Gondolin Capital, LP

Second Quarter 2022 Investor Letter

July 14, 2022

Dear Investor,

In 2Q22, Gondolin returned -13.7%, versus -16.4% for the S&P 500, -17.5% for the Russell 2000, -16.1%
for the MSCI World Index, and -5.8% for the Bloomberg All Hedge Fund Index. Since inception, Gondolin
has returned +3.6% (net of all fees), compared with -2.5% for the S&P 500 index, -23.5% for the Russell
2000, -11.5% for the MSCI World Index, and -2.1% for the Bloomberg All Hedge Fund Index. Gondolin
continues to outperform all major indices.

Administrative Matters
• As of June 30, 73% of the capital is invested in long equity positions, 16% held in short equity
positions, and 11% held in cash. The current posture remains very defensive.
• I have advised investors looking to invest on a tax deferred basis into Gondolin to set up “Self-
Directed IRAs” if they can. These IRAs will only be taxed upon withdrawals from the IRA (usually
roll-over 401k’s), thereby avoiding paying cash taxes annually on Gondolin’s investment gains
each year when they occur. Please reach out if you have question on this investment structure.

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Returns Since Inception and Year-To-Date Still Higher versus Major Indices

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Performance Commentary for 2Q 2022
The second quarter of 2022 continued to produce stock market returns that are spiraling lower across
global stock markets and all asset classes, as accelerating inflation trends and subsequently rapid interest
rate increases are attempting to head-off the greatest inflationary threat since the 1970s. Unfortunately,
because of the unique supply-driven nature of most of these forces (e.g., labor, commodities, food), it is
not only likely that high levels of annual inflation (+6-9% Y/Y) are likely to persist, but it is also more likely
that we will enter a recession soon as a result. The backdrop for the next twelve months will likely be:
volatile consumer demand, driven by job losses that have just started to begin, and belt-tightening from
consumers that are feeling squeezed as their expenses rise at a rate ~2x faster than their wages.

Gondolin’s biggest winners in 2Q22 were entirely in the short book: Coinbase Global (+75%), Snapchat
(+64%), Wayfair (+61%), Qualtrics (+56%), and Zoominfo (+44%). The five biggest losers were Cleveland
Cliffs (-52%), Domo (-45%), Uber (-43%), Viasat (-37%), and Zillow Group (-34%). Given the disparity in
returns between the short versus the long book, the biggest sin in 2022 so far was not to make the short
book much larger earlier in year (versus the ~10-15% original target range), but as the market likely nears
a bottom over the next twelve months, Gondolin will continue to focus on the long-term returns of its
favorite longs, as opposed to near-term outperformance due to the shorts.

In 2Q22, we added three new long positions and ten new short positions. New long equities include travel
website Expedia (EXPE), movie and television conglomerate Warner Brothers Discovery (WBD), and
search advertising giant Google (GOOGL). New short positions include marketing analytics software
provider Qualtrics (XM), legacy data center REIT Cyxtera (CYXT), New York office REIT SL Green (SLG),
airline wi-fi provider Gogo (GOGO), lithium miner Albemarle (ALB), marketing database subscription
provider Zoominfo (ZI), private equity financier Owl Creek (OWL), media and advertising app Snapchat
(SNAP), and children’s retail store owner Five Below (FIVE). These latter ten companies will continue to
face tremendous cyclical and structural risk over the next couple of years, which is why they’ve been
targeted as short positions.

As we work towards the end of 2022, I want to re-iterate the two objectives of Gondolin:

1. Strong double-digit annualized returns (~15-20%/year), after all fees are paid
o Gondolin finished 2021 +19% and is currently +5% annualized since inception versus
material losses for all major indices
2. Material out-performance versus all core indices (>5%/year)
o Gondolin is currently outperforming all core indices by 7-11% in just its first ~1.5 years

I have conviction that these goals can be achieved despite the current inflationary and likely recessionary
backdrop.

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Housing exposure starting to outperform the market

In 2Q22, our significant housing exposure has moved from large underperformance to large
outperformance. While I believe that trend likely flatlines for the rest of 2022, housing should be great
outperformer in 2023, despite a worsening backdrop for mortgage rates and consumer demand. I
continue to see housing as one of the best places for capital, given the broad-based health of most
homeowners versus prior cycles, and near-record cheap valuation levels for housing stocks. Most of the
US housing industry has become a replacement industry, limiting risk from new construction declines.

Specifically, the sales of new single-family homes have already corrected ~20% from the 2021 boom levels,
back to a normalized level, and this contrasts with most other industries that have only just begun to
correct from their bubbles. Significantly higher mortgage rates are still ahead over the next 3-4months,
however, and that will likely keep a lid on valuations until the mortgage rate peak is in.

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Expectations for 2022: Stagflation Likely Ahead, Similar to 1970s for a While
As mentioned prior, compared with last quarter, the probability of an incoming recession at some point
over the next year has increased greatly in just the last few months. The reasons for this are the result of
a series of ongoing supply-side shocks, the likes of which higher interest rates and even materially lower
demand are probably unable to overcome, potentially driving prices higher even when demand is
lower…this type of dynamic hasn’t happened in >50 years and is known as stagflation, which often
produces flattish returns for the stock market broadly, as volumes and profit margins can have volatile
swings and recessions are more frequent. On a positive note, this is a great time for active hedge fund
investing (versus passive/ETFs) because we can capture outsized returns from volatile stock swings in both
the up and down markets, especially with long concentration in catalyst-driven ideas.

The last era of heavy inflation that occurred during a recession was during 1968-1982. During this time,
passive investing, fixed income investing (bonds, annuities), and long duration assets (real estate,
technology) tend to do poorly, while proper active investing (e.g., long/short) and value-based investing
tend to do well. That prior era included both interest rate and inflation acceleration amid energy squeezes,
supply-side shortages, changes in global trade (tariffs), and significant regulatory changes
(energy/materials) – all of which we are seeing again today, so the similarities here are numerous.

Gondolin remains well positioned for a period of stagflation. The strategy will be to maintain a high level
of conviction short positions in overvalued technology and consumer stocks (~15-25% of assets), maintain
a high level of cash (~10%), and focus the long asset exposure on catalyst driven ideas.

The S&P 500 (1968-1980, white line) was flat for ~12 years during the last bout of high inflation and
rising interest rates (blue line). The market will continue a flatline until rates eventually exceed inflation

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The federal reserve has a significant amount of catch-up to do in terms of raising interest rates, as was
noted late last year. Recently, the United States hit an all-time record low “real interest rate”, which is the
difference between the government 10-year yield (3%) and the annual rate of inflation (9%); that negative
real interest rate is currently -6% and that is effectively the gap that is required close before the federal
reserve begins to lower rates again. Note that we are even further behind than the in the 1970 era, when
the federal reserve fell ~4-5% below annual inflation growth rates on two separate occasions.

Where is the market bottom?

I am increasingly asked where the market is going to bottom. While that is a fool’s errand this early on
and with so much policy decisions (positively or negatively), I would look at the downside to the S&P 500
index in the following way: (1) first, use a high and prolonged government bond yield (e.g., 5-6%, vs today’s
3%) and therefore an even lower S&P 500 multiple of ~13x, versus today’s ~16x and a pre-COVID range of
18-22x, as these two items are inversely proportional; (2) second, one should decline the S&P 500 Index’s
earnings by ~10%, which was a typical EPS decline in a recession with an inflationary backdrop (thus,
$240/share -> $220/share for the whole index). That sort of analysis gets me to an S&P 500 downside
scenario of ~$3,000, versus $3,800 today. With what I currently know and expect, I would anticipate
covering most of the short positions and deploying most of the available cash back into the market at that
point, as the vast majority of the valuation damage will likely have run its course by then. I also feel
comfortable with that level as a “going all-in” point because it would assume a mere 5% annualized growth
rate since 2010, despite an S&P 500 growth rate of ~8% since 1950, and ~11% since 2010. We may of
course never actually get that low, but that is a rough approximation I think of how bad it could it get.

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Macro Backdrop: Inflation Check
In 2Q22, commodity and energy prices have begun to retrace significantly, as a recession is now getting
priced into manufacturers’ future purchasing. At the same time, the typical seasonal slow-down in buying
(late summer, early fall) is hitting things like lumber, steel, aluminum, and stored gas/oil. Prices remain
significantly above prior level and I do not think the volatility is close to being over for most of these
commodities. We’ll know much more when seasonal buying returns in the late fall/early winter months,
and thus whether this is really “the end of commodity inflation” or whether this is simply a local bottom
and we have another large upswing coming in 2023.

Oil Rig Count (Supply/Production) still significantly lagging oil prices (Demand)

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Portfolio Holdings as of June 30, 2022

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Equity Initiations in 2Q22

Regarding newly initiated short positions – SL Green (SLG) and Cyxtera (CYXT) each face significant
structural headwinds as their legacy assets (office buildings for SLG, old data centers for CYXT) continue
to see significant re-lease pressures amid higher maintenance costs (energy, construction costs), while
higher cost of capital further raises the prospect for dividend cuts.

Albemarle (ALB) is the largest lithium manufacturer in the world, which is used in electric vehicle batteries
and energy storage, but with the supply of lithium growing 2-3x the rate of demand over the next few
years (notwithstanding a recessionary impact to EV vehicle demand), the price of lithium is likely to
collapse back to normal in 2023/24, erasing most profitability with it.

Zoominfo (ZI) is a marketing database for employee information, used to market services to professionals
– it is a newer company that’s very existence is threatened by increasing privacy around personal
information, while exposure to small business advertising and marketing plus annually-renewed
subscriptions could make revenues meaningfully more cyclical than the market expects; similarly,
Qualtrics (XM) is an “experience and product management” subscription company also highly exposed to
small/medium businesses with similar annually-renewed contracts that provide great cyclical risk versus
most other software businesses; both XM and ZI are incredibly expensive (40-50x P/Es) and have
tremendous downside in terms of valuation as the SMB boom cycle winds down and the tech bubble
continues to burst.

Blue Owl Capital (OWL) is a financier of private equity and venture capital acquisitions that is likely to see
significant declines in revenue as their core industries (e.g., technology) see a long period of valuation
down-rounds and their services are deemed highly cyclical and market highly competitive to boot.

Gogo (GOGO) is an airline wi-fi provider that re-sells the capacity of other satellite operators to business
jets – however, the launch of Viasat’s satellite constellation in 2023/24 will eat up most of Gogo’s market
share and likely jeopardize the existence of GOGO’s revenue stream.

Snapchat (SNAP) is a popular social media app that caters to very short attention spans and deleted posts,
prompting an exceptionally low ability to convert users into advertising dollars – it always shocked me
that this was once a >$100B business that generated no actual cash flows, and their exposure to a cyclical
advertising backdrop (similar to XM/ZI in some ways) will see revenues pressured, margins lower (wages),

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and a way-too-high valuation continuing to reverse despite a decline of ~80% peak/trough already. Finally,
children’s retailer

Five Below (FIVE) – another very expensive consumer business (~25x P/E vs the S&P @ ~16x) – is seeing
a confluence of negative catalysts: (1) revenue slow-down as more expensive and discretionary
toys/trinkets are less in vogue and increasingly commoditized, (2) margins are compressing on higher
wages, higher store and product costs, and (3) cost to build/lease new stores continues to rise double
digits each year.

Regarding newly initiated long positions – the content creation bubble has finally burst (see Netflix…)
and with it a dramatically changing backdrop for the likes of how we view content, including for Warner
Brothers Discovery (WBD), which is now one of the largest conglomerates of content generation
(movies/TV) and over-the-top subscription services in the world; Warner Brothers’ recent spin-off from
AT&T (including their famed HBO franchise) has combined with Discovery TV, the most popular live TV
series owner in the world (HGTV, Food Network, TLC) – while their significant synergies (cost cuts) around
content spend and licensing deals will keep growth up no matter a recession or level of inflation. WBD is
guiding for $8B in free cash flow next year compared with a market value of just $32B, @ a mere 4x, versus
what I think should eventually trade >10x.

Google (GOOGL) is a well-known best-in-class search advertising monopolist and we’re using its recent
~30% decline (peak/trough) to enter ownership of shares. Google generates annual cash flows of a small
country ($70-80B/year) and has >$100B in cash in the bank, making this one of the safest stocks in entire
market to own, while valuation is only at that of the broader market (~15x). Ad revenues are going to face
meaningful pressure in 2023, but this remains the best house on the global advertising block.

Finally, Expedia (EXPE) is mostly a duopolist in both of its markets: (1) airfare and hotel reservations
(against Booking.com) with its Expedia and Hotels.com brands and in its (2) short-stay/rental business
VRBO (against Airbnb); together these businesses continue to have large growth tailwinds globally, will
prove more recession resistant than the market is predicting, and the stock is a mere 7x its free cash flow
in 2023, nearly half that of the broader stock market in terms of valuation.

Please reach out via email (aballantyne@gondolincapital.com) or by phone (248-719-3843) if you have
any questions or would like to discuss the quarter’s results in greater detail.

Sincerely,

Adam Ballantyne
Founder and General Partner

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