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Global automobile sales decreased by 15% in 2020, amid the ongoing COVID-19 pandemic. Meanwhile, sales of battery electric vehicles (BEVs) and plug-in hybrid electric vehicles (PHEVs) were more resilient to the crisis, growing by 43% to more than 3 million. The global market share of BEVs and PHEVs increased from 2.5% in 2019 to 4.2% in 2020, and is expected to reach 38% by 2030. The growth is attributed to tightening emission regulations, favourable government incentives, improved technology, and better affordability. Europe and China have been leading the way in EV adoption, each accounting for over 40% of global EV shipments in 2020. Germany is now the second largest market after China, with 394,943 units sold in 2020.

Tesla was the best-selling brand in 2020, delivering half a million units, up roughly a third from its 2019 results. German carmaker Volkswagen Group (VW) is still trailing Tesla for EV sales, but the gap is closing fast. VW delivered 231,600 BEVs in 2020, tripling its deliveries in 2019, and is expected to surpass Tesla to be the biggest EV maker by 2025, if not sooner. In fact, VW has already become the number one EV maker in Europe in 2020. On its first Power Day held in mid-March 2021, VW laid out its plan to expand its e-mobility business by 2030, including building six gigafactories in Europe, using unified cell technology to lower battery costs by 30-50%, and expanding its global fast-charging network. The company targets 70% of all the cars sold by VW Group to be pure electric by 2030. Many other traditional carmakers have similar targets. BMW, for example, projects that fully electric models will account for at least 50% of their global deliveries by 2030; Renault-Nissan-Mitsubishi expects half of its EU launches will be pure-electric by 2025; Honda aims for 100% of its EU auto sales to be electric by 2025. It is estimated that the number of EVs sold will rise to 30 million in 2028, and EVs will represent nearly half of all passenger cars sold globally by 2030.

Increasing adoption of EVs also means growing demand for metals. The demand for copper, for example, is expected to increase tenfold between 2019 and 2030. Copper is used throughout electric vehicles and in charging stations and supporting infrastructure, due to the metal’s durability, high conductivity and efficiency. On average, an internal combustion engine (ICE) car contains 23kg of copper. Conversely, a BEV takes around 83kg of copper, about three times more. On top of this, several other secular trends are also driving demand for copper, including the increased consumer use of electronics and clean energy transition. In fact, copper is used in nearly all green technologies, particularly solar PV, wind, and energy storage. Fitch Solutions forecasts a shortfall of 489,000 tons of copper in 2024, and a shortfall of 510,000 tons in 2027. Recycling is an important part of the solution to meet future copper demand, as copper can be recycled as often as desired without a loss of quality. Currently, around 35% of global copper use comes from recycled copper, and this rate is expected to go higher.

Aurubis AG, one of the companies we own in our portfolios, is the largest copper producer in Europe, the second largest in the world, and one of the largest copper recyclers worldwide. The company produces over 1 million tons of copper cathodes annually, and they produce copper cathodes with a roughly 40% smaller CO₂ footprint than the global average for copper smelters. This is due to their high level of recycling and more efficient production methods.

Price, range, charge time, and charging infrastructure are among the main challenges to mainstream EV adoption. Enhancements to battery technology is the key to reducing the cost and improving EV’s performance. Gentherm Inc., a global leader of thermal management technologies and a holding of Global Alpha, provides a battery thermal management system. The system improves the performance of the battery packs in hybrid electric vehicles by heating the battery during cold conditions and cooling it during warm conditions, which increases the life of a battery pack. They also have a cell connecting system to provide a reliable and continuous flow of temperature and cell voltage information during the charging and discharging process, ensuring performance and safety. Horiba Ltd., another company we own in the portfolios, provides analytics and measurement equipment. While Horiba’s mainstay business is its automotive emission testing system, they also provide test and diagnostic systems for fuel cells and batteries through its subsidiary — Horiba FuelCon. The demand for fuel cells and battery testing was very strong and Horiba FuelCon tripled its production capacity in 2020. On the other hand, the demand for emission testing will not disappear any time soon, given tightening emission regulations, and the fact that emission testing is still needed for hybrid electric vehicles.  

The increasing charging demand will put significant pressure on the aging grid, especially during peak charging hours. The smart grid is the key to support this demand. With a smart grid, utilities can predict and manage EV charging. It also enables utilities to provide consumers with greater insights into their EV experience, including better understanding the cost of charging, and helping users set optimal charging preferences. Landis+Gyr Group, a holding we talked about in the weekly commentary on May 22, 2020, is a leading global provider of smart meters and smart grid solutions. Although there are delays with regulatory project approvals and installations of smart meters due to COVID-19, the mid- to long-term growth prospect remains intact. In addition to providing smart meters, Landis is making active investment in software development to add more higher-margin and less volatile revenue streams. In December 2020, Landis signed a partnership with Google Cloud to innovate the next generation cloud-based energy management solutions, which is the first partnership of this kind for the energy management industry. With a solid balance sheet, Landis is in a good position to make investments and benefit from the global megatrend.

UK money numbers continued to show absolute and relative strength in February, suggesting a coming domestic demand boom with unfavourable balance of payments and inflation consequences.

Charts 1 and 2 compare six-month growth rates of real narrow and broad money across economies. The UK tops both rankings, with recent monetary reacceleration contrasting with ongoing slowdowns elsewhere (although US growth is turning up again as stimulus payments enter bank accounts).

Chart 1

Chart 2

The preferred UK broad money measure here – non-financial M4, comprising money holdings of households and private non-financial corporations (PNFCs) – grew by 16.0% in nominal terms in the year to February. The comparable Eurozone measure – non-financial M3 – rose by 12.5%. Annualised growth rates in the latest three months were 14.4% and 9.5% respectively.

The Bank of England’s M4ex broad money measure grew by a slightly lower 15.2% in the year to February, with its annualised rate of increase slowing to 9.7% in the latest three months. M4ex also includes money holdings of financial institutions, which have fallen over the last three months* but are of limited significance for near-term demand prospects.

UK broad money strength reflects the large fiscal deficit and its entire financing by money creation, i.e. net sterling lending to the government by the banking system, including the Bank of England – chart 3**.

Chart 3

In 1985 then Chancellor Nigel Lawson introduced the “full funding” rule, which required deficits (and any increase in foreign exchange reserves) to be financed by net debt sales to the UK non-bank private and overseas sectors, implying no public sector contribution to broad money growth. According to this concept there has been zero funding over the last 12 months – domestic and overseas “savers” made no contribution to financing the deficit, which has been mirrored pound-for-pound by an increase in the broad money stock.

In terms of the “credit counterparts” arithmetic, monetary financing accounted for 15.4 percentage points (pp) of the 16.0% growth of non-financial M4 in the year to February. A positive contribution of 3.6 pp from sterling lending to households and PNFCs was offset by a 3.1 pp drag from other counterparts*** – chart 4.

Chart 4

The chart shows that official money creation made an even larger contribution in 2009-10, reflecting the Bank of England’s post-GFC QE programme. This was, however, needed to offset private money destruction as banks attempted to meet regulatory demands to boost their capital ratios rapidly by contracting their lending and shedding other assets. The net result was low broad money growth and inflation. There is no actual or potential monetary shortage to counteract now, and hence no monetary justification for QE on the current scale.

Broad money growth would have been even faster but for a diversion of liquidity into sterling bank deposits of overseas residents – monetary aggregates include deposits of domestic residents only. Overseas deposits grew by £49 bn in the year to February, equivalent to 2.6% of non-financial M4. The recent rise is the largest since before the GFC, when liquidation of the overhang of foreign balances triggered a sharp fall in sterling – chart 5.

Chart 5

Strong domestic demand prospects typically imply upward pressure on the exchange rate as expectations for monetary policy adjust. With central banks now committed to prolonged interest rate suppression, this linkage has been broken. Instead, the prospect of unchecked demand strength suggests a bigger current account deterioration and falling real rates as inflation accelerates. Central banks may be rehabilitating the monetary theory of exchange rate determination, according to which a rise in the relative supply of a currency (in this case sterling) results in depreciation.

The consensus appears complacent about balance of payments risks: the average current account deficit forecast in the Treasury’s monthly survey is £80 bn in 2021 and £84 bn in 2022, essentially unchanged from £74 bn in 2020 (£79 bn excluding trade in precious metals). The view here remains that a major blow-out is possible, based on the historical relationship with broad money growth – chart 6 – and a Brexit hit to the UK’s global export share.

Chart 6

*Due to reductions in sterling bank deposits of fund managers, insurance companies and securities dealers.
**The deficit definition referred to here is public sector net borrowing excluding public sector banks (PSNB ex). The public sector net cash requirement (PSNCR) includes financial transactions and was larger than PSNB ex in the 12 months to February (£330 bn vs £286 bn), mainly reflecting Bank of England lending schemes and the student loan programme. Monetary financing accounted for 90% of the PSNCR over this period.
**Net sterling lending to UK financial institutions plus net overseas and foreign currency lending minus capital and other net non-deposit liabilities.

With 2020 behind us and the first quarter of 2021 coming to a close, we wanted to take this opportunity to provide an update on our business and investment criteria. We are proud to announce that in spite of the COVID-19 pandemic, Banyan Capital Partners achieved record growth across its portfolio in 2020. The resulting increase in our aggregate portfolio value, persistent demand from our investor base and the confidence they have expressed in us has led to a broadening of our investment parameters to include larger businesses, and correspondingly increase the quantum of the initial investment we are capable of making as follows:

  • Businesses with an established track-record of generating EBITDA of at least $5 million;
  • Initial equity investments of between $10 million and $50 million per transaction.

While we are expanding the universe of potential investment opportunities, it must be noted that our approach to investing and the characteristics of the businesses we target remain constant. Specifically, we are committed to a long-term investment horizon and are focused on partnering with strong management teams leading businesses exhibiting the following traits:

  • Head offices in North America;
  • Recession-resilient business models;
  • Long operating histories and attractive financial metrics relative to their competitors;
  • High free cash flow conversion;
  • Stable historical growth and potential for strategic acquisitions; and
  • Strong market positions with differentiated product or service offerings.

For more information, please refer to the attached updated two-page brochure.

If you are aware of, or work with a business that fits the criteria set out above, please don’t hesitate to reach out. We are optimistic that our economy will successfully navigate the COVID-19 crisis and emerge stronger than ever.

Jeff Wigle
Managing Director
Banyan Capital Partners
(416) 564-0737
[email protected]

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.

Global six-month real narrow money growth is estimated to have fallen further in February, based on monetary data covering 70% of the G7 plus E7 aggregate calculated here. The decline from a July 2020 peak suggests a slowdown in industrial momentum extending through Q3 2021.

Turning points in six-month real narrow money growth have led turning points in the global manufacturing PMI new orders index by 6-7 months on average historically. The July money growth peak, therefore, suggested a new orders peak in January-February. The current high point of the orders index is November 2020 but this may have been surpassed in March. These are details: the key point is that the index appears to be reaching a peak on schedule, with money trends suggesting a significant relapse by end-Q3.

Chart 1

Cooler consumer goods demand is consistent with a coming industrial slowdown. Global retail sales fell between October and January, with early data suggesting another decline in February – chart 2.

Chart 2

Industrial output growth appears to have been sustained by a continued recovery in investment goods demand and – probably more importantly – a rebuilding of depleted inventories. Restocking, however, will have been accelerated by softer consumer goods demand and the associated output boost may be peaking.

A key point, often neglected, is that the level of industrial output is related to the rate of change of inventories. These are probably still lower than desired and restocking should continue. A slowdown in the rate of increase, however, is sufficient to exert a negative impact on the level of output.

A normalisation of US six-month real narrow money growth has been a key driver of the slowdown in the global measure, although smaller declines have occurred elsewhere – chart 3. US money growth should rebound strongly in March / April as the Treasury transfers cash to households from its account at the Fed (i.e. helicopter money).

Chart 3

A US rebound could drive a pick-up in global six-month real narrow money growth, signalling industrial reacceleration in late 2021 / H1 2022. This isn’t guaranteed, however: a further inflation rise will drag on real money growth near term, while nominal money trends elsewhere may continue to cool.

Analysis of US narrow money trends has been complicated by banks reclassifying some savings accounts as transactions accounts following a Fed decision to lift restrictions on the former. This artificially boosted the old M1 measure in 2020, particularly later in the year, when its six-month growth rate rebounded strongly – chart 4. The numbers used here attempt to correct for this distortion but the suggestion of a significant slowdown was disputed by some readers.

The debate has now been resolved by the recently released Q4 financial accounts – these contain M1 flow data adjusted for reclassifications and other discontinuities. The fall in six-month growth of the break-adjusted M1 series during H2 2020 was similar to that of the corrected measure calculated here.

Chart 4

A global industrial slowdown in Q2 / Q3 may not be reflected in GDP data because of services reopening. The latter, indeed, could contribute to industrial softening as consumer demand switches back from goods to services. The judgement here is that industrial trends are a better guide to underlying economic momentum and a more important driver of markets, partly reflecting a stronger correlation with equity market earnings.

A simple rule for switching between global equities and US dollar cash discussed in previous posts holds cash when six-month growth of global real narrow money is below that of industrial output. A negative cross-over occurred in October 2020 and – allowing for data publication lags – resulted in the switching rule recommending a move to cash at end-2020.

Real money growth was below industrial output growth in January and early indications are that this remained the case in February – chart 5. The rule, therefore, will continue to recommend cash in April and, probably, May. The rule is currently about 4% offside since the end-December switch. Such a drawdown is not unusual and compares with a 32% gain when the rule was in equities between end-April and end-December 2020.

Chart 5

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.

With 2020 behind us and the first quarter of 2021 coming to a close, we wanted to take this opportunity to provide an update on our business and investment criteria. We are proud to announce that in spite of the COVID-19 pandemic, Banyan Capital Partners achieved record growth across its portfolio in 2020. The resulting increase in our aggregate portfolio value, persistent demand from our investor base and the confidence they have expressed in us has led to a broadening of our investment parameters to include larger businesses, and correspondingly increase the quantum of the initial investment we are capable of making as follows:

  • Businesses with an established track-record of generating EBITDA of at least $5 million;
  • Initial equity investments of between $10 million and $50 million per transaction.

While we are expanding the universe of potential investment opportunities, it must be noted that our approach to investing and the characteristics of the businesses we target remain constant. Specifically, we are committed to a long-term investment horizon and are focused on partnering with strong management teams leading businesses exhibiting the following traits:

  • Head offices in North America;
  • Recession-resilient business models;
  • Long operating histories and attractive financial metrics relative to their competitors;
  • High free cash flow conversion;
  • Stable historical growth and potential for strategic acquisitions; and
  • Strong market positions with differentiated product or service offerings.

If you are aware of, or work with a business that fits the criteria set out above, please don’t hesitate to reach out. We are optimistic that our economy will successfully navigate the COVID-19 crisis and emerge stronger than ever.

Chinese money trends have been signalling an economic slowdown in H1 2020. This appears to be playing out but the PBoC has kept policy tight and narrow money growth has fallen further in early 2020. A Chinese slowdown could derail current global reflation optimism.

Covid base effects are distorting year-on-year growth rates of coincident economic indicators so a two-year comparison is more informative. Retail sales and fixed asset investment slowed sharply in January / February but industrial output gained further momentum – see chart 1.

Chart 1

Output strength is probably explained by additional working days due to covid travel restrictions that shortened workers’ holidays and reduced factory idling – this suggests payback in March / April. The NBS PMI manufacturing new orders index peaked in November and fell to its lowest since June last month.

An economic slowdown had been signalled by money trends: six-month growth rates of narrow and broad money peaked over May-July 2020 at modest historical levels, moving lower during H2 – chart 2.

Chart 2

Six-month broad money growth stabilised in early 2021 but is below the post-GFC average, while narrow money growth has fallen further. Sectoral detail shows weaker expansion of both household and enterprise narrow money holdings, consistent with the joint slowdown in retail sales and private investment.

China has retained its bottom place in a ranking of six-month real narrow money growth across major economies despite falls elsewhere – chart 3.

Chart 3

The expectation here had been that the PBoC would respond to early economic slowdown signs by partially reversing its H2 2020 policy tightening. Instead, it withdrew liquidity before the holiday to protest an easing of money market rates in December / January. Three-month SHIBOR has backed up to 2.7%, almost double its low in April / May 2020.

The suggestion that monetary policy is restrictive is supported by a flat yield curve – chart 4 – and weak core inflation: consumer prices ex. food and energy were unchanged in February from a year before.

Chart 4

China led last year’s economic recovery and the expectation here has been that a Chinese slowdown would presage a loss of global industrial momentum into Q3 2020. Assuming that this scenario plays out, a key question is whether new US fiscal stimulus will drive a growth rebound during H2. This will hinge on the extent to which another deficit blowout in Q2 / Q3 is reflected in US money trends. Growth of the weekly broad money series calculated here has firmed slightly – chart 5 – and a significant pick-up is likely in late March / April as households receive stimulus payments.

Chart 5

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.