Understanding opportunity cost

Wednesday, Jun 8th 2022

Investor Update

We’ve elected to exit Target (TGT) and Coinbase (COIN) in the Flagship strategy while trimming Five Below (FIVE) in the Opportunities strategy. Proceeds from all three holdings will replenish our cash reserve, which we plan to deploy into higher conviction holdings in the future.

Opting for cash

Investors define opportunity cost as the potential difference in outcomes between investing in one asset vs. another vs. not investing at all. There are situations when we believe the best use of your capital is holding cash vs. waiting for our thesis to play out. In other words, the opportunity cost of remaining invested in a company is higher than holding cash.

Although we’re bullish on Coinbase and Target long-term, the opportunity cost during this volatile period is too high. We’d prefer cash today to quickly deploy on market weakness in higher conviction holdings, with higher return potential, while maintaining the option to reinvest in these names as we did with ServiceNow at lower prices.

Coinbase (COIN): Our thesis on Coinbase (COIN) was simple; Coinbase has the scale, talent, network effects, and secular tailwinds to grow into one of the crypto market’s premier investment platforms. Coinbase demonstrated a remarkable pace of innovation and diversification of its revenue streams, including NFTs, wallets, institutional services, staking, etc. So what changed?

Tough economic times construct lasting legacies, and COIN’s response to recent volatility has given us pause. We’d hoped the company would win more trading volume market share in this environment. Management’s hiring and rescinding job offers could impair their ability to ship new products and attract top talent. People are the crown jewel for a company looking to go zero to one.

Coinbase has evolved into a “show me” story. The opportunity cost of hanging around the hoop is too high as the company may be entering a prolonged period of slowing trading volumes and growing market share losses. We chose to sell our small stake in the stock and use the proceeds to replenish our cash reserve. We also harvested tax losses for clients, which may help offset gains elsewhere in clients’ portfolios.

Target (TGT): When first investing in Target (TGT), we believed its unique omnichannel model and rapidly growing e-commerce business would enable it to win market share and drive consistent earnings growth over the coming years, despite harsh macroeconomic conditions.

Management had built a stellar reputation over the last five years. They did a masterful job evolving Target into an industry leader through initiatives such as same-day fulfillment and BOPIS, or buy online, pick up in-store. Impressively, online sales had grown to 20% of total sales, compared to just 6% in 2018.

Throughout our diligence process, we were highly aware of and extensively discussed the two key risks of this investment: execution and supply chain headwinds. Ultimately, we believed that the company’s discounted valuation, strong execution track record, and robust growth potential outweighed those key risks. Unfortunately, we were wrong.

While we acknowledge and are sympathetic to the macro headwinds facing the retail industry, we are disappointed that Target’s navigation of the supply chain industry woes has been notably worse than that of its peers.

Over the past two months, Target’s management team has lowered its future earnings guidance two separate times, citing increased fuel/freight costs and inventory mix, among other things. Our issue with this? Surging gas prices and shipping delays are well-known factors that didn’t unexpectedly emerge over the past few months. This leads us to believe that these missteps are more company-specific and due to poor management execution.

Like Coinbase, this has evolved into a “show me” story, and we don’t have the confidence in management to bet on a comeback; the opportunity cost is too high.

Five Below (FIVE): In stark contrast to recent TGT missteps, FIVE has consistently delivered on its reputation as the industry standard for flawless execution, and our long-term confidence in the company remains unchanged. However, amid increasing speculation surrounding slowing consumer spending and elevated inflationary pressure, we have decided to tactically trim our position in FIVE. The current challenges of the macroeconomic environment could prompt more conservative growth estimates relative to consensus, and this move to replenish our cash reserve in Opportunities felt prudent.

Uncertainty abounds in today’s market, but after these moves, we believe we can generate higher returns by being more nimble. We plan to deploy our cash reserve as opportunities present themselves, and as always, thanks for the opportunity to manage your capital.

Onwards,

John Bottcher and Justin Yoo

Titan Investment Analysts

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