Curated Insights 2019.02.01

One big thing

For years Seder measured everything on horses. Nostril size. Excrement weight. Fast-twitch muscle fiber density. And for years he came up empty-handed. Then, Seder got the idea to measure the size of a horse’s internal organs using a portable ultrasound. Bingo. He hit pay dirt. Seth Stephens-Davidowitz tells of Seder’s discovery in Everybody Lies: He found that the size of the heart, and particularly the size of the left ventricle, was a massive predictor of a horse’s success, the single most important variable. That was it. Heart size was a better predictor of horse racing ability than anything else. And this is what Seder knew when he convinced his buyer to purchase American Pharoah and disregard the other 151 horses at auction. The rest is history.

Hans Rosling echoes this sentiment in Factfulness when he discusses the importance of a single measure in understanding a country’s development—child mortality: Do you know I’m obsessed with the number for the child mortality rate? … Because children are very fragile. There are so many things that can kill them. When only 14 children die out of 1,000 in Malaysia, this means that the other 986 survive. Their parents and their society manage to protect them from all the dangers that could have killed them: germs, starvation, violence and so on. So this number 14 tells us that most families in Malaysia have enough food, their sewage systems don’t leak into their drinking water, they have good access to primary health care, and mothers can read and write. It doesn’t just tell us about the health of children. It measures the quality of the whole society.

Rosling’s use of childhood mortality and Seder’s use of heart size perfectly exemplify the power of heuristics. A heuristic is defined as “any approach to problem solving or self-discovery that employs a practical method, not guaranteed to be optimal, perfect, logical, or rational, but instead sufficient for reaching an immediate goal.” While Rosling and Seder don’t perfectly describe the systems they are studying with a single measure, they are able to gain important insights with little information. Sometimes it helps to have lots of variables/measures, but sometimes you only need to know one big thing.

Enhancing eBay: A letter to the Board of eBay

While surprising to many, only 10% of items sold on eBay today are sold via auction, and fewer than 20% of items sold are used goods. As a result of its ability to successfully evolve and grow with the broader e-commerce market, eBay today is the world’s second largest online retailer outside of mainland China, with #1 or #2 market positions in most major geographies. Furthermore, eBay owns two other leading franchises – the premier online secondary ticket marketplace (StubHub), and a portfolio of best-in-class international classifieds websites.

Online classifieds is a fast growing industry that has benefited from a stark shift from print to online channels. Against this positive macro backdrop, the usage of online classifieds platforms continues to grow rapidly. As with all network-driven businesses, online classifieds is an industry where scale matters and success is driven by establishing a strong leadership position. In any given geography and vertical, one to two competitors generally take the majority of the market and enjoy compelling economics. Many leading classifieds platforms operate with EBITDA margins in the 40% to 60% range, with some as high as 75%. Based on our review of comparable businesses, conversations with former employees and research on the sector, we believe that eBay Classifieds Group currently operates at a much higher level of profitability than the core Marketplace, with estimated EBITDA margins that should be in the range of 45% to 55%.

As a result of these strong market tailwinds, attractive economics and significant incumbency advantages, leading classifieds businesses garner extremely attractive valuations. The average publicly traded classifieds business trades at a mid-to-high-teens forward EBITDA multiple. Furthermore, there has recently been significant acquisition interest in this space from both strategic and financial acquirers, resulting in transactions all valued at more than 20x EBITDA over the past several years.

As the leading player in a high value business with competitive barriers to entry, StubHub enjoys an attractive economic model. Today, StubHub enables the transaction of more than $4.5 billion in ticket value, up roughly 50% over the past four years. Benefiting from its market-leading position, revenue growth has surpassed GMV growth with sales up nearly 70% over the same time. While StubHub is indeed a “marketplace” for tickets, the very nature of tickets makes this platform and the features required highly distinct from the core eBay Marketplace. Despite efforts over the years to better integrate the two platforms through initiatives such as cross-promoting tickets and merchandise, eBay has never succeeded in extracting meaningful strategic synergies.

StubHub is non-core to the eBay Marketplace but would command significant value as a market-leading, scale business. The second-largest player in StubHub’s market, VividSeats, has been acquired by private equity firms twice in the past three years. The most recent acquisition came in 2017, when it was acquired for ~16x EBITDA. The third-largest player is Ticketmaster, a competitor which is part of the larger LiveNation that conducts not only secondary ticket sales, but also primary ticketing and the production and promotion of live music events. While LiveNation’s other businesses have varying economic profiles, LiveNation currently trades at ~14.5x EBITDA.


Swiping right on InterActive Corp

Maslow’s hierarchy of needs suggests friendship/intimacy/family are far more important than entertainment (sub-set of self-actualization). Pricing for PayTV subscriptions are $80-$120/month, though PayTV is generally regarded as a melting ice cube as consumers shift online. While MTCH being able to command similar ARPUs as PayTV is not my base case, the wide disparity between the ARPUs and relative importance between the two indicates significant latent pricing power for MTCH.

As Tinder’s total addressable market (“TAM”) penetration remains low (est. 50m users vs 600m singles ex-China), TAM is potentially underestimated because of the exclusion of non-singles (as noted above, a significant portion of Tinder users are non-singles), and paid user penetration is low (~4.1m average subscribers vs est. 50m users; OkCupid 2015 paid user penetration was 5.7x that of 2012 while MAU doubled and Tinder’s first-year increase in paid user penetration post-monetization was greater than that of OkCupid in 2012, per MTCH S-1), MTCH can likely grow its Tinder’s subscriber base indefinitely.

Replication of MTCH’s core dating brands is difficult due to the need for network effects stemming from initial user liquidity. Capital is not the limiting factor – dating apps with high marketing spend (i.e. hard paywalls) tend to have inferior economics as a result whereas dating apps with the best economics tend to stem from viral adoption which requires little to no marketing spend (i.e. Tinder).

Risks of new dating apps usurping MTCH’s position is mitigated by user compartmentalization of different apps and a largely unsaturated market. Users tend to compartmentalize different dating apps for different sexual strategies. For example, Tinder/Bumble are geared towards casual sexual strategies whereas Match/Coffee Meets Bagel (“CMB”) are geared towards serious sexual strategies. As a result, the average user uses more than 3 different dating apps at one time – per 2Q18 earnings call.

ANGI is in the business of helping contractors improve job turnover/time utilization and helping consumers access quality home services at lower prices through its marketplaces. Its moat is derived from network effects between consumers and contractors and economies of scale in sales and marketing. Recreating ANGI requires significant and multi-year investments in a large sales force (to attract high-quality contractors) and marketing (to attract consumers) to initiate the flywheel. Matching a contractor with a consumer is incredibly hard as the marketplace needs to have the exact capacity available at the zip code level. In addition, matching algorithms are improved with experience and data, which favors incumbents like ANGI. Moreover, given ANGI is pricing at 3%-4% take rates (per IAC 1Q17 shareholder letter) which are far below any comparable marketplace business; any new competitor would likely need to sustain operating losses due to the relative difference in scale.

ANGI has a long reinvestment runway. 90% of discovery occurs offline for US home services; consumer awareness is the bottleneck – the company with the largest sales and marketing budget and lowest customer acquisition costs (i.e. ANGI) is highly likely to acquire the most mindshare over the long-term. Per IAC 2Q16 shareholder letter, an average household has 6-8 jobs per year, with ANGI taking ~1.5 jobs, implying significant room to grow its “job-share”.

While skeptics view Amazon HomeServices as potential existential threat, this is overblown given Amazon’s core advantages are in product e-commerce, not service. Even if Amazon were to significantly ramp up its home services business, the market remains heavily under-penetrated, allowing multiple long-term winners. Such a scenario would also likely be a net benefit to ANGI as it would raise consumer awareness and hasten the transition from offline to online. Furthermore, it takes many years to build a large network of high-quality service professionals and attract a large consumer base, as ANGI can attest to. At the current time, Amazon’s home service business remains nascent.

In my view, ANGI’s primary competitors are Frontdoor and HomeServe. Frontdoor’s primary market is the US whereas HomeServe is largely UK/EU with some US exposure. Whereas ANGI provides a marketplace connecting consumers and contractors, Frontdoor and HomeServe provide home service plans.

Platforms like YouTube can and do get a large portion of the economics of their creators’ content due to their market position. Vimeo provides content creators with better economics – YouTube and Dailymotion takes 50% and 30% of a content creator’s revenue while Vimeo, in addition to a 10% cut, makes money through content creators subscribing to its creator platform. It allows content creators to monetize their content much more profitably through transactional videos-on-demand (“VODs”) instead of advertisements despite the higher content creation costs of transactional VODs. Per IAC 2Q18 shareholder letter, average revenue per subscriber (“ARPS”) at Vimeo has grown 15% per year for the last 4 years (ARPS was ~$100 per IAC 2Q17 shareholder letter), and is accelerating.

Grainger eyes mid-size companies as it invests more in Zoro.com

Grainger is investing in Zoro—which caters to smaller businesses than the larger customers that tend to use Grainger.com—to further develop its staff, expand its number of available SKUs, improve its website features, and expand its web analytics and digital marketing. In effect, Grainger will help Zoro follow in MonotaRO’s growth curve, Macpherson said.

MonotaRO has “20 million items on their website, and we are making investments in Zoro to be able to expand our offering [on Zoro.com] dramatically over the next several years,” he said on the conference call, according to a transcript from Seeking Alpha. He added that he expects Zoro’s improvement projects to be completed by the end of this year, and that Zoro will “remain profitable through the transition.”

“Zoro continues to grow very strongly,” he continued. He added that Zoro currently has several million SKUs but will eventually expand to more than 10 million. Zoro operates internationally, with dedicated e-commerce sites in the United Kingdom and Germany as well as in the United States. It also maintains an online shop on the Zoro section of eBay Canada.

As it expands its available inventory and improves its website, Zoro is also expected to increase its number of mid-sized companies in its customer base, Macpherson said. But Grainger doesn’t expect it to cannibalize many mid-size company accounts from Grainger.com, which caters more to larger customers seeking its selection of industrial and maintenance, repair and operations (MRO) products and services, he said.

Grainger has also been working to increase its overall market share of mid-size companies for industrial supplies—now at about 2%, but down from prior share figures—both by “reengaging some” customers and acquiring new ones, Macpherson said. “I would say the new-customer acquisition has been very solid over the last quarter, and we expect that to continue,” he said, adding: “Most of that is acquiring new customers digitally, and then … building a relationship with those customers.”

Ruane, Cunniff & Goldfarb Q4 2018 investor letter: a2Milk

a2 is a New Zealand-based producer of premium milk and baby formula with an unusually long story behind it. Sometime around five to ten thousand years ago, scientists believe that a genetic mutation began to proliferate throughout certain global populations of cows, changing the protein with the exciting and original moniker A2. Cows that inherited the mutation, by contrast, started to produce milk containing a second protein labeled–you guessed it–A1. While this is far from settled science, some researchers and nutritionists believe that because people have only been drinking A1-bearing milk for a relatively short period by evolutionary standards, our bodies have a harder time digesting it than “pure” A2 milk.

A good analogy here is Greek yogurt, which is believed in some quarters to confer health benefits you can’t get from regular yogurt. While Greek yogurt, like A2 milk, is a commodity product, companies like Fage and Chobani have built big businesses by wrapping compelling brands around it. a2Milk is attempting to do the same thing, to great effect thus far. Riding powerful consumer trends favoring products perceived to be healthy and natural, a2 has become the leading premium milk brand in Australia while making rapid inroads into the massive and quality-obsessed infant formula market in China. An effort to penetrate the US milk market is also showing early promise. Notwithstanding its remarkable success to date, a2 remains a young company, and much will depend on whether management can navigate a thorny distribution landscape in China, solidify the positioning of an embryonic brand and exploit growth opportunities in new geographies and product lines. With good execution, particularly in China, we think a2 could become a much larger business than it is today, more than justifying the statistically high price-earnings ratio we paid for our shares.

NYSE, Nasdaq rival aims to shed light on fee profits

IEX, which itself pays the big exchanges’ fees for data and connectivity, estimated the big three’s charges are between 10 times and 19 times its own costs for market data and as much as 41 times its costs for physical connectivity. In dollar terms, IEX said that while its yearly cost of providing a type of market data feed to its firm customers is $12,000 each, it pays the NYSE $226,320 and Nasdaq $196,000 annually for a similar offering. IEX’s business model differs from that of the big exchanges because it doesn’t charge its customers annual subscription fees for data and connectivity. Instead, it charges based on the size of customers’ trades executed on the IEX venue.

Their industry group, the Securities Industry and Financial Markets Association, or Sifma, has been fighting the exchanges’ fee increases in the courts for years. In a letter to the SEC last fall, Sifma provided its own analysis of trading data and other costs. This analysis estimated that in 2018, firms paid about 10 times to 30 times more than they had in 2010 to receive the same market information. This is partly owing to the proliferation of charges incurred for the same basic data, the report noted.

The exchanges don’t disclose profit margins for these kinds of services. In the most recent quarter, Nasdaq said its information-services unit, which includes market data revenues, generated an operating-income profit margin of 65%.

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