Welcome back to Capital Conversations. I’m Simon Wotherspoon, Head of Perks Private Wealth. And joining me as always, the man who’s survived more regime changes than I’ve had hot dinners, Christo Hall.
Thanks, Simon. Yeah, good to be with you. We’ve got some pretty interesting moves going on at the moment. So looking forward to having a discussion about that.
Yeah. this is the first podcast of the new year, 2026, since we did our last. In fact, since the beginning of this year, there’s been that much geopolitical and macro events. I mean, I was still probably hung over when the US started to move into Venezuela only in about the second or third of January. And of course, they captured President Maduro then. There’s been increased tensions between the US and Iran.
Obviously, Trump was pretty focused for a while there on Greenland or even Iceland, as he called it at times. And then more recently in Switzerland, the Davos. 2026 was dominated by talks of geopolitical fragmentation. even in the last, what we’ve just over one month, it’s been plenty of stuff going on. So how are you seeing things, Christo? How do you play or how do we navigate these times?
Yeah, and just, you know, and the other addition is we now know who the new Fed chair is going to be. And that’s, these events are all being digested by the markets. Lots of moving parts here. We’ll just start with the geopolitical first. as you mentioned, we’ve had Venezuela, Iran, Greenland have been front and centre of the Donald. And look, when you look at what the real driver is behind all of those moves, it’s about commodities. So in the case of Venezuela and Iran, it’s all about oil.
Let’s cut to the chase because both those countries are meaningful producers of oil. If Trump can do a deal on the supply of oil from those countries, he’s going to able to force the Russians to the table regarding Ukraine in a lot stronger position. So that’s what’s driving that. And then Greenland’s also about the critical minerals as well and the strategic benefit of that location. So, you know, that’s getting a lot of airplay, but it hasn’t really been driving the market moves to the degree that we’ve seen from, I think, the pending appointment of a new Fed chair, whose name is Kevin Walsh, And the market’s digesting what that means.
He’s been on the, he’s been on the, on the FOMC, the committee before he served as a member and the way that he’s going to conduct himself is going to be very, very interesting from an interest rate policy perspective. And that’s what the market is trying to obviously digest. So he’s been seen to be perhaps a little bit more hawkish than what the market was hoping with other possible nominee. Yes, it’s quite interesting.
He’s been a bit of both. he’s dovish in that he’s very much a believer in loose regulation around around banks, particularly so, you know, very encouraging of loosening financial conditions, which normally is obviously good for markets. But he’s also shown in the past, particularly, I think it was during the GFC. He’s also shown a propensity to be able to make very, very tough decisions around, fiscal constraints. So the market’s really trying to grab us to which way he’s going to go here. But then, you know, in the middle of this, we’ve got this, you know, overarching scenario of the bond market beginning to back up because again, you’re seeing still some inflationary fears out there in the world, even though they’ve been in the US, they’ve been managing it quite well. And we’re still looking at some rate cuts in the US. But you’re obviously looking at like countries like Australia, and we’re now in, you know, rate rising mode. But the reality is, the US, the economy is performing pretty well. So you know, where those rate cuts transpires is debatable to the degree of the market’s thinking.
But then what is overarching all of this is obviously what’s happening around AI, particularly around the hyperscalers and just on the amount of money that’s being spent by these big players in the form of capital expenditure. It literally is in the trillions of dollars. It will be over the course of the next few years.
Yet the revenue base of some of these companies, even though they’re meaningful, they are small compared to the capital expenditure that’s been, you know, that’s been forecast by them. So the market’s getting very worried. There’s just not going be any return on that spend at all. It’s going to be and that’s, that’s what’s really spooky.
There’s a bit of fatigue there, doesn’t it?
The market was very excited about AI and the capital expenditure.
And now, unless there’s a revolutionary model or something changed dramatically, feels as though the market’s a bit fatigued. Yeah, that’s right. And valuations, of course, were highly elevated. So when you’ve got those sorts of those sorts of issues on high valuation. And when you have a much higher percentage of market ownership by index funds that don’t care about valuations, they just move with, they’re based on capital flows or fund flows. It works both ways. And so we’re seeing that effect now. So we’re seeing some pretty brutal moves.
We’ve seen the moves in Bitcoin particularly as well. That’s been very dramatic.
Similarly, in gold and silver, mean, commodities had just about parabolic run ups and probably a week ago, they started to collapse to some degree. That’s right. So a lot of that’s around, you know, around leverage as well. there’s, you know, there’s plenty of dynamics at play here. But you know, what’s happening is we’re in a scenario where if I look at the shape of the yield curve in the US, we’re in this scenario which is called a US bear steepening scenario. And what that means is when the long-term yields like the 30-year yields are rising faster than the short-term yields. So you’re getting a steepening of the yield curve. And why that’s important is that’s reflecting that the term, what’s called the risk term or the term premier is rising.
There’s inflation risk occurring and it often leads to more bond issuance, more supply, which forces rates up at the long end. And that is, know, that obviously those higher rates are what drive, you know, discount rate impacts on valuations. Those higher rates of market, the market sort of pricing it is really about the now renewed concern about stickier inflation and longer-term inflation.
Yes, that’s right. We talked about Fed and Kevin Walsh, but this is more about the structural inflation, isn’t it?
That’s right. It’s about structural inflation. And if you look around, you know, all the Western countries have cut back, know, are coming back or wanting to cut back on immigration. know, immigration has been a big driver of big driver of economic growth, you know, historically, but also being a provider of cheap labour to lot of the developed world. And if you step back from that, then the cost of labour, and we’re seeing it even in Australia, the other unions, even here in South Australia, the nurses are asking for a pretty punchy pay rise. Not saying they don’t deserve it, because they probably do, but governments just can’t afford to pay these.
But that is the second order effect of cutting immigration is you’re going to see growth in wages and that is inflationary. So there are these issues that we’re really grappling with at the moment and it’s creating a lot of heightened volatility in the market, which I think is going to be a defining feature in 2026. This is going to take some way to play out how historically sectors, the winners and losers have behaved during these times of bear stifling in the US because obviously those valuations then tend to be reflected in Australia. It’s interesting. So if you look at who the winners are, normally it’s the banks benefit from that because they’ve got steeper yield curves, which improves their net interest margins, which is important for mortgage pricing. So they get some pricing power.
We’re obviously seeing mortgage rates go up now as long as it doesn’t send the economy into recession. But Australian economy is still doing OK. So, they should be a beneficiary of that. Clearly, energy and commodities are a benefit of improving economies. And as I said, the US economy is still doing OK. Europe’s doing fine economically. And so is Australia. So the economy in this world is still a lot pretty good. China’s obviously slow, but it’s still looking to grow at 4 to 5%. It’s a long way from its 8 or 9%, but it’s not 1 or 2 % either. So that’s looking all right. But clearly with rising commodity prices, that does benefit the material producers. And even though they’ve been pulling back, the non-oil companies have been real beneficiaries of rising copper, rising zinc and rising aluminium, etc. So cash flows improve.
Yeah, the interesting one is, you know what it means for oil and gold and oil I touched on with the geopolitical scenario. Yeah, that’s really hard to know how that’s going to pan out. Because to me, it’s saying more supply. That’s what I think Trump wants to try and get inflation under control, as they continue to cut rates in the US.
As part of that narrative, but you know, that’s going to be that’s going to be a hell of a negotiation between the Iranians and Venezuelans. And gold is a bit of a different beast here. It’s mixed. I obviously, it’s a great hedge against geopolitical uncertainty, which we’ve seen. And we’ve seen, you know, central banks being big buyers of gold, particularly China. you know, more or less times the retail punter in China has been, has had an insatiable appetite for buying gold, you know, higher real yields and only a headwind and we’re now getting higher real yields. So that’s what we’re seeing way on the gold price in the short term. Because you know, gold, you know, gold has no dividends, there’s no yield, no income. So and the other thing, of course, is US dollar denominated. And we’ve seen the currency. That’s the other thing we need to talk about is the US dollar weakening. And obviously, the Australian dollar being a beneficiary of that.
Australian dollars probably appreciate around 11 or 12 % since we did the last podcast is my guess around there. So it’s an interesting one about the US dollar and how that relates to the Aussie dollar. mean, in the short run, you can understand particularly with the strength of resources and the Aussie dollar tends to be a resource led currency and the US weakness, you can understand the short run. Is it structural? Is it sort of a long-term structural on the US dollar.
Well, I think there’s a couple of points here. I want go back to that comment first. Gold is not priced off earnings or, or growth, whereas the other commodities are linked to industrial production, industrial output, whereas gold is really linked to that. There’s been a retail demand, the consumer has got completely different drivers. So that’s why it may behave differently. And that does have some links to the currency because obviously, you know, for those that even though gold’s priced in US dollars rather than holding bonds, for example, US treasuries, which have, you know, which have a much higher correlation to the performance of other US dollar assets.
Gold has a lower correlation. So you’re seeing money from these central banks going into gold. have been because, know, when you’ve got the look, you’ve got, you know, one of the or the largest economy in the world, know, putting tariffs on other countries, you know, they don’t kind of feel very compelled to go and buy your bonds. Why would they? So they’re looking, they’ll be looking for other obviously for other avenues to still keep that US dollar exposure, but not have the same correlated assets, you know, to the to the US economy. Getting back to the question on the US dollar, I mean, it’s a really interesting one. So I think you are seeing this desire that we want to have diversification continuing away from the US dollar. There’s huge deficits in the US as we know. The balance sheet continues to expand. The interest expense that has to be serviced around the bonds is absolutely phenomenal. It’s huge as it grows. So there’s a bit of concern about the, you know, about the balance sheet of the US. And that’s why you’re also seeing some of that money leaving the US as well as some of obviously the geopolitical reasons. And it’s where we are in the race cycle as well. mean, you know, Australian rates are now the highest in the Western world. So, we’re a beneficiary of that the carry trade, you’re getting the money out of the US getting higher rates in in odds. So that’s been another driver of where we are.
We’re actually ahead US as far as rate movements go.
They’re still cutting, probably got another one or two to go. We’re in tightening phase. but the structural issue goes to the balance sheet of the US. And I think that’s ever-present. And I think that’s something we need to be mindful of. Well, we could talk for a long time about all this geopolitical macro issues. There’s plenty going on, but we do need to move along.
And before we introduce our special guest today, Christo, I want to come back to you for your spray of the day. And I’m interested to know who you target your spray of the day at this time.
Yeah, well, it’s really interesting. So this is not so much about the operating business of this company, but it’s more around the governance of the company. I think it’s important to highlight this to the audience because governance can have a material impact on share prices, regardless of whether the operating business has changed or not. And that is something we all need to be aware of.
Governance is very, very critical when that goes to the quality of the board, the quality of the CEO, et cetera. And the company I to ⁓ highlight is WiseTech, and it’s a beautiful business. It’s actually a really, really great business. And for those that don’t know WiseTech, it’s basically a logistics software company that builds solutions and software platforms to help companies manage global freight and supply chains.
So it’s a really interesting spot. And it was a market darling going back about probably back to September 2024. mean, the stock was trading about $125 or around there from memory, had a market cap in the mid 30 billion. So it was a decent sized company. But then we had some serious governance issues that began in October 2024 around the founder Richard White’s, I suppose, inappropriate relationships and payments to women within the group. And in one day, the stock fell 18 % because he was forced to step down as the CEO. And given he was the founder and the brains behind the company, really caused the market to, he didn’t leave the company, he just stepped down as CEO, but that caused a huge issue.
And then since then, we’ve gone into a bit of a governance crisis here where in late 24, early 25, we had a number of the non-executive directors and the chair resign over disputes with the founder and CEO, Richard White, over what his role will be going forward. And when that happened, the stock was down 20 % in a day. So you’ve had, again, another big drawdown in one day. And then the third event was, again, in early 25, we saw ASIC announced that they’re investigating the share trading of Richard and others, sorry, from late 2014 to early 25, around some insider trading, alleged dealings, and the stock was down 16 % on that day. So in the space of 18 months, we’ve had three very, very big daily drawdowns.
In aggregate, around about 54 % off the share price, the stocks off 62 % anyway from its peak. So those and those three events that have caused that have all been really kind of governance related issues. So that’s why it’s important to highlight this as an example of why good governance is absolutely paramount. When you know when you look, it’s not just about the business when you’re looking at investment thesis, absolutely the company it’s it’s that’s want to consider that.
Right, so no one’s safe, Christo, when it comes to your spray of the day. This brilliant business, no doubt. A market darling, as you say. But yeah, clearly, pretty average governance, so no one’s safe.
So we need to now turn to our special guest. Today, we’re joined by someone who knows the Australian small and mid-cap landscape better than almost anyone in the business. Silvo Barac, founder and chief investment officer at 442 Capital.
Silvo spent more than 18 years in funds management, specialising in emerging companies and building a long-term successful track record investing in Australian listed and small companies. Before launching 442 Capital, he was head of listed equities and senior portfolio manager at a boutique investment firm where he managed over $1.1 billion on behalf of wholesale and high net worth clients.
And a couple of years ago now, Silvo founded his own ⁓ funds management business, 442 Capital, and he leads his emerging companies fund and high conviction long-term strategy. Well, Silvo, thanks so much for joining us. Perhaps for people that don’t know you, might start by telling us a bit about yourself, a bit about your background, what got you into investment markets and perhaps what was the catalyst for you starting your own fund, 442 Capital.
Thanks, Simon and Christo. Really appreciate you taking the time and having me on your podcast.
Great. Welcome.
Pleasure to be here. Originally I was born in Croatia, we migrated to Australia in the early 1990s. I started investing in listed equities at the age of 15 or 16 and I developed a bug for investing at a relatively young age, because of the people I think that my father spent time with and associated with. And so there was always a lot of conversations about investing, stocks, markets, business. And, you know, on a Sunday afternoon, had friends come around to the house, that’s, my dad would sit there for hours talking about the stock market and I’d be 12, 13, 14 years old and I’d sit right next to them and listen. I started buying shares as a 15, 16-year-old and I haven’t stopped since. And so it’s always been a passion. I went on to study commerce at university, obviously post-grad studies, but I’ve been investing in my personal capacity and then you know, capacity my entire version of my career.
It’s always been a big, big part of mine. It’s been a hobby for me for as long as I can remember.
I’d be interested to know then, Silvo, over the journey, and perhaps you’ve given us bit of insight with your father, but who’s been one of your biggest influences as far as investing? And even perhaps if you think about today, who are some of the investors that you admire.
Well, I think some of the biggest influences on me as an investor not been necessarily other investors. They’ve been people that have run businesses and run them successfully. observing people that have run companies and run the right way has helped mold me and my philosophy as an investor right throughout my investing journey, I suppose.
You often meet people in what we do day to day, you meet people that run businesses the right way and think about and care about their businesses and care about actually creating shareholding value. I suppose we have the benefit of researching, studying, analysing thousands of companies. And there are many examples of how not to do it.
And there are very few examples of actually how to do it right. so, and that you can see through the test of time. So businesses run well, run the right way with a focus on creating long-term shareholder value and long-term value in the company are the ones that you tend to do best from. And so you will have almost prototype businesses and prototype, approaches to running a company irrespective of the industry that you can see just work time and time again. And so it can be a different business irrespective of variety of different industries but the principles are always the same.
So that’s always been, I can call out individual names, but I think it’s more about the practices. We’ve got an investment in our portfolio today in a company called Supply Networks. It’s a business that’s been listed for a very long time. It’s very much under the radar. It’s got the same number of shares and issue today that it had 20 years ago. It’s never raised capital from external shareholders. It’s driven organic revenue growth 18 to 20 % per annum consistently for the last 20 years. And the dividends that it pays out to its shareholders year in, year out have grown at over 20 % per annum. what makes that business a success is the obsessive approach that they have to planning, investing and making every dollar that they put back into the business work. they take very long-term decisions and execute it against them in a very careful way. And it’s just translated to strong shareholder returns. Now, the share price is appreciated 20-fold in the last 12 to 13 years.
And that’s a byproduct of them just executing and driving profits. That’s the sort of business we want to invest in. gravitate towards almost irrespective of the industry. So when you look at your career in funds management, and perhaps this will lead to the setting up of 442 Capital.
Has that investment philosophy you’ve just outlined there, is that carried all the way through your career since you started? ⁓ Or is that something now that you’re embedding within the 442 ways that you’re managing portfolio?
That’s a really ⁓ important question, Christo, because previously, just to give you some context, I was a partner in a business for over 13 years within that construct, you always have different philosophies, no matter how hard you try to create one framework. Different investors get attracted to different things. And so the benefit of being on out and set up for four to capital is that we’re in complying, incomplete control of.
What we invest in and what we don’t invest in. And it’s about applying that investment philosophy consistently. And so my philosophy has evolved over time. There’s no two ways about it. if you go back 15, 20 years ago, businesses, for example, where you can make a lot of money as an investor would have been those that were consolidating and rolling up their industries.
Now that could have been in the retail industry, it could have been in the trade distribution industry, it could have been childcare centres, it varies. But if you look back through the history of time, whilst those businesses scaled, through consolidation, actually that didn’t create a lot of shareholdings. The capital that strategy consumed was significant and the return that they got on that capital was very poor. And so whilst they got big, it wasn’t very efficient. if you want to call that the flavor of the month, I suppose, 15, 20 years ago. but it’s not an enduring strategy by any stretch of the imagination. And I could say that even from a young age because you could see those businesses that stay the course and just stay in their lane and invest back in their own assets year in, year out.
There’s just more profit. Some years will be 5 % more, others you’ll be 15 % more. But they just keep pushing that needle in the right direction. So my philosophy has evolved over time. But I think it’s a philosophy that really should stand and does stand the test of time.
Do you find that the opportunities still there?
Given the way the markets evolved and the way that capital financing has evolved over the years, are you still getting those opportunities that’s defined for growth?
Yeah, well, to be honest, I think my single biggest concern as an investor in listed markets is that the opportunity set is shrinking in terms of quality assets. There’s plenty of businesses out there.
But the ratio of good quality versus bad quality, think, is increasingly not in our favour. Good businesses are often taken off the boards, taken off the exchanges because there is less and less patient capital in the market. And so if you want to the company the right way, invest capital for the long-term benefit of shareholders. Often you have to make decisions that in the short term might not be accretive to profits. In fact, it might even actually mean that your profits don’t grow for a year or two. If you’re a private company, that’s no problem. You’re making long-term strategic decisions. In the public landscape, investing in public companies, increasingly the market is very focused on what’s the result for the next three months, six months, 12 months, and I mean, who makes the decisions?
Any decisions when they invest in anything for a three or six month return. And so good quality, well run, well governed businesses are actually choosing in a lot of instances to come off the boards, go private because their capital that’s backed them into their private vehicle is far more patient, far more strategic than what public market capital is. And that is one of the growing challenges of actually investing in public markets.
I mean, as you’ve said, the better businesses do have that longer term thinking and they sort of disregard short term noise and so forth. you seem to have a knack for finding those sorts of businesses and have experienced for a long time. But, the world seems to be more and more so obsessed with short term noise and short-term macro and all these things, which is exacerbated by social media and the media cycle, etc. How do you stay anchored to those fundamentals and let’s say not get distracted by some of that noise. There’s a few elements to that that you need to get right. First of all, the most important component of that is…your capital, your capital base that you’re in that we are investing in the market needs to think and feel like it’s a permanent capital. And so the only advantage that we have over any other investor in the market is that we can take a long-term view.
I actually really enjoy volatility. I think volatility is our friend. It’s never been more volatile out there than what we’re seeing at the moment, which I think is actually quite good. But fundamentally, in order for you to be able to invest in businesses that have got a long-term mindset and that are deploying their capital in the right way.
Our capital equally needs to have a long-term mindset, and it equally needs to be patient. And so we have to learn to disassociate share price performance from company performance. more often than not, the two are dislocated in both directions. the share price often represents the anxiety and euphoria of many, many individual shareholders, whereas the operating performance simply reflects how well management is actually running that company. And so what we keep anchoring to is understand the long-term strategy of the business, understand the uniqueness of those assets. Are they unique? How hard would it be for someone to replicate what this business has created? How much capital would it take? How many years would it take? What are the barriers to entry? Are they getting an appropriate return on their capital? And if it is a high return and an appropriate return on capital invariably someone wants to go and is attracted, others will be attracted to those returns. it’s often in the assets, it’s often in their footprint, whatever that may be, there’s a lot of intangibles in that as well. It’s the people, it’s the culture, it’s the strategy that they set, it’s how they execute against that strategy. And so our job is to understand all of those elements.
But we can’t take a long term. It’s very hard for investors to actually take and make long-term investment decisions if your capital isn’t of the similar mindset. And I actually think, perversely, it’s never been a better time to be a long-term investor because…for a range of reasons. And one that’s very topical at the moment is that there’s a lot of passive capital in listed markets and that’s driving distortions in the market.
So you mean index funds, things like that?
Index funds, ETFs, passive strategies. On one hand, you can see CBA trading at $160, $180, $190, which on any fundamental metric may not make a lot of sense. That’s a weight of money pushing up the value in that share price. But on the other hand, there’s some really, really high-quality businesses that are completely ignored by that passive capital. And that’s where often, provided that the attributes of that business that makes sense to us, that’s where we can find some good opportunities.
And you mentioned some of the quality filters that you look at, perhaps define those, if you could, a little bit more as to what appeals to you to put the stocks into the stocks that meet that criteria into the portfolio and just about the portfolio construction itself.
How you think about that, how you think about, you know, risk within that framework as well.
So the investors have got an understanding of that. Absolutely. So the investment philosophy, the key tenets of our investment process is rest on return on capital.
We need to understand how a business intends to deploy capital, where are the assets, how much of that free cash flow that the company generates is being redeployed back into the business as a person being paid out as dividends. And so, and where? And so the capital that a company puts into its business today won’t give you a return for five years, at least. You you’re always sort of laying the foundations for the next stage of growth. So when you look at a company and its financial metrics today, the profits that they’re generating today, I would describe as the tip of the iceberg. What you really want to understand is the iceberg.
Profits don’t really tell you much other than it’s a point in time outcome. But the profits are entirely a function of what the companies done over the last five and 10 years. So really what we spend a lot of time on is understanding how the company has deployed capital, where, why, what’s the strategy. if a company is generating $10 million in after-tax profits and it’s put $50 million into the business over last 10 years. In order to achieve that, that’s a 20 % return on an after-tax basis. That’s a very attractive after-tax return on capital. So that informs you a lot about the actual quality of the business.
Why is it able to achieve those types of returns? What is it about the industry that are in that enables them to do that? Is that luck or is that there’s a very smart strategy around that? And so if you can understand how well…company has done that over last 10 years, 15 years, 20 years, it will tell you a lot about the future, provided it’s the same management team and the same strategy. So it’s a really important focus for us because return on capital drives share price. That’s the single biggest determinant, whether or not the share price be higher or lower on a 5-or-10-year time frame.
So if a company chooses to retain 100 % of its profits in its business every year and it delivers a 30 % return on those profits. So puts it back into the business it continues to deliver a 20 or 30 % after tax return. That’s a company you want to be involved with. There’s something about that industry that LA enables it to do it. Or it’s something about its service levels, its product, its footprint, its brand. There’s something that you need to understand what that is. that’s the anchor.
Cause it goes to the heart of what the business is about. If you want to understand the business, you’ve to understand the balance sheet. If you want to understand the business, you have to understand the cash flows. That’s really important. So in my opinion, and history shows that they’re effectively, you can over complicate investing, there are really two really significant drives of share price value over the time. It’s return on capital and return on incremental capital. And that’s the first thing. The second thing is dividend growth in dividend per share because you can only pay more dividends if you’ve got more free cash flow. And so if you go back and look at companies over time, if dividend per share is growing and return on capital is strong and or improving, they’re fantastic recipes for share price and shareholder bank correction.
So do you have a minimum threshold then based on that criteria that you have to meet before stocks go on the portfolio?
It varies. It depends on, you know, if I said to you, you have a monopoly asset and it gets a 15 % return on capital and it’s in effect a regulated asset.
Then that’s very attractive because the competition parameters are attractive. If it is an industry that’s got genuine competition, really need to invest in businesses that are generating at least a 15 to 20 % return on capital because you can effectively get 5 % in the bank. So what you want is you want businesses that are getting that…As opposed to putting your money in the bank, the company’s putting that profit, it is generating back into its own assets. And it’s getting a 30 % return on that capital as opposed to sticking into the bank and getting a 5 % return. And so for me, we know that if we can find assets that have got those types of attributes, that profits will grow. Now, that may not meet markets’ expectations in any given period. Quite frankly, it doesn’t really matter. What matters is that every year, you see evidence of good sustainable profit growth but the capital discipline remains. The thing that’s, so it does vary and you’ll see that in our portfolio. our portfolio has a representation of businesses across many industries. We invest in healthcare companies, we invest in what I would describe as critical and essential infrastructure, trade distribution businesses, software companies, financial services businesses, but the lens that we look through, each and every one of those companies is very similar. And one of the things you have to understand is the competitive dynamic and industry structure. That often can determine whether or not the profits are enduring and whether or not the business actually has the capacity to put more capital to work. So what we look for often is can a business put more capital to work? It’s important, preferably in organic initiatives. If it can’t, then profits can’t grow. Simple as that.
As my question before about the sizing of positions and perhaps the number of stocks in the portfolio with a risk lens as well around that. Can you just talk a little bit about how you think about the sizing of positions in the portfolio?
My view is that, that portfolio construction is as equal as important as stock selection.
You want to drive discipline in your portfolio construction. I want to be very focused on making sure that we can drive good returns through the cycle, our broad parameters are that we won’t have more than 7 % in any one company investing in the portfolio. So typically we buy up to 5 to 6 % if it gets in excess of 7 % and closer to 8 % we’ll start taking profits. And also we won’t have more than 15 % of portfolio exposed to anyone in the street. And so invariably what that means is that if you have a stock in the portfolio that’s gone from a 5 % to an 8 % weighting, what that means typically is that it’s actually overshot in the short term.
I mean, very rarely does a company grow profits at 30 or 40 % or 50 % a year. So the valuation parameters are important. then invariably would have more value in the rest of the portfolio. So it drives that discipline around, well, let’s make sure that if we’ve had a stock in the portfolio that’s done particularly well for us, that means that on a relative basis, there’s more value now in the other securities in our portfolio, so we should be reallocating our capital to those other securities. So that drives that balance.
So we don’t want to have more than 25 stocks. 20 to 25 is sufficiently diversified. I don’t believe in having 50, 60 stocks in your portfolio. I think you can’t know 60 stocks in the amount of detail that you need to know in order to make an informed investment decision. I think that’s just too hard. I think having 20 to 25 drives discipline because it forces you to allocate your capital in a strict manner. There’s competition for your capital understand what the future looks like in a lot of details so that we can be high conviction. in our research, high conviction in our view with what the future looks like. And that actually should translate into less mistakes and less pain.
Can I bring you back a bit to you talked about regulated assets, for example, and then those that are in competitive spaces. And one of the key competitive threats or sort of disruptive threats at the moment is AI you whilst you’re focused on Australia and so therefore not necessarily exposed directly to the NVIDIAs and Microsoft, cetera, AI no doubt is a big opportunity as well as a threat ⁓ in Australia and to businesses in Australia. How do you think about AI when you look at your businesses and perhaps you could give a couple of examples or an example of companies that the market views as having that AI threat, but perhaps you see differently.
Well, it’s interesting because it’s very topical at the moment. AI, I mean, it’s dominating news headlines and investor sentiment, not just here in Australia, but literally right around the world. And in particular, as it relates to technology companies, software companies, two-sided marketplaces, you know, classified platforms and the like. It’s interesting because I think the burden of proof…is now squarely rests on the shoulders of those incumbent companies. And so if you’re a software vendor, in the market for 25, 30 years and you’ve compounded revenues at 15, 20 % a year and you haven’t put a foot wrong, a lot of the companies in Australia would fit that bucket, certainly the businesses we look at, all of a sudden, in a relatively short space of time.
There’s some serious question marks as to whether or not your existing business model will actually survive and continue to prosper under a new technology environment and evolution in the global operating platforms so to speak. the way I frame it is that the burden of proof is squarely on the shoulders of those existing companies, that they can actually continue to invest in their businesses in the way they have over last 25, 30 years, such that they take full advantage of the new wave of technology that’s coming down the pipeline.
I’ll give you an example. So we’ve been long standing shareholders in a business like Technology One. Technology One is a Queensland, Brisbane headquarter company. It’s been listed for well over 20 years. Its last year generated $600 million in revenue, $170, $180 million in operating profits pre-tax. It has no debt, $300 million of cash in the bank.
1500 plus clients or recurring revenue subscription-based software revenue. The success of that business is largely being driven by their propensity to invest in their software and invest in their product and in their customer experience. So, you know, if you look historically that businesses, you’d give it a lot of ticks in terms of how it’s been run, but in terms of its balance sheets, cash flow, but also its culture and the product that they sell. But that share price is, you know, pulled back probably 35 to 40 % in the last three or four months. And nothing’s changed. So at this point, nothing’s changed.
So what are investors worried about? What they’re worried about is hard to unpack in its entirety, but there’s some big important components. Firstly, the cost of software development is changing. The mechanisms and the manner in you would develop software today and in the future is changing rapidly. That means that the cost will come down. That means your capacity to produce more software will increase. And it may well mean that it will enable new competitors to actually start up and compete with incumbents a lot quicker and a lot more efficient than previously thought.
But to give you some context, so if you take a business like Technology One, and this would apply to a lot of software businesses, if you go back 20 years, their product would have been designed, architect and engineered in Australia, and then it would have been built or manufactured in Australia. At some point between today and 20 years ago, the actual manufacturing of the software went offshore, and it was done in low-cost labour markets like India, Malaysia, Vietnam. Very bright people very highly educated and they could develop software at scale. What the new low-cost environment is actually artificial intelligence. So rather than having humans write software, you will have machines and that is now happening.
And that is absolutely exciting, I think, for a lot of companies, including Technology One. What Technology One has is 30 years’ worth of data, huge amount of IP in terms of its specific industry verticals. It’s got the wherewithal and the propensity to invest in software development tools. And even as we sit here today, they’re a big user of all those AI platforms that we hear a lot about in the everyday practice of actually and performance of manufacturing software. So really the burden of proof now rests within that they can sort of continue to develop software in an AI first world, AI environment world. So what I mean by that is that you can call it the AI software layer.
So, you know, in software businesses went from developing their software on-prem to in the cloud. Now are developing their software in an AI environment, which is also in the cloud, but it’s a different environment. And that will drive huge amount of efficiency. They will make that transition invariably. The question is whether or not someone can disrupt their business. That’s the question. So where does the disruption come from?
The first concern is that their customers will be able to develop their own software. Now, these customers are regulated entities, not technology companies. And the burden for them is to make sure that all their information, all their data, everything they do is…stored in a safe and secure environment and that they can perform their functions using software that is relevant to their operations. So anyone that wants to compete with Technology One has to overcome a whole host of regulatory hurdles before they even get to the starting gate. My sense of where the world will evolve to is that those businesses that are the best at or that have the capacity to adopt AI productivity tools into their operations with the ones that actually create the most amount of shareholder value.
So I would not want to be number two, number three, number four sitting in verticals that technology one operates in, as an example. Because if they are capable of investing and driving software development faster, more efficient, more product because their product development pipeline is enormous. So to actually reduce the time between when they conceive and design and then manufacture a product, that’s going to be a big advantage for an incumbent. But they’re the challenges that they’ve got and so there’s nervousness out there that their customers can now go and build their own software, which is…hard to imagine because that means that you still need to have that architectural and engineering expertise sitting in your office, which often you don’t, or that they can go and buy software off the shelf from someone in the US, as an example, which my sense is what we’re seeing and the way the world is evolving is that if you take the four or five largest, large language model operators in the market at the moment, which is Gemini, which is owned by Google, or Chat GPT, which is owned by OpenAI, Grok, Claude, which is owned by Anthropic. the numbers, the capital that they’re putting into their platforms is enormous. Chat GPT, it’s somewhere in the order of $30 billion a quarter.
So that’s $120 billion US a year. That’s one. So for them collectively to get a return on their capital, it’s inconceivable that they would go and compete with Technology One in a vertical that is very unique to Australia and New Zealand. But what is conceivable is that they would open up a corporate head office in Australia and go and offer their tools and their their development environment to a group like Technology and Wine and Services, develop your software here and it’s cheap and I can see that playing out over time. But the burden of proof now sits with technology, we want to prove that that won’t be disrupted.
It leads to another conversation about circular financing that’s occurring within the AI sphere. Do have any thoughts on that and the problems that you’re seeing around that potentially?
Well, I mean, right now, as I say, you’ve got…tens of billions of dollars of capital going being invested every quarter but five or six of the largest companies in the world. Now some are public. You know, if you take say Google, you’re in particular, incredibly well, or even Microsoft, which owns 50 % of OpenAI, incredibly well funded businesses and they’ve got a lot of free cashflow that they generate from their existing assets and they can’t put that capital to work. Now, if they get it wrong, the worst that happens is they tear up that capital, but they go and they live to find another day.
In contrast that to Chat GPT which has to go out every six months or 12 months and raise more capital from investors. Anthropic is the same. mean Anthropic has got a three, its last valuation is 350 billion. just announced a 20-billion-dollar capital raise and an employee share plan sold on a 350 billion dollar valuation. when you’re growing this, and I believe that their revenue run rates about seven billion. like really, really big multiple. So, you in order for you to believe that 350 billion makes sense, you need to see a pathway to $35 billion revenue pretty quickly. and the exceptional growth rates and the cash burn in businesses like those is extraordinary, like nothing I’ve ever seen before.
They have to almost be in vigilance about what they’re doing because they need to convince the world that AI is real. And I think it is real, but there’s a lot of funding. It’s very capital intensive. so, yeah, there is a lot of round robins going around at the moment. As a crack starting to show, mean, I think it was last week, Microsoft reported and something like 45 % of its growth was due to its sort of inherent demand through open AI. And as you say, it’s sort of, there’s all this sort of hope that that $7 billion of revenue needs to become 35 quickly. And if it doesn’t, there’s a whole range of different businesses like Microsoft as an example, but even copper and the inputs into data centers, et cetera, that could have a flat effect.
So, yeah, it feels like, as you say, AI is real, but there’s a lot of this inbuilt hype around it that needs to be proven if not, in relatively short space of time, you could start to see some of this implode, is that fair?
Yeah, I mean, it needs to work, bottom line, it needs to work. They need to drive extraordinary growth to justify where they are at the moment. So if you take the Microsoft example, 50 % of their capex at the moment and going forward relates solely to Chat GPT. And so your counterparty is Chat GPT or OpenAI. It’s got $20 billion of revenue, but it’s burning multiples of that in terms of cash. So it needs to keep raising money in order to able to pay their bills to you.
So it’s it and so you know Nvidia injects capital into chat or OpenAI. It allows then OpenAI to go out and buy computer chips called GPUs, which in video sells to them and so on and so forth. it’s. That’s the circular finance that Christo is talking about. And that is an obvious concern. It’s a real concern. You know, we’re entering uncharted territory. it’s seismic shift in technology. The operating environment will become used to. But the problem that we’ve got right now is that none of these companies can afford not to invest. Because if OpenAI is real, meta don’t want to miss out. And nor does Google. And so they’re almost compelled to invest. I actually think that these at the consumer end, you know, whether it’s Chat GPT, or whether it’s Gemini, whether it’s Grok, the answers consumers, that’s becoming very commoditized. There’s not a lot of distinction between one or the other when you actually use it. You ask it a question, it gives you an answer. That’s at the consumer end. At the enterprise end, it’s different. So where they’re trying to monetize themselves actually is to sell, as we said before, tools, development tools, AI productivity tools, as they relate to enterprise. And that’s where OpenAI is trying to invest. That’s definitely where Anthropic is going. And so that’s interesting.
But I think they can see pretty quickly that at that consumer end, it’s not easy, particularly when you’re up against a behemoth like Google. So one of the things that Google have, that none of the other guys have, I suppose Google and Meta, is that they’ve got a huge installed user base. It’s massive. And so they not only already know how to monetize that, but they can actually offer the AI tools almost for free if they really wanted to. Because they cross-subsidise, you could almost see a scenario where at some point some of these platforms have to consolidate and that might happen down the track.
Can I just bring it back to Australia and still AI, but we were talking before the podcast about one of Australia’s favourite pastimes being property and realestate.com. And I know your funds and investor in realestate.com has been for a long time. That to us seems at least at the service level like a sort of AI being threat and Christo was commenting about using Gemini or Chat GPT.
I was using Chat GPT and was basically trying to get an estimation of a house value. And what I found was when I looked at what Chat GPT produced versus REA and domain, it was more accurate. I think that’s the thing I found interesting is that, you know, how relevant is the data?
How time sensitive is the data within REA and domain as far as getting the right answer to the user, to the consumer versus that of something like a Chat GPT, which seem to be much more close to the mark?
I’m at the same point with REA as I have with Technology One. Time will tell, they’ve now got the burden of proof to demonstrate that they won’t be disrupted. In fact, that indeed could be a beneficiary as a business. So you take a step back and you say, what is REA?
realestate.com.au, Australia’s largest, most successful online property classified portal. And the essence of that portal is that people go there to research properties, search for properties that they either want to buy or that are contemplating selling. And so they’re doing their homework and looking at a whole host of comps. And it’s the largest, most trusted two-sided marketplace in Australia. It has 13, 14 million Australians that visit that website every month and on average they visit this website 10 times a month. So it’s about 130, 140, 150 million visits a month and on average each person spends about 35 to 40 minutes on the website each month. There are important statistics. because that is what the real estate agent is looking for. The real estate agent is interested in doing one thing and one thing only and they want to sell a property.
If you are an agent and you’ve been instructed by your vendor to go and sell their property, which is their most valuable asset, the last thing you’re going to do is not have that property listed on realestate.com.au. again, the risk now is is that can that property make its way onto Chat GPT, will consumers search for properties in that environment as opposed to a dedicated property portal.
It’s early days, but the numbers suggest that…people initially started looking for properties on Chat GPT. There was an initial spike. That traffic shifted from Google to Chat GPT, and now it’s actually subsiding and shrinking. Why? Because the content’s not there. You can’t find the listings. So will it be there in the future? It’s possible, but In what context? And so the single biggest, the most important element of the platform is that as a consumer you know that all the properties are listed on that platform and as a vendor you know that all the consumers are looking at your property on that platform. And so for as long as that dynamic doesn’t change the business will not be disrupted.
Now, again, as a company, have historically invested heavily in technology. They’ve got a really strong track record of investing in technology. And it would appear that that will remain the case. recently tried its own in four or five states in the US, in a limited capacity to list properties and it failed, so they shut it down about a week ago. Google came to Australia in 2010, 2011 and tried to make properties listed for sale, show properties that are listed for sale on their Google Maps application, and they trialled it for about six months and then shut it down and left the market.
When you’re looking for property, when you’re searching for property, it’s obviously a significant investment that you’re making, whether it’s selling or buying, it’s a big decision. Typically, you want to make sure that you make the right decisions at every step of the way. So you want to make sure you point the right agent, you want to make sure that you know when to sell, and you want to make sure that you can extract the maximum value for your asset.
As a vendor, if somebody said to you that 10 out of 11 leads for your property comes from realestate.com, one comes from Domain, and zero comes from everywhere else. That is the consideration, that is what you’re contemplating. All you’re interested in as an agent is that when you put that property up for sale, you want to know where those leads are coming from. So the single biggest value that REA drives is actually for the real estate agent and for them to actually attract prospective buyers for their property. at this stage, there is nothing to suggest that the REA is at risk of being disrupted. What they need to do is what they’ve always done, which is to continue to develop terrific products for their customer who’s the real estate agent and to ensure that that as a platform they continue to invest in tools that make the user experience as attractive and as frictional as it’s been for the last 20 years.
Again, I would use the analogy or a relevant example for me would be a business like ResMed. So about two years ago, we invested in ResMed, share price had halved in the space of three or four months. And for 20 years, the company had missed a bit.
Every year, there’s more revenue, there’s more profit. It’s a fantastic company, no debt and lots of cash.
It generates a huge amount of free cash flow. But in the space of two months, the share price just halved. It halved because there was a concern the advent of weight loss drugs, Ozempic and other strains of these weight loss drugs would result in people losing weight, of course, and that it would cure their sleep apnea.
So what ResMed do is they manufacture sleep apnea devices to help you sleep at night if you do have sleep apnea. So the worry was that the primary cause of sleep apnea is obesity and excess weight and that if you take these pills you lose weight and you’ll cure sleep apnea. The share price halved and the share price halved at a point where the financial performance of the company had actually never been better, you know, I found that really interesting because as I’m trading on 13 times free cashflow, the business gets a 35 % return on capital.
It is the gold standard. It has 90 % market share around the world. And if you look back over 20 years, it’s never missed a beat. every year more revenue, more profit, growing return on invested capital. So really interesting. And so we did three or four months of really intense research to satisfy ourselves that the company could sustain its profit and grow modestly. Because it didn’t have to grow a lot for us to get a return.
And so why that’s instructive, that in the space of 12 to 18 months, what was deemed to be a real risk to the business is now, in reality, a tailwind for the company.
One of the simple biggest things, the best thing that’s ever happened in this business are actually these pills. Because what it’s driving, it’s driving people to the doctor, doctor saying, okay, we’ll put you on a pill, but before we put you on the pill, we want you to go get a test of four or five other underlying conditions. You actually might have sleep apnea. physicians in this industry have never been busy. Their pipelines, their waiting times and patient lists have grown exponentially.
The reason I raise that point is that investors sentiment is transient. Investors can swing from fear, euphoria and despair very quickly. And what will be interesting to see as it relates to sort of technology companies, whether it’s REA or Technology One, in 12 to 18 months, whether or not these businesses have just continued to sort of grow their revenues at historical rates, grow their profits at historical rates, and actually become beneficiaries of AI and haven’t had their businesses dismembered, but that’s where we’re at now. So ResMed at that point, couldn’t convince anyone that their business is actually intact. Every quarter they release great results, the market just ignored it. But eventually sentiment turned.
And so our job is to try and understand what’s real, what’s not, and try and take advantage of that.
So when you’re looking at the portfolio now, what’s the favourite pick of silver in the portfolio at the minute?
So more recently we’ve added, probably over last six to 12 months, a couple of new investments in the portfolio. One is an infrastructure business in New Zealand called Channel Infrastructure. I think it’s a really nice and quite a unique asset. So what they do is basically own and operate a pipeline, that is used to distribute petroleum, diesel and jet fuel across New Zealand. it’s a very strategic asset.
It’s about $100 million a year profit every year and it’s on a take or pay basis. And it supplies Auckland International Airport with 100 % of its jet fuel. It’s a very, very nice asset. We bought on a 7 % dividend yield. And what I like about it is it’s an incredibly strategic asset. And we looked at all these parliamentary inquiries. We did a lot of research and looked at parliamentary inquiries because I’m quite surprised that there’s actually no redundancy around this. 50 % of all New Zeal and fuel nationally is supplied through this pipeline and 100 % of Auckland International Airport jet fuel. It’s a very, very nice, very strategic asset. It’s an import terminal, but the port that it operates has about 150 hectares of surplus land. That site’s now been deemed and zoned as an economic, precinct for electricity and energy, for the whole country. and from that perspective what’s interesting to me is that it could become a property development play.
So there’s 150 hectares of land on the site that can be redeveloped over time. And our tenants will pay us a lot of money or a reasonable amount of money to utilize the site and also our storage and distribution infrastructure. So it’s a 10, 15-year opportunity. But when we bought it, it was a $700 million market cap, 750 with $100 million of operating profits. There is a pathway for that business to grow its profits over time to probably 150, 160 million and that could be worth a lot more than 700 million the other business that we invested in more recently is a business called Navigator Global. Navigator Global takes effectively, it’s in the business of taking equity stakes in alternative fund managers. We similarly actually, $140 million of pre-tax profits, about a $700 million market cap when we invested in it. There’s a clear pathway for this company to grow. Why it’s interesting is that when you compare it to a business like Pinnacle, which is a well-known Australian company, its business model is very similar. It generates about the same amount of profits, probably a little bit less, but it’s five times the asking price.
So this is an example of a company that passive money and passive capital has forgotten about. This is a bit almost of a hedge against that issue we talked about before, the shrinking listed markets and the growing private markets. They’re backing private capital. Yes, exactly. And it’s actually, it’s a very well-run company and it’s said it’s five to six times earnings. It’s a really good, it’s a very attractive valuation. We’ve done well out of it. Give it time, but I think it’s got more room to go.
So this has been an excellent conversation, very insightful. We tend to finish with a bit of a quick fire question series, don’t think too hard. Your first answer is usually the right one. So I’m just going to fire off.
You ready? So best investment you’ve ever made?
The best investment I’ve ever made would have to be the Intercontinental Stock Exchange.
So that’s an Australian company, but it’s a US company. Excellent.
One thing you’d never invest in?
Biotech.
And if you were in funds management, what would you be doing?
That’s a really good question. I’d probably be a farmer, but a pretty bad one. So is that a retirement plan then? No, well, I grew up, you know, my upbringing was farming so I suspect if I wasn’t doing this I would have been dragged into that by someone in my family.
Well, this might be a segue into this next question.
Aside from the companies in 442 Capital, perhaps your home, what else do you have in your personal portfolio?
No, that’s it. That’s it. We like the alignment. Yeah, so, you know, I don’t invest outside of the fund. So all my personal capital is in the fund. So yeah, 442 Capital is my only, he’s my personal investment vehicle.
Good, I like that.
And one last one, coffee or wine? What’s your preference? Coffee. You’re in South Australia remember? The wine capital.
Well no one drinks anymore.
So, thank Thanks again Silvo, it’s been great to have you here.
Thanks guys.
Yeah, I really appreciate the insights.
No, thank you. Hope to get to do it again soon, at some point down the track.
Thank you.
