Scottish Mortgage on SpaceX and running winners vs taking profits

In our latest Insider Interview, Kyle Caldwell sits down with Scottish Mortgage’s deputy fund manager Lawrence Burns. In part one of our interview, topics discussed include SpaceX. Burns explains how he approaches position sizing when a holding becomes a larger part of the portfolio (with SpaceX accounting for 15.1% at the end of January).

Burns also explains how both the public and private companies are valued, whether the 30% limit on unlisted firms is proving restrictive, and outlines how Scottish Mortgage Ord (LSE:SMT) hunts for the “next generation of era-defining companies”.

A selection of questions was submitted by interactive investor customers on our social trading network ii Community.

• Our Services: SIPP Account | Stocks & Shares ISA | See all Investment Accounts

Kyle Caldwell, funds and investment education editor at interactive investor: Hello, and welcome to our latest Insider Interview. Today in the studio, I have with me Lawrence Burns, deputy fund manager of Scottish Mortgage Investment Trust. Lawrence, thanks for coming in today.

Lawrence Burns, deputy fund manager of Scottish Mortgage Investment Trust: Thank you for having me.

Kyle Caldwell: So, Lawrence, lots of our customers are well versed in the way Scottish Mortgage invests. For those who are less familiar, could you summarise your investment approach and the way you invest?

Lawrence Burns: So, Scottish Mortgage is a long-term, growth-focused portfolio. We’re not looking to position ourselves for short-term market movements or macroeconomics. We’re looking to find and identify the rare, small number of exceptional companies that drive long-term markets and long-terms returns, and we’re looking for those globally. We look from all around the world and we look at them across public opportunities and private. In many ways, what Scottish Mortgage offers is exposure to the future of the economy. It offers insurance against change and disruption. And that’s really what we try and provide our shareholders.

Kyle Caldwell: As you’ve mentioned, you own a mixture of publicly listed companies and private firms. The current split at the moment is 64.2% for public companies and 35.5% for private firms. Scottish Mortgage has a 30% limit for private firms. Is the fact that you are over that limit down to your position in SpaceX, which now accounts for 15.1% of assets?

Lawrence Burns: Yeah, so that’s right. We have a 30% limit on our unlisted portion, but I think an important point is that it is at time of purchase. So, we’re able to go above that and not be forced sellers of our private companies. And our private companies happened to have done phenomenally well recently, particularly driven by SpaceX. It’s seen a large increase in its valuation and it’s exactly the type of company that we look for, outliers that can deliver a large multiple return.

• Where investment professionals are investing their ISA
• Ian Cowie: are you braced for AI apocalypse or buying into AI optimism?

Kyle Caldwell: Could you talk through how you scrutinise valuations for both the publicly listed companies and the private firms?

Lawrence Burns: I think there’s a distinction there between how we value companies as investors and make decisions and the valuations that feed through to the net asset value (NAV). So, if you mean how we as investors value them, quite often what we do is scenario analysis, multiple scenarios for a company, looking at some of the worst outcomes and some of the best outcomes.

We create analysis of how large we think the market will be in five and 10 years’ time, what the revenue for that company will be, so its share of the market, its profit structure, its margins. And what the market will pay in 2030 or 2035 in terms of an earnings multiple, and we try and work out if it’s attractive from that. That’s true across public and private.

But what feeds into the NAV is different. What feeds into the NAV of public companies is their public share price, and what feeds in for the private companies is a private company valuation that me and Tom as managers of the fund are not involved in. That’s set by an independent valuation committee, independent of the managers, supported by an external firm that does valuations for us that are signed off by the board.

Those valuations with private companies are about trying to assign a value that is our fair estimate value of, if we were to go out and sell the shares today, what we would get for it on behalf of our shareholders. So, we mentioned SpaceX just then. SpaceX is valued at $800 billion (£594 billion), and that’s simply based off the last large third-party transaction in December that was done at $800 billion. Myself and Tom Slater as managers, we get an email regularly about these updates. We’re not involved in setting the valuation of the private companies.

Kyle Caldwell: Coming back to SpaceX, I have a couple of questions from interactive investor customers on our social trading network, ii Community. The first one asks, how and when do you decide to rebalance investments like SpaceX or Anthropic when you are still positive on the company’s prospects, but they become a bigger part of the portfolio?

Lawrence Burns: A key part of our philosophy is that when you’ve identified an outlier, to try and as much as possible capture the outlier returns and not truncate them by giving up too early.

I think there are two reasons when a company’s been really successful that you end up often selling down. The first is you go to that scenario analysis and you go, actually, the upside, it’s quite hard to see a pathway to make five times our money from here.

So, if you go back in the past, both NVIDIA Corp (NASDAQ:NVDA) and Tesla Inc (NASDAQ:TSLA) used to be large holdings in the trust, at 10% or so. And for both of those, there came a point where we did that analysis and went, still a great company, but we can’t see a reasonable pathway, in the case of Nvidia when it was at $3.5 trillion, to get to $10 or $15 trillion. So we took major reductions to those holdings and brought them down significantly.

The second element is what we don’t really want is any one company or one investment view to dominate long-term outcomes of the fund. We don’t want one holding to dominate. So, there’s a slight risk management perspective there, where over time we’ll look to redeploy capital into new and hopefully exciting ideas. So, those are the two things that keep in check holding sizes over time.

• Fund Focus: what the Iran conflict means for your portfolio
• Alternatives to the most-popular ISA funds

Kyle Caldwell: So, in regards to SpaceX, it’s a 15.1% position. Are you holding that position at the moment rather than taking profits?

Lawrence Burns: I think at the moment SpaceX is an active discussion. We see that there’s huge potential in the future, but that has to be weighed against the fact that there is now a very large holding in the trust.

Kyle Caldwell: We have another question on SpaceX and that question is whether you are worried about the SpaceX xAI merger. The person who asked the question said it feels like SpaceX has bailed out two bad businesses. What’s your view?

Lawrence Burns: Well, I think if you look at xAI, they went out and tried to raise money at the start of this year. The press reports are initially that they tried to raise about $15 billion. The demand was so great, they ended up raising $20 billion.

So, there is a view of people investing a lot of money in this business that this is not a bad business, that this a leading-edge frontier model company that has real advantages within the field of AI. That merger, the valuation was the same as that one where the investors invested $20 billion. So, this was not a company that is doing this merger because it needed capital to be supported anyway.

I think the other element is that there is a strong argument about the ability to vertically integrate these companies, particularly around SpaceX and xAI. The first leg of grow for SpaceX has been about putting thousands of satellites in orbit to provide us with global broadband through satellites, and that’s still being rolled out and has been incredibly successful.

The next big lever could be putting data centres into space, where you get reductions in energy cost because you get solar power and you don’t need batteries and so on, and using that to actually deal with some of the compute issues we have here on Earth.

And so by integrating that with an xAI, you could end up with a very powerful proposition. So, if you take a step back, I would say the valuation is validated. It wasn’t a business that needed this merger in terms of capital, but it is one that, combined, provides a very interesting long-term investment case.

Kyle Caldwell: Another customer asks for you to describe your idea generation process and as part of analysing a company or considering the investments you own in the portfolio, how much do you factor in the wider macroeconomic backdrop?

Lawrence Burns: For idea generation, I think one thing that makes our task easier is that we’re quite specific that we’re looking for the next generation of era-defining companies. That rules out quite large swathes of the market of what we’re looking for.

What helps us quite often in that hunt is networks of company founders and private companies and academics that rarely tell you exactly what company to buy, of course, but they help tell you what the new trends are, what they are seeing in terms of business models, and who they respect. That, I think, helps a lot in idea generation, that leveraging of that network.

Then, in terms of the macro, what I would say is you always have to take macroeconomics into account to some degree. But there are some investments in areas where it matters more.

We think a lot about the macroeconomic implications for our holdings in Latin America, where macroeconomics is more volatile. We think quite a lot about the macro and broader political situation when there are holdings in China, and we’re cognisant of what our overall weighting in China is.

So, we do take those factors into account, but in the ideal world, what we’re looking for is companies that can deliver phenomenal growth, almost irrespective of macroeconomic conditions.

I said Latin America earlier. MercadoLibre Inc (NASDAQ:MELI) is an example of that, where over the last 10 years, they'll have grown revenue something like 35-fold, even as the economy may have declined in US dollar terms. So that’s what we are looking for, companies that can rise above the macro, but at the same time, taking it into account as part of that scenario analysis.

• DIY Investor Diary: why I ditched tracker funds for one space stock
• Ian Cowie: holding on for more after trebling money in under a year

Kyle Caldwell: Coming back to the 30% limit on unlisted companies, another customer asks whether that limit is restricting you and will potentially lead you to miss out on the next big opportunity, as many companies are opting to stay private for longer?

Lawrence Burns: I think we’re cognisant of that because of the success for a number of our private companies, we’re above that limit and we can’t add to new companies. That’s absolutely correct.

I think the key thing to bear in mind is how quickly that situation can change. If you read the current press reports, it will be that SpaceX is looking to IPO in the middle of this year or late this year. And if that happens suddenly, the opportunity, the ability to invest in private companies is something entirely back on the table. So, it’s something we’re aware of, we’re conscious of, but we can see various pathways in which that potentially gets changed very quickly.

Kyle Caldwell: Lawrence, thank you very much for your time today.

Lawrence Burns: Thanks for having me.

Kyle Caldwell: That’s it for our latest Insider Interview. For more videos in the series, do hit the subscribe button and hopefully I’ll see you again next time.