Online advertising - the only way is up!
We have invested in businesses like Expedia, Yahoo and Qihoo in the past and we currently have 14% of our portfolio allocated to these types of businesses. We like these businesses as there is a clear tailwind out of traditional media expenditure towards digital media advertising. Companies that we invest in, that are directly exposed to this trend, are spread around the world and include Criteo, a global digital performance marketing company, Alphabet, whose core assets are in Google, which generates search advertising and Youtube, which generates its profits from online video advertising. We also invest in a number of online advertising and transactional businesses in China which include Zhaopin and Autohome.
We have a larger proportion of our online advertising portal investments in China at the moment as the rate of growth in this region is much faster as the market is not as developed as the western world. In the following charts you can see that the size of digital advertising expenditure in China is well below the US but it is catching up and growing at a much faster rate than the US. However, the US is still growing at a healthy clip and Alphabet and Criteo are benefiting from this trend. Alphabet and Facebook are getting 70-80% of every incremental advertising dollar being spent on digital and their growth is showing no signs of slowing. We met with the CEO of Colgate recently and discussed how South American millennials are spending all their time on Facebook and YouTube. Colgate, like most other large corporates, are diverting more of their advertising spend to these mediums.
Chart 1: Digital advertising expenditure (USD million):
Source: Iresearch, Nomura Research, Nomura estimates
Chart 2: Digital advertising growth rates:
Source: Iresearch, Nomura Research, Nomura estimates
Online advertising portals in China
We think that China and Asia have incredible prospects for growth over the next several decades and look to invest in these structurally advantaged media businesses. While we are finding it harder to find mispriced businesses of this kind in the US, we are not having trouble finding them in the rest of the world, especially in Asia. I have included a recent quote from Charlie Munger, who sums up China nicely: “What I like about China is they have some companies that are very strong and still selling at low prices. The Chinese are formidable workers and they make wonderful employees and there is a lot of strength in that system. The Chinese government helps its businesses, it does not behave like the government of India which doesn’t help its businesses at all. That’s what I like about China”.1 Munger went on to say that he only has three investments: Berkshire Hathaway, Costco and an investment in a Chinese fund. We also agree that there are tremendous opportunities in Chinese companies and have done well out of them so far and expect to continue to do well out of the region going forward.
As we all know, advertising expenditure is shifting quickly from traditional media to online and this is no different in China. In 1H16, while advertising declined in newspapers (-41%), magazines (-29%) and tv (-4%), it actually increased by 27% for online advertising.2 There is a similar trend in the general Chinese economy as growth shifts from older industries like manufacturing to more new age service industries. Therefore, our focus in China has been in structurally growing industries such as consumer, healthcare and online advertising.
We invest in businesses like Zhaopin, the leading online employment classifieds business in China, which has recently been bid for by Seek and Chinese private equity. This is the third bid that Zhaopin has received over the past year and I get the sense that we are nearing the end of this bidding war for our shares. We have every degree of respect for Seek and what they have managed to achieve in Australia and globally over the past decade and have every confidence that Zhaopin will continue to emulate this success in China. We have invested in Zhaopin since their initial public offering in mid-2014. The company's 2017 second quarter financial results compared to its 2014 fourth quarter financial results, show that the business grew from 89.5 million registered users and 244,000 unique customers back then to 130 million registered users and 395,000 active unique customers today.3 They have now overtaken the incumbent 51 jobs, who initially had more unique customers but now only has 337,000. If you have been following our fund over the years you would have read my constant praise of the company and the management team led by Evan Guo. I am sure Evan and the team will continue to do a good job and will continue to grow this business at a steady clip over the next decade. The company has over US$5 million in cash, highlighting the strength of the balance sheet and given that it has the other criteria that we look for, being an owner-managed business (Seek and the Bassat brothers control the company), a growing business with strong free cash flow and a business trading at an attractive valuation, it is no surprise that it has received three bids by private equity.
We have also done well out of Autohome, the leading automotive online advertising business in China, over the past six months as well as over the past five years. Autohome was spun out of Telstra at the end of 2013. We bought in during the IPO as we liked the business and managed to buy in at an attractive valuation. The valuation quickly ran above what we felt was fair value in 2014 and we subsequently sold out. Like many of the companies that we have in the past invested in, we continued to monitor the progress of Autohome despite not being a shareholder in the business. Fortunately at the end of last year, we got the opportunity to buy back into the business at an even more attractive valuation than what we paid in 2013.
Autohome operates two websites, autohome.com.cn and che168.com, providing independent content to automobile buyers. They provide a library of automobile features and data, new and used automobile listings and user generated content. 67% of automotive advertising expenditure is currently done on vertical websites with Autohome leading the sector with a 25.5% market share due to its high quality automotive content and large user base.4 We have spoken to a number of automotive car dealers in China, who are Autohome’s main customers and it is quite clear that this is the most efficient form of advertising to attract car buyers. One told us that the cost per lead is only 30RMB on Autohome compared to 200-300 RMB through traditional channels. Further the success rate of converting leads from Autohome is much higher than through competing portals. Therefore we have every bit of confidence that the management team will continue the double digit earnings growth that they have achieved in the past, well into the future.