Posts In: Idea Exchange

Facebook – making implicit assumptions explicit

Obviously, Facebook has been in the news a lot recently. And Geoff has written a couple of articles that touch on the company directly and indirectly. Also, I’ve been reading up on the company recently and thought it would be interesting to post about whether Facebook could be a value investment.

 

This is basically just addressing directly some of the implicit assumptions that get made when you look at a fast growth stock like Facebook. I’m not going to go into Facebook as a business in detail. This is more about testing how realistic assumptions about Facebook’s growth really are. Now that said – I do have a view on Facebook’s business quality. In short – it’s extreme. This is a company that can convert 35 – 40% of sales into free cash flow while growing at very very fast rates. But I’m not going to break that down or look at the sustainability of the business in this post.

 

First, I am going to start with the premise that, economically, Facebook is a media network wholly dependent on advertising revenue. Right now, that’s true. There is a tiny amount of non advertising revenue, but it is immaterial. Of course, this may not always be true. It could find other sources of revenue. But that is completely speculative.

 

So we can say, one, the addressable market for Facebook is global ad spending. And two, we can assume that ad spending will grow over time with nominal GDP.

 

The most recent figures I can find estimate global ad spending for 2018 to be $558 billion. Obviously, you can find other estimates, but they’re not going to be hugely different, so we can work with that figure.

 

Let’s assume that grows at 4% per year for the next 10 years (roughly, nominal GDP – maybe this is a bit on the conservative side). 2028 ad spending would be $826 billion.

 

Now let’s look at Facebook. 2017 sales were $40.7 billion. Then let’s assume Facebook can grow sales at 15% per year for the next 10 years. This gives 2028 sales of $164 billion.

 

If Facebook grows like that, it will get further scale benefits so I am comfortable assuming a 40% free cash flow margin. That gives free cash flow of $65.9 billion.

 

Shares outstanding could be 3,603 million in 2028 (assuming dilution of 2% a year). So, that gives free cash flow per share of $18.29.

 

If you assume a 15x FCF multiple for “mature Facebook”, that gives a 2028 value of $274/share. So, roughly 65% higher over 10 years. Now, some of that is quite conservative. For example, it gives no credit for the huge cash buildup that would take place over this period (though that raises questions of capital allocation which are not easy to answer in Facebook’s case). It quite probably understates what Facebook’s margins could look like. And a 15x multiple is pretty cheap for a business of Facebook’s quality, even if it’s just a nominal …

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National Cinemedia (NCMI)

Would very much appreciate everyone’s thoughts / comments / feedback / criticism. If there’s interest, I might follow-up with a full writeup.

Notes

• NCMI has the #1 market share for on-screen advertising (about 50%)
• The industry is an oligopoly with NCMI and Screenvision having about 85% market share
• Basically NCMI owns the right to run a 30-minute pre-movie show in its founding members US theaters, which includes advertising. This right is backed by long-term exhibitor agreements with the founding members which, to the best of my understanding cannot be revoked
• Let me repeat, 90% of the opportunity around NCMI revolves around their ability to monetize the 30-minutes BEFORE the movie trailers start
• Founding members (and co-owners of NCMI) are AMC, Cinemark, Regal
• NCMI derives revenue principally from selling advertising during these 30 minutes
• NCMI has produced stable OIBDA margins since its IPO as well as relatively stable revenues
• NCMI, Inc., the publicly listed entity owns a 49.5% stake in NCMI, LLC. The rest of LLC is owned by the founding members
• AMC, the largest owner of NCMI, LLC is being required to divest the majority of its equity interests after an anti-competitive DOJ ruling (this was a condition for its takeover of Cinemark)
• AMC has until June 2019 to dispose of 9.5% of its stake (to reduce its stake below 5%)
• At the same time, 2017 had a relatively mediocre movie slate and attendance was down. Somehow this led to the stock falling from $16 to $5
• At its current price of $5.24 NCMI trades at a 13% dividend yield
• The company pays out almost the entirety of its free cash flow via dividend to shareholders and founding members
• 2018, so far, has been a better year in terms of theater attendance led by Black Panther
• Optimism and pessimism about the slate come and go, offset by probably 6 to 12 months
• MoviePass could help increase theater attendance as well

Further Comments

• I find this situation highly interesting and am looking for reasons why this traded at a 5-6% dividend yield forever and now should trade at 13% yield. Note I am using dividend yield as a simplified proxy for FCF, which is somewhere in the range of $120MM-$150MM per annum (to LLC, not Inc, so cut this in half)

Risks

• Further decline in theater attendance
• Weakening in pricing power if the US moves due to impact of reserved seating/online ticketing. Advertisers may be worried that nobody will watch the pre-shows (which start 30 minutes before the advertised movie start time) if this happens
• AMC somehow finds a way to wiggle out of its contract with NCMI as once it only owns <5% of NCMI, LLC interests are less aligned
• The threat of cinemas losing their exclusive right to screen movies a couple of months before DVD/other releases

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Amadeus: An Aggregation Platform and IT Business That Will Grow Along with Airline Passenger Volumes

Member write-up by Philip Hutchinson

 

Amadeus is a large, Spanish-headquartered IT company serving customers in the travel industry, tied to the long-term growth of transactions in the global travel industry.

 

First, let’s talk a bit about what the company does. Although all of Amadeus’ activities relate to the travel industry, the company is in effect two completely separate businesses: the operation of a global distribution system (“GDS”) and the provision of software to companies in the travel industry – mainly airlines.

 

Amadeus was founded in the 1980s as a partnership between four European airlines: Air France, Iberia, Lufthansa and SAS. (At this stage, it was only the GDS side of the business – the software business came later.) A GDS is, essentially, an aggregation platform sitting between users of travel services – principally travel agents – and providers of travel services, such as airlines, hotels, train operators, and the like. So, it is a two-sided marketplace, aggregating both supply – the inventory of flights, hotel rooms and so on – and demand – travel agents and other travel intermediaries (for example, corporate self-booking platforms). The Amadeus GDS, like other GDSs, is a transaction-driven business model, principally earning fees when reservations are placed. Fees are also earned for services provided to travel agents.

 

Some years later, in the early 2000s, Amadeus launched what has become its IT business. This business is the provision of software to airlines to manage various aspects of their operations – from customer search and booking, through to ticketing, reservation, check-in, baggage, and weight management of the aircraft. Similar to the GDS, Amadeus operates a transaction driven business model, charging its airline customers fees on a per passenger boarded basis.

 

I mentioned that Amadeus was initially founded as a partnership between four European airlines. In 1999, the company was listed, only to be the subject of an LBO by Cinven and BC Partners (with three airlines – Air France, Iberia and Lufthansa – also taking stakes). The company was subsequently re-floated in 2010 following a successful period of private ownership and has remained public since then.

 

Given that Amadeus has two very distinct businesses, it makes sense to address these in turn.

 

First, though, I set out some financial information for the business from 2007 – 2017 which should give you some context as I discuss its principal operations. All figures (other than percentages) are in millions of Euros.

 

	2007	2008	2009	2010	2011	2012	2013	2014	2015	2016	2017
Revenue	2,578	2,505	2,461	2,593	2,759	2,910	3,104	3,418	3,912	4,473	4,853
Gross profit	1,908	1,878	1,869	1,940	2,081	2,163	2,300	2,538	2,868	3,323	3,562
Operating profit	468	467	549	312	831	833	888	956	1,053	1,212	1,323
Pretax profit	218	237	372	66	668	721	824	898	1,004	1,144	1,263
Cash from operations	890	785	836	700	980	991	1,023	1,087	1,273	1,493	1,557
Interest	-197	-416	-140	-134	-168	-165	-57	-58	-53	-65	-23
Capex	-183

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AA PLC (LSE:AA)

Opportunity:

• Long-time market leader in UK roadside assistance.
• Very little competition (RAC, Greenflag) in durable, niche industry.
• Incredibly predictable, high return on capital business.
• Strong competitive advantages: high customer retention, high switching costs, strong brand, excellent economies of scale / high barriers to entry.
• Normalized FCF ~315MM; EV 3.440B; FCF / EV yield of 9.1%.

Risks:

• Highly leveraged after sale by private equity owners.  
• Mature, slow growing industry.
• Exposure to loss of insurance referral business in the future (autonomous vehicles).
• Recent management turnover.

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Young and Co’s Brewery PLC

I recently mentioned, commenting on Jayden Preston’s excellent post analysing the Cheesecake Factory, one of my holdings, Young and Co’s Brewery PLC (“Young’s”). I thought it would be interesting to do a write-up of the company as it’s a very interesting company and also one that, I suspect, most members may not have heard of.

 

You can find information on the company here:

 

http://www.youngs.co.uk/

 

http://www.youngs.co.uk/investors

 

https://beta.companieshouse.gov.uk/company/00032762/filing-history?page=1  [this link is to Young’s entry at the registry of publicly available company filings in the UK – if you select “accounts” you can read a selection of Young’s annual accounts going back to the 1970s.]

 

I will first provide a very brief overview of the company before setting out a bit more detail of why I think it is an interesting company to follow, and one that should provide an acceptable investment return over time.

 

Overview

 

Young’s own and operate circa 170 pubs in London and the South East of the UK (despite the name, Young’s do not do any brewing – see further below). These pubs are positioned firmly at the premium end of the market and offer food and drink in well maintained, characterful pubs (each with its own individual character), but also a clear, consistent, identifiable company-wide brand. So, basically, like CAKE, Young’s operates in the casual dining sector, but (in a way that I think is uncommon outside the UK) combines both casual dining and bar-style drinking.

 

They explain their business model very simply as operating premium, individual and differentiated pubs – operating well invested pubs at the heart of their communities, primarily in London and the South East.

 

Ownership

 

Before going into the detail of Young’s business, there are three factors I think most Focused Compounding members would agree are investment positives for Young’s and which I think mean that any long term, business focused investor should be interested in the company:

 

• The stock is relatively illiquid
• The company is still family-controlled
• There are two classes of share, voting and non-voting. The non-voting shares typically trade at a substantial discount to the voting shares – currently c22%.

 

The non-voting shares are identical in rights to the voting shares except for voting (so you get the same dividend, would get the same price in any takeover (extremely unlikely), etc.) – you just don’t get to vote on shareholder resolutions. The value of a vote is however negligible – so if you do invest in Young’s you should always buy the non-voters.

 

Overview of the Business

 

Young’s was founded in 1831 as a brewery and pub company, taking over the Ram brewery in Wandsworth, south-west London, and five pubs. Over the ensuing years, the company gradually built up its estate of pubs, which now stands at c170, with a further c80 “tenanted” pubs (that is, pubs where Young’s owns the property and leases it to a tenant who manages the pub, in return for rent and other fees). Young’s sold the brewery arm of the business in 2006.. And they …

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Dice Holdings (NYSE:DHX)

I was wondering if anyone here has looked at Dice Holdings or has a good working knowledge of the Staffing & Outsourcing industry?  The stock looks very attractive if it can be stabilized under new management.  …

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Safestyle UK PLC (LSE:SFE)

• Safestyle has the #1 position in the UK replacement window and doors segment.
• The company has a simple, proven business model that has seen them grow market share for 12 consecutive years (up from 4.1% in 2005 to 11.2% in 1H2017).
• Safestyle has a Fort Knox balance sheet with net cash position of 17MM GBP.
• The business is highly cash-generative with negative working capital. Long-term median returns on tangible capital are greater than 200%.
• An increasingly regulated market suits larger business’ that have the infrastructure to operate within the regulations.
• Fragmented market + structural competitive advantages + superior proposition = sustainable market share gains + opportunities for margin enhancement.
• Market should grow at long-term nominal GDP of 3-4%, but through market share gains, Safestyle should grow revenues at >4% and earnings at >6% per annum over the next cycle.
• Long-time CEO with skin in the game and history of good execution.
• Historical P50 P/E of 15 and P50 EV/EBIT of 11.7 for a company with net cash, very good profitability, and good growth seem very conservative, but the current P/E of 10.9 and EV/EBIT of 7.8 seems way too cheap.
• 5-year annualized return of 19 to 24% seems possible (9-10% FCF yield + 4-6% earnings growth + 6-8% multiple expansion).
• The main risk is an economic slowdown in the UK that sees a reduction in renovation, maintenance, & improvement (RMI) spending. There are already signs of this occurring in the segment; however, Safestyle has historically taken market share in tough market conditions and is well placed to do so again.

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Auto Dealership Groups

Thesis

• Auto dealership groups with scale are attractive businesses with good profitability and attractive growth opportunities driven by industry consolidation.
• Dealership franchises are protected from competition by regional exclusivity. They earn high margins on vehicle parts & servicing by acting as the warranty arms and parts distributors for their major automaker partners.
• Despite similar economics and growth opportunities, U.K. auto dealerships look cheap relative to their global counterparts. Vertu Motors plc (LSE:VTU) looks particularly cheap despite less debt / risk, better past growth, improving margins & profitability, much better cash flow generation, and better growth opportunities.
• Vertu Motors has a great management team including a young founder / CEO with skin in the game, a sound strategy / track record of execution, and excellent capital allocation.
• The largest dealership groups have the unique ability to thrive in both good times in bad. Profitability is better during downturns in the economy that you’d expect while offering significant opportunities for further industry consolidation at attractive prices.
• Key industry risks sound worse than they probably are. Threats to the dealership model are likely overblown because OEMs are unlikely to abolish it and online retailers like Amazon have numerous hurdles to overcome to compete directly with dealerships (eg. Distribution & servicing outlets).  It is unclear whether ride sharing is a threat or a boon to dealership sales & profitability and the impacts of autonomous vehicles is farther off than valuations suggest.
• OVERALL: Vertu Motors is an above average business, with excellent management, a reasonable risk profile, trading at a very attractive price.

Industry Overview

• How do auto dealerships make money?
  • Most automotive dealers sell new & used vehicles and automotive services (including maintenance & repair).
  • They also often help arrange automotive finance and insurance products for their customers. Many sell parts & accessories as well. 
  • Ultimately, car dealers have four key goals: sell you a car; sell you a car loan (or get you to lease the car); sell you insurance; and get you back to the dealership for service and eventually a trade in.

• What geographic regions did I study? 
  • I looked at four regions of the world with established auto dealership groups: North America, Europe, Oceania, and the U.K. 
• What are the business economics like? 
  • Dealerships get more than half of their revenues from new-vehicle sales, but most of car dealership profits come from the sale of used cars, parts and service, from acting as a middleman in securing loans and leases, and from the sale of so-called Finance & Insurance products like extended-service contracts.  The key to the business is less about making huge profits on the sale of new cars and more about the repeat business from servicing those vehicles.
  • While there is small need for capital (dealers ‘floorplan’ their operations, with auto finance companies and other lenders owning the cars that have been sold), the initial capital outlay to build a dealership can be immense (in the U.S., a larger auto dealership can cost $20-$30MM to build), and due

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