We had seven stock prices advance and two decline. The largest contributor was Xometry followed by Avalara and Progyny. Repay and Goosehead were our decliners.

Xometry reported great Q2 results. The highlights included an acceleration in marketplace revenue (up 17% over the previous quarter and 55% over Q2 2021), impressive marketplace gross margin growth (up to 29.2% from 27.4% in Q1 2022 and barely 20% in Q2 2021), new product rollouts to make accessing the marketplace easier for both buyers and sellers and record new buyer additions.

Avalara was our second largest contributor as a result of announcing a deal to be acquired by private equity firm Vista Equity Partners. The purchase price is nearly three times the price of where we built our core position, and we also took some money off the table along the way at higher prices. Nonetheless, we are disappointed in this result. We were not surprised by the intent to sell the company, but the timing – during a deep bear market in software – made no sense for a company with a straightforward growth plan and a large untapped market and led to a price which we believe significantly undervalues the company. On the bright side, we have a strong portfolio at very attractive prices to reinvest the proceeds when the deal closes in Q4.

Progyny reported strong earnings with gross margins hitting a new high. Importantly it also had positive things to say about their selling season which was winding down and gives strong visibility into next year’s revenue growth which should exceed 30% on top of this year’s 50%+ revenue growth.

Repay is wrestling with a short-term headwind from decreased issuance of consumer loans which slows down their ability to process electronic payments on those loans. The world of personal loans and B2B payments is inexorably moving from paper to electronic payments, and Repay will be there to facilitate that transition. But in the interim they had to shave their expectation for internal gross profit growth for the year from 20% to 15%. The long-term adoption of electronic payment methods, however, continues unabated.

ven though its stock price declined as the market fixates on short-term macro concerns, primarily around housing, Goosehead had as strong of a quarter as we could have hoped for. Goosehead attracts customers in many ways, but the most cost-effective way is through relationships with real estate agents and mortgage brokers who recommend them to new buyers because of their great pricing and the breadth of available coverage. A housing slowdown like what we are currently experiencing is undeniably a headwind for Goosehead, but the company has other arrows in their quiver and the powerful advantage of a substantially better consumer offering. Proving the point, policies in force have grown by 35% over the last year showing the resiliency of the business. When you are building a huge, growing annuity of renewal commission revenue as Goosehead is, policies in force is the metric that matters.

But, the answer to low profitability for carriers is higher rates which is ultimately a triple boon for Goosehead. Higher rates lead directly to higher commissions since commissions are paid as a percentage of premium. Higher rates lead to more consumers shopping for insurance which disproportionately helps Goosehead and accelerates their share gains at the expense of the large captive insurers like State Farm and Allstate since Goosehead represents more than 150 carriers and that breadth of choice almost inevitably leads to better prices for end consumers. And higher rates ultimately restore profitability for the carriers which will lead to an accelerated restoration of contingent commissions. We are very excited about the set up for Goosehead for 2023.

During the quarter, we reduced our exposure to Avalara because of the announcement of its being acquired and the stock’s trading up to near the deal price. We also reduced our position in Xometry as the stock ran up. We reduced our Repay position tactically in order to reduce realized taxable gains, but we will add it back in Q4. We added to every other name because of the value throughout the portfolio. Our exposure to Progyny increased as its stock price reacted to the positive earnings. We added most to Goosehead. It faces near-term headwinds, but in our view its current valuation is completely untethered to the real economy reality of the strength, resilience, and growth of its business. Nothing is going to stop the power of superior choice, value, and service that the Goosehead model delivers, and its runway of growth is enormous.

We recently attended the first ever investor day for a company. Perhaps because of his inexperience hosting such events, the co-founder hardly referred to the lengthy slide presentation and instead spoke entirely off the cuff about the history and future of the business. As you know, we think there’s a lot more wisdom in the words of a successful leader of a great business than there are in a Wall Street sell-side research piece. This business leader did not disappoint. His discussion contained many nuggets that collectively were the equivalent of a 15- minute MBA program.

My favorite pearl of wisdom came when the executive was asked about the company’s expansion plans. The person asking the question referred to the company’s spectacular growth and share gains, record margins and profitability, large geographic expansion opportunity, and incredibly attractive return on recent capital investments. The expectation was set for an announcement of substantial expansion and capital expense. Instead, the business leader (the COO) surprised everyone. Drawing on his real-world experience over decades and with the commonsense practicality and caution that comes from owning 25% of the business, having the business represent his entire fortune, and deep concern for his 9,000 employees the leader simply said, “You can lose a lot more money in times of prosperity than you can when times are tough.”

There are many ways to set cash on fire during prosperous times. Among the most popular bad practices are: massive expansion of physical plant, capacity and hiring after an unsustainable tailwind; huge buildup in inventory, especially inventory that depreciates quickly or for specific applications that may wither; the ever- popular exciting, ill-timed, overpriced acquisition; and perhaps the dumbest of all, the huge share repurchase done as a concession to some short-term oriented activist or to make financial metrics look good while neglecting the long-term investments needed for the business. And the business school endorsed practice of using cheap debt to fund these happy-time investments only compounds the misery. The funny thing about cheap debt is that it eventually needs to be repaid, and you never know what the rate environment will be like when the debt comes due. Investing with a low return threshold because money is cheap and business is currently strong is a sure way to destroy value, although it is a practice that has fed the families of investment bankers for generations.

Many companies vie for the title of “Poster child of ‘what were you thinking?’ over-investing during times of relative prosperity”. It’s hard to beat News Corp’s 2005 acquisition of Myspace (remember them?) for $580M which they divested a few years later for only $35M (although we’ll see what happens to the $44B Mr. Musk has paid for Twitter...). Bed Bath & Beyond certainly belongs in the pantheon of bad capital allocators. At various times during the last decade, they had a business generating north of $10B in revenues and $1B in free cash flow, a debt free balance sheet, $1B in cash, and an $80 stock price. Despite the ever-present existential threat of Amazon and the move to digital shopping and the need to reinvent the business, the company and its board chose to spend approximately $9B on share repurchases at an average price approaching $50 per share. What do they have to show for it today? A fading brand and business on the road to irrelevance and losing hundreds of millions of dollars every year, about $2B in net debt plus another $1.5B in lease obligations that is effectively debt, and a $2.58 stock price.

The manager’s warning about losing money in times of prosperity and the parables related to those who choose to ignore is directly assimilated into the Owls Nest approach. It is why we invest in great companies during times of headwinds rather when the company is everyone’s favorite and enjoying a cloudless environment. Buying during turbulent times greatly reduces the risk of a sugar-high induced bad allocation decision like the ones mentioned above, and companies can never invest in with higher and more certain returns than they can during tough times. Quality companies with cash-laden balance sheets and multiple vectors of growth can go on offense while weaker competitors bail water as fast as they can to stay afloat. It logically takes some time for the headwind to play out and become a tailwind and fully show the power of the moat-expanding investments made during the challenging times, but they are the best investments a company can make.

The recent dramatic increase in interest rates has punished the stock prices of growth companies, but it happily ushers in a period of rational capital allocation which favors strong leaders with significant growth and share- gaining opportunities. A competitor with seemingly unlimited ability to absorb losses is problematic no matter how untenable the business model is. Those competitors can poach talent, bid up the price of assets and acquisitions, sell below cost, etc. The retrenchment or total elimination of flimsy competitors who were successful in raising and burning money takes a lot of pressure off our companies and will allow for higher return investments in a more benign environment.

Above, we spoke to Carvana in part because we are looking at CarMax (Ticker: KMX). We have not purchased any KMX stock yet, but the set-up is getting very interesting. They face the same economic headwinds, but they run a much more disciplined and operationally sound business. Their digital offering has essentially caught up to Carvana’s, and their balance sheet is infinitely stronger allowing them to go on offense as Carvana, which is laying people off left and right in an attempt to avoid a death spiral, retreats. We aren’t there yet, but stay tuned. The situation is beginning to feel very similar to how it did in 2000 when the environment was tough and Wayne Huizenga’s AutoNation shuttered its used car super store business declaring such a model could not make a profit. He and Wall Street were wrong about the model, and the stock was a 100 bagger off the depressed lows, handily outperforming the likes of Amazon.

You own strong companies that are gobbling share in their markets. Our portfolio has a median debt to cap of only 9.6%, and they do not have bills coming due for dumb investments made when times were good. They have strong organic growth with a median organic growth rate of 20% and are now in a position to invest and augment that growth in the years ahead. Their stock prices might be down for a variety of macro reasons mainly, but their fundamentals and long-term prospects are as strong as ever. Just as the COO’s great advice seemed counter- intuitive, so too is that fact that now when headlines are full of doom and gloom is a great time to put fresh money to work in great companies.

For the benefit of any first-time readers, the hallmark of the Owls Nest Partners approach is the purchase of industry leading growth companies when a temporary headwind has recoiled the fundamental growth drivers and compressed its multiple. This typically happens as hot money “renters” exit and drive the price down. There is no such thing as a free lunch: we can only receive our requisite value if we accept that our companies will appear “catalyst-less” and uninteresting for some time. We believe we are wildly overcompensated for this modest level of patience, especially since it is in these moments that a company can invest in its own business with the highest returns. There is wonderful optionality associated with a well-run, shareholder friendly, cash- laden company that is able to aggressively put money to work during a temporary headwind.

It is our belief (and experience) that our future outperformance will not be driven by any economic or market forecasting prowess but instead by ten unique investments, each playing out over time. We perceive these investments to have modest downside due to high quality and low expectations, and very significant upside as growth and margin expansion return in spades. We seek reasonable ballast and diversification within the portfolio as a result of our natural conservatism (strengthened by our co-investment alongside clients) and our predisposition to avoid crowded trades and instead invest in temporarily out of favor areas.