Baron Opportunity Fund: Latest Insights and Commentary

CONTRIBUTORS

• NVIDIA Corporation sells semiconductors, systems, and software for accelerated computing, gaming, and GenAI. NVIDIA’s stock rose on continued strong demand for its GPUs at the epicenter of the generative AI revolution. NVIDIA continued to report unprecedented rapid growth at scale, with quarterly revenues of $26 billion growing 262% year-over-year, datacenter segment revenues of $22.6 billion up 427% year-on-year, and operating margins of 69.3%. NVIDIA’s growth is even more impressive as it is nearing a new product cycle with the Blackwell chip going into production in Q3 and speaks to the urgency of demand for GPUs as customers are not willing to wait for the next generation architecture despite its improved performance-to-cost ratio. Management has commented as well that Blackwell would be supply constrained well into 2025. While the stock's strong performance has pulled forward some of the longer-term upside (which we manage through position sizing), it is still early in the accelerated computing platform shift and the adoption of GenAI across industries.
• Shares of software megacap company Microsoft Corporation increased on robust quarterly results, with key areas showing strength and solid FQ4 guidance. Cloud revenue of $35.1 billion was up 23% year-over-year, with both Commercial bookings and Azure accelerating 31%. Execution around costs continued to be crisp, with gross margins of 70% offsetting ramping amortization from significant CapEx spend. Early commentary for FY 2025 was also positive. We remain a long-term investor in the company.
• Broadcom Inc. is a global technology leader with a broad range of semiconductor and infrastructure software solutions. Its semiconductor solutions focus on digital, mixed signal, and analog products across a variety of end markets, while its software products help customers plan, develop, automate, manage, and secure applications. The stock rose on strong earnings results on the back of two key growth drivers, AI semiconductors and the VMWare acquisition. The company once again increased its outlook for AI-related revenue, now expecting $11 billion or more this year, up from a prior estimated $10 billion. VMWare remains on track for rapid sequential growth while reducing operating expenses, driving faster-than-expected margin expansion and accretion. We believe Broadcom is a key beneficiary of AI infrastructure investment, with its industry-leading switching silicon and other chips and its custom silicon business supporting hyperscale customers with their own custom accelerators. We also believe the VMWare integration will drive more accretion than current consensus forecasts.

DETRACTORS

• CoStar Group, Inc. is a provider of marketing and data analytics services to the real estate industry. Shares detracted from performance in the quarter along with the broader software sector. Most software companies experienced a slowdown in new sales activity in early 2024, leading to guidance reductions and multiple compression. We believe CoStar shares were also impacted by concerns that the company’s second quarter financial results will show a deceleration in net new sales of its residential product following outstanding first quarter performance. We remain encouraged by traction in CoStar’s residential offering although recognize that progress may not be linear. CoStar began to monetize its new Homes.com platform in February. We believe early momentum can be amplified by the recent NAR class action settlement, which has the potential to disrupt the residential brokerage industry and enhance the return on investment for brokers advertising on Homes.com.
• Viking Therapeutics, Inc. is a developer of metabolic disease medicines with focus on diabetes/obesity and MASH (fatty liver). Shares declined as biotech investment specialists leaned into an alternative mechanism for obesity called amylin inhibition and seemed skeptical that Viking will be acquired (a view we disagree with). In addition, a reconstitution of the most well-known biotech index (XBI) caused forced selling by many long/short strategies as they reweighted their positions. We remain investors. Viking’s lead asset, an injectable and oral version of a GLP-1/GIP combo medication, is a direct competitor to Eli Lilly's Mounjaro/Zepbound. Viking’s second asset competes with Madrigal’s just-approved MASH asset. Both of Viking’s drugs appear to be more efficacious than their competitors and serve end markets that are potentially the largest ever for the industry.
• Exact Sciences Corporation is a cancer diagnostics company whose flagship product is Cologuard, a stool-based screening test for colon cancer. Shares fell during the quarter following a disappointing Q1 report in which the company signaled it would ramp up sales and marketing efforts, raising investor concerns that it needed to spend to drive growth. There is also continued concern around competition from liquid biopsies. We exited our position.

When reviewing performance attribution on our portfolio, please be aware that we construct the portfolio from the bottom up, one stock at a time. Each stock is included in the portfolio if it meets our rigorous investment criteria. To help manage risk, we are aware of our sector and security weights, but we do not include a holding to achieve a target sector allocation or to approximate an index. Our exposure to any given sector is purely a result of our stock selection process.

Baron Opportunity Fund (the Fund) appreciated 4.43% (Institutional Shares) in the second quarter, trailing the Russell 3000 Growth Index (the Index) by 337 basis points due to stock selection and, to a lesser extent, headwinds from an assortment of style biases.

Adverse stock selection in Health Care and Information Technology (IT) accounted for most of the underperformance in the period. Weakness in Health Care was partly due to sharp declines from the Fund’s biotechnology holdings, namely Viking Therapeutics, Inc. and Rocket Pharmaceuticals, Inc. Viking develops metabolic disease medicines with focus on diabetes/obesity and MASH (metabolic steatohepatitis, i.e., fatty liver). The company’s lead asset is VK2735, an injectable and oral version of a GLP-1/GIP combination weight loss medication that directly competes with Lilly’s Mounjaro/Zepbound. Both of Viking's main assets appear to be more efficacious than their competitors' in two exceptionally large revenue end markets. After spiking more than 350% in the prior quarter, Viking’s stock detracted as biotechnology specialists have leaned into an alternative mechanism for obesity called amylin inhibition and don't view Viking as an attractive acquisition target (a view we disagree with). The recent rebalance of the well-known SPDR S&P Biotech ETF (XBI) also pressured Viking’s share price due to forced selling by many long/short strategies to reweight their positions.

Rocket specializes in the development of gene therapies for rare genetic diseases outside of oncology. Currently these include Danon disease, Fanconi’s anemia, LAD-I, and Pyruvate kinase disorder. The first three drug treatments should all commercially launch by 2025, generating substantial potential revenue for the company. In the near term, Rocket’s shares continue to be pressured by a three-month FDA delay to their initial commercial asset in LAD-1 and the added overhang of slow gene therapy launches from bluebird bio in sickle cell disease and BioMarin in hemophilia B. Given the life-saving nature of Rocket's therapies and the high unmet need for treatments and cures for each of these diseases, we retain conviction in our investment.

Another source of weakness in Health Care was Exact Sciences Corporation, a cancer diagnostics company whose flagship product is Cologuard, a stool-based screening test for colon cancer. Shares fell during the quarter following a disappointing Q1 report in which the company signaled it would ramp up sales and marketing efforts, raising investor concerns that it needed to spend to drive growth. There is also continued concern around competition from liquid biopsies. We exited our position.

Within IT, meaningfully lower exposure to Index heavyweight Apple Inc. was a material drag on performance, accounting for about 90% of the relative shortfall in the sector after the company’s shares appreciated 23% in the period. Declines from semiconductor holdings Advanced Micro Devices, Inc. (AMD) and indie Semiconductor, Inc. also weighed on performance, overshadowing continued strong performance from NVIDIA Corporation. AMD’s shares fell during the quarter as investors wrestled with the company’s competitive positioning in the AI compute market relative to NVIDIA, which continued to strengthen its full-system solution offerings at a rapid pace. AMD also updated its MI300 revenue expectations for the full year to “greater than $4 billion," missing high investor expectations despite being more than $1 billion over the prior revenue estimate. Over the long term, we believe AMD and its unique chiplet-based architectures will play a meaningful role in the rapidly growing AI compute market while it takes share from Intel within traditional data center CPUs, albeit now a slower growth market than prior expectations. With its strong product portfolio based on proprietary designs and advanced packaging, AMD is well positioned to benefit from share gains and underlying market growth.

Indie is a fabless designer, developer, and marketer of automotive semiconductors for advanced driver assistance systems and connected car, user experience, and electrification applications. The company’s shares fell after management guided revenue growth for fiscal year 2024 below expectations for the second quarter in a row as its customers continue to absorb excess inventory. While indie conservatively expects to maintain a healthy 20%-plus year-over-year growth rate, well above industry and peer benchmarks, and management expressed confidence in a robust second half given more than 20 new projects, investors are concerned the inventory digestion could last longer into 2024 than initially expected. Despite near-term softening, indie remains well positioned for growth over the medium and long term, especially with its $6.3 billion design win backlog and significant program ramps anticipated in 2025, including a marquee radar-related rollout, the largest program in the company’s history. We believe indie can continue to significantly outpace the broader industry and reach nearly $1 billion in revenue by the end of the decade with premium margins, supported by its contracted visibility.

Other performance headwinds came from poor stock selection in Real Estate, where CoStar Group, Inc.’s shares were down sharply, and lack of exposure to mega-cap company Alphabet Inc. in Communication Services, which together detracted nearly 180 basis points from relative performance. Shares of real estate data and marketing platform CoStar declined alongside the broader software industry during the quarter. Many software companies experienced slowing new sales activity in early 2024, leading to guidance reductions and multiple compression. We believe CoStar shares were also impacted by concerns that the company’s second quarter financial results will show a deceleration in net new sales of its residential product following outstanding first quarter performance. We remain encouraged by traction in CoStar’s residential offering although recognize that progress may not be linear. CoStar began to monetize its new Homes.com platform in February. We believe early momentum can be amplified by the recent NAR class action settlement, which has the potential to disrupt the residential brokerage industry and enhance the return on investment for brokers advertising on Homes.com.

Somewhat offsetting the above was solid stock selection in Consumer Discretionary and Industrials along with lack of exposure to the lagging Consumer Staples sector. Strength in Consumer Discretionary and Industrials came from electric vehicle manufacturer Tesla, Inc. and private rocket and spacecraft manufacturer Space Exploration Technologies Corp. (SpaceX), respectively. Tesla’s shares performed well as the company continued to drive vehicle manufacturing costs lower, accelerate the launch of new models, and invest heavily in its lucrative AI initiatives. Shareholders reaffirmed the CEO's compensation plan, alleviating personnel and legal uncertainties. Despite material operational complexities resulting in significant shutdowns of key manufacturing facilities and lower sales volume, Tesla presented better-than-expected margins in the quarter. It expects to launch a lower cost model as soon as late 2024, which should result in accelerated revenue growth, reduced manufacturing costs, and increased factory utilization. The company continued to advance its autonomous driving capabilities, expanding its already significant data centers and developing its humanoid robot Optimus. These investments increased confidence in the attractive growth opportunities that remain ahead.

SpaceX is generating significant value with the rapid expansion of its Starlink broadband service. The company is successfully deploying a vast constellation of Starlink satellites in Earth's orbit, reporting substantial growth in active users, and regularly deploying new and more efficient hardware technology. Furthermore, SpaceX has established itself as a leading launch provider by offering highly reliable and cost-effective launches, leveraging the company's reusable launch technology. SpaceX capabilities extend to strategic services such as crewed space flights. Moreover, SpaceX is making tremendous progress on its newest rocket, Starship, which is the largest, most powerful rocket ever flown. This next-generation vehicle represents a significant leap forward in reusability and space exploration capabilities. We value SpaceX using prices of recent financing transactions.