Allow me to get right to the point. Here’s an example of a well-run, well-financed company that I really admire, but for which the price just clearly isn’t right.
“CEB,” as it’s known, provides research, support, education, and best-practice studies to corporate executives. The model is interesting in that it also allows executives to learn and benefit from one another through shared problems and guidance. Because much of the work CEB does is shared and almost “templated” so that many clients can benefit from the same solutions, the company benefits from a certain economy of scale, and can pass this to its customers and offer extremely low prices relative to its peers.
Despite its low prices, the company enjoys huge margins and fat returns. Dependent on its intellectual capabilities, the company is not at all capital intensive, yet earns high returns on equity with no debt. The balance sheet is pretty, cash flow is strong, and management is phenomenal.
Which brings me to my next point. I and some colleagues had the good fortune to meet the company’s CEO, Tom Monahan, a few days ago and spoke with him about the business. Mr. Monahan is clearly talented, vibrant, and passionate about his work and CEB. He and the management of CEB are a far cry from the wildly overpaid executives elsewhere who do little to increase shareholder value.
Mr. Monahan discussed the firm’s competitive advantage, which would have been a concern for me had I not understood it a bit better. Because the company (cost-effectively) serves around 80% of the Fortune 500, it can offer its shared solutions for a wide array of business problems, and retains a pitching point enjoyed by virtually no other firm of this kind. This moat allows for easier and easier sales as it grows, and provides immediate legitimacy for potential new clients. Furthermore, the company has over a 92% renewal rate from its customers, demonstrating that CEB’s offerings are adding value for its customers. On the most basic level, it would be difficult for a competitor to displace CEB in its market.
As should be obvious from a quick glance, the company has grown extremely rapidly over the past years. Of course, past performance is no indication of the future, which brings me to the future growth and the (unfortunately high) price. As the company continues adding to its “portfolio” of clients, marginal growth potential must, by mathematical law, diminish. While they certainly haven’t saturated their potential market, 80% of Fortune 500 companies is a good indication that growth is unlikely to be as explosive as in the past, and certainly should not accelerate.
The way I see it, growth can still be driven in a few ways: continue adding clients, tap into previously untapped pricing power (as the “moat” grows, CEB may realize that its prices, which are around a quarter of what some competitors offer for consulting sevices, do not fully capture their customers’ willingness to pay), and adding to the portfolio of smaller clients who otherwise couldn’t afford more pricier traditional consulting services.
That said, the price, at around 48 times earnings, is very high and makes me uncomfortable. For instance, the company would need to grow free cash flow at something like 20% over the next ten years and 3.5% ad infinitum thereafter just to justify its current pricetag. Granted, this can happen and the company does have a low cost of capital, but it’s simply not a big enough margin of safety.
Nonetheless, this one’s on my radar screen, and I’d be thrilled to scoop some up at a better price.
“CEB,” as it’s known, provides research, support, education, and best-practice studies to corporate executives. The model is interesting in that it also allows executives to learn and benefit from one another through shared problems and guidance. Because much of the work CEB does is shared and almost “templated” so that many clients can benefit from the same solutions, the company benefits from a certain economy of scale, and can pass this to its customers and offer extremely low prices relative to its peers.
Despite its low prices, the company enjoys huge margins and fat returns. Dependent on its intellectual capabilities, the company is not at all capital intensive, yet earns high returns on equity with no debt. The balance sheet is pretty, cash flow is strong, and management is phenomenal.
Which brings me to my next point. I and some colleagues had the good fortune to meet the company’s CEO, Tom Monahan, a few days ago and spoke with him about the business. Mr. Monahan is clearly talented, vibrant, and passionate about his work and CEB. He and the management of CEB are a far cry from the wildly overpaid executives elsewhere who do little to increase shareholder value.
Mr. Monahan discussed the firm’s competitive advantage, which would have been a concern for me had I not understood it a bit better. Because the company (cost-effectively) serves around 80% of the Fortune 500, it can offer its shared solutions for a wide array of business problems, and retains a pitching point enjoyed by virtually no other firm of this kind. This moat allows for easier and easier sales as it grows, and provides immediate legitimacy for potential new clients. Furthermore, the company has over a 92% renewal rate from its customers, demonstrating that CEB’s offerings are adding value for its customers. On the most basic level, it would be difficult for a competitor to displace CEB in its market.
As should be obvious from a quick glance, the company has grown extremely rapidly over the past years. Of course, past performance is no indication of the future, which brings me to the future growth and the (unfortunately high) price. As the company continues adding to its “portfolio” of clients, marginal growth potential must, by mathematical law, diminish. While they certainly haven’t saturated their potential market, 80% of Fortune 500 companies is a good indication that growth is unlikely to be as explosive as in the past, and certainly should not accelerate.
The way I see it, growth can still be driven in a few ways: continue adding clients, tap into previously untapped pricing power (as the “moat” grows, CEB may realize that its prices, which are around a quarter of what some competitors offer for consulting sevices, do not fully capture their customers’ willingness to pay), and adding to the portfolio of smaller clients who otherwise couldn’t afford more pricier traditional consulting services.
That said, the price, at around 48 times earnings, is very high and makes me uncomfortable. For instance, the company would need to grow free cash flow at something like 20% over the next ten years and 3.5% ad infinitum thereafter just to justify its current pricetag. Granted, this can happen and the company does have a low cost of capital, but it’s simply not a big enough margin of safety.
Nonetheless, this one’s on my radar screen, and I’d be thrilled to scoop some up at a better price.
