RF Capital Management Q1 2025 Letter

Dear Investors,

In the first quarter of 2025, RF Capital returned -2.43% ¹ net of all fees. In comparison, the S&P 500, Russell 2000, and MSCI ACWI generated returns of -4.59%, -9.48%, and -0.94%, respectively, over the same period.

For FY2024, RF Capital returned +2.78% ¹ net of all fees. Please check your individual statements for your exact returns.

Unfortunately, our holding in Zengame was a significant drag on performance. This is one of the problems with long-term, legacy holdings. Over a multi-year time frame, the stock price should be going up directionally – assuming we are right about the company. However, the share price may be volatile in the short term.

At the end of 2024, our portfolio had 24 holdings. Our top 5 positions accounted for 54.33% of the portfolio. As usual, our top holdings made up the bulk of the portfolio and will be the ideas that drive our returns going forward. The remaining 19 holdings combined for just 18.43% of the overall portfolio.

Additionally, we ended FY2024 with a 27.24% cash position. We anticipate deploying capital aggressively this year given the volatile markets. The market chaos and news headlines provide plenty of investment opportunities for us going forward.

In this letter, we will discuss portfolio management, our firm’s performance, and some of our holdings. Next, we will provide a recap of media appearances, an operational update, and our market outlook for the rest of the year.

Timing Issues And Portfolio Management

As of Q1 2025, our cash position is down to 14.13%. However, cash positions varied across all managed accounts due to trading and timing issues. For example, Sprouts Farmers Market (SFM) is notably missing from a few portfolios due to the new influx of capital. SFM wasn’t a “Buy” in terms of valuation at the time of those inflows, so we didn’t purchase additional shares.

However, this is an aspect of trading and portfolio management that we may have to re-think our stance on – especially for companies that fall under the “compounders” category. Ideally, every investor owns the same companies with the same position sizes. Over the long term, that is certainly the case. In the short term, the number of companies and position sizes may vary. This particular omission in some portfolios hasn’t been favorable.

On the other hand, the benefit of not buying at high valuations is downside protection. In general, companies that hit all-time highs in terms of multiples tend to revert back to a normalized level over the long term. We want to avoid losing money for investors as much as possible. The margin of safety principle is compromised when we buy at all-time highs just for the sake of having the same portfolio composition for all investors.

In any event, we will keep this situation in mind as a case study going forward.

Our Performance

As of October 27th, 2024, we completed our seventh year of operation. Here’s our performance² over the last one-, three-, and five-year rolling periods at the end of Q1 2025:

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Overall, RF Capital’s performance has been satisfactory – especially over the rolling 5-year period. We have beaten the major market indices by a wide margin as shown above.

However, major market index returns aren’t on our minds. We only provide the numbers as context for the effectiveness of our investment strategy. We don’t have a benchmark.

Our goal for the next three years is to continue optimizing and improving our investment process. Ideally, our returns over the next three years will reflect our commitment to excellence. Although the actual returns are out of our control, we would certainly like to increase the margin of outperformance as much as possible by the end of 2027. We would love to have a 10-year track record that the entire team and our investors can be proud of.

Despite our “moonshot” vision for the firm, we also maintain reasonable expectations given the state of the markets and investment management industry overall. Over the long term, we would be quite pleased to generate a 15% return, net of all fees, over full market cycles and rolling 5-year periods.

Sprouts Farmers Market

Sprouts continues to perform well and has posted strong Q1 2025 results. QoQ, SFM’s net sales, comp store sales, and diluted EPS growth increased by 18.7%, 11.7%, and 61.6%, respectively.

The high EPS growth rate may or may not be sustainable over the long term. However, SFM is currently executing at a high level. The gross and EBIT margin profile continues to improve. SFM also continues to open new stores. For FY2025, management is projecting at least 35 new stores. This is certainly doable and is actually shy of their target store count growth rate of 10%. We would like to see them hit that target, but it’s best to be prudent going forward in the current environment.

Comparable store sales growth also looks great and comes at a time when other retailers are struggling. E-commerce sales has been growing at a high rate as well. The addition of Uber Eats as a partner has certainly helped.

Going forward, Sprouts will continue to benefit from tailwinds based on current healthy living and wellness and longevity trends. The company’s upside potential also remains strong given a potential store count of 1,200 stores in the US. Currently, there are 443 stores in 24 states. As long as they keep opening new stores and maintain decent comp store sales going forward, SFM still has a long runway for growth. Additionally, the customer loyalty program that is currently being rolled out will be a comp driver for 2026 and beyond.

Our only concern with SFM is the elevated valuation multiples. As value investors, we prefer to own companies that are optically cheap. However, SFM’s current valuation is certainly justified given the growth in sales and earnings.

For that reason, we continue to hold SFM. The valuation isn’t egregious, and we are perfectly content with maintaining our position. From our initial purchase price of $15-$16/share to the current share price of ~$172, it’s been quite the ride. SFM is the perfect case study for why it pays to hold investments for the long term – even if it feels boring to hear about and see the same company in the portfolio year after year.

Zengame Technology (2660.HK)

Unlike Sprouts, Zengame hasn’t performed well in terms of share price. From our initial purchase price of HK$1.15/share several years ago, the price reached an all-time high of HK$5.88/share in December 2023 before coming back down to HK$2.26/share today.

Despite the depressed stock price, we still think Zengame remains an attractive opportunity. However, the investment thesis has changed, and we are certainly cognizant of that.

Zengame continues to have hit games in its portfolio that generate revenue from in-game item purchases and ads. The current flagship game is Fingertip Sichuan Mahjong, and it consistently ranks in the Top 5 in its category on the iOS bestsellers list. Also, Fishing Master is a game that’s rising in popularity. The game has broken into the Top 20 lately and may break the Top 10 if the game continues its current growth trajectory.

The deep-value valuation multiples are what really make Zengame a compelling investment. Depending on how cash and short-term investments are accounted for, Zengame trades for less than 2x EV/EBIT and the pretax return on invested capital is between 29% and 48%. The company is also currently trading for ~5X earnings and FCF, 0.84x tangible book, and 1.07x NCAV. There’s also a 6.6% dividend yield. In other words, the company has all the key metrics stacked in its favor.

The company is being priced as if it was in permanent decline. We’ve seen much worse companies trading at these multiples. So the question then becomes whether or not Zengame can recapture its previous growth in terms of revenues, earnings, and KPIs.

For the base case, we would view Zengame as a no-growth company going forward. This is a pessimistic view, but it’s best to go with this conservative scenario. Even in a no-growth situation, there’s enough delta between the base case and the market’s perception of the company for us to make money on the stock. The floor valuation has already been established.

If the company does, in fact, continue to grow, there likely will be significant upside in the share price. Continued growth from Mahjong isn’t out of the question, and it seems like there will be more growth from Fishing Master going forward. All the other games in Zengame’s gaming portfolio are also free options. Any of their existing games could explode in popularity. Overseas revenue is another way the company could grow.

At current prices, it pays to be invested to see what Zengame can do over the next two to three years. All high-growth companies go through bad quarters and years at some point. Regardless of whether or not the slowdown is temporary or permanent, our downside is protected going forward. If the stock price goes any lower, it would qualify as a Graham net-net. Even in that scenario, we would be happy to own the company. Zengame would certainly be one of the highest quality net-nets globally.

Our Other Holdings

Our remaining holdings aren’t as exciting as Zengame and Sprouts. Going forward, we’ll sell the majority of these investments to raise cash for our most compelling ideas in “Book 2” (our secondary portfolio where the companies haven’t been given an allocation in our live portfolio).

However, we did make one new purchase this year in a company that will remain undisclosed at this time. We believe this company has some serious upside if all goes according to plan. It’s worth noting that this company isn’t part of our usual playbook. The company is currently unprofitable and their entire pipeline of products isn’t in stores yet. However, we believe this company will be cash flow positive this year. Also, some of their products will make their way onto store shelves soon. In our view, the inflection is inevitable if management executes on what they say they are going to do. There are many shots on goal with this company, and if one or more key events happen, this company could be a multibagger. As we develop more conviction and increase our position size, we hope to provide more commentary on this company in the near future.

Media Appearances

We’ve made a few media appearances via interviews and podcasts since our last investor letter. In case you missed any of them, here’s a recap:

• In May 2024, we had the pleasure of conducting an interview on Idea Brunch with Edwin Dorsey. There, we covered a wide range of topics – from our background and investment process to our favorite ideas. The interview can be found here.
• In November 2024, we talked about special situations investing and Joel Greenblatt’s book, “You Can Be a Stock Market Genius,” with Clay Finck on We Study Billionaires (TIP 677). This was a fun conversation because special situations aren’t talked about much and the book is one of our all-time favorites. The YouTube video can be found here. The podcast is also available on Spotify and Apple Podcasts.
• In December 2024, we did a presentation for the TIP Mastermind Community. There, we provided an overview of our investment process and shared a couple of our favorite ideas. Please reach out if you would like a copy of the presentation deck.
• We also appeared on the Planet Microcap Podcast in December 2024 with Bobby Kraft. This was another great conversation where we discussed our background, investment approach, and a few names. The YouTube video can be found here. The podcast is also available on Spotify and Apple Podcasts.

Going forward, we will continue to do more podcasts and interviews. Given our infrequent investor letters, it’s best to provide our thoughts on investment management, markets, and our favorite ideas in other formats. So please reach out if you have any suggestions for publications and podcasts that you would like to see us in.

Operational Update

In June 2024, we welcomed Yuthpati Rathi to RF Capital as an Investment Analyst.

Yuthpati began his career in tech. His professional experience includes valuation and marketing ROI modeling at Salesforce and Adobe – which shaped his strong analytical foundation and commercial acumen. Yuthpati holds a Master’s in Analytics from Duke University and an engineering degree.

During his time with us, Yuthpati has contributed meaningfully to our research efforts – particularly in uncovering opportunities in under-followed and deeply discounted Hong Kong and Singapore-listed equities. His hands-on experience in tech also helped us understand business workflows where we wanted to understand the role of technology. He also played a key role in primary due diligence, serving as our point of contact when engaging with companies via meetings and investor conferences.

Yuthpati continues to support our team with targeted research and due diligence. His passion for investing, paired with his diverse, unconventional background, has made him a strong and reliable contributor to our investment team.

Outlook

We have never been more excited about the future, given the current state of the global economy and markets. Our opportunity set has widened significantly. We continue to add companies to “Book 3” (our watchlist) at a fast clip. Additionally, Book 2 is extremely attractive right now on a risk/reward basis.

Going forward, we anticipate turning over the majority of “Book 1” (our live portfolio) to make way for several of the companies in Book 2. As a result, we’ll reconstitute Book 2 with companies from Book 3.

From an operational standpoint, we are even more excited about the firm’s prospects. We referenced RF Capital 1.0 and 2.0 in previous letters and interviews. Given the current direction of our firm’s trajectory, we are on the cusp of RF Capital 3.0. In conjunction with the global economy and volatile markets, there has never been a more exciting time to be investing at RF Capital than right now.

We have a renewed sense of urgency and are operating at high energy levels daily – excited by what’s to come in the near future. Speed and accuracy is paramount given the opportunities that we’re seeing in the markets. All of the work and investments that we’ll make this year will set us up for the next 3 to 5 years.

This window of opportunity may not be there in a few years’ time. Thus, it’s highly recommended to add additional capital to the fund today if it makes sense within the context of your overall investment portfolio.

We are also currently open to new investors. It would be greatly appreciated if you could refer any friends that may be interested in investing.

As always, thank you for your support, continued interest, and referrals. Please email me at roger.fan@rfcapitalmanagement.com if you have any questions, concerns, or comments.

Best regards,

Roger Fan, Chief Investment Officer

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Editor’s Note: The summary bullets for this article were chosen by Seeking Alpha editors.