Swimming Through Muddy Waters: Q1 2025 Letter

In Q1 2025 the portfolio returned 8.0%, vs the S&P 500 at -3.9% and Nasdaq at -9.4% (the end of the letter contains monthly performance since inception as always).

Being Nimble

Q1 2025 was perhaps the closest I’ve ever felt to understand what being a “trader” feels like. Moves happened fast both to the upside and downside. Companies would be undervalued on a relative and absolute basis and suddenly 1 month later would be stretched. As someone who would love to just buy and hold great companies for the long term, the challenge becomes when stuff just doesn’t make sense to hold at certain valuations.

The great example of this was Costco at a 60x PE. No one is saying Costco is not a phenomenal business that will compound earnings with steady consistency over the long term. However, at that valuation, it is no longer a quality value investment. It is more of a bet on passive fund flows supporting that multiple than it is on the business quality itself.

Another great example was Deepseek. High quality companies sold off on unqualified fears and allowed for great gains but only if you stayed nimble as since then the sector has round tripped.

Which brings me to another point. When a whole sector goes down, I think it’s hard for an investor to say a particular company is discloated. As a vocal Google bull last year, lots of people have been asking me why I’m not all in on Google. The reason is because there’s no dislocation right now. Yes it’s cheaper than the rest of the Mag 7 but all of the Mag 7 is trading down so the relative dislocation is minimal. Last year Mag 7 were all trading up besides Google. This was where the dislocation made no sense.

Across the universe of companies I track (approximately 40 or so), in Jan I saw some bargains, by Feb I saw none. That freaked me out I went from 20% cash in Jan to 45% cash in February as I sold assets that were in my opinion relatively overvalued and on an absolute valuation assuming too much consistent growth 5 years + out.

That action turned out to be the saving grace as I was able to redeploy back into high growth companies (which I had started to be significantly underweight in Jan/Feb, a weird position to be in for someone who considers themselves to be a value growth investor). Companies like Atlassian, Monday, Robinhood, Remitly, Mercado Libre, are all at attractive relative and absolute valuations to me and are now back in the portfolio or new adds.

Even “quality compounders” that I thought were too expensive made it back in like S&P Global, Topicus, Amphenol.

Shifting Global Order

Regardless of what you think about President Trump’s actions, I have to say that the result seems to be countries like Canada and all across Europe taking their own defense seriously. The President has been clear to these countries that they need to contribute more to protecting the globe. While we can all talk about AI, this is the 2nd biggest trend I see in terms of the wall of money and consistent spend that will be occurring as a result of these nationalist policies around the world.

The first order effect is obviously defense. I still own Rheinmettal but put on a medium sized position before JD Vance’s speech and quickly saw a 50% run up which once again turned me into a trader causing me to sell upon the hype into the German budget vote and then add back after. Kraken Robotics in Canada is a small cap that should also benefit not just from Anduril but also Candian, UK, and Australian governments spending more on home defense.

The second order effect is where I am finding very compelling opportunities. Infrastructure spend is also a nationalistic policy. France has announced “plug baby plug” causing their waste management stock Veolia Environment to be up 25% YTD. Eutelsat is up 110% YTD as a result of Europe deciding they don’t want to rely on Starlink.

This led me to MDA Space, a company I will talk about in a future letter. It is a top 5 position for me. But while most folks are focusing on the European nationalist policies. The Canadian nationalist policies are also going to ramp up. And unlike most of Europe, Canada actually has massive budget surplus from the natural resources they export. So while MDA Space is quite attractive today trading at 10x FWD EBITDA for a secular space story in geospatial data collection, lower earth satellites, and robotic arms for space (to help with repairs) all with a declining cost curve, I don’t think that bakes in the spend that is likely going to come from Canada’s government, Telcos, and other key industries saying we don’t want to rely on a US based satellite constellation (Starlink) when we can have our own.

Kelly Partners Group Deep Dive

These days I’m finding less and less dislocations in medium to large caps and plenty in small caps. My largest positon is Kneat (a company I’ll discuss at another time). But when you find quality business models and management that you can own and grow with over time at <$1B valuations, it’s as close as I can get to “venture investing” in public markets. And small cap land is one of the few areas you can get that in public markets given how long some of the private companies are taking to go public.

So what that here’s a deep dive into Kelly Partners Group, a top 6 position for me. If you’d prefer to listen, Andrew Walker and I did a podcast on it a few months ago: https://www.youtube.com/watch?v=0nrQvHPtIxQ&ab_channel=YetAnotherValuePodcast.

Overview

Simply put, Kelly Partners Group is a high quality compounder in a small cap body that has the potential to 10x+ in the future. Kelly Partners acquires, operates, and improves accounting and tax firms. While the PWCs of the world cater to large enterprises, KPG is focused on the local firms that serve SMBs and individuals. Unlike many other acquirers, KPG truly becomes a partner in the businesses they acquire. KPG buys 51% of the target so as to have majority ownership but enables the existing partners to keep 49% and participate in the upside alongside the improvements and business that KPG will bring with their honed business system over 17 years.

Founder

KPG was founded and is run today by Brett Kelly. Brett has an incredible history. Growing up in Australia, he wanted to find mentors to learn from on how to be successful and lead a good life. So he did what any 20 year old kid would do and cold-called prominent Australian business leaders and investors to learn from them. He ended up publishing a book with his learnings and has since gone on to publish 5 books in total spanning wisdom learned from investors and business operators. He is a student of history, learning machine, accountant, thoughtful capital allocator and business builder. Brett owns 49% of the business today and takes the Constellation Software model of incentivizing his employees and acquirees to purchase the stock so as to align everyone with the goals of KPG. High insider ownership aligns external shareholders nicely with the teams building the business.

Business Overview

Accounting & tax firms are recession resistant. In a tough macro, of course some business customers could outright fail but most of the time individuals and SMBs continue paying taxes as mandated. There’s also natural pricing power built into a certain extent. If the accountant increases their service fees by 5-10% annually, the weight of churning is very high. Customers are much more likely to simply pay the increase than try and switch all the context to a new accountant while also causing potential disruptions to a task they don’t want to do on their own.

KPG’s acquiring targets also benefit from localized network effects. I personally use a boutique tax firm that works with mostly VC clients. The way I learned about them was from other VCs. Client retention is so high that they no longer are accepting new clients or referrals! So you have a high retention, low CAC business which equals strong & stable free cash flow generation. However, there are always inefficiencies in a business. This is where KPG coming in as a partner can impart best practices and bring together the portfolio to learn from each other. KPG regularly increases margins by a significant amount for its companies from single to low teens to nearly 30%. 

Competitive Positioning

The business has roughly doubled in size every 3.5 years. Of course this does get harder to maintain as larger or more deals have to be pursued to reinvest the cash flows and continue to compound at the same rate. The larger the deals become, the more competition from PE, from companies like H&R Block & CBIZ (public competitors), and from other players (Thrive, a VC fund, is incubating an accounting rollup). So how does KPG compete in this playing field besides the alignment in terms of the partnership/ownership structure?

This is where decentralized and centralized decision making comes into play. The centralized part is M&A. Right now KPG is still small enough that every acquisition is meaningful which means Brett Kelly takes a look at it and helps make a decision with the team. The decentralized aspect is the scouting program. As KPG expands beyond Australia into North America and Europe it is hard for a centralized M&A program to source and vet every deal. KPG turns the excellent business operators they acquire into scouts for the business given the alignment that all employees have with KPG’s success as a whole. Who else would be better equipped to acquire other great accounting & tax firms in LA than someone local who already knows the ecosystem and benefits from the growth of the assets KPG owns.

Reason to Own

KPG has a $370M EV, has historically doubled the business every 3-4 years, has reduced share count since going public, is rolling up a fragmented industry, has significant expansion prospects in new regions with even larger TAMs, and has a board member, Lawrence Cunningham, who’s only two other boards are Constellation Software and Markel, both worth nearly 100x KPG’s current EV. Management is highly aligned with external shareholders, transparently shares metrics at every earnings call in a concise capital allocation framework, and is committed to building a durable & lasting business. 

At 32x TTM EBITDA, it’s not necessarily “cheap” but if you believe in the long term prospects I think it’s a reasonable relative valuation and an absolute bargain over the long term as this has the potential to 10x over the next decade. That 32x TTM EBITDA also doesn’t include the operational improvements from KPG’s business system that will occur in the acquired businesses whose EBITDA is rolling up to the total amount in 2024. 

Why Tech Investors Don’t Need to Just Invest in Tech

Some people may ask what a “tech investor” is doing investing in a small cap accounting rollup. To that I would say, you can apply learnings from CAC, TAM analysis, culture, industrial organization, gross & net retention, investing through the income statement, and much more to other industries and find hidden gems. The background of being a tech investor I believe uniquely enables an investor in quality businesses to understand components that others may miss by being overly focused on the quantitative vs the qualitative. Founder mode for the win!

FYI I wish all businesses would have this level of transparency. Let’s evangelize more clear Capital Allocation frameworks like this!

Monthly Perfomance