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Steven Chen
Steven Chen
Articles (206)  | Author's Website |

Classifieds: A Winner-Takes-All Space

Investors should look for a proven track record of super-normal cash returns on capital

April 30, 2020 | About:

The classifieds business model is not complicated. It connects buyers (or “consumers” in the industry term) with suppliers (or “customers”) through grouped publications and charges advertising fees.

The inherent simplicity does not preclude a wide moat from being dug out, with the help of the so-called two-sided network effect and the associated barrier of entry. Consider the old-fashioned newspaper as an example. Businesses like to advertise at the most influential local newspaper with the most volume of subscribers. Meanwhile, readers who look for something of interest (e.g., jobs, cars, houses) feel it is most productive to browse through the most comprehensive classifieds. This is partly why, during those old days, you typically saw only one or two newspapers really thriving at your local town. It is also one of the reasons for its attraction to Warren Buffett (Trades, Portfolio) in terms of investments.

“The ads themselves delivered information of vital interest to hordes of readers, in effect providing even more ‘news.’ Editors would cringe at the thought, but for many readers learning what jobs or apartments were available, what supermarkets were carrying which weekend specials, or what movies were showing where and when was far more important than the views expressed on the editorial page.

In turn, the local paper was indispensable to advertisers. If Sears or Safeway built stores in Omaha, they required a ‘megaphone’ to tell the city’s residents why their stores should be visited today.

Indeed, big department stores and grocers vied to outshout their competition with multi-page spreads, knowing that the goods they advertised would fly off the shelves. With no other megaphone remotely comparable to that of the newspaper, ads sold themselves.

Over the years, almost all cities became one-newspaper towns (or harbored two competing papers that joined forces to operate as a single economic unit). This contraction was inevitable because most people wished to read and pay for only one paper. When competition existed, the paper that gained a significant lead in circulation almost automatically received the most ads. That left ads drawing readers and readers drawing ads. This symbiotic process spelled doom for the weaker paper and became known as ‘survival of the fattest.’”

We all know that the printing-based media, in general, has been in a secular decline, with readers embracing an increasingly digital world. At the same time, the proliferation of online portals has been quite phenomenal. Internet technologies brought the traditional classifieds model up to a new level, with higher accessibility, scalability, profitability and efficiency. What stays unchanged here is the same old type of economic moat for those market leaders.

With a "which came first - the chicken or the egg" problem, it is incredibly challenging to build an online classifieds site from scratch. To allure customers to advertise, you need a critical mass of consumers, and vice versa. Before anyone stands out, the competitive landscape remains quite dynamic and foggy. Nonetheless, investors have their unique advantage – they do not need to figure out (or guess) the future winner; instead, we can choose the ones who has already won. In the space of online classifieds, we at Urbem would define “the winners” as the sheer dominators with the best proven track records of super-normal cash returns on capital for years.

Our top conviction picks in this space go to the two vertical site operators in the UK – Rightmove (LSE:RMV), the nation’s largest real estate portal, and Auto Trader Group (LSE:AUTO), the UK’s largest digital automotive marketplace. Both companies consistently generated high returns on assets over the year – over 30% for Auto Trader and an astonishing 200% for Rightmove. Additionally, both had a free cash flow conversion rate of above 1.0 every year for the past few years, meaning that the business is able to generate more cash for its owners than the accounting profit. Behind the financial outcome is the fact that both platforms capture roughly 80% of the viewership when it comes to their respective domains.

On the downside in the online classifieds space, we think that investors should be particularly careful with the dynamics and competition associated with technology and business innovation. For instance, according to Mitula Group, many industry leaders in the space have foreseen the business model may move towards transactional revenues, which we would regard as lower-margin and higher-CapEx. Moreover, aggressive moves from substituting services outside the industry like social media and search engines can be worrying.

Finally, me must note that classifieds portals are often region-specific, and therefore they often do not "travel" well, limiting the runway for secular growth.

Disclosure: The mention of any security in this article does not constitute an investment recommendation. Investors should always conduct careful analysis themselves or consult with their investment advisors before acting in the stock market. We own shares of Rightmove.

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About the author:

Steven Chen
Steven CHEN is a quality-focused, business-perspective investor (with bottom-up opportunistic approaches), an ex-hedge fund analyst on Wall Street, a serial entrepreneur, computer scientist, and free-market capitalist.

Steven is the Managing Partner of Urbem Partnership, a value/quality-focused investment partnership fund (www.urbem.capital).

Steven can be reached at [email protected], LinkedIn, or WeChat (ID: LSCHEN2005).

Also, check out his column at Smartkarma on the Asian market - www.smartkarma.com/profiles/steven-chen

Visit Steven Chen's Website


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