Letter from Ron | Q2 2024

Letter from Ron

July 16, 2024 | Download PDF

“The Internet’s Final Frontier: Remote Amazon Tribes.” The New York Times. June 2, 2024.

Jack Nicas and Victor Moriyama, two The New York Times reporters, “hiked more than 50 miles through the Amazon to reach remote Marubo villages.” That was to see what happened to villagers who had just received a Starlink satellite internet antenna...which “connected” the tiny, closed civilization, among the most remote indigenous villages on the planet, to the rest of us...courtesy of Elon Musk’s SpaceX. The benefits of “video chats with faraway loved ones and calls for help in emergencies” are obvious. Connecting to the outside world also has drawbacks for villagers who need to plant and harvest and hunt to survive...and whose “young people have gotten lazy…learning the ways of the white people.” “But please don’t take our Internet away,” the female leader of one village plaintively asked the reporters. Gwynne Shotwell, SpaceX’s President and Chief Operating Officer, described her recent visit to a school in one of these villages. She was repeatedly “hugged” by young students. She said, “It was one of the best days in my life.” I will interview Gwynne at the Annual Baron Investment Conference on November 15. That will be her second appearance at our annual meeting.

“Want to Buy SpaceX stock? You have to know someone.” Wall Street Journal. May 19, 2024

Sounds almost like “Would you like to buy the Brooklyn Bridge?” doesn’t it?

On May 19, 2024, WSJ reporter/analyst Micah Maidenberg wrote about extraordinary investor demand to invest in Elon Musk’s “privately owned” SpaceX. Since 2017, Baron has consistently purchased SpaceX shares annually on behalf of Baron mutual funds, partnerships, private clients, and proprietary accounts. Baron’s approximately $1 billion investments at cost are now valued at $2.68 billion. We think those investments could increase materially in value in the next 10 to 15 years. We expect to continue adding to this investment whenever we have an opportunity to do so.

SpaceX’s current two most important businesses are “Starlink” and “Launch.” Starlink is a satellite broadband Internet service. Starlink’s satellite broadband serves the entire Planet Earth from its 6,500 low earth orbital (LEO), low latency satellites. Starlink’s LEO constellation will ultimately consist of more than 15,000 satellites. Starlink’s business is enabled by competitively advantaged SpaceX rocket ships that are “reflyable.” “Reflyable” means that SpaceX rockets can be used over and over and over again…just like an airplane…and just like Star Trek spaceships. SpaceX reflyable rockets provide a dramatically “lower cost to space” than governments and commercial interests have previously achieved. We estimate SpaceX cost to orbit will soon be less than 10% the cost of traditional launch businesses!

We think of SpaceX as the “railroad to space” … and analogize SpaceX rockets to America’s railroads in the late 1800s. Railroads enabled our nation to settle America’s West. Railroads then were a dramatic improvement over wagon trains. Just like reflyable rockets are a dramatic improvement over expensive rockets that can be used only once. No other commercial enterprise or government has been able to refly rockets…which, when you watch SpaceX landings, you too will quickly understand why it is such an awesome feat.

Since the 1960s, the United States has reached orbit with rockets mainly powered by Russian technology. Those rockets can be used only once before burning up in our atmosphere! Each launch  could easily cost a lot more than $100 million. One of the unusual coincidences in my life is that from 1966-1969, when I attended George Washington Law School in the evenings, I worked during the days as a patent examiner in the U.S. Patent Office. There, I was assigned an unusual “art”... chemical coatings. In that role, I granted patents on golf ball covers…and heat resistant coatings shielding nose cones that carry astronauts returning to Earth!!!!

Approximately 90% of the mass to orbit from Planet Earth is currently launched by SpaceX. Elon estimates that when SpaceX Starship, the 400-foot tall, largest rocket ever launched from our planet, has been “derisked,” 99% of all mass to orbit will be flown by SpaceX! Whether for commercial interests or governments.

Micah noted the growth prospects for SpaceX are so favorable that many investors seeking to purchase SpaceX shares willingly pay unusually hefty annual management fees plus “carried interest” in profits they earn. “Carried interest,” most often 20% of profits, are paid to managers who do not risk their own capital but are paid a percentage of your profits. A much different model than for “active” mutual fund managers like Baron, which typically charges annual management fees of 1% or less of net assets…with no carried interest.

I interviewed SpaceX’s President and Chief Operating Officer Gwynne Shotwell at the 2019 Annual Baron Investment Conference at New York’s Metropolitan Opera House. The theme then, “What’s Next?,” couldn’t have been more appropriate. That is since it was only a few months before the COVID-19 pandemic. After my interview with Gwynne, she was asked by several Baron Funds’ shareholders in the audience how they could invest in SpaceX? “Talk to Ron,” she answered. Several Baron mutual funds have significant investments in SpaceX.

The largest holdings are Baron Partners Fund (13.2% of total assets) and Baron Focused Growth Fund (10.3% of net assets). Tom Pritzker, Hyatt Hotel’s Chairman, and my friend since 1979, wrote me recently. “Just saw Gwynne Shotwell interviewed at Aspen Ideas Festival. OMG!!!! What an awesome endeavor. I’m so glad to be associated. You could see on her face the joy of what she is doing. Thank you for convincing me to invest.”

We expect a lot more businesses to be in the path of demand created by SpaceX. Like “Starshield,” a satellite network to protect our Homeland…cargo and ordnance transport anywhere on our planet in 32 minutes point-to-point… manufacturing in zero gravity… data centers in space powered by the sun which Elon calls that “giant nuclear reactor in the sky”… cooling for SpaceX’s massive orbiting GPU data centers from absolute zero space temperatures…and data for AI “training” transported to and from Earth by Starlink to those data centers... to list just a few of the possibilities...in addition to Starlink’s base business of connecting virtually every square inch of our planet...whether on land, including deserts and mountains...on sea...or in the air.

Goldman Sachs and Morgan Stanley estimate very high annual profit margin revenues will be available to Starlink during the 2030s, which they currently approximate at $1.25 trillion...which is growing double digits annually. During the 2030s, Musk expects SpaceX to obtain a substantial percentage of the highly profitable revenues while enabling terrestrial telcos to improve and increase the services they provide to their customers.

“I’m Monroe Freedman. I’m your contracts professor.” That is what Professor Freedman, standing in the well of a George Washington University Law School classroom, announced to us. He then held up a thick textbook with a blue hardcover titled, Cases and Materials on Contracts by Monroe Freedman.” “This is the text we will use for our Contracts case law class. Please read the first three cases. We will discuss those cases Wednesday night. Class dismissed.” Professor Monroe Freedman. George Washington University Law School. September 1966.

From 1966 to 1969, I worked as a patent examiner in the United States Patent Office (USPO) by day and attended George Washington University Law School in the evenings. Being a patent examiner required what the U.S. government considered a “critical skill” ... in my case an undergraduate degree with a major in chemistry. My patent examiner position exempted me from the Vietnam War draft. The USPO also granted me a partial scholarship to attend law school in the evenings...which I did...although I left law school in the summer of 1969 after seven semesters… one semester short of graduation…mired in $15,000 debt…which is about $150,000 in present day dollars!!! My parents were not exactly pleased by my decision.

Professor Freedman was my favorite law school professor. After introducing himself to my first evening law school class and giving us that homework assignment, the professor left the classroom. His teaching assistant then instructed the 100 law students in class to “Pick up a Contracts by Professor Monroe Freedman textbook from the tables by the classroom door as you are leaving. See you Wednesday.”

When we returned to class two evenings later, Professor Freedman asked whether we had read the cases? Everyone raised their hands signaling “yes.” “How do you think the first case was decided?” the professor then asked us. “Please explain your answer.” Nearly everyone raised their hand and Professor Freedman began to call on students eager to impress him. Our answers were nearly identical. “No, that is not what happened,” Professor Freedman responded. “The Plaintiff won because…” The professor then asked how we thought the second case had been decided. Again, hands shot up, although, sensing a trick, this time not so many. Again, all the students gave nearly identical answers. “No, that is not what happened. This is how and why that case was decided, …” Professor Freedman explained... exactly the opposite of what had seemed to us obvious. Finally, Professor Freedman asked us about the third case. This time fewer still raised their hands. Once again Professor Freedman explained why we were all wrong.

That experience shaped my view of the rule of law. My opinion crystallized further when, as law students, we were taught, “When the facts are against you, argue the law. When the law is against you, argue the facts.” Which, bottom line, made me believe that the most talented, skillful lawyers will almost always win. Regardless of facts and what seem to be plainly written rules and laws. Nothing has dissuaded me since.

Baron Capital was founded by me and two others in 1982.

We now have 212 employees, including 44 exceptional and mostly long-tenured analysts and managers…and outstanding performance since our inception. In the 42-year history of our business, we have never had a layoff despite periods when our economy and stock market have struggled. This is one reason we have been able to attract…train…and retain outstanding employees…who have achieved great results for our clients and fellow investors. How did we not just survive but prosper while trying to abide by rules subject to varying interpretations? When Supreme Court decisions are often 5-4 or 6-3?

We operate Baron Capital with several overriding principles. “Question Everything”...“Own It”...“Anything is Possible” and “Exceptional Takes Time” are our bedrock principles. Another is “We Invest in People”.... exceptional individuals at Baron who study companies and are supported by our talented staff. ...as well as in the exceptional executives whom we trust who manage our portfolio companies. So, assessing character of individuals and, of course, their innate intelligence and life stories…as well as judging growth prospects and competitive advantages of businesses are the basis for our investment decisions.

“Growth + Values” was the theme of the 2018 Annual Baron Investment Conference. I have written before about a rabbi’s sermon several years ago during Jewish New Year services that I often think about. “Would your younger self be proud of the life you have lived? Would he like you?” So, with that as a guidepost in a world subject to many interpretations of the same words, we want to trust the people in whom we invest to “do the right thing”... Since it would not be possible to write a rule for every possible circumstance, we need to trust their judgement and ethics... Not that we would necessarily make the same decisions. Just that the executives had carefully considered all the facts and circumstances and met their obligation to keep their word and do what is in the best interests of their employees…community...and owners of that business…even if not necessarily for their personal benefit.

Warren Buffett in his folksy manner recently said, “I try to buy stocks in businesses that are so wonderful that an idiot can run them. Because sooner or later, one will.” When your portfolio is as large as Berkshire’s, of course, you need to place more emphasis on durable competitive advantages than on any one individual manager’s talent. While Baron also focuses on businesses we believe are competitively advantaged...we give unusual weight to manager talent that can have a greater impact on smaller and mid-sized businesses’ growth prospects.

Baron Capital puts its trust in extraordinary individuals who manage the businesses that Baron Capital owns. We invest in those individuals on behalf of our clients and ourselves...our interests are aligned with our clients’ since our personal assets are commingled with yours.

“The Dow should hit 30,000 in 10 years...50 or 60,000 in 20 years.” I made that remark on CNBC’s Squawk Box in 2013. You can look it up on the CNBC website. The Dow Jones Industrial Average was then 14,000. Nouriel Roubini, an economist nicknamed “Dr. Doom” for his pessimistic forecasts, was skeptical during my interview. My response? “I don’t believe in stock market predictions by economists. I believe in fortune cookies. Last night my fortune cookie said, “All the efforts you’re making will pay off.” Ron Baron. CNBC. Squawk Box. February 5, 2013.

In what seems like the blink of an eye, 11 and a half years have since passed… and the Dow Jones Industrial Average, following precedent of the past hundred years, has more than doubled and now exceeds 40,000! David Schneider, our Head Trader, has worked at Baron since 1987. He remembered that 2013 interview when so many were bearish…and my views were controversial…and forwarded the segment from the CNBC website to our fellow Baron employees. David noted that in 2013 while most “investors” were focused on the next quarter’s results, few believed the stock market would double in 10 years…and double again in the following 10 years! David also enjoyed my “fortune cookie” comment, as did the CNBC anchors…although I don’t think Nouriel, who takes his economics seriously, thought it humorous.

My point was simply...that the stock market and our economy are inextricably linked. That nominal historic economic growth in America is approximately 7% annually, 2% real and 4% to 5% from inflation. During my entire lifetime. That means the economy has historically doubled about every 10 years. So has the stock market. Despite world wars, civil wars, recessions, depressions, financial panics, pandemics, high interest rates, low interest rates, high unemployment, low unemployment, civil unrest, and controversial judicial decisions.

We expect inflation to continue averaging 4% to 5% annually over the coming decades…not 2%… and the growth rate of our economy in both real and nominal terms due to advances in technology…especially AI…to accelerate! Also, for quality of life to improve in coming years just like it has over the history of our country. In the early 1900s, for example, the average life expectancy was about 47 years. One third of all children born today will live past 100! Warren Buffett recently commented that quality of life improves about sevenfold every 100 years. My bet is that due to Elon and others…and AI…this assumption may be too conservative. Further, inflation at historic 4% to 5% annual rates means that most things like food …homes…tuition…salaries…clothes…cars…you name it…double in price every 14-15 years. We believe investing in stocks is an attractive way for most of us to protect our savings against inflation…and to participate in the growth of our economy.

Baron will continue to invest for the long term in exceptional executives who lead competitively advantaged growth companies. We believe the purchasing power of your money will continue to fall in half every 14-15 years…and stock prices will double about every 10 years. Our goal is to double the value of our investments every 5 to 6 years by investing in businesses that are doubling in size over that time horizon.

Since their respective inceptions, 16 of 19 Baron mutual funds, representing 96.6% of Baron Funds’ AUM, have outperformed their primary benchmarks and 12 Funds representing 94.1% of Baron Funds’ AUM, rank in the top 20% of their respective Morningstar categories. 10 Funds, representing 70.1% of Baron Funds’ AUM, rank in the top 10% of their categories. 8 Funds, representing 53.0% of Baron Funds’ AUM, rank in the top 5% of their categories. We believe our Funds have outperformed by not being the same as the market.

Baron Partners Fund is the number one performing U.S. equity fund (out of 2,059 share classes) since its conversion in 2003 from a partnership to a mutual fund.* According to a third party report commissioned by Baron Funds’ independent trustees, “there were no peers that...were a reasonable style match for that fund.”

As of the date of this letter, Baron Capital has more than $43 billion in assets under management. We have earned more than $44 billion in realized and unrealized profits since 1992 when we managed $100 million!

Thank you for joining us as fellow shareholders in Baron Funds.

Respectfully,

P.S.  The theme of the 2024 Annual Baron Investment Conference is “Building Legacy.” Like Elon, we have a mission. Ours, like his, is to make a difference in people’s lives. We have impacted lives due to the exceptional returns we have earned for investors. This, in our opinion, is due to Baron Capital’s unique investment process…exceptional people…and outstanding performance…our legacy...that we believe will allow our business to last 100 years…at least…and still enhance the lifestyles of the families and institutions that choose to invest with us.

Businesses in which Baron invests for our clients generally invest in their businesses to become larger enterprises over the long term….it is not to maximize their current profits. Baron does the same. Baron focuses on what is in the best interests of its clients…not on maximizing my family management company’s current profits. We have never had a layoff in the history of our business. This, we think, is just one of the reasons...there are many...that Baron attracts and retains the most talented and awesome individuals. It’s not just how we treat our fellow employees. It is also about the opportunities we provide to work with the exceptionally talented people we hire… and, due to our reputation as owners not traders, our analysts are offered chances to study incredibly interesting businesses.

P.P.S., We hope to see you at the 31st Annual Baron Investment Conference on November 15, 2024. It will take place, as it has since 2005, at The Metropolitan Opera House at Lincoln Center in New York City. This fall, we will celebrate our 42nd year in business. These annual conferences are typically attended by more than 5,000 Baron Funds’ shareholders and Baron clients. I promise you will learn a lot from the exceptional CEOs who manage the competitively advantaged growth companies in which your savings have been invested.

We’re sure you’ll have a great time…and learn a lot. The entertainment at lunch and in the afternoon will be awesome, as usual. We will also continue with drawings for what have become traditional Tesla door prizes before lunch. Three of them, those amazingly beautiful automobiles…the safest ever made on Planet Earth…are given at our expense…not yours. Just like all the expenses incurred that day. Ours. Not yours. It is our way to “thank you” for trusting us to manage your family’s hard-earned savings. We can’t promise investment returns…but we can promise we will try as hard as possible to continue to achieve outstanding results. See you November 15. Oh, yeah. You’ll have a better chance to win a Tesla than to win the lottery!!! That I can guarantee.

One more thing. Don’t forget to get an absolutely delicious ice cream cone on the Lincoln Center Plaza at the end of the day. This year, we will have six Scream Ice Cream trucks waiting for you as you leave the Lincoln Center campus. I have a small personal investment in the Scream Ice Cream business. One college summer, I drove an ice cream truck, and when I had the chance to go back to my “roots” by investing in Scream, I grabbed it. The cones are “on the house.” Just tell the ice cream man, “Ron sent me.” And don’t forget to pick up a “swag” bag as you leave. This year, in addition to our “Building Legacy” Baron conference t-shirts made by FIGS, you’ll find a big chocolate chip cookie to sustain you on your trip home. Enjoy!!

Registration for the Conference begins on Monday, August 26. Register early as seating is limited.

Additional Must-See Resources

• Baron Funds (Institutional Shares) and Benchmark Performance 6/30/2024

• Baron Capital's Top 30 Holdings - As of 3/31/2024