KIP 2022 Annual Letter

Mistakes, Mistakes, Mistakes

Almaty, Kazakhstan

The Kan Investment Partnership – an informal partnership with only one partner other than myself – returned 1.18% after fees (BP fee structure) in its first full year of operation. Despite the satisfactory performance on paper, the decision making behind it was anything but.

Despite being ~ 70% invested and keeping ~ 30% in cash with a few 1-share tracking positions (invested an average of 73% throughout the year), the partnership is really made up of just two businesses now: Kaspi.kz and Meta Platforms. Such a large concentration in two companies is not a conscious move, but rather a byproduct of a series of poor decisions, one OK decision, and one simply abysmal, unforgivable mistake. Allow me to elaborate.

Starting in February of last year, the Partnership was gradually built up with a collection of mediocre businesses at mediocre prices that simply seemed “cheap.” Attaining any sort of worthwhile result by partnering with such companies and management teams would have been nothing but pure luck. As Mr. Greenwald would say, I was the guy running through a dynamite factory with a burning match, only (thankfully) a few dynamites caught on fire and blew the whole thing into the sky. Fortunately, the size of the funds I worked with were much smaller (only my own) and hence the damage has been minimal, although no less painful.

Businesses like Alibaba, Meta, Tutor Perini, and Global Cord Blood Corporation (the list goes on) should have never been owned in the first place, due to Circle of Competence (CoC) and management reasons. I have – somehow – managed to exit most of these businesses, but retained ownership in Alibaba and Meta. This was not due to my thinking that these businesses warranted my ownership, but rather because the loss in these ownerships was by far the largest. As the market value of these two businesses continued falling, I kept adding to my ownership, essentially throwing cash into a pit I should not have been in at all. 

Subsequently, I had a chance to see firsthand the raw power of cognitive dissonance and human irrationality — only I was unfortunately facing the audience rather than the stage. Even after I realized – deep down – that (1) both these businesses were outside my CoC and (2) even if that weren’t so, I’d never have the ability to understand them at a level deeper than their average shareholder  (i.e. no edge) I still retained ownership and, even worse, added to it in an attempt to average down and potentially minimize losses in case the shares rebounded. 

I finally came around to selling my ownership in Alibaba around November, but chose to stay with Meta. Alibaba was absolutely a no-go: there is simply no way of analyzing government regulation and, consequently, the permanence and sustainability of the moat. China is a uniquely hard area to analyze when it comes to technology businesses, and I’ve learned that the hard way. I was going to do the same for Meta, but chose to retain ownership after Zuckerberg’s letter and a rereading of the last 5 years of earnings calls and annual reports. This is not a decision I am entirely comfortable with, but I don’t think entirely comfortable situations exist in business ownership – there is always at least one thing you worry about. So that’s that for a series of poor decisions.

The only objectively good decision I have made this year is partnering with Kaspi.kz. I think the investment community can learn a tremendous amount from the story of Kaspi and Mr. Lomtadze – both in terms of strategy, capital allocation, business organization and structure, and the importance of culture and people (The Harvard Business School seems to agree). The business is buying back shares, expanding on existing and new lines of business, and – more importantly – continuing to obsessively focus on the customer, delivering value at a cost (both to the business and to the user) that others will find hard to match. From Postomats to Government Services and its SME Superapp, Kaspi is leveraging its reputation and core competencies to continue building products and services from scratch. As previously mentioned, however, no company is going to be worry-free to own. In Kaspi’s case, my source of discomfort lies in mainly two areas. 

First is the exposure to consumer credit. Kaspi, as of Q3, has 2.8 trillion tenge in loans to customers, and a TFV of 3.6 trillion tenge for 9M ‘22. A large chunk of TFV is made up of BNPL products on low-ticket items with an immediate take rate on the sale (and usually no interest to the customer). Having both a bank and a retailer (its own marketplace), Kaspi’s BNPL has economics far superior to that of the traditional BNPL business abroad (Affirm, Afterpay, Klarna). The main issue, however, lies in general purpose loans or, more importantly, the competition for short-term consumer credit. Ever since Kaspi entered the market, it has become exponentially easier to obtain credit for the every-day consumer.

Traditional banks like Halyk, however, have entered into competition for these customers with similarly structured products. Competitors lower rates and (in my opinion) lower lending standards to a level that they might not have been comfortable with before – it is essentially a race to the bottom. The short-term, small-size nature of the loans – combined with data on consumer behavior no other business in Kazakhstan has access to and an algorithm that is remarkably efficient in parsing through this data – provides Kaspi with some flexibility. It has proven during COVID that it can keep default rates relatively low, retain a high level of collection, and quickly scale back exposure if needed. If we were to enter an extreme recession here, however, that might not be the case. Kaspi is almost certainly not going to go out of business and might get to capitalize on the weakness of its competitors, but the worry is there nevertheless. This is something I spend a lot of time trying to track and understand.

The second worry comes from several competitors who shall not be named that both directly and indirectly compete with Kaspi through methods I deem to be flat-out illegal. These competitors are of a size and scale that makes them a large player in their respective markets, and whose collapse would have a pronounced impact on the overall economy and hence on Kaspi. I am not qualified to comment on whether these are actual frauds, but a simple look at the way these businesses are run and structured (and the types of products they sell) leads me to believe that that is the case. 

Kaspi is a prime example of how one good business can “atone” for several poor ones. It is also, however, an example of how the benefits of one good decision are wiped out by a series of mistakes. In other words, it is as much about what you don’t do as it is about what you choose to do. It is still early to evaluate the decision behind Kaspi. As Buffett said:

“We never take the one-year figure seriously. After all, why should the time required for a planet to circle the sun synchronize precisely with the time required for business actions to pay off? Instead, we recommend not less than a five-year test as a rough yardstick of economic performance. Red lights should start flashing if the five-year annual gains fall much below the return on equity earned over the period by American industry in aggregate.”

Finally we come to a decision with which I am still very disappointed to this day (or, more precisely, where I am disappointed with myself). As the previously mentioned decline in Alibaba and Meta took place, I needed somewhere to take funds from as I was almost 90% invested. This sacrificial lamb came out to be Alimentation Couche-Tard, a business and organization I deeply admire and respect. ATD was up about 30% and made up a decent portion of the Partnership. My thinking was far from clear, and I sold all but one share of ATD to reinvest the proceeds into my two cash furnaces. I was, quite literally, cutting my flowers and watering the weeds. Investing is hard.

Thankfully, I had the foresight to retain one share to track the business. The story of Alimentation and Mr. Bouchard should be studied by everyone. Annual reports are available online all the way back to 1997 when the business was trading at as low as $0.17 CAD. The same shares are selling for $59.50 CAD today. It is a remarkable journey of obsession over one central idea matched with pristine execution and remarkable organization-building. In his ‘22 Letter to Shareholders, Mr. Bouchard wrote that he “was moved to tears” when we found out that ATD was named one of Forbes’ 2021 “World’s Best Employers.” He went on to say:

“Following the Gallup announcement, I wrote to my leadership team that ‘I was dreaming of seeing such a day when we would be recognized for our culture of empowerment and focus on our people.’ ”

I wholeheartedly believe that Bouchard really was moved to tears. He is a remarkable man and an operator that is in a league of his own. Partnering with such a man back in 2021 was nothing but luck, and yet it taught me numerous important lessons and helped shape the philosophy and framework I employ today.

I am of the opinion that acquiring fractional ownership in a business is indicative of a conscious decision to partner with the people (both at the top and at the bottom) who are in charge of running the place. You are choosing to associate yourself with these people, and accept responsibility for any sort of result – good or bad – that they produce. I admire and appreciate people like Bouchard who strive to build genuine organizations, and disapprove of (if not detest) those that treat shareholders as “annoyances,” employees as “cogs in a machine,” and shareholder capital as one’s “personal piggy bank.” Unfortunately, a lot of the businesses I was previously a partner of had the latter category of management.  

Bouchard is (and was) a “no-brainer.” I see my decision to sell as (1) unbusinesses-like and (2) a sort of betrayal of a close partner (although he of course has no idea I even exist). I think shareholders should reciprocate the way they are treated and viewed as by management. In ATD’s case, Bouchard and Hannasch treated me as a genuine partner and rewarded me financially simply for having trust in them, and yet the same cannot be said about my treatment of them and their “canvas.” Such behavior is the most painful and is hence the lesson I am likely to keep with me going far into the future.

I never expected to have a fully ready-to-go collection of businesses in the first full year of dedicating time to the Partnership. As mentioned in a previous post, wonderful businesses are a rare anomaly rather than a guaranteed occurrence. Neither do I expect to have the full collection finished by next year – I’m assuming that the Partnership is really going to pick up any real momentum 2-3 years out, but we will see what happens when we get there.

More importantly, I do not (and cannot) expect any sort of outperformance over the long-term, at least based on my current skill and knowledge base. Any outperformance will be largely attributable to luck, and underperformance (minor or otherwise) is generally expected. My goal is to collect and build out a range of inputs (framework, philosophy, allocation, risk-management, depth of analysis, overall skill) that provide a sustainable output of satisfactory long-term performance (5% above market-rate returns). Simply put, I do not deserve to outperform given where I am today – the hope of course is that this changes at some point, and that I can rationally and consciously expect above-average performance. 

The collection of businesses I am an owner in is – in aggregate – not yet “set up” for strong underlying performance. Again, I expect this to change only 2-3 years out; meanwhile, I will continue searching for remarkable organizations and (more importantly) remarkable people to partner with.

On a side note, I have found that some people in the investing world are “unqualified commentators” – people who always try to have something (usually negative) to say about someone else’s performance, the decision of a legendary investor, or something else they are uniquely unqualified to talk about. Unless their last name rhymes with “Puffett,” I strongly suggest you do not take any of this commentary at face value. 

This year has been incredibly rewarding, despite being one of the toughest and most challenging in my life – especially with all the things going on here at home. I cannot thank enough all of the people that have helped push me along this journey. These people are now in the dozens, and I owe so much to them. I am ridiculously lucky to find something I am so interested in this early, and the people I meet along the way make it all so much more worth it.

Thank you all.

December 31, 2022,

Ilya S. Kan