Scottish Mortgage on Elon Musk, private firms and cutting Nvidia

Deputy manager of Scottish Mortgage Ord (LSE:SMT) Lawrence Burns sits down with ii's Sam Benstead to discuss how he manages his portfolio. He explains why around a quarter of the portfolio is in unlisted companies, and goes into depth about two companies going through strong and weak periods of performance, SpaceX and Northvolt.

Burns also gives the investment case for some of the largest stocks in the portfolio, including MercadoLibre, Nvidia and Moderna. He also comments on Scottish Mortgage's buyback programme, which has seen more than £1 billion spent on closing the discount to net asset value.

Scottish Mortgage is one of ii's Super 60 fund ideas.

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Sam Benstead, fixed income lead, interactive investor: Hello and welcome to the latest Insider Interview. Our guest today is Lawrence Burns, deputy manager of Scottish Mortgage Investment Trust. Lawrence, thanks very much for coming into the studio.

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

Sam Benstead: Private assets are an important area for Scottish Mortgage. They're worth about 25% of the portfolio, and there's actually more private companies than public companies in this investment trust. So, why do you buy private companies? What is the advantage for shareholders?

Lawrence Burns: It's been a hugely important thing for Scottish Mortgage, and there's a few reasons. We'll start off with the softer ones, which I think really matter. The first is that if we tried to get to know companies doing that for the first time at an IPO is not a good way to meet a company.

They've been trained by investment banks what to say, what not to say. So, they're not going to tell you the weaknesses and the downsides to the business in the same way. It's a really high-pressured environment because it's a large transaction of a lot riding on it for them, and they'll be doing back-to-back meetings all week, so you're not really going to be building a relationship in that environment.

So, if you look back at some of the public companies that we've owned as private companies and still own today, companies like Spotify Technology SA (NYSE:SPOT), companies like Meituan Class B (SEHK:3690) in China. They've delivered a really positive return. But I think we've been able to do that at a larger holding size, and with more conviction, because we've known them in the years before they were public. And that, I think, gives an advantage of perspective.

A second reason to this would be that trying to understand change in the world is really hard. You can think of it like building a puzzle. But if you're only investing in public growth companies and not private, it's a bit like trying to construct a puzzle with half the pieces missing.

It's really hard to understand how the world is changing without that perspective because private companies are the ones that are pushing lots of very interesting changes. They're also the companies that are challenging to disrupt a lot of the public companies.

When I went to the [Silicon] Valley in 2016, it was really helpful for my understanding of NVIDIA Corp (NASDAQ:NVDA) and its competitive advantage to go and meet a range of start-up companies that were hoping to disrupt Nvidia with AI-specific chips and that helped improve understanding and improve conviction.

The other reason for private companies is simply that these assets just aren't accessible elsewhere. They're not in an index. Most people can't easily buy shares in SpaceX, most venture capital funds, private companies and private funds can't buy shares in SpaceX.

If you as a consumer are able to, you're probably not going to be paying what you pay as a fee for Scottish Mortgage, it would be multiples higher. So, I think providing that access really matters.

I saw a list the other day of the most valuable top 10 unicorns in the world. Five of them are in Scottish Mortgage's portfolio. So, it's the ability to own that next generation of winners before they're public, I think, that really matters.

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Sam Benstead: Two high-profile private companies you own are Space X and Northvolt. But they are going through different periods of business success at the moment. Space X doing very well, Northvolt doing less well. Can we have some more information about these businesses?

Lawrence Burns: SpaceX is doing fantastically well as you rightly said, it's our largest private holding. It might be the most geopolitically important asset in the world. They've nearly monopolised private-company access to space.

A few reasons why that matters, and it speaks to the growth point you were talking about, is Starlink, sending satellites into low-Earth orbit. Why are they doing that? Internet connection; planes, ships, battlefields, dead spots in the US with their partnership with T-Mobile.

About 2.6 billion people still don't have an internet connection. Through Starlink they have a much better chance of getting that internet connection. They're growing at about a million subscribers a month. They have 7,000 satellites in orbit now that are SpaceX. That's two-thirds of the numbers that are currently active satellites around Earth. They hope to take that 7,000 to 45,000.

One further thing that I think is absolutely fascinating, that's available on their website for people to look at, they also see SpaceX in the long run as being a human and cargo transportation system for Earth. So, it's an ability to get material or people anywhere in the world in under 40 minutes, which has huge implications for transport, for humanitarian aid, and again for military assets. So, I do think it is one of the most important companies in the world today, and it's on a fantastic trajectory.

Now, you're quite right. Northvolt has been in a much more difficult place recently, and I think the investment case there has very much deteriorated.

Originally, the investment case was that Europe needed lithium ion batteries to support the development of its own electric vehicle industry and its energy storage industry. There was an advantage to not being reliant on China for that supply and they could do that quite effectively by leveraging hydroelectric power in Sweden, and that would also make the emissions of the batteries that were being produced lower.  And so they were quite quickly able to accumulate $40 billion of backlog of order from big automotive companies like Volkswagen.

Now, what's gone wrong? I think it's a combination of factors. One, execution in scaling up that battery production has not been as we would have hoped. Two, you've seen a general slowdown, particularly in the West, of EV demand and that has made life more difficult.

But I also think the third has been that specifically the companies in Europe that were hoping to develop EVs have just had less success. They are not looking like the winners of the EV space and to the degree that it really has, I think, impacted the degree to which they're able to support and want to support Northvolt.

I think the output of that is that in some ways there's only really two EV companies that are producing profitably at scale. It's Tesla Inc (NASDAQ:TSLA) in the US and BYD Co Ltd Class H (SEHK:1211) in China, both of which are holdings of ours. But for Northvolt it's been a very, very difficult time.

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Sam Benstead: Elon Musk runs Space X alongside Tesla, another big position for you. He's also now very close to the US government. So, are his political ambitions a good or bad thing for you as an investor in his companies?

Lawrence Burns: In some ways that's a very complex question. If you have Elon Musk being incredibly close to the president-elect, it is not implausible that he's in a good position to advocate for policies that matter to him. Now, that could be really helpful, for regulation around self-driving and autonomous, and that's helping Tesla and Aurora Innovation Inc Class A (NASDAQ:AUR).

Potentially, SpaceX has a lot of contracts with NASA in the US government. And, again, that could be helpful for Space X, but the reality is we've got to see how that relationship develops over time.

And there are also some costs around it in terms of the risk of alienating another part of the political spectrum in America and the impact that has on brand. But it does allow Elon to really strongly argue for the regulation and the environment that is going to make his companies the most successful versions that they can be.

You mentioned that he's done lots of jobs simultaneously. The two things I would say around that would be, one, he has shown remarkable ability to juggle successfully very large roles. I don't think there's anyone else in the world that could build the world's leading electric vehicle company and leading space rocket company at the same time. And, as you know, he's also done Neuralink. He's also done Boring, and had lots of other things on the side.

The second [thing] that gives us a degree of comfort is the quality of the broader teams and cultures that he's built in these companies that are running it day to day and are doing a fantastic job. I think one of most underrated qualities of Elon Musk sometimes is his ability to attract talent and motivate it. And that's what we see both at Space X and at Tesla.

Sam Benstead: What's your latest thinking on Nvidia? It's a company you've owned for a long time, it's been very volatile and I know that you've been selling down your stake but still own a relatively large position.

Lawrence Burns: Nvidia has been a huge success for us. We first invested £64 million back in 2016. Since then, you're right, we've been reducing and in total we have sold, and therefore taken as profit, £1.2 billion. We also still have a £555 million stake remaining. So, it's still a large holding.

Why have we taken that money out? First, we still believe in the very long-term potential of artificial intelligence (AI), and that's reflected elsewhere in our holdings in the portfolio. But as we look to do our scenario analysis with Nvidia, we found it increasingly difficult to chart a path to, how do you make multiples of your upside from here?

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Today Nvidia is worth about $3.6 trillion. It's the world's most valuable company. So, I think to hold it, or to continue holding it as the fund's largest holding, you'd have to believe that you can make five or 10 times, potentially, return from here. So, the idea of a $10, $20, $30 trillion company is something that we haven't been imaginative enough yet to sketch out.

And then we're also aware that it's entirely plausible that there could be air pockets of demand, that even as AI tools improve, it might be that businesses just take time to develop how to use these properly. And that could be a difficult period.

We're aware that Nvidia and the type of company it is and its history, it's always been a painfully cyclical one. That's why we've just taken some of those profits out of the holding and just resized it with a holding size that's more in line with where our convictions currently are.

Sam Benstead: Moderna is another high-profile position in Scottish Mortgage. But unlike Nvidia, performance this year has been quite disappointing. Why do you still like this company?

Lawrence Burns: Its execution and its opportunity has been less good than we would have hoped. Its ability to commercialise some of what is developed scientifically and some of its communication with stakeholders in different ways hasn't been always ideal.

But I think what has followed largely the trajectory that we would have hoped is the scientific validation of its platform.

So, since that Covid vaccine in 2021, it's gone on to develop a leading flu vaccine. It's gone on to develop a vaccine for RSV. There was no vaccine for RSV when Moderna Inc (NASDAQ:MRNA) started working on it and it's gone on to develop a treatment for cancer that can reduce the rate of death by about 44% versus the standard of care for skin cancer, for melanoma. And it's continued to shift more of its programmes and pipelines towards a more mature stage, towards the phase three stage.

So, all that has been encouraging and that's why we still own it, because the potential for Moderna to work from here is still quite significant given the number of shots on goal it has.

But what we regret looking back is that it was the size of the holding that we had initially. It was just too large relative to the maturity of the company, to the challenges that lie ahead for it.

I think the upside from here is tremendous, and I don't regret that we owned it because I think it is the type of company Scottish Mortgage should own. But I do regret the size of the holding we've had.

Sam Benstead: The largest position in the portfolio is MercadoLibre Inc (NASDAQ:MELI). This is a company that people at home may not have heard of. Can you please give us the investment case?

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Lawrence Burns: So, we would have added to it when it had quite a large drawdown. I don't have the figures at this time, but in 2022, [maybe a bit in] 2023, and it was those additions that have helped it become the largest holding it is now because it's rebounded back at two and above pandemic highs.

So, why do we own it? So first, it's pan-Latin America. So, it has a lot of its headquarters in Argentina and also in Montevideo in Uruguay, but it operates across Latin America, a region of 650 million people, a GDP of about $6 trillion.

It is going after, very successfully, two of the biggest opportunities in any economy: retail, financial services. If you look around the world in e-commerce, penetration in the UK is about over 30% of retail sales are online. In China, that's also over 30%. In the US, it's about 25%, globally, it's 22%, in Latin America it's 13%. So, there's a really big long-term opportunity for them and also bear in mind that the penetration in other countries is a moving target, not a static target.

In addition to this, they have this huge opportunity in financial services because in the UK about 2.6% of adults don't have a bank account. In Latin America, 70% of people are either unbanked or underbanked. The banking industry is oligopolistic, super-profitable, charges some of the highest interest rate spreads in the world, charges high fees, loathed by customers. So, the opportunity for disruption there is really huge. And how are they doing that? They're doing that because it's on an app, so they don't have an expensive branch network to maintain. They don't have 100,000 employees, so they have a lower cost to serve the population.

They have the data advantages that the banks don't have from serving a sliver of the population because they know everything that people have bought on that marketplace, and often on credit as well, so that gives them great data to do the lending.

When I was in Buenos Aires in June and I saw the founder, Marcos Galperin, for him, the ambition is to be, if not the largest financial services company in Latin America, at least the second largest. And that's a multi-trillion dollar revenue for financial services in Latin America. So, we think that's a huge opportunity with them going after both of those targets simultaneously; retail and finance.

Sam Benstead: Scottish Mortgage is on a 12% discount to its net asset value currently. You've been buying back shares, about £1 billion worth, over the past year to try and close this discount. So, has that buyback programme been successful? And will there be more buybacks to come?

Lawrence Burns: If you look back to March, the board made the announcement that we were going to spend at least £1 billion in a share buyback programme. This financial year, the discount in the trust, I think, has been about 8.9% in the first half of the year. If you compare that to the first half, last year, it was 16%. So, there's been a significant tightening in the discount.

One of the factors behind that has been, the role of the buyback. Going forwards, the key thing is the words "at least £1 billion". We've done £1 billion buyback, but we continue to be committed to doing more as part of that, and to ensuring liquidity for shareholders and ensuring that in normal market conditions, the trust trades near par.

Sam Benstead: Finally, the question we ask all our guests, do you personally invest in your portfolio?

Lawrence Burns: Yes. I regularly add to my position in Scottish Mortgage. If you were to look in my ISA, you would find it has one holding. And I'll give you one guess which holding that is, it is Scottish Mortgage. I have never sold a share of Scottish Mortgage ever and I don't have any plans to anytime soon.

Sam Benstead: Lawrence, that's great to hear. Thanks for coming into the studio.

Lawrence Burns: Great.

Sam Benstead: And that's all we've got time for today. You can check out more Insider Interviews on our YouTube channel where you can like, comment and subscribe. See you next time.