In a nutshell

Connor Haley (Alta Fox Capital) made a presentation (video and slides) about multi-baggers.

It turns out two thirds of the performance of multi-baggers comes from multiple expansion, and one third from EBITDA growth.

In the case of $CTS.TO I’ve extracted as much as I can reasonably expect from multiple expansion, and I see risk on the EBITDA front going forward.

Risk vs uncertainty

I sold ~most~ all of my $CTS.TO position. This has been a 3x bagger for me in about one year.

On one side, I can imagine Ian Cassel reading this and shaking his head while saying: “LEAVE YOUR WINERS ALONE!”.

On the other, there’s Mohnish Pabrai saying: “Risk and uncertainty are NOT the same!”.

So what happened with $CTS.TO that led me to sell?

What happened is not new - it was a known development for at least a few months now. But (thanks or because of Mohnish, we’ll see whether I get to blame him later), my interpretation of this development has changed. The development in question is the expansion in Europe. I should say, another voice that had a BIG influence on my decision was that of Bruce Greenwald, an extremely knowledgeable proponent of value investing. I’ve just discovered him and I don’t know how good of a practitioner he is or what his returns are, but I can tell he knows his stuff (note to self: I need ot read his book). In his talks, Bruce emphasizes the importance of local moats in a service-first world and the risks associated with geographical expansions.

Let me try to make the link with $CTS.TO. When I invested initially in 2020, I saw that they had a tried and proven sales model that was very susccesfull with the mid-market. I also understood how they were creating value with their economies of scale. Finally, their runway in North America seemed pretty deep.

So why am I not excited about the European expansion? I’m attracted to high uncertainty, low risk businesses. And I cannot find a way to view this expansion as low risk. The way I interpret risk (again, I’m basically just parroting Mohnish here) is the possibility of capital loss. And I do see a possibility of capital loss in Europe, whereas I didn’t see it as long as they stayed in the US since it was just a rince & repeat kind of play. In Europe, I don’t know if their sales model will be as effective as it is in the US. The CEO has stated multiple times the importance of culture when they consider potential acquisitions. Well now the company is about to enter England and Germany, what are the cultures like over there? I don’t know! What I do know is that competition will be more fierce (the CEO has said so himself) and acquisitions will likely be less cheap.

Also, I’m not sure at all that they will be able to leverage their North American platform. Again, this is a service business. You have to be able to talk to people on the phone, meet them maybe, etc. How are you going to do that accross the Atlantic? I think this means you basically have to create a platform from scratch, and that requires capital More importantly, building a new platform was not part of my initial investment thesis, which revolved around a proven, easy and repeatable recipe.

Now, the expansion could work out and I could reread this in a few years, see the stock trade 5x higher and want to jump off a bridge. It’s totally possible. But I have no way of being sure, and I can’t even have a reasonably high degree of certainty. If I was forced to quantify it, I’d pick 15% as a reasonable likelihood of failure. That’s too high for me given the size of this position, especially at the current valuation: about $1.9B EV, with $56M ttm EBITDA, so 34x multiple for a company growing ~30% YoY.

I know Mohsnish said not to sale a great company even if it looks optically expensive, but in this case I feel like there’s risk ahead that was not there before. Maybe I’m missing something about the true potential of the company and making a big mistake because of that, and I will accept it as the limit of my abilities.

I used the money to buy other companies which in my view have higher uncertainty but lower risk. I don’t feel like naming them since I’ve decided to do my best to avoid commitment bias.

Post-mortem

I’m writing this part abour a week after the first one.

I wonder how much I was swayed by the desire to be active, the thrill of the action, moving money around, etc. It’s hard to say. The truth is, I did see other ideas I was very excited about return-wise (e.g. $EMO.V) which were fighting for my capital. I think this is a legitimate reason to reallocate ressources.

I also wonder whether I was trigger-happy and moved too soon, before having any sort of confirmation of my doubts. In other words, I don’t know for sure that there are problems ahead for $CTS.TO, far from that. Maybe I should have waited for the problems to manifest themselves before taking such drastic actions.

Ian Cassel said: “The great ones always make you regret selling.”. I hope I didn’t sell a great one.

p.s. I kept a micro position just to keep an eye on future developments