4 lessons from our first year running an ASX small cap fund - and 3 stocks we now own as a result

GQG vs PTM total return (incl. dividends) since GQG IPO ~3 years ago. Source: Factset

Despite the opposite direction of net flows, GQG still trades on a high dividend yield of 8.8% (compared to PTM's 6.8%), much of the GQG share price growth has been driven by organic earnings growth, not valuation multiple expansion.

We mentioned GQG to the Livewire community here back in October 2023 here and in July 2024 here and here.

Our pick for the next 12 months is Catapult International (ASX: CAT), $622 million market cap @ $2.40/share.

Sports technology company Catapult is seemingly nothing like GQG. Catapult provides sports wearables and software to professional sporting organisations.

However, we see parallels in how the two businesses are perceived. Despite a marked acceleration in profitability, the market perception of Catapult as a cash-burning, upfront one-off revenue business has been slow to adapt to the reoccurring nature of its sales, as evidenced in its 3.5x EV/Sales multiple.

Catapult is now the clubhouse leader in the high-growth (around 20% p.a.) sports technology and analytics market. However, CAT only has a circa 17% share of that market, meaning the runway for growth and expansion is very long.

With private equity investments, streaming, e-Sports, sports betting, women's sports and the professionalisation of college athletes driving more money into the sports business, team owners are more incentivised than ever to use data science to optimise how they allocate resources, manage their assets (players) and invest in winning.

With Catapult now operating on over 40% incremental margins, we see a substantial opportunity for investors to generate outsized returns from a $2.40 share price.

Lesson 3: There are no shortcuts. You must do the work.

Example: Global Data Centre Group (ASX: GDC)

Return last 12 months (incl. dividends): +72.0%

GDC is a listed investment company that holds stakes in data centre assets globally. It was a foundation holding in the Seneca Australian Small Companies Fund.

Having followed GDC for some time, we were attracted to its exposure to data centre assets with exposure to high-growth segments across under-serviced geographies. However, the most exciting feature of GDC was the steep discount to peers like NextDC (ASX: NXT) and Macquarie Technology (ASX: MAQ). We valued GDC conservatively at ~$3.00, believing that book value was understated.

However, this valuation was unlikely to be realised without a catalyst (identifying catalysts is a critical part of our investment process across all products at Seneca). For GDC, this catalyst became clear when management overhauled their incentive structures – meaning they would make millions in the event assets were sold and the resultant capital returned to shareholders. 

Source: GDC company announcements.

Show me the incentive, and I'll show you the outcome. 

GDC share price. Source: Factset

The asset sales then began:

April 2024: GDC first sold its data centre in Perth for $39 million.

May 2024: Etix edge data centre business sold for 52% premium to book value.

September 2024: the well-publicised, blockbuster sale of hyperscale data centre giant Airtrunk completed for $24 billion. GDC owned a 1% stake in Airtrunk, equating to $1.59 per share after fees. 

In 2022, GDC was unloved, suffering from interest rate hikes (lower cap rate valuations for data centres) and a spike in European power prices (key cost input for data centres). It was only through individually valuing the parts of the business, repeatedly meeting with management, and gaining an understanding of the incentive structures that we were able to build sufficient conviction to keep buying GDC shares.

To uncover opportunities like this, a $146 million market cap company that doesn’t need to raise capital, it’s unlikely you’ll find analyst research coverage to rely on (except maybe here). You need to be willing to do your own work and develop your own conviction.

We briefly mentioned GDC to the Livewire community here in June 2024 here.

Our pick for the next 12 months is Ingenia Communities Group (ASX: INA), $2.02 billion market cap @ $4.95/share.

Ingenia operates retirement villages, land leases and holiday parks. Land leases are targeted at downsizing retirees, providing people with a vibrant community to live in, while saving them money. In short, it costs people about 20% less than owning outright, can free up equity in the family home, and provides additional social benefits.

Like GDC, we think the sum of the parts at Ingenia is worth more than the whole. Supported by declining bond yields (lowers the cost of funding for developments), Ingenia looks primed for a significant re-rate and/or a spin-off to realise the true value of the business.

To build conviction here, you need to do the work to ensure that Ingenia is not plagued by some of the problems that have befallen former market darling and competitor, Lifestyle Communities (ASX: LIC), which we have long been sceptical of.

The LIC share price has come under pressure after a July Four Corners report on Lifestyle Communities' excessive fees, specifically the deferred management fee (4% p.a. capped at 20%). Without a significant turnaround in demand, LIC may end up breaching its debt covenants.

While certainly not a positive for the sector, we think this could actually benefit operators like Ingenia and Stockland (ASX: SGP)’s Halcyon, with more transparent fees and stronger reputations.

Ingenia is growing organically. Its FY24 result beat earnings expectations, reporting +17% EBIT growth, above guidance of 10-15%. We think along similar lines to major shareholder HMC Capital and believe a spin-off of the holiday parks business, to leave a pure-play retirement communities business would be highly accretive for shareholders.

We see upside up until around $7.00 for INA.

Lesson 4: Your network matters

Example: Sun Silver (ASX: SS1)

Return last 12 months (incl. dividends): +300.0%

We were fortunate enough to get on the best-performing resources IPO of the year, Sun Silver. SS1 listed at 20c, opened +150% at 50c, and trades at ~80c currently, up 300% since listing. 

We detailed our SS1 thesis before its listing in a comprehensive note to the Livewire community here back in May 2024 here.

Sun Silver has the Maverick Springs project in Nevada, USA. Proximal to the Carlin Trend, which is prolific for low-cost gold and silver mining, Maverick Springs hosts one of the largest silver JORC resources on the ASX and was initially offered at a fraction of the price of comparable peers.

The important lesson here is Sun Silver was bought to market by a small, largely unknown corporate adviser from Perth with no broker support and limited roadshow – there was only a handful of funds who had the opportunity to bid and as far as we know, we were one of two or three who invested.

Accessing deals in 2024 is not that difficult. If you’ve got the right-sized chequebook and know enough brokers, you’ll see plenty of off-market deal flow. The problem arises if you bid into a good deal, you’ll likely get scaled back heavily. And if you don’t get scaled back, chances are you’ve bid into a deal you’ll soon wish you hadn’t.

The real money is made when you can secure a substantial allocation to a deal that’s so good, that it doesn’t need a broker. For that, you probably need a personal network of friends who are at the age when they are starting businesses, pegging ground, listing vehicles and raising money for projects.

I just happen to be in that age range, and growing up in Perth (as well as working in the mining industry) means sometimes I get access to unique, mispriced opportunities. It’s not the first time. It probably won’t be the last.

While we won't name any specific picks here just yet, we're starting to see several transactions of interest in the pipeline. And given we're seeing cyclical, ultra-bearish headlines like this one in the AFR, we think this is time to start doing the preliminary work because when the IPO window opens, it tends to open hard and fast.

In Summary

A single year does not make a top-performing fund. While we are pleased with our results and for our early investors, we fully expect to be running this Small Companies Fund for decades to come.

The fund is currently invested across 35 small and mid-cap companies on the ASX. The fact that our highest expected return positions in the portfolio have yet to eventuate leaves us excited for the year ahead.

Click here to access the monthly performance update on our website.

If you'd like to discuss this article, investing with Seneca or your portfolio, feel free to book a free consultation with me.