Peter Thiel (Paypal founder, investor in Facebook, Space-X) recently gave a talk at a Stanford course "How to Start a Startup" and although it focused on how to build a great company it was very insightful on how investors should evaluate companies.
His dominant message is that competition is for losers. What you want to build (or invest in) are companies that are essentially monopolies. There are essentially two variables that determine company value: "x" the amount of value created and "y" the percentage of value that is captured. Peter uses Airlines vs. Search as an example. Airlines create a substantial amount of value and generate ~$195 billion in domestic revenue (2012) vs. Google with revenue slightly over $50 billion, but whereas airlines were only marginally profitable, Google piles up cash. The size of the market "x" is clearly the less important factor in value creation than the "y" percentage of the value you can capture.
Peter also discussed the timing of when value is created. In 2001 he looked at Paypal's discounted cash flow forecast and found that 75% of the value was created in years 2011+. He finds that this is typical in most tech companies and that 75-85% of the value is coming from cash flows that occur in years 10+. He reasons that because growth factors are easy to calculate we focus on those, but the more important question is will the company be around in 10 years. Durability is thus a key determinant in whether value is created.
Warren Buffett has benefited greatly from investing in companies where the long term cash flows turned out to be reliable and Jeff Bezos, founder of Amazon, once stated
I very frequently get the question: what's going to change in the next 10 years?... I almost never get the question: what's not going to change in the next 10 years?... the second question is actually more important… because you can build a business strategy around the things that are stable in time.
According to Thiel, there are three characteristics to a monopoly:
- Proprietary Technology
- Network Effects
- Economics of Scale
He believes there are only two broad categories where people started a venture and made money. One is vertically integrated complex monopolies (think Ford, integrated oil companies, Tesla, Space-X) and software.
So the hunt begins. Where are the monopolies?
Priceline (PCLN) - Priceline has the high margins associated with a less competitive business and essentially operates in an Oligopoly with Expedia. They don't have proprietary tech or a strong network effect, but they have an amazing economy of scale and will arguably be in business in 2024 still capturing value. With a market cap of $57 billion they're valued at ~28x earnings which is inline with their earnings growth rate of ~30%. Not a deal, but a great company.
Genworth MI Canada (OTCPK:GMICF) - Genworth is a mortgage insurance company in Canada that shares the majority of the market place with CMHC, a government backed organization. Pricing is high, they benefit from economies of scale but growth is limited, even with CMHC looking to slow down its backing of mortgages. I own it and it's steady, but not a high flyer.
Intrexon (NASDAQ:XON) - Intrexon is a synthetic biology company with a $1.7 billion market cap and $33 million in TTM revenue. It partners with companies and uses its knowledge to create proprietary technology the companies can use. It's young, growing quickly and could one day be a behemoth if it can capture enough of the value it creates through its royalty stream.
SolarCity (SCTY) - SolarCity is the largest residential solar panel installer in the US. They don't have proprietary technology, but have started their own PV panel factory to enable economies of scale and are growing quickly. At a $5.0 billion market cap, $221 million in TTM revenue and an operating loss it will take time to see the eventual value they can create and capture. A key limitation will be the ability to finance all of the installations (which are then typically paid out on a monthly contract for energy use) as rates rise in future years.
I highly recommend watching Peter's talk, it can be viewed here.
Have you invested in any monopolies that we should look into? Please let us know in the comments.
Disclosure: The author is long GMICF.
The author wrote this article themselves, and it expresses their own opinions. The author is not receiving compensation for it (other than from Seeking Alpha). The author has no business relationship with any company whose stock is mentioned in this article.
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