Little ASX software share to explode once everyone wakes up: fundie

Ask A Fund Manager: Eley Griffiths’ Nick Guidera tells 2 ASX shares that he loves right now and one that’s completely overhyped.

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Ask A Fund Manager

In part 1 of our interview, Eley Griffiths portfolio manager Nick Guidera revealed his secret sauce for evaluating shares to buy. Now in part 2, he tells us 2 ASX shares that are hot right now and one that he says is completely overhyped.

Overrated and underrated shares

MF: What’s your most underrated stock at the moment?

NG: One of our most underrated stocks is a company by the name of Playside Studios Ltd (ASX: PLY). So Playside is a Melbourne-based gaming company that is in the development of online games.

MF: That IPOed late last year, didn’t it?

NG: It did IPO late last year, correct.

It’s founder-led, so it fits with our process. Gerry Sakkas is the founder, who’s leading the vision there. Gaming stocks globally are in hot demand, and it’s very difficult to get exposure to gaming businesses in Australia, particularly ones of this quality – that have very good management teams, that are aligned with a good strategic plan. 

The industry outlook is very, very strong. In addition to that, they’re not just what you would call a work-for-hire, where they’re developing games on behalf of other participants in the industry. What they are doing is they’re taking a risk on particular franchises to see whether they can develop something that is meaningful over time and will ultimately generate a significant amount of revenue.

In the last few months, they partnered with one of the Hollywood studios to get the franchise [rights] for Legally Blonde, which will allow them to develop an online game that is based around the characters in the movie that is Legally Blonde. Just [recently] they announced a partnership with another Hollywood studio to get access to the Godfather franchise, to develop a number of games around that. 

This company is very early stage, and also very small in the scheme of things. But that’s our job – to identify emerging companies that are earlier in their journey with great fundamentals, good management team, with a good path to growth – and we think it’s pretty exciting.

MF: How’s the price going?

NG: It had a very strong debut, like a lot of IPOs [initial public offerings]. I think as the market has shifted away from tech and growth stocks towards value in cyclicals through earlier in the year, some of these stocks have been left behind. So you’ve seen the stock more recently around the 31.5-cent level. From memory, it was a 20 cent IPO. 

MF: Did you buy in the IPO?

NG: We did, yeah. I think the high of this stock was 49 cents at the end of December last year.

Right at the moment, I think it’s primed for more attention. You know what I mean? It doesn’t have a whole lot of coverage. It’s small, there are other stocks in the market that retail investors are particularly focused on. I think as this stock gets more exposure to the market and institutions out there, you’ll see a greater interest in it.

MF: What do you think is the most overrated stock at the moment?

NG: One that we think fits that camp is e-merchants, so EML Payments Ltd (ASX: EML).

This business has been around for a long time. I went and saw them in 2014, when they launched general purpose reloadable cards into the Australian market, which at the time was seen as very innovative. Customers like Ladbrokes were looking for ways in which to reward their members in a way that was appropriate. 

This business has changed dramatically. It’s expanded offshore, it’s moved into the US and Canada. It’s moved into the gift and incentive business, and subsequently into virtual account numbers.

For us, we think the market is very over-enthusiastic around the opportunities for this business in terms of the outlook for the industry, which I think one analyst put it recently as a $1.1 trillion industry. 

I think it’s a very competitive market and their history of execution has been questionable. They’ve certainly had some good periods, but they’ve also had some challenges. For us, the market is not discounting that at all. It’s a very expensive stock for what it is. 

One analyst characterised it recently as a ‘fintech’. I’m not 100% sure it’s a fintech. It certainly is a technology business that happens to play in reloadable cards. But it has a very significant shopping mall business – there are some question marks over the sustainability of shopping malls and whether we see malls shrink over time, which we think we’re already starting to see. 

But the market is still willing to pay significantly north of the market multiple for this business, despite its track record and the inherent risks in it.

MF: If the market closed tomorrow for 5 years, which stock would you want to hold?

NG: The stock I would put in there would be Temple & Webster Group Ltd (ASX: TPW)

This is pretty controversial at the moment because it did go up a lot last year, but I think the market is obsessed with how a number of these e-commerce retailers will trade as they comp their success through 2020. 

The first pass for Temple & Webster was an update they provided to the market in April, which saw them cycle their April comps, I think up 20%. So from memory, the April comps were north of 100%, so they added an incremental 20% to that growth. Albeit the percentage growth had slowed down, they were still able to grow the dollar growth off a much higher base.

They also flagged to the market that they wanted to use… a significant amount of revenue opportunity to invest back into business for the longer term. Some investors were a bit shocked by this and were happy to exit the register. We saw it as an opportunity as we believed that this management team can kill the category and be an extension of where they already are, which is the number 1 furniture and homewares retailer because the offline players are so far behind.

If the market were to shut today and we’d come back in 5 years, we’re still going to be buying furniture, we’re still going to be buying homewares, and there’s a very good likelihood that the logistics and the online experience is going to be far superior to what it is today. And having the best brands with the best brand awareness in that space with hardly any competition gives me confidence that this business will be a lot bigger in 5 years’ time. And they’ve already proven now that the unit economics of this business work at a smaller scale, so at a larger scale [it] would be even better.

Looking back

MF: Which stock are you most proud of from a past purchase?

NG: The stock I’m most proud of from the past is Megaport Ltd (ASX: MP1) at $2. Actually, it was $2.10 to be exact. 

Megaport is a stock now that is a high-flying tech stock, but in 2017, it was a misunderstood networking business that the market was confused by. It was very early-stage in its revenue, and it was trying to, I suppose, differentiate to the market around what its unit economics could be. 

Having been shareholders in NextDC Ltd (ASX: NXT), we spent a fair amount of time understanding cloud computing and data centre growth globally. One of the key missing fixtures from the data centre growth was data centre connectivity. 

[Megaport] had a product which ultimately meant you could reside in any data centre across the world where Megaport had a point of presence, and connect to another data centre in the world in a very cost-effective, seamless way without a whole lot of provisioning time.

At the time in 2017, the need to move data between data centres was not as prevalent, but as we’re all aware, the data has grown and grown, and people’s data needs to become more complex. 

There are a number of cloud providers, there are a number of SaaS softwares that are used by enterprise, and the need to move data between data centres has become a very big need. Being the first mover in this market with a product which resonates with consumers, where Fortune 500 businesses that engaged with has grown exponentially over time – what you see today is a company that is at break-even point with an $80 million revenue base, with a global footprint and the number 1 data centre connectivity player out there.

In addition, they’re moving outside of just data centre to data centre, to particular networks that allow connectivity from external networks into a data centre out through SD-WAN. They’re looking at cloud-to-cloud. There’s all sorts of different opportunities that they’re pursuing. You can say the unit economics of the business stacks up, and management has been aligned the whole way and have continued to execute on their strategy and grow this business consistently quarter in, quarter out.

MF: You bought it at $2.10, so it’s become a 6-bagger for you guys?

NG: Yeah. I think our exit price was not the highs at $17, it was about $14. So still 7-bag. That’s not too bad. 

The reason for the exit was largely because for the Emerging Companies Fund, we are only allowed to hold stocks when they go into the ASX 200, we can’t add to them. So at some point, we have to sell them, which is usually up to 24 months. So we saw a window to refine that exit, and that’s why we moved out of the stock. 

We’re very much still engaged with the stock. It is a stock that we will look to buy back in our Small Companies Fund in time. But we think right at this moment with the market positioned the way it is towards cyclicals and global growth, that we will have time to do that.

MF: Is there a move that you regret from the past? For example, a missed opportunity or buying a stock at the wrong timing or price.

NG: Probably the most interesting experience was the COVID drawdown of February and March. 

This fund’s been alive for 4 years, our other funds have been alive for 17. So we’ve seen the GFC, we’ve seen a number of drawdowns over time, but I think that the panic that gripped markets through March last year, as COVID started to take over the world and economies were shut down, and the way of life that many of us knew was possible was thrown into question… we saw a number of quality stocks just be completely decimated.

My biggest regrets were two-fold. 

One, selling a number of quality stocks into that March drawdown because we were worried that this COVID scenario could go on for months and months and months. Even though they had a great business model, it wasn’t pandemic-proof, and as such, what that business would look like in 12 months’ time, given where their cash position was, where their customers were based, their reliance on global freight, whatever it may be, meant that we weren’t comfortable having an investment in that stock through that period. 

Subsequently, the response from governments and reserve banks globally, and the amount of liquidity we’ve seen into the system very much held up the economy and provided a path out of that COVID drawdown a lot faster than a lot of people thought.

My second regret would be not buying some of these stocks at their lows or close to their lows, and waiting a few weeks until I got comfort that there was a more sustainable path. Because, typically, you don’t see a drawdown and then a sharp rebound. It typically will be volatile over that period of time. So I suppose my conservatism around not participating in buying some of these growth names at the deeply, deeply discounted levels in March 23, 24, or 25 – waiting a few weeks – probably meant I spent an extra $2 higher. 

But I had more conviction, I suppose. I could have got some bargains and I probably shouldn’t have sold some of my quality names because ultimately quality prevails over time.

MF: I don’t think you are the only one who has regrets from the events from February and March last year. It was a crazy time, wasn’t it?

NG: It certainly was, and if anything, it’s taught us all in the market a lot of lessons about how we invest, what companies are ultimately good businesses, and resilience. 

We’re in a market, at the end of the day, that’s subject to so many external factors that no matter how fundamental your investment thesis may be, if the external factors are out of your control – ie Federal Reserve stepping into markets – then there’s an old saying: “Don’t fight the Fed”. I think there’s some truth to that, or a lot of truth to that.

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Tony Yoo owns shares of Temple & Webster Group Ltd. The Motley Fool Australia's parent company Motley Fool Holdings Inc. owns shares of and recommends EML Payments and MEGAPORT FPO. The Motley Fool Australia's parent company Motley Fool Holdings Inc. owns shares of Temple & Webster Group Ltd. The Motley Fool Australia has recommended EML Payments, MEGAPORT FPO, and Temple & Webster Group Ltd. The Motley Fool has a disclosure policy. This article contains general investment advice only (under AFSL 400691). Authorised by Bruce Jackson.

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