Baron Funds Commentary on VRSK, RBA, TIF, RL, WU, RIMM, Others
Like Warren Buffett, one of the factors we consider in assessing a company is its ability to establish and maintain solid “economic moats.” An economic moat is a structural competitive advantage which enables a company to rebuff competitors while generating good returns over an extended period of time.
Identifying companies with long-term, sustainable competitive advantages is neither obvious nor easy.We conduct substantial and extensive research on each company to understand its business, its management team, and its opportunities. We have to be knowledgeable about the industries in which the company operates to understand the company’s competitive advantages. Our research and understanding of these competitive advantages allow us to identify mis-priced stocks that do not reflect the long-term potential of those businesses. We speak with a company’s competitors, service providers, customers, vendors, other shareholders, consultants, as well as other industry participants and experts. Below are some examples of the kinds of competitive advantages we look for.
High Replacement Costs
Genesee & Wyoming (GWR), an owner/operator of short-line regional freight railroads in the U.S., Australia, Canada, and Mexico, owns about 10,000 miles of track, and its lines feed into the larger Class One railroads. Not only is the replacement cost of that track extraordinarily high, but competitors cannot attain the zoning or right of way to build new track.
Unique Products & Services
MSCI (MSCI) is a provider of investment decision support tools to global investment institutions. MSCI’s domestic and international equity indexes, including its flagship MSCI EAFE Index, its Barra risk analytics tools, and its proxy research and voting service, Risk Metrics, are well known and have significant market share. The company owns all of its index-related historical data, so any firm that wants to use the company’s sophisticated analytical tools must license the data from MSCI.We believe that MSCI’s significant market share and continuous product innovation, coupled with SEC rules that limit the ability of mutual fund asset managers to change their benchmarking indexes, creates a barrier to entry. Because MSCI’s products are deeply embedded in its client work flows, MSCI has superior retention rates and advantageous pricing power.
Verisk Analytics (VRSK) is another example of a company with a unique product that carries high switching premium.The company provides data used by property and casualty insurers to underwrite policies. Its database contains more than 15 billion records, and it would be nearly impossible for a competitor to accumulate the same depth and breadth of data, yielding high retention rates for the company.
C.H. Robinson (CHRW), an industry-leading transportation broker, is an excellent example of a company whose technology competitive advantage leads to high operating margins. C.H. Robinson is an “asset light” business. It does not own any trucks, trains, planes or ships and does not have a stake in the freight; it has sophisticated IT systems that provide a complete view of the shipping spot market. Its scale and technology are the company’s key competitive advantages, as their expansive network of shippers and carriers is hard to replicate. This allows the company to take advantage of the bill-pay spread between shippers and capacity providers in real time at any point in the economic cycle, allowing it to maximize gross profits by efficiently matching independent shippers with truckers and other carriers.
Dominant Market Share
Ritchie Bros. (RBA) is the world’s largest auctioneer of used industrial, agricultural and transportation equipment. Its dominant market share attracts customers because of the company’s global liquid market place, where customers are likely to receive higher prices, which would, as a result, produce higher revenues. In our view, the company’s competitive advantages will continue to grow due to network benefits, giving the company continued pricing power.
Another company with dominant market share is Nielsen Holdings (NLSN), a global information and measurement company that provides its clients with a comprehensive understanding of consumers and consumer behavior. It measures what people watch, and has become the de facto standard for measuring TV audiences in the U.S. It also measures what consumers buy, and this data is used by consumer packaged goods companies and retailers to measure sales and market share, and to launch and grow new products. Nielsen’s dominant and critical competitive advantage yields high retention rates and significant pricing power.
A strong brand is another form of competitive advantage. Tiffany (TIF) and Polo Ralph Lauren (RL) are good examples of companies whose brands are so strong there is an inherent competitive advantage created. Other companies may try to imitate their products, but that blue Tiffany box and the Polo Ralph Lauren logo are strong hurdles for competitors to overcome.
Western Union (WU), the leader in person-to-person money transfer, has a massive global network that enables it to take huge market share. Its understanding of the legal and regulatory requirements that allow money to be sent country to country allow it to operate efficiently in a global anti-money laundering framework, a big competitive advantage in a world of persistent terrorist threats. As new payment technologies arise,Western Union can deploy them instantly and globally, while competitors may have to employ a region-by-region roll out.
Some companies may appear to have strong long-term competitive advantages, but those advantages may deteriorate and may not be sustainable.We were early investors in Research in Motion (RIMM), known for its Blackberry smart phones, an early leader in smart phone technology and the preferred choice in corporate settings. As the market became increasingly consumer driven, and competitors such as Apple’s iPhone and phones using Google’s Android platform began to emerge with fast and easy Internet browsing, touch screens and thousands of apps, RIMM lost its market leadership position and its competitive advantage, and we exited our position.