Letters to Partners – Coho Capital

Dear Partners,

Coho Capital increased 6.3% in 2016 compared to a rise of 12% in the S&P 500.  Our portfolio did not participate in the post-election rally, which was led by heavily leveraged, commodity and industrial companies.  It is always nice to beat the markets, but we consider annual results short-term in nature and focus our efforts on compounding capital over the long-term.  Over the last five years, Coho Capital has increased at 20.2% per year compared to 14.7% for the S&P 500. We utilize the S&P 500 Index as a comparison because it is the most difficult index to beat over time.  We realize our investors have alternatives for their money and want them to compare the performance of Coho against their best option, an S&P 500 Index fund.  Given our global mandate to seek value, we could utilize the MSCI ACWI Index as another way to assess performance.  Relative to the MSCI, Coho Capital has returned an extra 10.6% per year, resulting in aggregate outperformance of 92.5% over the past five years. In our note about Amazon, we wrote about investing in businesses that are inevitable.  Part of what makes a business inevitable is a self-reinforcing business model.  Google is a great example.  The company processes three billion searches per day.

coho capital

Every individual search refines future search results, further optimizing the accuracy of Google’s search algorithm.  This feedback loop continually strengthens the efficacy of Google’s search product while simultaneously widening its competitive moat.  Compare the virtuous circle of Google’s business with the vicious cycle of a mining business: A mining company mines surface level ore first, but upon depletion must drill further into the earth incurring greater costs the longer it is in business.  Thus, the business becomes structurally weaker over time.

There are not many self-reinforcing business models in the world, but of those available we feel there is a greater representation within the technology sector than any other segment of the economy.  Value investors are often quick to dismiss investments in technology companies for fear that competitive moats are ephemeral.  The evidence is strong in this regard, with technology’s inexorable march vaporizing former sure things.  But what if we have entered a new paradigm?  The phrase “new paradigm” may set off alarm bells, but it is our contention that software focused business models possess more durable moats than when hardware ruled the roost.  Venture Capitalist Marc Andreessen advanced this notion in his seminal essay “Software is Eating the World.” Many value investors view technology through a hardware
-centric lens, a view premised upon the manufacturing of non-essential gadgets with ever shrinking margins.  After a brief window to make money, bankruptcy is all but assured once someone invents a better mousetrap -essentially, grist for the creative destruction at the heart of capitalism.  The shift from a hardware-centric to a
software-centric world, however, has turned this notion on its head. Software-centric business models are some of the most compelling in all of business; light capital expenditures, infinitely scalable, high switching costs, and naturally conducive toward network effects.  In short, many of the qualities one sees in a self-reinforcing business.  We want to own these types of business and the Market is offering them to us at attractive prices because too many market participants remain
focused on a hardware-centric notion of technology.

We scooped up several self-reinforcing business models at attractive prices during the second half of the year.  They are profiled below:


We have studied Alibaba for a long time beginning with our investment in Yahoo, which represented a backdoor way to acquire Alibaba, not publicly traded at the time.  In our year-end 2013 letter, we wrote the following on Alibaba:

“Founded by former English teacher Jack Ma, Alibaba is a phenomenon.  The company dominates the world’s largest e-commerce market with a 49% share, compared to Amazon’s 20% share of the US online retailmarket.  Approximately 73% of all online retail transactions in China utilize Alibaba’s online payment platform, Alipay.  Alibaba possesses profit margins of 44% compared to 0.5% for Amazon.It would not surprise us if in a few years’ time, Alibaba is amongst the world’s most highly valued
companies. “

We visited the company again in our 2014 mid-year letter, as we outlined our rationale for purchasing Softbank:

“In short, we continue to believe that Alibaba represents one of the most compelling growth stories in global markets.  With a nearly unassailable position within its business segments, enviable economics, and a long runway for growth, we believe Alibaba has a shot at becoming one of the most valuable companies in the world.”
It is fair to say our thesis on Alibaba has not changed.  The company has a lot of things we desire in a business: network effects, switching costs, scalability, and latent pricing power.

Read rest of the interesting and valuable letter to the partners here