This week, Global Alpha is taking a look at one of the more remarkable consequences of the COVID-19 pandemic – the impact on the pet industry. Pets4Homes, the United Kingdom’s (UK) leading free pet classifieds and information site, produced a report on the UK pet trade. At the peak of the first lockdown last May, demand for puppies more than doubled. This is unsurprising given that 94% of pet owners said having the companion animal helped their mental health. Further, 86% said owning a pet improved their mental health, and 84% said having a pet made them less lonely. It is likely that prospective owners wanted to experience the benefits of owning a pet as well.

There were 420 prospective buyers for each puppy offered for sale in the Pets4Homes classifieds, and the average price of puppies for sale in 2020 was £1,875, an increase of 131% from the prior year. And we thought the residential housing market was hot! The demand for cats and kittens also rose during the pandemic, but the average price increased a more moderate 42% from 2019. However, this price dynamic also resulted in more unsavory aspects – the rise of online scams and thefts. Dog thefts increased 170% in the UK compared to 2019.

The supply and demand disconnect has eased somewhat since the peak in May 2020. Increased activity from breeders has helped the supply side of the equation, while gradually easing lockdowns and increased pet ownership has helped slow demand. COVID-19 has undoubtedly given a positive tailwind to a market that was already undergoing structural growth. In 2020, the population of cats and dogs reach 21 million, an increase of 1.4 million from 2017, which in turn increased the estimated market size to £7 billion. The trend of humanizing pets can be seen in the increase in average spending. Dog owners, for example, spend £80 a month on medical treatment, food and insurance. Also, 59% of dogs have some form of insurance, while cats sit slightly lower at 41%.

CVS Group (CVSG:LN), a core holding in the Global Alpha portfolios, is a leading vertically integrated vet services provider in the UK. As well as a large UK presence, CVS Group also operates practices in the Republic of Ireland and the Netherlands. The integrated nature of the business allows CVS group to provide services throughout the life cycle of a pet. The typical life expectancy of a dog is 12 years, while for a cat the life expectancy is between 14 and 17 years. This translates into a lifetime cost of pet ownership for a dog of £16,800, while for a cat, it is estimated at £8,800^[1]. CVS Group offers first opinion practices, laboratory tests, specialist referral interventions, online food sales via Animed Direct, and compassionate end of life care and cremation services.

Consolidation of UK veterinary practices has been a significant feature of the market, yet the market is still fragmented. CVS Group is the second largest player by number of premises with over 450 in the UK. IVC Evidensia, a private company is Europe’s largest veterinary care provider, operating over 800 premises in the UK. CVS Group has completed eight acquisitions thus far in the financial year, which ends in June. The focus continues to be on small animals and the company states that the pipeline of acquisition opportunities is strengthening. With a strong balance sheet, CVS Group possesses the funds to continue this strategy.

Despite the strong share price performance over the past two years, valuation for CVS remains reasonable. According to Bloomberg, CVS Group is trading at 16.2 times 2021 EV/EBITDA. Meanwhile, according to press reports, a new round of financing for IVC Evidensia values the company at over €12 billion and at almost 30x forward EBITDA.

In a recent trading update, CVS Group continued to exhibit strong growth, driven by the core practices business, but also supplemented by very high growth from the online Animed Direct division. Vacancy rates for veterinary surgeons, the largest determinant of profitability, remain stable, meaning excellent growth at this level also. Around 40% of active small animal customers (430,000 customers), are signed up to the Healthy Pet Club. This service offers discounted products and services for a monthly fee.

To conclude, a rising number of pets, the continued humanization of companion animals and the increased value placed on their care, advancements in treatment and resulting in an extended average life, make the long-term dynamics of the pet market very appealing and Global Alpha continues to see CVS Group as well positioned to benefit.

[1] Pet Care – A Dog is For Life Charles Hall (Peel Hunt), March 22, 2021

From the onset of the COVID-19 pandemic in 2020, questions were raised about the feasibility of hosting events, such as the Tokyo Summer Olympics, which were expected to be one of the more notable economic casualties. In what marked a year of many firsts, the International Olympic Committee (IOC) made the unprecedented decision to postpone the event to 2021, instead of cancelling it. Why is that? An easy answer would be that the only other times this decision had to be made, during World Wars I and II, decision-makers did not know how long the Olympics would have to be postponed, making it an easier choice to cancel the games altogether.

A more thorough look at the economics of Olympic events provides a more complex answer. It is well known that hosting the Olympics is a costly endeavor, and has become more so over the years as the number of participating countries and number of sports have increased significantly. Since 2000, the average cost of hosting the summer Olympics has been upward of US$5 billion in infrastructure investments and operational costs. Further, the benefits of hosting the event are heavily debated, with many arguing that there is no net benefit, even when accounting for indirect gains from tourism and other variables. As such, following the US$45 billion Beijing games in 2008 and the US$20 billion Rio de Janeiro games, many cities voiced their skepticism and withdrew their candidacy for the 2022, 2024 and 2028 games. The wave of withdrawals forced the IOC to assign the 2024 and 2028 Olympics to Paris and Los Angeles as early as 2017, as they were the only remaining viable options.

With that in mind, it is not hard to imagine why the IOC would be wary of not giving Tokyo the opportunity to recoup some of its costs after almost a decade of preparation and a well-known failed bid for the 2016 Summer Olympics and Paralympics that cost the city US$150 million. Indeed, the Olympic Committee has strict infrastructure requirements for hosting the summer games, which is usually much bigger in scope than the winter games. For example, the committee requires the host city to have a minimum of 40,000 available hotel rooms, in addition to other transportation requirements, such as airport capacity and train lines.

One of the more direct ways for host cities and the IOC to recoup their costs is through sponsorship programs. The highest level of partnership is through the Olympic Partner Programme, which grants category-exclusive marketing rights to the Summer, Winter and Youth Olympic Games to a select group of global companies and is used to fund IOC activities and costs. Created in 1985, the Olympic Partner Programme provides the IOC with a range of support, such as technology, staff deployment, marketing, essential services to athletes, and broadcasting experience.

Under the Olympic Partner Programme there are three categories of local sponsorships to support the staging of a specific Olympic event. The local sponsorship programme for the Tokyo Olympics is comprised primarily of Japanese companies that stand to enhance the image of the events. Unlike other sporting events, no commercial advertising is allowed at the venue under the Committee’s clean venue policy. Instead, the sponsors obtain various levels of rights to use Olympic and Paralympic designations and imagery, such as the logo, as well as to the right to supply their products and services to athletes and spectators.

Global Alpha owns shares in a company that is directly involved in the local sponsorship programme for the Tokyo Olympics: ASICS. ASICS is a renowned manufacturer of sports shoes, sportswear and sports equipment that sponsors many Olympic athletes around the world involved in activities such as tennis, running, wrestling and more. Headquartered in Japan, the company was created in 1949 under the name of Onitsuka Tiger. The modern name ASICS is derived from the Latin proverb “Anima Sana In Corpore Sano,” which means a “sound mind in a sound body,” and the company has remained committed to this philosophy to this day.

In 2015, the 2020 Tokyo Olympic Committee announced that ASICS was selected as a gold partner of the Tokyo 2020 Olympics, the highest local sponsorship level, and that it would be supplying the uniforms for the Japanese teams and volunteers. Under the IOC product-category exclusivity policy, ASICS is the only company allowed to advertise under the sporting goods section, often thought to be one of the more lucrative sections. We expect the company to hold up well to the scrutiny stemming from the exposure.

Strength

• Solid brand recognition
• Strong expertise in biomechanics and material science, reflected in their shoes’ quality
• Outstanding ESG profile

Weakness

• Lagging in fashionable sports shoes and sportswear

Opportunities

• Growing worldwide interest in healthy activities, especially performance running
• China embracing performance running, as reflected in the number of marathon events rising rapidly

Threats

• Competition within the industry
• Rising costs of raw material and labor

While the company is not allowed to disclose the cost of the sponsorship, it expects to spend a total of $US128.5 million on event-related expenses. Unlike some of the experiences of past host cities, there is good reason to believe that Asics will be able to make a profit from its investment, and that the event will provide a good tailwind for the company over the next few years.

COVID-19 has led to a turbulent economy characterized by faster adoption of technology, increased environmental urgency and inflation from unprecedented stimulus. The widespread government support is resulting in inflation across many goods as economy rebounds quickly. Fortunately, the debt service ratio of consumers in the United States (US) is at a 40-year low, meaning they can probably handle rising prices for some time.

While certainly not linear, inflation is exacerbated by the unprecedented stop-and-start occurring across economic sectors, especially when comparing goods versus services. Demand is high for some products such as those related to home improvement, yet low for others like restaurant equipment. Demand for goods are presently outweighing demand for services in a major way. The imbalance is inflating prices notably through a supply chain shock that has significantly increased transport prices. The US Consumer Price Index is higher by 11% y/y at the goods level, while its service counterpart is down 5% y/y.

The rush for certain goods, such as personal electronics has created a global semiconductor chip shortage. As a result of increased demand, the personal computer sector grew by 10% in 2020, and surging demand in the fourth quarter reached 25.4%. The impact of this high demand was felt across the entire technology supply chain.

Why are automakers shutting down production?

Automakers spent $43 billion on microchips in 2019, representing 10% of global semiconductor sales. Chips are more critical to automakers than automakers are to chip manufacturers. In 2020, car manufacturers planned for a 35% drop in sales, but ended up with a drop of 8%, thus they quickly needed more chips to fill inventories. These emergency chip orders went to the back of the line behind larger electronics clients, which had better estimated their future needs during the crisis. The impact on 2021 production could mean 1.5% of new cars not being available, a material number that will certainly affect availability and pricing.

The average electric car features roughly 3,000 chips. Cars have become a laboratory for human machine interface, where manufacturers continue to innovate at a frantic pace. This will certainly continue to provide us with interesting investment opportunities. There are a number of emerging human interface trends that will change the way we use our cars, including:

• Screens: A full-screen interior, with infotainment screens up to 48 inches wide on the dashboard.
• Voice commands: As voice recognition technology evolves, so does its complexity, with functions from adjusting following distance in adaptive cruise control, to fully self-driving cars that don’t require physical steering, braking, or acceleration input.
• Touch to movement: BMW is already using gesture control technology, where cameras “see” hand movements to perform in-vehicle functions. Taking it further, under development is technology to give the sensation of virtual touch response in the air using ultrasound.
• Driver assistance: Rather than the constant go, stop, and steer motions a driver must perform, driver assistance commands are alleviating the need for attentiveness and active participation.
• Virtual assistants: Based on emotional and physical demeanor, machine learning can predetermine the best outcomes for driving routes, temperature control, communication and musical preferences.

Global Alpha is exposed to the noted trends and futuristic electronics in the automotive sector. Gentherm (THRM:US) is the uncontested leader in thermal management with heated and cooling seat systems. Among new smart products, Gentherm is launching its ClimateSense system, featuring sensors that detect heat from each passenger and optimize the climate with exterior conditions throughout the car. The company expects to save up to 50 miles driven in electrical capacity.

Cerence (CRNC:US), a leader in speech integration and digital content delivery for the automotive industry, is launching Cerence Look, a new product enabling drivers and passengers to interact with points of interests outside the car, like a machine co-pilot. Mercedes-Benz is the first carmaker to launch this technology in its Travel Knowledge feature.

These trends confirm that carmakers will continue to increase their dependence on technology and semiconductor chips.

The chip shortage will subside but could signal an onshoring trend in semiconductor production. Taiwan-centric TSMC, the world’s largest semiconductor manufacturer, controls over 70% of the world’s chip production.

Industry players sensed the importance of strategic semiconductor assets, and 2020 was one of the highest years on record in terms of M&A activity. Global Alpha is participating in this phenomenon, as three different companies have publically disclosed their offer to acquire one of Global Alpha’s holdings, Coherent (COHR:US), a leading provider of laser-based technologies to the semiconductor industry.

The chip shortage crisis provided additional insights, including a supply quasi-monopoly by TSMC with its mega factory, heightened international trade tensions, and the erratic effects of an intense stimulus or expansive monetary policy. Historically, the situation is very similar to the 1970s oil crisis, without the geopolitical catastrophe. Interestingly, the semiconductor has become the new oil; the most critical component to every machine we use. Now, we just need to hope that lessons learned from the 1970s can help us handle higher levels of inflation.

Every day we deal with vast and rapidly growing amounts of data. Some of us might even feel like we are drowning in this deep ocean of messages, emails, spreadsheets, images, sounds, and videos. To make sense of it, various organizations employ diverse data analytics tools that help them gain insights and identify new opportunities. If acted upon appropriately, they can lead to improved decisions, better outcomes, and happier stakeholders. However, we should not neglect the risks associated with data and sophisticated technology. Hackers, criminals, and terrorists also leverage technology for their benefit, often at the expense of companies, citizens, and governments. To mitigate these risks, organizations worldwide need to stay ahead of them by processing their data and identifying actionable insights.

This is exactly what Cognyte Software, one of our portfolio companies, has been enabling its clients to do. Its security analytics tools help to fuse and analyze the data siloed across organizations, connecting the dots and providing critical information at the right time to prevent multiple threats before the damage is done. The environment is highly fluid, as well-funded and organized perpetrators relentlessly evolve their skills and methods to achieve their goals and avoid detection. Security organizations, in turn, cannot afford even a moment of complacency.

This brings to mind the Red Queen effect, in that organizations must adapt and evolve to survive. Cognyte turned that challenge into a big opportunity, recognizing the need for a scalable, open-analytics platform that provides real-time, actionable intelligence that can help find a needle in a haystack. Its cutting-edge solutions are driven by artificial intelligence, and are used by the most sophisticated security organizations across the globe. In one reported case, a European client’s investigative team leveraged Cognyte’s platform to prevent a radical group from driving a large vehicle into a crowd. More than 1,000 corporate and government clients in over 100 countries see Cognyte as their reliable partner to manage their security challenges and empower them to protect lives and assets and make the world safer.

Cognyte operated as a division of Verint Systems for more than two decades until a spin-off was completed in early February 2021. As a global leader in security analytics software, Cognyte empowers governments and enterprises with actionable intelligence to address a broad range of security challenges, including threats to national security, business continuity, and cybersecurity. The company has a strong track record of solving complex security challenges and unmatched domain experience. Over 400 government customers account for 80% of total revenue, while around 600 enterprise customers make up the other 20%.

Revenue mix

• Software revenue (42%), including primarily term-based and perpetual licenses.
• Software service revenue (45%), including support and cloud-based SaaS subscriptions.
• Professional service and other revenue (13%), including installation and integration services, customer-specific development work, and others.

Target market

• Cognyte estimates its total addressable market at $30 billion, evenly divided between government and enterprise sectors, with a steady growth rate of 10% per year¹. Security challenges are becoming more complex, with rapidly growing data and the increasing adoption of open analytics tools by security organizations among the key industry tailwinds.
• The market is highly fragmented. Despite being one of the leading players, Cognyte has a market share of 1.5%.
• Some public peers include a point solutions vendor, FireEye, and big data analytics vendors, Palantir and IBM. Cognyte differentiates itself from competitors through a focused security analytics approach, deep domain expertise, and by creating a holistic view of data in delivering actionable insights. However, Cognyte primarily competes with organizations’ in-house capabilities. Governments and enterprises have traditionally approached their security challenges with homegrown solutions. In our view, these tools cannot keep up with the evolving threats, are costly to build, and complex to maintain. For this reason, we see a secular shift towards open-analytics platforms.

Growth strategy

• Increase penetration of existing customers.
• New client wins.
• Developing partners to expand in enterprise vertical.
• Bolt-on acquisitions.

Strengths

• Cutting-edge security analytics and artificial intelligence (AI) technology. Broad portfolio addressing a wide range of security challenges.
• Unparalleled security domain expertise and focus.
• High revenue visibility. Large portion of recurring revenue (~50%), significant contribution from repeat customers (~90%) and a healthy backlog¹.
• Well-diversified client portfolio (across segments and regions).
• High customer stickiness.
• Strong balance sheet.
• Seasoned management team with strong track record.

Opportunities

• Margin expansion.
• Fast and wide adoption of open analytics software.
• Industry roll-up opportunities.

From 2018-2020, as a division of Verint Systems, Cognyte recorded strong financial results, with revenue and EBITDA compounded annual growth rate of 8% and 26%, respectively¹. EBITDA margin saw a very impressive expansion of 500 basis points to 18% over the same period. As a standalone public company, Cognyte announced three-year financial targets of double-digit revenue growth and EBITDA margin expansion, driven by faster adoption of open analytics software and ongoing revenue mix improvement. Given the strength of the underlying business and vast opportunities ahead, we believe this trajectory could prove to be conservative.

In the last week, record cold weather hit most of the United States (US), causing gas and power prices to spike across the country, from less than $3/btu to over $600. Texas regulators ordered rolling blackouts as the cold weather froze wind turbines, and snow and ice reduced solar energy production. Some experts were quick to blame renewable energy as the cause of these blackouts. Even if the growing use of wind and solar energy meant the grid may be less reliable, Texas still produces over 50% of its electricity from non-renewables, and that was also affected as gas was in short supply and water pipes froze. In this commentary, we will provide an update on the situation regarding renewable energies.

In 2020, more US states mandated renewable energy targets.

With or without these mandates, 2020 was another record year around the world for the growth of renewables. In the US, 78% of new electrical generating capacity commissioned was renewables, according to a review by the Federal Energy Regulatory Commission (FERC). Combined, it accounted for 22,451 megawatts (MW) or more than 78.09% of the 28,751 MW of new utility-scale capacity reported to have been added last year. Wind (13,626 MW or 47.4%) and solar (8,543 MW or 29.7%) each contributed more new generating capacity than natural gas (6,259 MW or 21.7%).  

Current capacity of renewables is now above 24% of total capacity in the US and should exceed 30% by 2025.

We often hear that renewables require subsidies to compete with oil and gas, coal and nuclear. Let’s take a look at the total cost and production cost of these various sources. The costs include capital costs, operations, maintenance, and de-commissioning and remediation. Recent major global studies of generation costs note that wind and solar power are the lowest-cost sources of electricity available today.

What about the reliability of wind and solar energies? If they could never represent 100% of generating capacity, what should the base load be? We can see in the above chart that geothermal energy is also attractive in terms of costs. It’s clean and renewable, and better yet, is available 24/7, meaning it could be a base load energy. However, in 2019, geothermal only represented 0.5% of US electricity generation. 

There are signs that things could change. A report released in May 2019 by the Department of Energy suggested that US geothermal power capacity could increase by more than twenty-six times by 2050, reaching a total installed capacity of 60 GW, thanks to accelerated technological development and adoption. This is turn would greatly reduce costs. 

Since 2008, we’ve held Ormat Technologies in our portfolio, a world-leading geothermal energy company. Ormat Technologies (ORA US, ORA IT) was founded in Israel in 1965 to pursue its objective to further develop renewable energy. Active in the geothermal field since the early 1980s, the Integrated Two-Level Unit (ITLU) was a vital development in maximizing the thermodynamic efficiencies of lower-temperature resources. The patented ITLU design revolutionized the industry and, to this day, distinguishes Ormat from other companies. The company has been public since 2004, and has established its headquarters in Reno Nevada. Further, Ormat is an energy producer with 933 MW of production globally. Another important achievement is regarding the world’s largest single binary geothermal power plant – the Ngatamariki in New Zealand – that began its commercial operations in 2013.  Ormat provided the engineering, procurement and construction for the 100 MW geothermal project that delivers sustainable energy to power 80,000 homes annually.

In addition to its geothermal expertise, Ormat is now a leading player in the field of energy storage and management. Its solutions started from energy and demand response management, and energy storage systems. The company provides grid operators with the power to enhance grid performance, stability, and responsiveness, while delivering capacity at the right time and the right price. It also provides commercial, industrial and municipal clients with reliable and good quality power solutions, as well as peak shaving and demand charge management solutions to lower their utility bill and, in the unregulated markets, provide ancillary market services to generate revenue.

Coming back to Texas, last August, Lone Star Demand Response, LLC and Viridity Energy Solutions, Inc. signed a new five-year business-to-business agreement to continue the delivery of first-class demand response (DR) curtailment management services throughout times of high electricity demand. This will bring Lone Star Demand Response into a position to carry on with protecting the various generation and transmission systems from overloading during peak times and to fine-tune the demand to match the available supply. While Lone Star Demand is not part of the portfolio, Viridity is owned by Ormat.   

In short, geothermal and energy storage may be the solutions to increase the reliability of electricity production while keeping with the goal of increasing renewables and reducing the environmental impact.