Seeking Alpha

Collectors Universe Has A Huge Moat

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About: Collectors Universe, Inc. (CLCT)
by: ValueZen
ValueZen
Value, special situations, Deep Value
Summary

Collectors Universe (CLCT) provides collectors and investors in rare coins, trading cards and sports memorabilia with an essential service that grades and authenticates collectible items.

They are the market leader with huge barriers to entry and pricing power.

By buying shares of Collectors Universe today, investors could expect an annual return of 10.2%.

Collectors Universe LogoSource: collectorsuniverse.com

Collectors Universe (CLCT) provide collectors and investors in rare coins, trading cards and sports memorabilia with an essential service that grades and authenticates collectible items.

They have a strong reputation and brand name among serious hobbyist, coin dealers and investors by providing a standardized system of authentication and assessment of condition to an otherwise very subjective market. Customers don't have many choices when choosing a reliable service to grade their collectibles, which makes Collectors Universe the market leader with huge barriers to entry and pricing power.

Because of their huge barriers to entry and pricing power as explained later in this article, we see a stable and growing business that can yield 10.2% returns based on a current dividend yield of 2.6% plus a FCF yield of 7.6%.

Business Overview

Collectors Universe business model is simple to understand. They provide authentication and grading services to collectors of coins, trading cards, autographs and sports memorabilia. They generate revenues when someone sends an item to Collectors Universe for authentication by charging a fee. The fees can range from $1 to $9,135 depending mostly on turnaround times and the specific service requested by the customer.

The authentication and grading services are done by experts with many years of experience. This is a must, as to avoid potential fraud in a delicate market. It involves a two-step process in which the collectible item is first stripped of any identity before it is graded by the experts to avoid any preference or influence. After it is graded, the item is sent to a senior expert which has the final word about the assigned grade.

The value driver of the business model relies on the volume of items graded and the fees they charge customers for doing so. It is a business that relies on human talent and is subjective in nature. It also operates within a very tight niche that can be separated into two groups: a group that collects items as a hobby and a group that collect items to speculate about the future increase in value, if any.

They operate under three reportable segments: PCGS (Professional Coin Grading System) for coins, PSA (Professional Sports Authenticator) for trading cards and PSA/DNA for autographs and memorabilia. As a percentage of revenues, PCGS takes top spot with 62% of revenues and PSA 38% in FY 2019, from 74% and 26% in 2017 respectively. Clearly the growth engine behind Collectors Universe is coming from PSA.

Huge Moat

There are two competitive advantages I can think of when analyzing a business model like the one Collectors Universe has: “Know-how” barriers to entry and Network effect.

The “Know-how” barriers to entry comes from the expertise required to identify and grade collectible items. This is an industry that relies on the expertise and judgement of professional graders which makes it hard for potential competitors to enter the market. Collectors Universe has been operating since 1986 and has so far authenticated over 70 million items. The sheer amounts of items sent for authentication is a reinforcing activity that allows experience to build up in a very subjective industry. Authenticators proficiency comes from looking at thousands of items analyzing every detail possible and building a database to use as an anchor point:

As of June 30, 2019, we employed 71 experts in our authentication and grading operations, with an average of 12 years of service with the Company. Our experts include individuals that either (i) had previously been collectibles dealers or were recognized as experts in the markets we serve, (ii) have been trained by us in our authentication and grading methodologies and procedures, or (iii) had gained authentication and grading experience at competing authentication and grading companies. – Annual Report

The company also benefits from network effects which in my opinion is one of the strongest competitive advantage

How is this possible?

The sports memorabilia market is estimated to be a $5.4B market. The collectible coin market is an estimated $3.4B market.

In both markets PCGS and PSA are market leaders. This is important to understand because they provide the market with the necessary brand name recognition customers need to execute a transaction involving cash and trust. This is where the network effects come into play.

PCGS and PSA have built strong brands around them. They are very well known within their tight communities. It is true that not every card or coin graded by the company will result in an increase in value. Many blogs claim the opposite saying that most items graded will lose value because not every card or coin is special. But PCGS and PSA provides an essential service in a world of subjectivity: a standardized assessment of condition. Collectors know the grading system and sellers know what they have on hand. In a sense, Collectors Universe created the liquidity in the marketplace.

As more people become aware of the PSA and PCGS brand name, trust becomes a key component in the marketplace. It is a guarantee that gives buyers and sellers stable ground around transactions. As more people use the grading services provided by PSA and PCGS, the greater the moat becomes. This makes it difficult for new competition to enter the market and has the added benefit of customers seeking their services:

It’s much like on the PSA side of our business, if somebody has a high-end Babe Ruth item, whether it's an autograph or card something like that, at this point because of our brand strength we don't have to go out and ask for those types of submissions. They sort of naturally come to us but you do have to be very competitive on modern and modern is where the volume is so we’re making a concerted effort on the coin side to build that that domestic modern business as best we can. – Q4 2019 CC

Remember this is a very emotional marketplace. Collectors have an emotional attachment and they would pay any fee to have their collectibles graded if they think it is worth a lot of money. Therefore, the company possesses pricing power which management has commented about:

Over the past nine years, we’ve had nine consecutive years of top and bottom line growth in the division, we have raised prices and raised the ASP every year for nine consecutive years, yet we have the biggest backlog in the history of our company. – Q4 2019 CC

To some extend we think of Collectors Universe as having the same business model as rating agency Moody’s or S&P. Rating agencies provide a needed service to corporations issuing debt if they want to have the blessing of investors.

It is then not far fetched to think about Collectors Universe in the same context. A collector wanting to sell a vintage Babe Ruth card needs to have it graded if they want to get the most amount of money when sold. The buyer needs to see the PSA logo in the graded card for them to even consider spending huge amounts of money in such collectible. The grading service then is a must have for any transaction to occur.

The competitive position of Collectors Universe and the moat surrounding it can be observed by looking at return measures and profitability margins:

Source: quickfs.net

Compared to Moody’s:

Source: quickfs.net

Return measures and profitability margins are very similar between both companies. Both companies enjoy significant moats as seen by high returns on capital that has persisted through-out the years with no signs of mean reversion.

Valuation

Collectors Universe has no public peers, so a comparable valuation is out of question. It is trading on a TTM P/FCF of 13.55x or a FCF yield of 7.4%.

The strength in the business model give us confidence in the cashflow generation of the company. By buying shares of Collectors Universe today, investors could expect an annual return of 10.2% (7.6% in FCF plus 2.6% in the dividend yield).

We see investing in shares on Collectors Universe as a long-term hold due to the competitive positioning of the company.

Risks

The company is not immune to economic downturns. If a recession happens, collectors would be less willing to spend money grading and authenticating coins, cards and memorabilia. This is also an industry that could face secular decline as new generations become less interested in collecting items. If such headwinds appears, it won’t matter how strong the moat is as the business will be affected.

Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.