AFR – Seven Questions with Graeme Carson by William McInnes

05 Dec 2019

Graeme Carson is a director and portfolio manager at Cyan Investment Management.

What was the reason behind exiting Afterpay after holding it since IPO?

Firstly, the decision certainly wasn’t based on any questions around the quality of the business. Afterpay has been one of the most well executed growth companies we’ve seen and we continue to like the business and respect the management team.

Graeme Carson sees regulatory pressure on the horizon for Afterpay. Paul Jeffers

That said, at Cyan we look for growth and like to be invested early in the company’s lifecycle, ideally with an entry point at a market capitalisation of less than $200 million. Afterpay still has strong growth ahead, but with a market cap around $8 billion it’s priced aggressively, coupled with an increasing competitive response and potential regulatory pressure on the horizon.

Further, we only hold around 30 investment positions and are completely index unaware, so don’t focus on relative performance and can concentrate on finding the next big growth company. So with all that in mind we decided to recycle the investment capital into new opportunities believed to offer better risk-adjusted outcomes. Hopefully one of them becomes the next Afterpay.

What’s a stock in your portfolio you’re really excited about?

I’ll mention a couple, both less than $100 million in market cap and offering growth, but in vastly different ways.

Firstly, Oventus. A medical devices business operating in the sleep apnoea space and beginning to gain traction in its US market expansion. The vast majority of the R&D capital has now been spent and the resulting product is gaining strong support within the medical industry.

Historically, it’s struggled to find the right path to market, but its lab-in-lab strategy is currently being rolled-out in North America and the potential upside is enormous. The product is yet to deliver any material revenues, so there is still execution risk, but Oventus has the potential to partially displace some of the industry incumbents such as Resmed.

The other is Quickstep, a Sydney-based advanced manufacturer of high-value carbon-fibre products, predominantly for the defence industry. It’s been listed for a long time but we invested earlier this year on the belief that the new management team had improved the existing operating business and were positioning for further growth.

Thankfully our timing has been fortuitous and the business is now profitable and margins are expanding. We fully expect this momentum to continue into FY20 with both organic and new contract revenue growth, combined with further margin expansion. The best comparison is Austal of a few years back, then turning the business around completely.

Have you been moving away from high growth stocks?

No, we remain very much focused on growth. There seems to be a current perception that the market is split into growth and value, with growth represented by the tech-based WAAAX juggernauts and value being other “boring traditional” businesses. In reality, it’s nowhere near that polarised.

Given we invest at the smaller end of the market there are always a good number of opportunities … it’s just a matter of working hard to find them. That said, we are finding it difficult to justify some of the valuations in the tech and fintech space, but there are many other companies delivering strong earnings growth at more reasonable prices.

Admittedly, you need to pay forward to an extent but if the company is stronger year on year through investing capital in its own business, at reasonable returns, the valuation will grow over time.

Have any IPOs caught your eye in the last few months?

The end of the year can often bring a rush of IPOs, particularly at the smaller end of the market, and this year the corporate window is well and truly open.

As always, it’s a bit of a mixed bag in terms of quality but two that have caught our eye are Aerometrex and Carbon Revolution. In terms of Aerometrex, think Nearmap but with a few points of difference and operating in a more niche market.

Carbon Revolution manufactures carbon fibre wheels for high-end sports cars such as Ferrari. There appears to be a lot of demand for its technology and it has grand plans for growth, which will be capital intensive, but if they execute properly it will be a business many times its current size.

Are you comfortable holding Alcidion even after its more than 500 per
cent rally at the start of the year?

Yes. We invested earlier this year and have enjoyed returns ahead of our expectations, but we think there is a lot more growth ahead for Alcidion. The hospital sector is notoriously slow when it comes to adoption of technology for patient management and workflow, but the evolution is inevitable.

Alcidion has the relationships, the product suite and the service capability to become entrenched in hospitals in its current target markets of Australia, New Zealand and the UK (with new regions to come). It is now capitalised to execute its growth plan and we firmly believe that patience will be well rewarded (pardon the pun).

We’re always looking for new TV to stream. Anything new or old caught your eye?

I’ve been streaming Godfather of Harlem on Stan. A new series based on the true story of a crime boss in the 1960s and others such as Malcolm X. Certainly not one to watch with the kids but it’s got me hooked.

Finally, a recommendation for a good value quick bite in Melbourne.

It’s hard to go past the dumpling houses in the city. There are a few to choose from but I recommend North East China Family in Flinders Lane. Good quality dumplings and seriously cheap.