Luis Sanchez drives home the Endor thesis (Podcast #107)

Luis Sanchez, founder of LVS Advisory, discusses his bull case for Endor AG, including why competitors can't recreate their product and how they benefit from the current boom in motor sports like F1 and NASCAR. You can find my notes on Endor here and Luis’s pitch at MOI here.

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Transcript begins below

Andrew Walker: All right. Hello. Welcome to Yet Another Value Podcast. I'm your host, Andrew Walker. If you like this podcast, it means a lot if you could follow it and leave a rating wherever you're watching.

With me today, I'm happy to have Luis Sanchez. Luis is the founder of LVS Advisory. Luis, how's it going?

Luis Sanchez: Great, man. Thank you so much for having me.

Andrew: Hey, thanks for coming on. I've been meaning to have you on for a while, because I know you and I share a big interest in match.com. But we're talking about a different stock today. Well, we'll get to that in a second.

Let me start this podcast the way I do every podcast. First, a disclaimer to remind everyone, nothing on this podcast is investing advice. That's always true.

But today, we're going to be talking about a very small, pretty liquid international stock. Just going to remind everyone, please do your own work. Please consult a financial advisor, not investing advice.

Second, I'd pitch for you. My guest, you run the exact type of portfolio. I love to have a thoughtful portfolio about ten portfolio companies in there. I know a lot of them. I really like them. I know you do great detailed work. That's going to be really obvious in the name we're talking about today. You pitched it at MOI. MOI is-- I can't remember what it stands for.

Luis: Menu of Ideas.

Andrew: Menu of Ideas. You did a great pitch there. I've got the deck. I'll be sure to include it in the show notes. People can check that out.

But that out of the way, let's turn to the company we're going to talk. The company is Endor. It's traded in Germany. I'll just turn it over to you. What is Endor? Why are you so interested in them?

Luis: Yes, for sure. Just to echo, I run a registered investment advisory firm based in New York. We are long shares of Endor. Just want to get that disclosure out of the way. Do your own work. I have a deck that I published. It's on my website. I posted it on Twitter.

Andrew: There'll be a link in the show notes. [crosstalk].

Luis: That'll kind of fill in some of the things we're talking about here. Look. I'll give the fifteen-second overview. Then we could unpack it. There's a lot to unpack.

Effectively, this is a riches-in-the-niches play. I really like companies that dominate a niche, right, with very strong unit economics. I would say Endor, they dominate a niche. The niche is growing at a double-digit rate. The niche is going to become more important over time. The mode is just super deep. It's founder-led. It trades at a very reasonable valuation. In fact, I would say it's even undervalued. That's just at a high level if you just think about it like that. I tend to like those setups.

To kind of dig a bit deeper, Endor, they own a brand called FANATEC or FANATEC depending on how you want to pronounce it. They're a dominant hardware provider in a niche called simulation racing.

Simulation racing is something that is at the intersection of a bunch of really interesting trends. What simulation racing is is it's basically people who are doing virtual races online. It kind of crosses with the video games but not exactly, because simulation racing actually has a lot more to do with professional racing like F1 racing.

The interesting intersection here is it's simultaneously a video game play, an esports play. Another thing that I think people misunderstand - it doesn't come across; it's a bit nuanced - in a lot of ways, you could think of Endor as kind of like a supplier to F1. It's a very integral and growing part of the F1 ecosystem, not just F1 but motorsports generally.

What they're providing with their hardware is an ecosystem of steering wheels, pedals, seats, basically, everything you need to do to set up a pretend race car in your house. They sell these for anywhere between-- I think the starting price is about eight hundred dollars. It goes up to thousands of dollars. If you really want to splurge, you could spend three or four thousand dollars on an Endor setup.

Let's see. It's kind of a luxury product in a way, because there are competitors. But their competitors are really much the lower-end equipment. Basically, their competitors are selling toys. They're selling a hundred, two-hundred-dollar toys. Endor is selling branded carbon fiber material with leather-wrapped wheels. They have all these partnerships with OEMs that get people excited. They sell limited edition wheels that people collect.

There're two primary audiences for their product today. One would be people who are very fanatical about racing esports. There's a bunch of seasons and leagues, virtual leagues. The most popular one's called iRacing. There're hundreds of thousands of people who are competing in these leagues. A lot of them stream on Twitch. A lot of them stream on YouTube. The people who make a living streaming, they're virtual-simulation racing. It's become a bigger and bigger end market, because there's real sponsorship behind it and increased viewership. The viewership is astounding. We could get to that in a minute.

The other audience for their products is people who actually want to go pro or people who are pro. I'm sure a lot of people are familiar with F1, the sport, or have seen Drive to Survive. But the logistics behind F1 are pretty incredible. There's only a handful of races per year. There're dozens of people that need to go to these races to set up all the equipment, sending the equipment over to Australia or Monaco. Recently, Miami is a huge endeavor.

If you're an F1 driver and you want to have real world, as real as it gets like practice, test driving tracks, and the most realistic conditions or just trying things out or just staying sharp, this is actually the best way to do it. Pretty much, every F1 team has a very integral simulation racing program with this type of equipment. Some of it is supplied by Endor. There's some other higher end, more like specialty niche suppliers.

The other aspect, too, is if you want to go pro but it's not viable to buy your own race car, this is an affordable way to kind of get real-world experience, go compete on the online tournament to get noticed. People are actually coming up through the ranks and getting noticed by teams and given a shot through this activity.

Andrew: I saw this in your deck and stuff. I kind of didn't believe you till you shared a video with me. It's a guy who's I don't think a full-out pro. He's a semi-pro. He streams. He competes it on tracks and everything. He was saying like, "Look. This is the best way. People are actually getting scouted by going and being elite at simulation racing." That's how you're scouting for new F1 drivers now.

He also said, "This is how I train. The skills are completely transferable. Sometimes I forget that I'm in a simulation versus a car."

I was really impressed by how highly someone on the inside spoke of it: not you and me, investors sitting at a desk staring at their screens but somebody who actually makes his livelihood from it. He was saying everything that you're saying.

Luis: Absolutely. This is also a fairly new thing. Endor was founded in the late 90s. Logitech's been selling play wheels. Growing up, I used to go to the arcade. It was like Cruis'n USA.

Andrew: Oh, yes. Oh, yes.

Luis: It's like a wheel. I guess it helps to talk about the evolution of this and where it's come from. That'll actually help explain the moat here.

If you think back to the arcade style wheels like the Cruis'n USA, that technology is very crude. Basically, what's controlling the wheel is this bungee cord, right? That's literally it. The wheel, they try to give you feedback on how you're turning through the bungee cord, right?

In the last ten, fifteen years, the hardware suppliers created this thing called belt-driven technology, using a belt to control the wheel. It gives a bit firmer feedback. It's a little bit more realistic. But it's still not quite there.

What Endor pioneered in the last five years really is what's called direct drive. Direct drive is effectively you're putting an engine behind the wheel, and the engine's giving you very precise movements. It's giving you very realistic - as realistic as it can possibly get - feedback on the wheel. You're feeling everything from how hard you're turning to kind of like the g-forces on the car, if there're bumps in the road, if the track is slippery.

That's like this combination between the wheel, the direct drive motor, all these equipment that you're using and then the software. The software is really good, too.

Andrew: That is my next question, the software behind this, right? Because what strikes me is I'm on it. I'm driving on the track. I'm feeling it differently if it's slippery or if I'm taking a hard turn at 400 miles per hour versus a soft turn at 20 miles per hour.

Is Endor making the software that's providing all this feedback? Or it's somebody else who's making the software, and it's obviously integrated with the Endor product.

Luis: Endor is not making software today. That is something that the company has called out as an opportunity in the future. They've called that out as an opportunity both in the sense of, yes, there's software that simulates the race. But they've also called that an opportunity to sell like training software to help people improve their game like coaching.

I actually have spent a lot of time covering the video game industry and covering esports. Training software is actually a really big business and other types of esports, interestingly.

Andrew: I know you've got Autodesk. You know all about software and everything and Evolution Gaming and Flutter. You've got tons of online gaming [crosstalk]--

Luis: And former shareholder of Take-Two and Activision. I've spent a lot of time. That's actually one of the reasons I was able to kind of really understand what this is and what it's not, right?

Andrew: There are two other interesting companies that I'd love to do a podcast at some point. That's in the future.

Let me back up for a second. The first question I always ask-- that was a great overview. I've got lots of places I want to go in this [crosstalk].

Luis: I actually like to say one thing about the software. The reason why the software is so good-- there're multiple providers of software with varying degrees from high-end to low-end. I'm not talking about video games like Mario Kart. There's an F1 game [crosstalk]--

Andrew: Don't besmirch Mario Kart on this podcast. We stand for Mario Kart.

Luis: The software, first of all, is primarily done with high-end gaming PCs, right? The tracks, for the most part, they're taking real world tracks, the actual racetracks, like the Monaco or the Miami. I don't know. I'm assuming they have Miami at this point.

They're not just taking an architectural blueprint of the track. They're laser scanning the tracks. They're getting all the bumps, all the turns, and putting realistic conditions.

You can go and do your own research and hear what F1 drivers say. But when we say like, "This is as close to driving a race car without driving the race car," it really is. It truly is professional-grade training equipment.

Andrew: Perfect. No. That's great. I've got some more points that I want to dive into there. But let me just back up for a second. First question I like to ask a few podcast guests. I'm a pro, because I'm asking it twenty minutes in.

But look. The market is a competitive place, right? When you make an investment-- obviously, you're making an investment, because you think on a risk-adjusted basis, it's going to generate alpha.

First question I like to ask. What are you seeing here that the market is missing that's kind of presenting this risk-adjusted alpha opportunity?

Luis: Absolutely. I apologize. My internet connection's a little unstable here.

I made this mistake when I first started looking at Endor. I was very skeptical of it. Most people view Endor as a video-game hardware supplier.

The business of being a video-game hardware supplier is it's just not a very good business, right? It's very cyclical. It usually tailwinds when there's a hardware console cycle. It's competitive. There's a ton of other video-game hardware suppliers whether it's Logitech. Endor competes directly with a company called Thrustmaster, Corsair. These are companies that typically don't trade for the highest multiples-- hardware itself is known to be not a recurring revenue model, right?

Where I started to get really comfortable with it and really got bullish is understanding to two to three things. The first is that given that their primary and market is more of, yes, leisure, but it's a serious competitive endeavor. I'm talking about the e-sport. I'm talking about also the folks who want to go pro.

If we just talk about the e-sport for a second, there's hundreds of thousands of people who are competing. Every quarter, there're seasons, right? If you think about it, these guys want to make sure they have the best hardware every season. They're constantly upgrading their rigs. Basically, Endor's system is modular.

Two-thirds of their sales, they're selling to existing customers who are making slight modifications. Maybe they want to change the wheel. They remove the wheel; keep the motor; they put on a new wheel. They want to buy a new pedal. They want to do something else. Maybe Endor comes out with a new upgrade that they didn't have before. There is this semi recurring nature with their core customer base.

The other idea is because they're supplying basically professional users, that's just not a very cyclical end market, right? Neither those are cyclical, right?

The other thing that I think took me a while to understand but really which I understood through just talking to a lot of customers-- I can go through how I did that. In addition to being a professional-grade training product, it's also a luxury branded consumer product where they sell things that are very high margin. They're using, in some cases, luxury selling tactics or scarcity marketing, collectibles.

There's a really interesting similarity here with WWE. WWE sells replica belts, right?

Andrew: WWE is one of my largest positions for a long time. You're really speaking my language when you bring WWE [crosstalk].

Luis: Endor has licensing agreements with almost all of the major car brands. They'll go say, "Oh, do you want to buy the replica wheel that Mario Andretti used to win this Grand Prix?" They'll make a thousand of them. They'll pre-sell these. On eBay, these will go for 3X the price, right?

Andrew: That's really interesting. Let me give one quick push back there. You compared it with WWE. The nice thing about WWE is WWE owns the IP, right? When they do these limited releases, they get to keep all the margins for themselves. Even if they did a limited release of The Rock or something, The Rock doesn't get the money. The WWE, I believe, actually own the character, so they keep it.

Whereas with Endor, if they're going in a typical and were probably like, "Ferrari just won the championship. You're a big Ferrari F1 driver. Here's a limited release five hundred Ferrari We are the Champion Wheels," they have to license that from Ferrari, right?

Yes. Endor's the biggest and the best player here. Disney, I've heard people say, "Oh, this company has the license to Disney products. That's an edge." Like, "No. Disney's a competitive killer. They're going to suck every bit of economics out from you. It's going to go to them. You just kind of make your cost of capital."

Why wouldn't all the margin for these limited releases go to the person they're licensing, not Endor?

Luis: Pretty much every wheel Endor makes is licensed. Every wheel they make is some kind of licensed. They're selling these wheels for five, six, seven, eight hundred, nine hundred, sometimes a thousand plus dollars per wheel.

Andrew: Just to clear. When you say every wheel is licensed-- I'm just looking if they're like every wheel has a brand. Oh, now I'm seeing it. Actually, now that I realize [crosstalk]--

Luis: If not every wheel, almost every wheel. It's a huge part of how they get people excited about this.

Andrew: When I zoom in on it, I am seeing like, "Oh, this one has the Ferrari symbol in the middle. This one has the BMW." Yes. Okay. I see that. Yes.

Luis: It doesn't take long to realize the unit economics are pretty good just by looking at their financials. Their gross margins are above sixty percent. Because they're selling these wheels for eight hundred dollars.

Yes. These are nice. They're leather wrapped. There's good material. This is what I mean when I say it's a luxury consumer product.

The way that I got comfortable with that is I got on Twitch. I spent a week watching Twitch streamers. I was subscribing. I was tipping them and making friends. I just was asking them a ton of questions, "Hey, why do you use this wheel?" I was also asking people who weren't using the Endor wheels like, "Hey, why are using the Thrustmaster wheel? Don't you know about Endor?"

It's really clear that anyone who's serious about this activity will eventually use an Endor wheel. It's aspirational.

Andrew: When you would ask them why they were using a Thrustmaster wheel which I'm assuming is their big competitor, why were they using Thrustmaster instead of Endor?

Luis: It's just because someone's streaming on Twitch. They're just trying to have fun playing the game. They're not serious about it or like, "Oh, my friend bought me this wheel," or, "Oh, yes. I'm not good enough to buy that wheel. I don't spend enough time on this where I want to spend a thousand dollars on a wheel."

Andrew: If you're a casual streamer or you're a ninja and you're a super serious streamer but streaming racing simulations isn't your best game, maybe you go with the Thrustmaster. But if your life is simulation, if you're trying to be pro or you're trying to build a real [inaudible], you're going to go with the Endor brand product.

Luis: Yes. Absolutely. Most people who stream on Twitch or esports, they will post their equipment in their profile. You could look. The vast majority of what people are using are the FANATEC products. If you look, a lot of celebrity drivers have YouTube channels and are live streaming on Twitch now, too. It's pretty much all Endor almost without exception especially the pros.

The other area that it really stood out is just by going on social media, going on Reddit, subreddits, subreddit for sim racing, subreddit for FANATEC. You really quickly understand that there's a massive cult following for this brand. People are posting their wheel collections. Usually, they're posting walls of wheels and all their different types of sim racing equipment. There's a real fanatical brand following.

I have studied some of the luxury companies. It really reminds me a lot of that kind of behavior.

Andrew: Let me ask. Not quite razor razor blade but a little bit like that where Endor comes out with a new model, new mod, new better pedals or whatever. People are going to upgrade, right? It does make sense to me that if you are an F1 driver, hundreds of millions of dollars on the line, you are always going to be paying for the absolute top end simulation equipment, because anything that saves a fraction of a second off your time is a huge competitive edge.

But if you are a serious Twitch streamer or something, how necessary is it to make upgrades? Because I do wonder. I have an Xbox in my house. I don't need to upgrade to the new Xbox. I don't play games that much or something.

How necessary is it really to upgrade your Endor? Or could you just buy one, rig once, then kind of use it for five years, so it's fully depreciated?

Luis: Yes. The industry has developed pretty quickly. Five years ago, compared to today, the technology has just been refined so much. I think there will continue to be innovations. Maybe the accuracy of the direct drives get better. Okay. Fine. Maybe if you're not super serious about competing, you don't care that much.

But a lot of it just has to do with being an aspirational product, right? When you're streaming and you post your equipment on your Twitch channel, and everyone sees it-- Endor is really really good about partnering with popular streamers and YouTubers in getting their products well-reviewed and well-followed. Most of the marketing that they do is either they sponsor leagues. They actually sponsor a real-world racing tournament which we could get to in a minute.

But a lot of it is just viral marketing, sponsoring social media influencers, and just creating this viral buzz around their product. They're very very savvy at it.

The other thing - this kind of gets into where I believe there's actually a really nice catalyst - is Endor really started in that more high-end hardcore segment of the market where their average unit, their average cost was really pushing two thousand dollars per rig.

They basically have three tiers of product. They have a Podium League, a CSL, and I believe it's called Sport. Now, they've been able to kind of get into lower price points without sacrificing too much quality. They recently launched a line that's actually specifically optimized for specific popular games on Xbox and PlayStation.

They're the official wheel of the new Gran Turismo game which came out in March which we think that's a huge growth catalyst in the next twelve months.

Andrew: Let's come back to that, because I do want to talk about the move into casual game, because it strikes me as both risk and opportunity.

Right now, as we're speaking, Endor trades for about fifteen euros per share. That's seventeen times price to earnings, if I'm looking at this correctly, which sounds nice. But I think the first thing anyone's going to ask when they look at this is they're going to say, "All right. Endor was a mammoth code beneficiary."

I remember we were talking about this before. My buddy, Jeremy Raper, when Endor was at five at the height of COVID, he was like, "Sales are exploding for this thing. You need to look at it, because the markets not picking up how big it is."

2018 sales, forty million in euros, seven million in EBIT, four million net income. I'm looking at your deck. 2021 was eighty million euros. Net income actually wasn't great, because they had some logistics. Probably we can talk about that. But net income triples from 2018 to 2020.

I was looking at the stock chart. The IPO was in 2006 and the stock does nothing for thirteen or fourteen years until COVID hits. Then sales explode.

I guess the first question anyone's going to have when they look at it is they're going to say, "Hey, I've seen this story play out so many times over the past two years," right? "Company explodes their earnings during COVID. COVID starts swinging away. People start going outside. People bought all the units they have." Peloton kind of comes to mind. They sold a lot of units in 2020 and 2021. Then they sold all the units. There's no one left to sell to.

When I look at Endor, I worry massive COVID beneficiary. Is there a hangover coming as we kind of lap [?] all these comps? As they said, "If you're F1, you're always buying the top end." But maybe a lot of the guys say, "Hey, I just spent three thousand dollars. I'm rigging 2020. I don't need to upgrade right now."

Luis: Okay. Great great question and definitely something that we thought about and we're concerned about.

There's a couple of metrics that we track. I'd say there're basically three key drivers of growth here. The first is esports competition. Those hundreds of thousands of people who are competing in esports, are they still going to be competing? Are they still going to be buying Endor products?

Actually, I don't have this in my deck. But there's actually data that you can track like the popular esports leagues for this. The most popular one's called iRacing. You see this huge step change increase in the number of competitors between 2019 and 2020. It goes from let's say twenty thousand competitors a season to a hundred thousand. Maybe it hit eighty thousand in 2020.

You can track every season. There're ten seasons in a year, twelve seasons in a year. You could see in each cohort how many people are playing on iRacing. What you'll see is not only has it maintained in terms of the number of competitors, but it's actually continuing to grow, so that in 2021, the seasons were bigger than 2020.

The early indications that we're getting in 2022 is we're seeing something on the order of about twenty percent growth over 2021 in terms of the number of people who are playing on the most popular esports competition, right? It's been a very steady number and kind of a gradual increase.

As far as we're concerned, most of the COVID beneficiaries have already started to roll over. You've already started to see if they were just temporary beneficiaries. You've already started to see if their end markets weakened. We're pretty confident here that this is maintained. We have basically monthly data going back for several years. Happy to share that with anyone.

The second thing is Endor, what this really is is it's part of the motorsports' media ecosystem. Motorsports is having a moment. F1 is having a moment. Drive to Survive is huge.

Andrew: You're cutting off my next question. You're hopping ahead of me. But I love it.

Luis: Drive to Survive is huge. It's huge globally. In the US, it's obviously having a moment, too. We just had the the F1 Grand Prix in Miami. We're having one in Austin. The Miami one was so successful; I think they're getting a permanent date.

The TV ratings for Formula 1 are the best I think in history, at least, the best in the last thirty years. According to some reporting I saw, so far in the 2022 season, there's a forty-nine percent increase in the TV ratings for F1 relative to 2021.

It's not just F1, because NASCAR ratings are actually up across the board as well.

Andrew: Really?

Luis: Yes. You could trace this. You could actually trace this. It's not just a Europe and North America thing. It's also Asia, China - F1's becoming a lot more popular - Latin America. This is becoming a very popular global sport. It's a really incredible wave. I see that continuing. That's a major driver of interest here for a number of reasons.

First of all, you have these celebrity drivers who are live streaming. They're talking about simulation racing in their interviews. They're posting about simulation racing on Twitter and their social media, on their YouTube channels.

If you're a fan, you go to these events. They have simulation racing rigs at the events. If you're a super fan and you want to be more interactive, you can actually virtually race on your at-home rig. It simulates how the actual professional drivers are doing in the race. You can get virtually race with them, right?

The video game thing, we talked about that. We can talk a little bit more about that. That's more of a call option. I think the video game growth is more of a call option for me.

But where this gets even more interesting is you see all the major racing organizations. It's not just F1. It's not just NASCAR. You're seeing the rally racing organizations. You're seeing the tier two, tier three racing organizations. They all are investing a ton of money into promoting, to creating esports leagues. They all have esports leagues, creating huge prize pools, attracting more racers. Now, what we're seeing is there're leagues that are even incorporating simulation racing into the main prize pool events.

There is a league called the GT World Challenge. Last year, they debuted this. There's a simulation race that happens the same weekend as the real race. The teams have a simulation race. Sometimes it's the main race. Sometimes they have someone else.

Last year, there were three points that were allocated towards the main racing championship points. It was very popular. They've expanded to the five points this year.

When I asked the CEO, "What is your growth thesis," his response to me was, "The merger between the virtual and the real-life worlds of racing." It's effectively a metaverse play. But that's a really exciting aspect of the long-term growth thesis here.

Andrew: If I can just hop in here and spitball in two things. Everything you said was interesting. But the two things in there that really opened my eyes were, A, NASCAR ratings being up. I remember since 2006, NASCAR's been in frequent decline. Small-cap investors might remember Dover Downs was publicly traded. Actually, another one was publicly traded, ISCA, I think if I remember, International Speedway.

They had real trouble, because NASCAR ratings kept going down, and their TV contracts were getting renewed. The fact that there's interest there shows me that there is a lot of interest in motorsports in general. It's kind of reviving. It's having a moment as you said. Obviously, F1 and Drive to Survive has that. But I think that has your legs.

Number two, I do think it's interesting. I love basketball, right? I can't go play LeBron James in basketball. It's not the same if I go load up NBA 2K and play LeBron James in basketball in NBA 2K.

But with this type of stuff, I do think the future is things that are really interactive. The cool thing about a driving simulation that so much mimics real life is I can load up and they can say, "Hey, here's a," I don't know. Mario Andretti is a popular survivor. Who's the guy who wins all the races in F1? I don't even know. I'm not a big F1 fan.

But you can load it up. You can actually challenge them. Or I'm sure at some point, they'll be, "Hey, you can pay ten thousand dollars and go have a three-minute race against this famous F1 driver," or, "Donate fifty thousand dollars to charity, and we'll put one person into an F1 simulation racing," or something. That really places you to these trends.

I just thought those were two really cool things you said that play really well into the trends going forward.

Luis: I'll expand on that, right, because there's this other aspect of just esports' viewership is also significantly growing. There's a lot of people who maybe have no interest in the real-world sport, but they like video games. They like esports.

All of the car brands, they have their sponsoring esports teams. Some of the F1 professional drivers are actually also competitors on the esports teams, because they love it so much.

The key here--

Andrew: People might-- go ahead. Go ahead.

Luis: The key here for the racing organizations and the reason why I think we're having a renaissance in ratings for the sports is because they've figured out how to reach young people. For F1, part of it was Drive to Survive. It was just incredible brand marketing. Netflix has just such a great reach. The way that they packaged it just made it so cool. They got so many new people interested in the sport.

The other thing is I've spent a lot of time setting the video game ecosystem. The demographics are really clear. Younger generations, Gen Z, they consume more video game entertainment than any other type of entertainment.

If you just look at the size of the video game industry, it's a two-hundred-plus-billion-dollar annual industry. It's larger than TV, movies, and music combined, right?

What these racing organizations are realizing is in order to get young people excited, they need to go to where they are which is Twitch, YouTube, social media, and video games. F1 has a video game that comes out every year. I don't think that was a thing five years ago.

Andrew: The company that made the F1 game, if I remember correctly, they were publicly traded. There was a bidding war between Take-Two and EA to buy them which I participated in way too small of a way, in hindsight. But there was [crosstalk]--

Luis: That was an incredible overbid.

Andrew: Were you involved there?

Luis: Unfortunately, I don't think I was.

Andrew: I had a token position. I thought it traded a discount to deal. I was like, "This is one of the easiest, strategic bolt-on assets I've ever seen. We make one sports game; there are two giant sports companies that come buy us and take all of the costs out." It sounds so easy in hindsight.

Let me ask another question. We kind of hit on why you think this has more legs than just the COVID beneficiary.

Luis: Yes and--

Andrew: Go ahead.

Luis: Maybe a clarification, too, is I don't think anyone, even racing fans, really even knew this was a thing before 2020, right? What happened in 2020 was they suspended real racing. F1, they had a virtual Grand Prix where the real racers all competed. They televised it.

NASCAR had a similar thing. They had a virtual NASCAR series. I think they had half a dozen races. I think on average, they got more than a million viewers per race on broadcast TV which, by the way, is unheard of in esports. They've tried to broadcast esports on major TV, and they never get good ratings.

But I think there was just this big introduction to what this was in 2020 that was very unique. Now, we're kind of just riding the wave of not just people now know about this and realize how cool the technology is but also just the wave of the popularity of the underline sports.

Andrew: Sports are a little bit of a network effect, right? If no one else is interested, it's not as much fun. But if all of your friends get interested and you go from five thousand followers to five hundred thousand followers in the sport, that does create a network effect where, yes, you want to keep investing into the things, so you can kind of stay at the top and beat your friends and stuff. That does create a network.

Let me ask the other question. Again, I think we've addressed why this wasn't just a one-time COVID bump. It was a little more sustainable, the interest in motorized sports in general, all the stuff.

But there is the question of valuation, right? Net income goes from four million in 2019 to twelve million in 2020. This is all in euros, right? I think in your deck, you're saying it's probably going to be around twelve, thirteen million in 2022. This is a two-hundred-and-fifty-million market-cap company in euros.

We're talking about paying seventeen, eighteen, twenty times earnings, right? I get there are tailwinds here. But this isn't going to be thirty percent growth or anything. I guess there's the opportunity cost of, "Why am I going to pay almost twenty times earnings for this when we're in a pretty brutal market right now and there's some pretty cheap stocks out there?" Why is this the best kind of risk-adjusted return?

Luis: For sure. There're two aspects of that. The first is on the revenue line where the company had a very unfortunate supply chain issue in 2021. Effectively, in 2019, they were doing forty million euros. Their business increased a hundred and fifty percent basically to 2020. There was a lot of momentum for them to sell more products in 2021, but they got stuck with the semiconductor shortage.

The company made a lot of mistakes internally in terms of just not carrying enough inventory and some other product issues that they had. But a lot of it's also not their fault, because they went from selling forty million euros a year to a hundred and something.

Andrew: I know this isn't Peloton. But you say the story, and so much of it does sound a lot like Peloton, right?

Luis: Yes. Yes. I think that's fair to a degree. But where they're basically at with it now is they basically had a couple of quarters mid-2021 where they just didn't have the inventory to sell. They addressed it by the end of the year. They basically had a record Q4. They're having a record Q1.

I think they're going to grow top line this year, somewhere in the neighborhood of fifty to sixty percent year-over-year. A chunk of that is just demand that shifted from last year to this year. Another chunk of that is all these other things that we mentioned, plus we're having a massive video-game hardware cycle right now.

On the revenue side, basically, I'm pretty comfortable that we're going to have double-digit revenue growth. It's really hard to know for sure. But from pre COVID - 2014 to 2019 - their revenue CAGR was over forty percent, right? This was always a fast grower. It was just a much smaller industry.

Another way to kind of benchmark this is they have a publicly-traded competitor. Thrustmaster is owned by a company called - going to mispronounce this - Guillemot. It trades in France.

Andrew: A-plus for effort. A-plus for effort.

Luis: I'm not going to try that again. Thrustmaster had a monstrous 2020 just like Endor did. And last year, Thrustmaster, on top of the 2020, grew an additional fifty percent in terms of revenue. They're also expecting continued strong growth this year.

Andrew: They're projecting growth this year. That's really [crosstalk].

Luis: What you saw with Endor is basically flat sales from 2020 to 2021. A lot of that is just demand shifting.

Then that leads to the obvious question, "Okay. Well, if you can't buy Endor, are you just going to buy something else?" But the problem is that - this is where why the riches-in-the- niches thing is really interesting - Endor is a monopoly at the high end. Basically, if you're trying to buy something that is more than a couple hundred dollars or euros, Endor is your only thing that'll give you any kind of semblance of quality.

What I mean by that is Logitech and Thrustmaster - there's a couple of other marginal players - haven't figured out direct drive. They're still using belt-driven technology.

Andrew: Oh, interesting.

Luis: You can't really--

Andrew: Is it patent? Is it patent that's preventing [crosstalk].

Luis: It's not patented. It's just not easy to create. That's why Endor had supply chain issues, because--

Andrew: I see.

Luis: -- it's just not an easy product to manufacture and to manufacture at an adequate cost.

Andrew: Interesting.

Luis: Just think about it for a second. I don't know if you've ever used a Logitech wheel. The most popular one's the G9.

Andrew: I think when I was a kid maybe.

Luis: These are plastic wheels. These are plastic. Endor is manufacturing things that are steel or carbon fiber, real materials that are automotive grade, right?

Actually, another interesting twist is that Endor now has a wheel that is interchangeable between a real race car and their own rig. Basically, Endor is making F1-grade products. Whereas their competitors are making toys.

Andrew: That does make sense. But I'm just pulling up Logitech's financials right now, right? Logitech, massive company, right? Massive company. I understand this is not their focus. But they spent three hundred million dollars in R&D in 2022. That's more than Endor's revenue, right?

I get you. But at the same time-- and this will actually bleed nicely to my next question.

Luis: Logitech tried to buy Endor during [crosstalk].

Andrew: Oh, did they? When did they try to buy them?

Luis: I think the company mentioned this in one of their calls. I think it was in 2020/2021.

Andrew: This will bleed nicely to my next question. I hear you. But I look at that Logitech R&D budget of three million. I'm like, "Really? If they really wanted to recreate the Endor thing, I get--

Luis: I don't think they could. We've done a number of calls with former employees. There're some [inaudible] calls out there, too.

Andrew: [inaudible] sponsor at the podcast. Thanks for lobbying it up for me.

Luis: Yes. Shout out to Stream as well. There's a cultural magnet that pulls anyone who really wants to work with the best technology through this company. What you'll see when you talk to anyone in the industry is it's like comparing LVMH to Coach or Kors.

Andrew: I looked at Regeneron for a while. I was just having trouble, because very similar to Endor or Logitech. I was like, "Look. Regeneron, they're annual sales budget is a fraction of Pfizer's R&D budget. How are they coming up with these technologies Pfizer can't replicate?"

The thing I consistently got was like, "Look. It's culture. If you're the top virologist in your field, it's similar." Google says their top engineer's worth a hundred times their average engineer, right? If you're the top virologist, you want to go work for Regeneron, because that's where the coolest stuff is getting done. Yes. You're going to get paid well at either place. Maybe you'd make more at Pfizer. But you just want to be on the cutting edge of the field. That really reinforces itself.

Luis: A couple other things that kind of demonstrate the point. The first is just Endor basically invented this direct-drive wheel. They've pioneered it. The founder is still the CEO. He's viewed basically as the Steve Jobs of the industry.

Andrew: My last question was going to be about him.

Luis: He is the guy. Basically, the way that this company is described is a group of simulation racing nerds who have a company. A lot of times, what that translates into is a company that's undisciplined. It's a science project. But this company actually generates real earnings.

The last thing I'll say about that moat there is Thrustmaster used to be the official wheel of Gran Turismo. They lost it to Endor this time. Thrustmaster used to be the official sponsor of a couple of these esports leagues. They lost it.

Andrew: That's awesome. That's really cool.

Luis: What you've actually seen is over time, you would think that they're generating excess profits. This is a growing industry. You'd think that competitors would come in and arbitrage that.

But what we found is their moats have only gotten stronger. Where people have tried to copy them and do things and try to bribe the tournament sponsors and bribe the video games to get those official sponsorships, they're unable to, because there's just such a gap in the product, right?

It's really one of these things where you have to talk to people in the industry. You have to talk to the people who actually use these products. Then you'll understand.

Andrew: I wish I could bump that part up to the first part, because that's the most interesting thing that reinforces the most for Endor that I've heard.

Let me ask last question here.

Luis: Should I address the margins?

Andrew: Yes. Go ahead.

Luis: Just the margin story. Basically, relative to where their operating earnings were in 2020, we believe that they're going to double or triple that over the next five years or so.

What basically happened was in 2020 - historically pre-2020 - they used to do an above-twenty-percent EBIT margin. But what effectively happened was their company, their industry blew up, right? They more than tripled their head count. They had to start building a much bigger, basically, production capacity and more fulfillment, more people in customer service. They had to just invest in the business to scale up.

That's led to growing pains. That's why 2021 was so painful, because they're hiring a ton of people. The supply chain also got really screwed up.

But they're at a point now where they've already made these investments. They have enough production capacity to basically more than three X the annual turnover without having to make incremental capital investments.

It's become a story of operating leverage where the company in their last earnings really said as they kind of get up to scale, they expect to hit an EBIT margin of at least twenty-five percent, right? They're basically at scale. The company itself is very bullish. The founder owns fifty percent of the company. He really believes in the growth story here.

But they see this massive growth, continued growth, and all of those different segments of the market that I mentioned. They see this being a three-hundred-million-plus-euro revenue story in three to five years. Now, they have the infrastructure to support that.

As we kind of get closer to that - this is going to be obviously a key thing that we monitor - we should see continued margin expansion. In the past, they have demonstrated these margins. We feel pretty good about the unit economics.

Andrew: Just to benchmark for everyone, you just mentioned three-hundred-million revenue, three to five years out, twenty five percent margin. At the height of COVID, 2020, this was under a hundred million in revenues. This was a twenty-one, twenty-two percent-margin business.

They're saying, "Hey, we can be way bigger. We can do way more in profits."

Let me ask you the last question here. Then I have one unrelated question for you. But last question. You said how they're moving into a little bit on the lower end, right? They're the official sponsor of the Gran Turismo. If you get that on Xbox and you want an Xbox controller, it's going to be more than just your plastic wheel that it's going to cost. But it's not going to be their three-thousand-dollar rig setup and stuff.

So they're moving into the low end. That's obviously an opportunity. I think the first thing that comes to mind when you have a technology product and you're moving to low end, you're like, "Oh, it creates a bigger market that attracts competition." You've addressed why that won't attract competition.

But I do worry. The history of the highest-end brand moving into lower-end products is not exactly great, right? You kind of destroy your brand. Or yes, you sell a couple extra units. But guess what? Your people who are paying three thousand, a lot of them look over and say, "Oh, we can get ninety-eight percent of the performance for fifty percent of the price. Let's switch there."

I do worry as they move into that. Do they start impacting the brand? Does that create some weird dynamics? Do you have any concerns there?

Luis: Yes. I'll just make a clarification on those estimates, too, the financial estimates. It's really hard to know for sure. Is this going to do two hundred million, three hundred million? There's a range, right? There's a range.

Andrew: The future is unknowable. I hear you.

Luis: A lot of that will just depend on, "Do you think F1 is going to continue to be popular in five years," right?

The company has also hired a lot of talent in the bench. They just hired a COO. They just hired people in between. We have a lot of confidence just based on who they've been hiring, that they can manage the growth, and hit the margins.

On the product moving into lower end, they're not really moving into the low end. They're moving into a lower end. They're moving into an average sale price between one thousand to two thousand, a little bit below a thousand like seven hundred to nine hundred, six hundred to nine hundred.

They're not going to be comparable or competitive with a one-hundred-dollar Logitech wheel. There're some wheels that are even cheaper. They're not going to create plastic toys. Basically, they're going to still create their high-end product. But instead of licensing like a McLaren, it's going to have like a Gran Turismo logo, and it's going to be for Xbox.

I guess the opportunity with the video game segment is by our estimate, there's a few million people who are more serious in the esports competition. In the F1 racing, there's probably a couple million people out there would be a customer of Endor which translates into them selling about fifty thousand to a hundred thousand units per year right now.

But when you start talking about video games, there's tens of millions of potential customers. Right now, we're having a huge hardware cycle where we just had a new Xbox and PlayStation come out two years ago. If you've studied the way hardware cycles work in the video game industry, all the best software for those hardware releases typically come out about eighteen months after the initial-hardware release, because it takes time for developers to optimize their best titles to get the most out of the hardware.

We just had the signature racing game for Xbox come out in November/December. It's called Forza Horizons. We just had Gran Turismo 7 come out in March. These are kind of like the Call of Duty and Halos of racing, right?

On average, a Gran Turismo game sells about ten million copies. Forza does a little bit less, right?

Now, FANATEC is the official wheel of both of those games. I just told you that right now, they're only selling fifty thousand to a hundred thousand units per year. We don't know what kind of attachment rate even if you think a sub-one percent penetration rate of that player base and you're already getting to fifty-k-plus incremental volume.

The good news - we've interviewed the company about this - is they built up their inventory for these products. They have the inventory to sell.

Yes. We're pretty bullish on that. It's kind of uncharted territory, because they're targeting a different end market. But it is kind of like an extension of the ecosystem, right? Because if you get really really into Gran Turismo and you start watching Twitch and then you see your favorite racer, your favorite driver, using the FANATEC wheel, that might make you interested in the product. Then what the company says is, "We want people to get in at the entry level, so they could start the process of upgrading their rigs and get more into it over time."

Andrew: Expand that [inaudible]. Expand the [inaudible].

Luis: I think there's actually one topic that I want to talk about which I want to address the liquidity of the stock and why I think that this is actually a temporary situation. I apologize; I don't think I put this in my notes to you.

Right now, the company trades on an OTC, orphan exchange in Germany. Only fifty percent of the stock is free float. The company is actively working on changing that. They are planning to up list to the Extra Exchange in Germany in the next year or two. Based on their earnings trajectory, we think that the company could support a much larger enterprise value.

The stock is a little bit hard to buy today. But we believe that when our thesis plays out, it won't be hard to sell.

Andrew: Look. One of the best things about these OTCs, you can get stuck in them. They take a while to buy. But the best thing is eventually a lot of them do up list. One of the only consistent catalysts I've seen that really works is you take a good company that's on the wrong exchange; you up list them. All of a sudden, people can buy it in the stock. It works a lot.

We mentioned Jeremy Raper was the one from whom I first heard Endor from years and years ago. But that's one of the best trades he makes consistently. It's, "Buy this company, backwater stock. They up list to the US," or, "They up listed to the top thing." It seems like that will happen here, because this is a real company.

Luis: The we way this plays out for us, if it works, is we think that the company up lists and compounds its earnings power. We think it's either going to get into that situation, or it's going to be sold, right, so then we won't have to sell it.

Andrew: I was kind of wondering at the back of my head. Wouldn't it make sense for F1 just to buy these guys, incorporate them into their bonds? I don't know. Maybe not. But I thought that was interesting.

Look, we've been talking for over an hour at this point. I've one other unrelated question for you. But before I hit that, talks a lot about Endor. We had a lot of really interesting points.

But I want to give you the last word here. Anything you wish we had hit harder? Anything we didn't hit that you think we should have hit on Endor?

Luis: Maybe in terms of evaluation, right? I think it's just kind of given the disruption they had in their supply chain. Looking at a backwards-looking valuation doesn't really make sense. There are no sell-side analysts. You kind of have to do your own work.

Andrew: That's my favorite type. That's my favorite type of company.

Luis: The way that we see it-- our numbers actually trade for low double-digit, multiple earnings on a forward basis. We think earnings are going to be two, three, maybe more, X over the next five years. We think that we're actually paying a really good valuation.

I was telling you before we started that it's not my goal to buy oddball stocks that are illiquid. This is actually probably the smallest company we own. Basically, the bar is much much higher to want to go down into something that's less liquid or a little bit [inaudible] like an international stock.

We basically think the risk reward is really great, because we think that we can three to five X over the next five years. We just don't see a lot of downsides. They have no debt. We really like the management team. It's a great product.

The risk is that maybe we overpay. Maybe it takes a little bit longer to up list. Maybe there's a bit of a COVID hangover. Maybe there's some temporary supply chain issues this year that make the story extend a bit.

We're okay with that long-term perspective. But we also just think it's super asymmetric. It's also just a company that not a lot of people follow and where we think that we've developed a legitimate edge on understanding the story.

Andrew: I think that's right. Based on some of the stuff you told me. Let me ask one unrelated question to Endor. You list ten portfolio companies in your thing. One of them is MoneyGram. Are you still following MoneyGram? Are you still involved there?

Luis: Yes. I'm still following it. I was actually pretty public. Last year, I put out my MoneyGram thesis. I think I even did a podcast about it.

Andrew: You didn't come on here. How dare you?

Luis: We talked about it. But I think the thesis played out a little bit too quickly, unfortunately. Our thesis was that it was very likely to be sold. It was sold.

Andrew: Well, it hasn't been fully sold yet. They held CDO [?].

Luis: It hasn't been fully sold.

Andrew: We haven't closed.

Luis: It hasn't been fully sold. Maybe the other thing we didn't mention is we run two portfolios. One of them is looking for these more growth-oriented companies. The other portfolio's event-driven where we do a lot of merger arb.

It's funny, because when MoneyGram announced its acquisition, it kind of transitioned from one of our portfolios to another one of our portfolios. The environment for merger arbitrage got really dicey this year.

At first, we decided to hold on to it, because there was a decent spread. We understood the story really well. We kind of liked the idea that if the deal got busted for whatever reason, we would actually like to own it even at a lower price.

But we actually decided to sell it a while back, not that long ago. That's more of just a market call. We've seen some things in the financing environment that have changed, not just this deal but a lot of other financial buyer-oriented deals that we've just gotten a little bit more concerned about. We actually sold it.

Andrew: No. [crosstalk]. Look, I--

Luis: We think it's really interesting. There's a lawsuit out there. We've done some work on the lawsuit. The company has made some really interesting statements about that lawsuit. I could talk about that if you like me to.

Andrew: No. You and I can have a quick chat offline. We're going to stop on podcast--

Luis: We're not involved as of the recording. We're very interested in the space. Maybe we'll get back involved, because we know it so well. We really like the company.

Andrew: Losers can feel free to reach out. The only reason I asked is, as you said, I think it's a regulatory investigation. It is a lawsuit at this point. There's a lawsuit.

Luis: The CFPB is suing them.

Andrew: The deal is at eleven. The stock, as we talk, is trading at nine-seventy. That is a big big spread, because people are worried that Madison Dearborn, the buyer, is going to try to use the regulatory crackdown to walk. Obviously, financing environment's gotten pretty bad since this deal was announced about three months ago.

People are saying, "Financing is going to be tough. We've got a regulatory crackdown. Is the buyer going to walk?" Nine-seventy to eleven is a huge spread. But the downside is probably in the six range. There's a lot of downsides if it still breaks through.

I think it's very interesting. But we can leave it at that. You and I could talk offline.

I'll just remind everyone. I'm going to include a link to Luis' pitch on Endor in the show notes. I'll include a link to his Twitter. If you want to go reach out to him and talk more Endor, try and figure out what's going on with MoneyGram, go ahead and reach out to him.

Luis, thank you so much for coming on. We will have to have you on again.

Luis: Thanks for having me, man. This is a lot of fun.

Andrew: Perfect.

[End]