Dear partners,
Thank you for your continued trust and support; you are the best partners I could ask for.
After two years of running the fund, I’d like to reflect on how things have progressed. Frankly, 2022 was embarrassing and we got off to a rough start. Digging out of a 35% hole at one point was very daunting. However, the one variable that mattered was the rate of improvement of our research process. Focus on that and the results would follow. Our strategy, in my opinion, wasn’t the problem since the rate of change of earnings relative to the price paid is simple logic, so it was the execution of the strategy that needed refinement. That led to the creation of our quality checklist, which enabled us to build a library of over 1,100 companies that we could constantly compare against each other.
While the early versions of this database identified Nvidia as the top company, my personal lack of imagination still led us to miss the early gains. This is just one of many examples where our quality database has singled out incredible stocks. Over time, I have come to trust our criteria more and more, enabling us to have a wide backlog of potential investments. The simple exercise of comparing and contrasting every company against the same quality criteria allows us to truly identify the special companies over the long run. While revenue growth data changes quarterly, the characteristics of a great management team, barriers to entry, and consumer value surpluses change much less frequently. To hold a business for the long-term, the metrics you focus on have to align with that goal. You can’t hold a business for decades if you only focus on the stock price.
As our research process improved, so did our results. After two years, we are now neck and neck with the S&P 500 net of fees, but there is still much more work to be done. Even though we’re up 69.8% year-to-date, I’m not satisfied. Our goal is to not just eke out similar returns to the benchmark but to downright crush it. To reiterate the strategy, we concentrate in the fastest-growing, highest-quality businesses at the lowest multiples we can find; this is the Infuse formula:
All else equal, a higher valuation will handicap returns. However, a low valuation with no growth and no quality, means no returns. It’s simple but not easy to identify great companies with low valuations. That’s because it’s a competitive marketplace. The best companies tend to have very high valuations since everyone knows they’re great.
Further, the formula is additive in the numerator so if we find an extremely high quality company with very little growth at a rock-bottom price, that could still lead to strong returns. Likewise, if we find a company growing rapidly but with lower quality and a cheap valuation, this could also work out. The problem with these set-ups, as we’ve discussed, is that it’s hard to hold them for a long-time since time is the enemy of a low-quality business. That’s why we try our very best to find opportunities that are in the top decile along the three vectors of growth, quality, and valuation. Very often, in the Infuse Formula, there will be a trade-off. One of the three may not be top decile, or two of the three may be second decile, or all three scores may be high but none reaching the top decile. There are almost always trade-offs because investing is competitive. If an opportunity really is a no-brainer, the price will usually get bid up. However, if you can be correct about a change in a business’s trajectory before it really shows up in the financials, that is where big money can be made. But it often requires a deep understanding of an industry or company.
It’s simple but not easy to hold a very concentrated portfolio of these fast-growing, quality companies at low forward multiples. Every company has its risks and valuation multiples can get stretched but when we do find those rare opportunities that score very highly on the Infuse Formula, we have to take advantage. As always, we have to talk a little bit about companies as well! The one I want to highlight this quarter is a tiny Swedish company named Intellego.
Intellego is a Swedish company specializing in dosimeters for ultraviolet light. There are three types of UV – A, B, and C. UVA rays are long-wave (315-400 nanometers) that typically cause skin cancer. UVB rays are medium length (280-315 nm) which usually cause sunburn. And UVC rays are short-wave (100-280) that gets absorbed by the ozone layer so we don’t hear about it too often. However, it has germicidal properties which means it is good for disinfecting.
Intellego’s dosimeters react to UV light and change color so that practitioners can measure the magnitude of UV for specific purposes. The original vision was from the founder/CEO, Claes Lindahl, when he bought the formulation in 2011 to see if he could help reduce sunburns. The idea was to provide a wristband that would change colors when you needed to reapply sunscreen. That product still exists but Lindahl found it to be too expensive to scale a consumer brand so the company pivoted to B2B sales in other applications.
With COVID, the one market that really took off was healthcare, which makes up roughly 70% of the current business. As mentioned, UVC light is germicidal which is great for disinfecting but it's also invisible so how do you know it’s working? That’s where dosimeters come into play. They are small paper cards that change color based on how much UV light they are exposed to.
Seems like a relatively simple business, right? Just sell paper cards to hospitals for less than $2 a pop and then sit back and relax. Well, it’s not quite that easy. Since the cost per card is so low, it doesn't make economic sense to have a salesforce going door-to-door among all of the different hospitals. So the company sells through distributors of UVC light into hospitals. The actual big light provider sells to the hospital and then the salesperson can add in dosimeters for validation. Unfortunately, the dosimeters weren’t selling through very quickly because it wasn’t high-value enough for the salesperson.
So now Intellego is backward vertically integrating and has purchased a couple of equipment resellers. The first one was Daro Group, one of the leading water disinfecting providers in the UK, for $12 million USD. Daro is set to grow 15% and be profitable this year. Intellego also started another reseller named Yuvio which offers UVC lamps for hospital settings. One interesting piece about this is that Yuvio resells OhmniLabs UVC robots, among other brands, that zoom around a room with a lamp to disinfect it. The autonomous robot companies love dosimeters because they reveal just how well the robots work compared to a stationary lamp. The stationary lamp may work very well in one particular area but germs obviously aren’t isolated to specific areas. Further, UVC companies that have low quality machines don’t like dosimeters since they expose the lack of radiation and therefore the lack of disinfection. Dosimeters are about 95% gross margins so the capital equipment reselling is much more capital intensive and low margin (far lower ROIC). However, it feels like a necessary step right now as the company tries to build distribution muscle and its moat.
As of Q2 2024, the company has done just over $22 million in revenue over the past twelve months at roughly 80% gross margin and 50% EBIT margin. Daro accounted for about one-third of the business in Q1 and dosimeters made up the rest. If we remove Daro, we find that dosimeters clock in at nearly 70% EBIT margins. Dosimeters, alone, also grew over 100% on the back of several large deals. It’s clear a very good business to sell as many dosimeters as possible but the problem of the low price tag still remains so it doesn’t make economic sense to sell directly to hospitals. Further, European hospitals aren’t exactly the most well-funded institutions. That’s why the curing side of the business is pretty exciting. The company has been in a two-year-long process with a German multinational that does more than $20 billion in revenue to sell dosimeters that validate UV light in the manufacturing process. By the end of the year, we should have some positive news from this customer. Instead of selling a dosimeter for $1.50, they typically sell it for $5 in the curing vertical and this contract alone could be worth the majority of the entire market cap if it takes off like Lindahl thinks it can.
Intellego is not limited to Europe though. The company’s heads of sales for North America and Asia actually work remotely in Alabama and Atlanta respectively. In fact, the founder even works from home. That’s one reason why opex has been so low and the company is able to put up such strong operating margins. There are about 6,000 hospitals in the US, which combine to account for about 1 million beds. In Europe, there are more like 30,000 hospitals that contain 2.3 million beds. Depending on how many dosimeters a hospital would use per day, we can come up with a healthcare TAM. At $1.50 per dosimeter, at 5 dosimeters per day, we get nearly a $100 million market if we assume all of those hospitals. We can change the dosimeters per day which is the real variable that has an impact. That’s why real-time validation is so important. Most hospitals with stationary UVC lamps may use a dosimeter initially and then think there’s no reason to use another one if the lamp hasn’t moved. That may be the case but it’s not the case with autonomous UVC robots that are cleaning an entire area as we discussed.
But the healthcare market is likely much smaller than the curing market. Intellego also uses its dosimeters in greenhouses in its horticulture verticals but let’s not even attribute much TAM to that as it’s still early days. The curing market is mainly focused on manufacturing companies. An automaker might use UV lights to speed up the paint-drying process, saving time and thereby money. In order to measure the level of radiation a dosimeter would be used. Anything that needs to be dried and hardened may be a potential market for dosimeters. The CEO/founder measures this market in the billions but that might be aggressive. Even so, directionally, the curing market is larger than $100 million and the average selling price for a dosimeter is more than 3x what it is in hospitals.
I think the main question most investors would have is: how defensible is a paper card? The answer is: you’d be surprised. Claes has three patents on the intellectual property, including very interesting applications like a QR code that would direct a UV robot to increase or decrease UV intensity and then shut-off based on the color of the dosimeter card. There is also an app that users can scan the cards and keep a running log of the exact color of each card for liability purposes. Imagine if someone got an infection after leaving the hospital and wanted to sue the hospital. Well, the hospital lawyers could show how well the area where the patient was staying was sanitized using the color of the card. In fact, hospitals in China are already starting to standardize this protocol for similar reasons.
Further, if you Google “UV dosimeters” almost all of the ones you’ll find are Intellego’s brand, even if they don’t explicitly say so since Intellego does white-labeling as well. The fact that Intellego is such a well known name in the industry coupled with its low-cost operation, means there is very little room for competitors to undercut on price. These cards sell for $1.50! Is it worth saving 50 cents in the event that the new card doesn’t work as well and doesn’t have a digital record management system? It’s just not really worth it. Now, at some point, if you’re using 100 dosimeters per day, it adds up. But the average healthcare associated infection costs $36,000 so dosimeters really act like insurance. It’s about validation and liability related to UV. In curing, if the light isn’t perfectly placed where you need it, an extra 30-60 minutes of curing time could be very costly. It’s well worth just going with the established market leader.
Another risk to mention is radiometers. These are electronic readers of UV light. They are typically at least a few thousand US dollars, routinely reaching $5,000, but they don’t have to be replaced. So it’s a larger investment upfront but they can’t be easily positioned to optimally measure UV light. I’m eagerly on the lookout for flexible radiometers but none have come to market yet. At the moment, due to the low cost and ease of use, dosimeters solve customers’ problems much better than radiometers.
There are plenty of risks with this story. First, the cash flow and balance sheet aren’t nearly as strong here as the companies I usually invest in. Intellego put in a strong cash flow performance in Q1 but heavily invested in capex to buy autonomous UV robots through its Yuvio subsidiary in Q2.
Along these lines, the first thing investors flag when looking at Intellego is the huge accounts receivables balance. In Q4 2023, receivables were 92 million SEK on roughly 107 million dosimeters sales for the year. Very roughly that implies 12 month payment terms. Management has explained that this was necessary in order to prove their value and then payment terms will shorten as time goes on. They are now guiding for receivables to be between 25-35% of overall revenue, which, if you annualize Q1’s results, it’s about 36%. So they are certainly on the right track. However, if we continue to see long payment terms, and cash keeps getting consumed, I think this will be a thesis breaker since customers aren’t truly paying for the value they’re seeing. Further, the balance sheet isn’t necessarily strong enough to weather it for much longer. My thesis is fairly focused on cash flow as I believe this year will be important for shortening payment terms and see some larger curing customers who should have the coffers to pay for the dosimeters. The company has also been able to sell Yuvio systems immediately (not leasing) as customers are eagerly ordering the advanced technology.
Second, there is a long checkered history with the company’s board. Over the past year, 4 of them have stepped down. To many investors, this is a glaring red flag. However, I think it’s more a function of the founder’s lack of network/resources in the early days rather than any maleficent intentions. Henrik Börjesson, Anders Ardstål and Per-Ola Rosenqvist have all stepped down, creating some controversy. Mr. Rosenqvist was convicted of insider trading so obviously he would have to leave the board. But that was his personal decision, not Claes’. Mr. Börjesson didn’t think he was qualified enough to take the company to the next level and Mr. Ardstål had too much on his plate.
Third, the company’s last auditor wasn’t great, which certainly added some bite to the bear pitches. But at Intellego’s last annual meeting, they announced an engagement with Deloitte and I’m looking forward to the first full-year audit. There was an accounting issue with the Daro acquisition that was yet another example of Intellego’s need to professionalize.
Fourth, the company still doesn’t have a full-time CFO. Further, the company had to delay its Q2 earnings report because its temporary CFO was on vacation. That doesn’t happen in professional organizations and shows that the company still has a long way to go in maturing.
Intellego is Claes Lindahl’s baby (CEO). He founded the company in 2011 and is still running it 13 years later. There have been many ups and downs over the years, including several years to even get the technology working and now the struggle of scaling the company despite a few problems with the auditor and board. With all of the challenges, Lindahl has remained strong and hasn’t wavered. In fact, over the last 4 months, he has personally bought over $400k USD and nows owns more than 12% of the company.
I don’t think it’s unreasonable to believe that the company could do $20 million in EBIT over the next 18 months. With $6 million in cash build, that would be a little bit more than 3x ‘25 EV/EBIT. For a company that could continue growing over 30%, with no customer concentration, a founder at the helm, a huge runway, and repeat customer behavior, that is far too cheap.
Closing
I’m honored to have you as a partner. Thank you for your trust and support. It enables me to think long-term and will be our own competitive advantage.
The stock market, like life, will have its ups and downs. All we can do is focus on what we can control and work hard to continually raise our standards. Our strategy is simple – hitch a ride to the world’s best entrepreneurs that are running the fastest-growing, highest-quality companies at the most attractive valuations we can find. Here’s to many more years of focusing on the inputs and letting the outputs take care of themselves.
Sincerely,
Ryan Reeves
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