What makes a perfect platform? Size, value, bargaining power, and economic moat
Companies: AUTO, G4M, JE/, MONY, RMV, ZPG
"A platform is when the economic value of everybody that uses it, exceeds the value of the company that creates it. Then it’s a platform." - Bill gates
In this article, we'll be talking exclusively about UK-listed aggregation platforms. Primarily we are looking at online, tech, or ecommerce companies that advertise or aggregate goods or services to end-users.
This model gives consumers greater surplus, as they spend less time looking for what they want while often paying a lower price as a result of the economies of scale and competition on the various platforms.
If you consider platform businesses within the Smiling Curve Framework, aggregation platforms by their nature sit on the right-hand side, especially those which possess strong branding, advertising, and marketing clout. By aggregating goods or services for the end-user and allowing those users to find what they want quickly, platforms can provide more consumer surplus and thus command greater loyalty from their users.
A few weeks ago, the Naked Fund Manager discussed this business model at length and why platform companies are so efficient. Here is my favourite insight from that article:
"There are reasons for caution... but picking the right ones [platform stocks] will see a perfect virtuous cycle. Network effects are a powerful thing and the bigger the platform, the more value to consumers, the greater position of power for the platform, and with that, there is a much-improved cash cycle, which often results in strong negative working capital and significant margin expansion."
Some notable examples of these internationally include ecommerce sites Etsy and Amazon, taxi disrupters Uber and Lyft, food delivery services UberEats and Deliveroo, as well as holiday and travel visionary Airbnb, streaming music innovator Spotify, and on-demand video pioneer Netflix.
There are several exciting and fruitful companies listed here in the UK that follow a similar model and benefit from the value, bargaining power, and economic moat that the model can offer. It is a handful of these that we'll be exploring in the following article.
JustEat is the perfect company to kick off a list of great aggregation platforms, as this online food delivery pioneer was years ahead of many that now follow its tried and tested method. JustEat was founded in Denmark way back in 2000!
To put it frankly, JustEat dominates the online food delivery market in 12 countries. The benefits of its recently redesigned platform are clear, hungry consumers get a better experience while restaurants benefit from increased marketing, and improved utilisation of headcount and assets.
JustEat has created an enormous economic moat for itself in the UK's delivery food market, with most takeaways (note: not restaurants) needing to be on the platform.
JustEat is a good example of a negative working capital platform. With very little accounts receivable versus accounts payable, it is essentially self-funding, i.e. the business brings in money immediately through facilitating the ordering process while paying the provider of the food at a later date.
In the past six years, JustEat hasn't reported more than £2m in accounts receivable, a consequence of all their revenues being received upfront from consumers. On the other hand, its accounts payable hit £50m in 2016. This shows the strength of the platform: as JustEat grew to scale, it was able to flip its cash conversion cycle and fund growth directly from its customers, while restaurants shoulder the upfront cost and receive their revenues once a fortnight.
JustEat also has considerable brand strength. It recently rebranded, and if you look closely at most takeaways and drivers (that aren't Deliveroo/UberEats), you can see its instantly recognisable logo.
Back in January, JustEat shares fell after results showed sales growth was slowing, with revenues forecast to grow 32% and then 22% in the next two years. However, it's operating margin improved by 9% last year and has a CAGR of 6.3%, meaning net profit is expected to double in the next two.
The shares currently trade on a lofty earnings multiple of 35x 2017 EPS and 25x 2018 EPS, but looking at the PEG ratio helps to understand why... the high growth expected from the Group results in a 2017 PEG of 0.94, just under the 1.0x generally assumed to show fair value.
Music retailer Gear4Music might be an odd choice for a list of platform stocks, most reading this will think "Isn't G4M just an online retailer?". Well yes, that's true - but the reason we've included G4M in the list is due to its site acting as an aggregator of the main manufacturers as well as it's own equipment, as well as its potential to reach scale and become the leading platform in the UK's music equipment retail market.
Could it become the one-stop-shop for musical instruments in the UK, and eventually maybe even Europe? Europe looks a trickier market, with the enormous Thomann.de website already very well established, but G4M is making real inroads nonetheless.
Gear4Music has been gaining momentum amongst AIM investors in the past year, with its share price jumping more than 400%. The Company that started off as a single store back in 2003 has since sold musical equipment to more than half a million people.
For those who aren't so familiar with G4M, think the Amazon or ASOS for musical instruments. It supplies goods from lots of companies and brings them into a unified platform that customers can buy through. It doesn't have the high-cost base of high street retailers and can use cheaper out-of-town locations to store goods.
It enjoys network effects and can provide consumers with a strong brand, lots of choice and value. Its business model disrupts high street retailers due to its structurally lower costs / higher scalability and is supported by a sophisticated digital marketing operation. Revenues are set to double between 2016 and 2018, from £35m to £79m, with PBT increasing significantly too.
Valuation showing relatively high PEG ratio
Like most platform businesses, G4M's valuation is at a premium with the share price trading at 57x 2017 earnings and 47x 2018 earnings. However, the growth that's being forecast by consensus estimates puts the PEG ratio at a lofty 2.25x, i.e. investors are paying 2x earnings per unit of growth.
3&4) Zoopla & Rightmove
There are two property portal platforms included in our list: Zoopla and Rightmove.
Zoopla was founded in 2008 and is now partially owned by Countrywide and the Daily Mail and General Trust. It started life imitating its more established rival, Rightmove, aggregating properties from UK estate agencies for prospective buyers while acting as an online advertising service for those agents.
Zoopla has since diversified its business, acquiring various comparison sites for energy, communications, financial services and more, while also offering property data insight services.
Rightmove was the first real disrupter of the UK property market, bringing a fresh online approach to marketing properties for the stale, but lucrative, estate agency industry. It was founded through a partnership by Halifax, Countrywide plc, Royal & Sun Alliance, & Connells, and listed in 2000.
Rightmove, soon to be followed by Zoopla, is a big beneficiary of the platform network effect. Its digital footprint and power eventually growing to far exceed that of its founders, commanding vast swathes of the web traffic of buyers and thus cementing itself as a vital advertising platform for the industry.
In 2016, Rightmove earned £220m in revenue and £129.5m in net profit, whilst Countrywide (the Uk's largest estate agency) had revenues of £737m and net profit of just £17.4m
Both Rightmove and Zoopla are nested solidly at the right-hand side of the Smiling Curve. The strength of these platforms is in their coverage and branding: they can stretch across the UK like no agent could and with much lower operating costs, while at the same time providing a familiar, reliable, and more enjoyable service to their users.
The battle for the "second platform" that OnTheMarket.com unsuccessfully** waged against Zoopla shows just how much strength, and how embedded, these platforms have become in their industry.
Valuations show slightly lower PE multiples but PEG moderately high
Rightmove is on a relatively low multiple for a platform-based business, trading on 27x consensus earnings in 2017 and 24x expected earnings in 2018. This perhaps makes more sense when you look at the expected level of growth in what is a more mature business, with a PEG ratio for 2017 comfortably over 2x.
Zoopla trades on slightly lower multiples than Rightmove with 2017/2018 forecast PE of 26x and 23x, but the forward PEG ratio is somewhat more attractive at around 1.5x each year.
** Knight Frank, Savills, Strutt & Parker, Chestertons, Douglas & Gordon and Glentree Estates founded OnTheMarket.com in a bid to compete with the dominance of Zoopla and Rightmove. It had failed to take significant market share as of the end of 2016.
When it comes to online marketplaces, few can rival the reputation of AutoTrader. The second-hand car platform was founded in a pre-internet age but has managed to transform its business into a sophisticated marketplace for automotive buying and selling.
According to the company itself, consumer surveys have found that its brand is known (once prompted) by more than 90% of people in the UK, that's pretty staggering.
AutoTrader's days as a fortnightly publication are a far cry from its current iteration as a savvy internet platform. Its user stats are impressive, attracting around 48m visits each month, with nearly 70% of those on mobile. Even more impressive is its market share: more than 80% of all time spent on automotive classified sites is on Autotrader.
One of the key advantages that AutoTrader has is its network and reach, giving it a significant economic moat. If people want to sell a second-hand car in a highly populated area, by all means, they can go to a second-hand car dealership: they do make a fair amount of money, it even made Sir Arnold Clark into a Billionaire. But within the marketplace on AutoTrader users will get a better price and access to a much wider (UK Wide) market. AutoTrader is always going to perform better than second-hand dealerships, hence the £4bn+ market cap.
Valuation attractive under the Greenblatt magic formula framework; High ROCE
Taking a quick look at valuation shows Autotrader scores well in Joel Greenblatt's magic formula rank, partly because it has an impressive 53% Return on Capital using 2017 forecasts it offers a 4% earnings yield.
Last, but certainly not least, is price comparison platform Moneysupermarket.com, founded in 1993 by Simon Nixon and Duncan Cameron. Probably as well-known to UK consumers as Auto Trader, MONY has significant staying power as an aggregator of financial services products.
One fundamental difference between it and Auto Trader is its economic moat, the former has cornered a huge part of the second-hand automobile market, while MSM has significant competition from other aggregators in its industry (like ZPG).
Valuation relatively low with respect to PE; High ROCE
The valuation currently discounted in Moneysupermarket's share price is a relatively average multiple of 26x reported 2016 earnings, and dropping to 20x 2017 consensus and 18x 2018. The PEG ratio jumps over the period from 1x for 2016 actuals up to c.2x in 2017/2018.
As with many platform companies, MONY enjoys healthy Return on Capital, rising from around 20% in 2013 to nearly 50% in 2016.