and only hiring 2 among other shenanigans. Henrik Fisker blamed his investors for the venture’s failure.

In 2016, Henrik launched a new company: Fisker Inc. This time he brought on-board both his wife (CFO) and daughter (Chief Marketing Officer). Unfortunately, this second try would end the same. It had an uncoherent and shifting strategy, poor operational execution, accounting shenanigans and an extremely well-funded and aggressive group of competitors.

From the outside it was hard to determine what the company’s strategy (if any) was. It started out promising to develop a hybrid luxurious sedan, but then pivoted to an all-electric SUV. It also announced it would target the lower-income consumers with prices lower than $50k. The company would only design the car with sales done directly to the customer on its website.

However, when the company finally presented its prototypes and started taking orders, it priced its models at: $37k, $50k and $70k. These competed directly with models from Volkswagen, Chevy, Hyundai, Audi, BMW, among many others. More concerningly their price/performance ratio compared poorly with models already in production by Tesla.

Other worrying signs of the leadership ethics (other than their past) were their easily disproven claims:

Fisker would use solid-state batteries: the technology is still not yet in prototype let alone production;
Management would take minimal wage to reduce cash burn: after selling $20mn of stock to buy an LA mansion;
Saying car was ready to launch while reports from insiders that the software was not working.

Given the strategy, woeful execution, high competition, and management lies, Somar was counting on Fisker running out of cash as being the catalyst for our short investment. Due to the SPAC listing, Fisker started its life as a public company with almost $1Bn in cash. Our analysis suggested this cash would bleed fast as production ramped up unless management was able to keep the stock price high to issue additional shares. It would depend on the commercial success of the vehicle and Somar collected data before building a position.

There were several early signs that our thesis was correct:

Fisker increased deposits asked from customers from $250 to $5,000, a clear sign of liquidity issues;
A widely followed car reviewer deemed Fisker the worst car he had ever reviewed;
Reports of software problems in the vehicle leading to limits in top speed and sudden car stops;
Multiple customers returning their cars for refund.

At the start of 2023 Management guided for 42.4k cars produced and 8% to 12% gross margin. If true, this would significantly reduce the company’s cash burn. Our analysis indicated this was not even close to reality. We started shorting the company.

What happened:

Fisker produced only 10k cars and sold only 4.9k cars;
Gross Margin was significantly negative: -35%;
The company lied initially reporting positive 7.5% gross margin and later had to restate this after going through 3 different Chief Accounting Officers in one month;
The company quietly raised more than $300mn of equity to repay a convertible bond offering.

Meanwhile their competitors, most notably Tesla, continued to report strong growth and cash generation in the same segment and increased our confidence that there was no place in the market for the Fisker offering. We shorted several times during the period. Our return in 2024 was almost 50% as we covered a few days before the company declared bankruptcy.

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Sincerely,

Pedro Ramos

Somar Capital Management

Our Letters

The Year so Far

Year in Review

Perspectives for 2023

Short Illustration: C3.ai

Short Illustration: Cazoo

Short Illustration: Astra Space

Short Illustration: Porch Group

Short Illustration: Mullen Automotive

Somar turns 6

A bedrock for prosperity

An illustration of a recent short

Discontinuities

Short Investing

The Long-Term and Return on Capital Employed [ROCE]

Numbers are hygiene, mission and values are destiny

Innovation: land of opportunity

Active Investment

Financial Turmoil

Liquidity vs. Mark to Market

Baltic Classifieds Group

Quick Market Commentary

Short Illustration: EBIX

Uncertainty and Scenario Planning

Short Case Study: Enviva

A year of several cross-winds

Cyxtera Technologies

On Holding

Somar Anniversary

Somar Anniversary

Year in Review

Short Illustration: Fisker

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