Dear Investor,

DMXASF’s NAV declined 5.0% (after fees and expenses) against the ASX 200 Total Return Index which declined just 1.0% for the month. The broader index held up well, propped by larger and resource companies. Meanwhile, smaller industrial to which we’re mainly exposed were weak as reflected in the ASX Small Industrials index down 3.4% for the month.

Portfolio Commentary

Following a weak January-March quarter, April saw the continued broad-based sell-off across the smaller company sector (excluding resources/commodities, which have performed well). Our portfolio has been impacted, in particular from the combination of large holdings falling moderately (Sequoia down 7%, and Pureprofile down 13%), and mid-sized positions falling significantly (EML Payments down 47% on a negative profit downgrade, Elmo Software down 28%, and Joyce Corporation, Janison Education & Nearmap each falling 17-18%). Despite portfolio holdings declining, a number of these were whilst concurrently providing what we considered to be positive market updates. One example being Frontier Digital Ventures which fell another 13% despite its strong update and a very positive longer-term outlook. The continued de-rating to its shares we believe simply reflects the market’s discounting of even very high-quality businesses but whose cashflows are longer-dated. Frontier is discussed in greater detail, below.

While most of the portfolio has been marked-down of late, there are bright spots. Cryosite rose 28% on no news. The company’s shares are fairly illiquid so can move fairly easily in either direction. We expect its continued recent strength is the justified follow-on from prior very positive updates, and associated ratchet of investor expectations for the business. Credit Clear, too, rose strongly (up 33%) on the back of a very positive update that highlighted strong progress in its international operations.

The DMX Capital Partners report includes updates on Top 10 holdings Ansarada, Credit Clear, PTB Group, Pureprofile and Sequoia, as well as on smaller holdings, Aeeris, Knosys and Yellow Brick Road. All of these are commonly held by DMXASF, and the updates are included as an Appendix to this report.

In terms of DMXASF-specific holdings, updates were mixed. Noteworthy were:

• EML Payments. EML suffered a 35% one-day decline (and 47% for the month) on the back of a trading update with FY22 forecasts downgraded. In essence, revenue growth is expected to be lower due to lower establishment fees and higher costs in their European business as it seeks to comply with its regulatory obligations. The update is clearly negative and a re-valuation/re-pricing to the shares warranted. Whether a 30-50% decline is an overshoot remains to be seen. But there are factors that suggest the market may be overreacting. First, there’s always a general tendency to overreact to bad news. Second, the news has come during a particular weak period in markets (especially for higher growth businesses). Third, and most alarmingly, the update was made just weeks after the company’s Chairman sold stock on-market. There’s clearly a bad smell with the latter, but again, we think this may be overdone. Directors are able to buy and sell securities. EML’s Chair has been a long-term significant investor in the business. While the $550k share sale seems large, it was just 3% of his ~$20m stake, and he has been a slow & consistent seller of some stock over the years and in a fashion we’d consider consistent with prudent personal balance sheet management. As with many things in life, the issue here is timing. And there are genuine questions to be asked around director trading windows, what is known in the boardroom at any point in time, etc. At these marked-down prices EML trades on an attractive earnings multiple, continues to have a strong long-term growth profile, and with its prepayments float, will be a substantial beneficiary of higher interest rates.
• Frontier Digital Ventures. Frontier’s shares continue to slide, falling 13% for the month. But we believe this is a function of negative sentiment toward higher growth and not yet profitable businesses. The company continues to report what we consider to be positive and reassuring results. With significant market opportunities in front of it, a rock-solid balance sheet with nearly $50m in cash, revenue approaching $100m, and a 50%+ growth profile, we believe the company has a strong mandate to continue to invest aggressively to augment their winner-takes-all business models in various emerging markets. Digital assets such as marketplaces have proven to be extremely valuable as they mature. Frontier is very well placed with its collection of quality assets across Latin America, Asia, and the Middle East/North Africa. The company’s strategy is to consolidate its ownership to 100% where it can, and with the platform now built out, attention has turned to monetisation, including a focus on driving lucrative transaction-based fees in addition to advertising revenue. Frontier is the sort of business that has asymmetrical return potential, and we remain confident in the potential for its shares to contribute meaningfully to the portfolio over time.
• Michael Hill International. Michael Hill announced a very positive trading update with same store sales up 5% across its store network. Pleasingly, gross margin continues to improve and it is worth noting that supply chain issues faced by other retailers hasn’t been a problem for Michael Hill given the nature of its products. Despite the strong update, its shares fell 5% for the month, giving back some of its prior gains. We believe the company continues to benefit from the combination of product differentiation & pricing power, together with a less aggressive competitive environment. Capital management remains a focus for the group, and we watch with interest how the company might utilise its very strong balance sheet (with, we assess, 10-20% of its market value surplus capital). That balance sheet position is being augmented by the recently announced sale of its Canadian consumer credit book.

Public v. Private Equity Availability

An area we’re particularly focused on is some of our interesting smaller software companies that have great core businesses, strong leadership, proven historic execution, significant market opportunities ahead of them, but perhaps where there’s an ongoing reliance on equity capital markets to support that growth. Portfolio holdings in this thematic include Ansarada, Janison Education, and PropTech. With PropTech, for example, users of their software rave about the product, and once embedded, costs to switch are high. The company enjoys some pricing power and is carefully taking advantage of that. It’s a high-quality small business, but in this capital market environment, the prospects of meaningful additional equity raising in the near-term (at the right price) are slim. Absent further raisings, replicating its Australian-centric model say in the UK would be challenging and growth would need to come organically and at a slower pace. There will remain significant core value, but that extra value-add through acquisition needs to be discounted. On the other hand, an unsupportive public equity market might prompt interesting businesses such as PropTech to move back into a private environment, either through private equity or seeking to be bought by a strategic acquirer. We see this as both a risk and an opportunity, and potentially a shame if we lose good businesses from the ASX.

In Summary

While markets are going through a challenging period, and our portfolio hasn’t been immune, we’re very pleased with the progress our companies are making. The likes of EML Payments disappointing the market reflects a clear ratchet down to our expectations for value, but by and large, the share price declines we’ve experienced in recent months represent a widening of the perceived gap between prevailing prices and our valuations. Such a dynamic makes the portfolio increasingly prospective, and for us as patient and opportunistic investors we’re enthused about the potential to generate meaningful value over the medium to long-term.

If you’d like to discuss the portfolio or the potential to invest or add to an existing investment, please contact Michael at any time on michael.haddad@dmxam.com.au or Sydney 02 80697965.

Thanks for your trust and support.