Further thoughts on TPG

Just a quick follow upon yesterday’s post about change and churn at TPG.

In a perfectly-competitive Adam Smith inspired world, no company earns an above average return on its capital. They all compete and innovate like crazy, but the benefits of efficiency and innovation flow through to the wider population in the form of lower prices and better products.

Of course the real world doesn’t work like that. Many thousands of companies earn high rates of returns and many don’t use much capital at all. Finding these companies and investing in them at attractive prices is the holy grail of investing.

Profit seeking motive

But never forget the principle. For all of its shortcomings, we do live in an economy full of profit seekers. And if you own a honey pot, you can bet your bottom dollar someone somewhere is trying to dip their paw in it.

TPG’s honey pot is a large one.

You could replicate the company’s physical assets for less than $1 billion ($980 million of net property plant and equipment and negative net working capital). Yet is enterprise value (market capitalisation plus net debt) is $6.8 billion. It was once more than double that.

So there is roughly $6 billion of intangible value attributed to the company at today’s market price. There is nothing at all wrong with that. As I said above, the best businesses all have value well in excess of their tangible assets. The excess represents the worth of their competitive moat.

But if you are going to invest in a business like this, you need to be sure of two things. Why does the moat exist? And how sustainable is it? (The Livewire interview below with Dr Philipp Hofflin from Lazard is an excellent summary of this concept.)

You probably know TPG better than me and I would be interested in hearing your thoughts. But TPG’s brands don’t seem to be strong enough to suggest pricing power. Most of us are not particularly loyal to our internet service provider. There are not really any network effects as most providers are using the same infrastructure. There are certainly some economies of scale, but I’m not sure how significant they would be relative to the other large players.

Value in the customer base

The main intangible asset here seems to be TPG’s 1.9 million strong customer base. I love database assets. The cost of acquiring all of those customers has been expensed in previous periods and the value doesn’t show up on the balance sheet. It has been a source of hidden value in some of Forager’s most successful investments.

What’s it worth? Once again, the world is not perfect and there are many benefits of incumbency. In a perfect world, however, the value TPG’s database would be what it costs someone else to replicate it.  The point of yesterday’s blog is that the cost of building that database is a lot less in a market where people are actively looking than one in which they aren’t.

Imagine if MyRepublic tried to acquire me last year. Firstly, they would have had to make me aware of them. That requires a lot of brand advertising. Then, incentivised me, motivated me to register and finally to sign up. That’s a lot of marketing dollars.

Market change impairs TPG’s value

Because I am out there looking for an alternative, though, all of those costs fall away. All they have to do is offer the best price and I am theirs for the taking (a few comments yesterday suggest the customer service is rubbish, so please don't take this as an endorsement of the product). Because of the NBN we all have a reason to look, and that means the cost per lead has fallen dramatically.

It is my theory that this impairs the value of TPG’s database. It is only that – a theory. The stock price has already fallen a long way and I don’t have a view as to whether today’s price is cheap or expensive. All I know is that there is still a huge amount of competitive moat in the current valuation. I can’t get confident the moat is that defensible. And that means it’s in the too-hard basket for now.

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Steve Johnson
Founder & Chief Investment Officer

Steve began Forager Funds in 2009, and now manages approximately $470m across two funds. Offering a listed Australian Shares Fund (FOR) and an unlisted International Shares Fund, Steve focuses on long-term investing in undervalued companies.

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