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Hayden Capital - Soundly Beating The Market Despite Significant Cash Position

|About: JD.com (JD), Includes: AMZN, BABA

Dear Superinvestor Bulletin Follower,

The reason that everyone is always in awe of Seth Klarman's long term investment performance record is that he has achieved it with the drag of a huge cash weighting.

Of course Klarman is aware that his significant cash weighting isn't a drag, instead having that dry powder is a valuable weapon.

Hayden Capital is a firm with a much shorter track record, but a track record of beating the market while carrying a lot of cash nonetheless.

Here is their Q2 investor letter:

Hayden Capital Q2 Investor Letter

In the letter Hayden details this new position....

JD.com (JD): Over the last few months, we have been building a new position in JD. JD.com is China’s largest business-to-consumer (“B2C”) company, and expected to achieve over $50BN in sales this year.

Our thesis for the company is consistent with our broader e-commerce framework – where retail is essentially a logistics business, and those with the lowest cost structure (and therefore passing on lower prices to consumers) will win.

Commonly known as the “Amazon of China,” JD has been doing just that. In the last few years, the company has been rapidly taking market share from Alibaba based upon its promise of faster delivery times, authentic quality products, and great customer service.

The key to this is JD’s one-of-a-kind logistics network, first built in 2007. In 2007, China’s logistics industry was extremely fragmented (and still is), with thousands of delivery operators – many of them under a franchised model. There wasn’t a UPS or Fedex to manage the solution from end-to-end.

Because of this, the biggest complaint from customers was that of slow shipping times and even packages which never arrived. Seeing this bottleneck to customer satisfaction, JD recognized an opportunity and chose to build one itself.

Over the last 10 years, JD has invested billions into its logistics network. This has allowed the creation of initiatives such as the “211 program,” where orders placed before 11am are delivered the same day, and orders placed by 11pm are delivered by 3pm the next day. Lately, JD has even begun wide-spread drone deliveries and is the first in the world to do so (OTC:LINK).

Alibaba on the other hand, still relies upon a partnership of third-party carriers (each with their own incentives and reluctance to help one another), to deliver its packages.

This type of instant gratification is habit-forming, and very hard for competitors to replicate. After Amazon Prime popularized two-day shipping, it forced many competitors to step up their game as well (and incurring higher costs in the process). It’s hard to go back to waiting a week for your laundry detergent, when you can have it the same day via Amazon Prime Now or JD.com.

This instant gratification and higher expectations are becoming the norm in China, as domestic consumption picks up and consumers become wealthier. GDP per capita is growing over 6% a year, and has increased from just $2K per person to over $8K per person in the last decade. On top of this, JD’s customers skew much higher (+$15K), typically focused on the higher-income, urban households. As these trends take place, consumers are increasingly looking for authentic brand-name goods, and better service (quick delivery, hasslefree returns, etc). JD is well positioned to capitalize upon this trend.

Evidence can be seen in JD’s market share gains, which have steadily grown 3 - 4% a year. Recently it reached 25% of China’s B2C market in 2016, vs. Alibaba’s 57%. This is a 47% increase from just 3 years ago, when JD only had 17% share.

On top of this, China’s broader e-commerce industry is growing at 19% y/y. The company is successfully taking a bigger piece of a rapidly growing pie.

In terms of the stock / market dynamics, there seems to be a large opportunity in US-listed Chinese ADRs. From my conversations with US-based investors, the vast majority seem scared to invest in Chinese companies, due to concerns about fraud, lack of knowledge of the market, Variable Interest Entity structures, macro concerns, etc. The reputation of Chinese reverse-merger frauds from the 2009-11, seemed to have created a narrative that all Chinese companies are to be avoided (despite JD being one of China’s largest tech companies, versus the fraudulent sub-$100M stocks of the early 2010’s).

In addition to these conversations, the “narrative” can also be seen when examining the top holders of USlisted Chinese names. Except for one large hedge fund family, there are few Western investors in these stocks (the list is almost entirely Asia dedicated funds). On the flip side, the Chinese customers who know and use these companies every day are unable to invest, due to capital controls restricting funds from going outside China.

This creates a favorable dynamic – one where the highest quality Chinese companies are without a natural shareholder base, resulting in very attractive valuations.

Where else can you find the #2 e-commerce company, serving the world’s largest population, with a highly loyal customer base, huge logistics advantage, and strong industry tail-wind (19% y/y growth)… all trading at 1x EV / Sales (~20x long-term EBIT), and growing at 40% y/y?

We were able to acquire shares of JD.com at an average cost of ~$37.
At the risk of looking foolish, I’ll go on record and say I believe there’s a good chance JD can become the #1 Chinese online retailer within the next ten years.

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Have a great day!

Reese Morgan

Editor, The Superinvestor Bulletin

Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.