This article is the final in a 6-part series examining how the drivers of value…
Our friend Bill Carey at Cortland Associates has frequently talked about benefitting from trends by investing in parallel, complimentary or adjacent businesses to the actual trend-maker. Many times, these parallel investments can be more profitable than the actual company driving the trend in the first place. Furthermore, if the company serves a particular niche in this trend-making industry, it will probably have no publicly-traded comparable. Uncreative sell-side analysts have a hard time with these “white space” companies and either won’t cover the company, or do not understand how to properly value it. This creates a terrific opportunity to value-focused investors that also aim to invest in quality businesses with desirable runways for growth.
We have invested in numerous under-covered “white-space” businesses and have done well with every single one in which we’ve invested. Amerco (UHAL) has a dominant market position in moving trucks and Live Nation (LYV) has effectively captured the lion’s share of the live music industry, from promotion to ticketing to advertising. We profited handsomely when we sold both investments. TripAdvisor (TRIP) is not quite an online travel agency and not quite a social media platform. It’s somewhere in between, and as a result, has become the most trusted place for advice on where to go, where to stay and what to do when you get to a destination. Billions of users rely on the platform every year, but the market hasn’t cared because it hasn’t effectively monetized this highly engaged ecosystem.
Our holding company investments EXOR (EXO) and Bolloré (BOL) have holding company peers, but are systematically ignored and are under-covered given the substantial share count that is controlled by each founding family. Each holding company has a very different set of assets, making cross-comparisons nearly impossible. Yet, in both companies, we’re getting a great collection of assets in tax-advantaged structures at massive discounts to fair value, despite being led by very impressive capital allocators. Many of their owned businesses have also taken advantage of “parallel” themes to the more obvious and secular trends that have taken place over the past decade.
Amerco benefitted from the secular shift away from home ownership towards rentals, where families move every couple years as opposed to every decade under the prior home ownership model. Live Nation benefited from the decay in music sales, as artists had to continuously make up for lost revenue by going on the road more frequently. The company is also enjoying the secular growth trend of consumers shifting discretionary spending away from things to experiences. TripAdvisor is also benefitting from the secular growth trend in this discretionary spending shift and its crown jewel, the Experiences segment, is driving a re-acceleration of its top line.
There are a myriad of other excellent examples of parallel investments that we have unfortunately not benefitted from, as Bill has pointed out. IBM’s total return was flat over a period of decades while its industry-leading mainframe business transformed nearly every industry imaginable. Database companies like ADP (ADP) and Equifax (EFX) created significant value on the back of the computing power revolutionized by IBM. As mainframes experienced significant pricing pressure and continuous re-investment demands, it was these companies that benefited from server cost deflation and they printed cash over the same decade that the technology-enabling company treaded water. When these businesses were at the beginning of their long growth runways, they had no publicly-traded peer and they defined a niche that later became a very large industry vertical on its own due to their initial success.
As Ford (F), GM and Chrysler (FCA) continued to churn out cars throughout much of the last half century, it was the media agencies on Madison Avenue that built more sustainable cash-generation machines than their Detroit customers. As the Detroit Three churned out cars and filled highways with their product, they all experienced dances with bankruptcy court throughout the last few decades while auto insurance companies minted money.
Over the past decade, as gold prices saw record highs, throughout the entire cycle, Caterpillar (CAT) generated significantly higher returns for shareholders than did gold or the gold-miners (GDX). Over this past decade, CAT has compounded investors’ capital at 10% a year while gold generated a 3.5% compounded return. Gold-miners, of course, have lost capital over this period at a 6.9% compounded rate, even adjusting for the few dividends received.
Similarly, as Bill has explained, Henry Shaw built a fortune selling picks and shovels to the droves of pioneers heading out west to claim their fortunes. In St. Louis, the “Gateway to the West,” his hardware store was the last stop for sojourners before hitting the wild west. We know of no families that built lasting wealth during the California Gold Rush, which started at the end of his career. Henry Shaw however, sold these wealth-seekers shovels, picks, and everything they needed for the journey out west. He built an enormous fortune doing so, retiring at the age of 40 as one of the largest landowners in the city and founder of the Missouri Botanical Gardens on some of this land.
In a similar vein, Ocado is a “white space,” company with no direct comparable, benefiting massively from the shift to e-commerce. Sure, there are fast-growing grocery retailers we can compare the company to, but this would ignore the fact that most of the future value of the company will come from its software and automated order fulfillment technology. Ocado is a sort of hybrid between an ERP SAAS company, a logistics company and a retailer. While the company isn’t under-covered, it is highly controversial and was the third most shorted stock in Europe when we bought our position.
Ocado stands poised to benefit from the long secular trend of retail transitioning over to e-commerce. Because of the nascency of this industry vertical to penetrate online channels, it is still “Day One,” for this industry. Ocado will not be the first business in GreenWood’s network to benefit from retailers’ attempts to defend themselves against Amazon. We have found, when faced with an existential crisis, companies will go to great lengths to ensure their long-term survival. Thanks to Ocado licensing its last two decades of R&D to their peers, early partners will have access to this technology overnight. They’re effectively transforming their competitiveness with the ease of one signature. Companies that lose access to this technology, like Walmart, will face a permanent cost disadvantage versus Amazon and Ocado partners, as the latter company has a 15% online EBITDA margin advantage in the UK versus its competitors with greater market share. Whether or not Walmart acknowledges this existential threat to its price leadership position remains to be seen. If the management and board is aware of the long-term advantage Kroger has just gained against their own franchise, we expect to see a bid for the company emerge in the coming months from Walmart.
If we do not, and the company expands their fulfillment capacity by a factor of 10x, and continues to sign international partners thereafter, shares still have fairly significant medium-term upside potential. Although the stock has recently gotten ahead of itself in incorporating good news from the partnership front, management has used the last year in the wake of the Amazon-Whole Foods transaction to their advantage and have made hay.
If Walmart fails to act, it is emerging as one of our favorite short opportunities. After it is done cramming price cuts down the throats of its suppliers, further weakening its own ecosystem, we believe the company is headed directly towards a corporate cul-de-sac as it loses grocery traffic and this lower traffic reduces opportunities to cross-shop the lower-turnover items it has in stock in its gargantuan stores. While Walmart is focused on rolling out $10 grocery delivery across its footprint, Kroger will be coming onto the market with a free to modest-charge delivery offering, and it will be able to deliver these orders profitably, while Walmart loses money on these orders. The quicker Kroger penetrates its geographic base, the quicker it can build a cost advantage over the former price leader in the US market, and the quicker Ocado will sextuple its free-cash-flow.
We have just posted a 36-page research report on Ocado to our investors, along with the model, and are working on numerous other “white space” businesses in our pipeline. Our result from Ocado over the past year is matching the very attractive returns available in such businesses.
What is your favorite “white space” company in the market today? We’d like to hear from you, and will be happy to share what we’re working on. These are under-covered pockets of quality in a market that immediately rewards “compounders” with nosebleed valuation multiples. Often times, these parallel or white space businesses also have a limited float and little ETF ownership, as founders seek to control the destiny of their niche gold mine. Scratch that, these businesses are far more profitable than any gold mine.
Like Henry Shaw, we’d rather sell the picks and shovels to these wealth-seekers. Or in this most recent investment, we’d rather sell the robots and software to groceries around the world rather than actually sell the groceries online.
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