The hidden monster monopolies of the ASX
While not technically illegal in Australia, monopolies have always been a touchy subject for regulators. The prospect of "anti-competitive" behaviour is constantly debated and has resulted in the ACCC blocking some massive mergers in recent times, including:
- BP acquiring Woolworth's $1.8 billion petrol station network (2017-2018)
- The $15 billion Vodafone and TPG merger, a decision that was later overturned by the High Court (2019-2020)
But overall, Australia remains a conducive environment to mergers and companies inorganically growing their market share, particularly on appeal: Corrs Chambers Westgarth reports that "the ACCC has lost every merger challenge that it has brought in the past 20 years."
From an investor perspective, the prospect of one large market player is an enticing prospect. With the moat that protects their market share and thus earnings, this could be the key to an all-weather portfolio winner. Warren Buffet is certainly a famous proponent of the principle:
"What we're trying to do is to find a business with a wide and long-lasting moat around it -- protecting a terrific economic castle with an honest lord in charge of the castle."
When it comes to domestic monopolies, the first names that come to mind are probably infrastructure names such as Sydney Airport or Transurban, where it simply isn't commercially (or physically) viable for other competitors to enter. However, there are a number of fascinating stocks operating in more nuanced industries that also exhibit monopolistic characteristics. These include:
- ASX (ASX: ASX): Until the recent entrance of the CBOE-owned Chi-X exchange, if a product wanted to list in Australia it was certainly through the Australian Stock Exchange platform. This meant ASX had complete control over listing fees and the like. They continue to host the majority of publicly-traded Aussie financial products, with over 78% market share.
- PEXA (ASX: PXA): 2021's largest IPO operates in the highly topical property sector. They are the dominant player in e-conveyancing, which streamlines the traditionally cumbersome process of property settlement. Their process covers transaction preparation, financial settlements and disbursements, and land title lodgements. Approximately 80% of all domestic property transactions go through their platform.
- Graincorp (ASX: GNC): This agribusiness and processing company has risen nearly 140% since the start of 2021. They specialise in the storage, logistics and processing of grains and oils. The company made headlines across March and April of this year after issuing 2 earnings upgrades in the lead-up to their record May results. The Ukraine conflict led to export disruptions across the Black Sea, significantly impacting global gain markets. The company reported that this has meant "buyers (are) looking for alternate sources of supply... further increasing both the demand for Australian grain and oilseeds and export supply chain margin." They operate along the entire grain supply chain, and possess significant market shares in almost every stage: Production (40-50%); Domestic demand (30-40%); Bulk-shipping exportable surplus (70-75%); Container-shipping exportable surplus (10-20%).
I don't know about you, but grain storage probably isn't where I would naturally go if I were on the lookout for a dominant monopoly to add to my portfolio. Accordingly, I reached out to 3 fundies to get their takes on the monopolies (or in most cases, 'near-monopolies') that may not be too obvious at first glance.
- Dion Hershan - Yarra Capital Management
- Michael Maughan - Tyndall Asset Management
- Leon de Wet - Elston Asset Management
Near monopolies are the real bargains
Dion Hershan - Yarra Capital Management
Most regulated monopolies are obvious, well understood and often fully priced to reflect the strong economics they generate. Since their low-risk nature tends to lead to stretched – and at times high-risk – valuations, it’s important to look beyond utilities, toll roads and airports. We find value often lies in what is ‘monopoly-like’ or in businesses with an unassailable competitive advantage. ‘Near monopolies’ are often real bargains, with expectations set low and valuations compelling.
In our opinion Seek (ASX: SEK) and Carsales (ASX: CAR) squarely fit that definition. Their market share is anywhere from 3-5 times that of their closest competitor, they have become synonymous with finding a job or selling a car and the economics reflect their market positions.
Both companies have high margins already, Seek at 66% (ANZ margins) and Carsales at 55% (Group margins) but their unassailable leadership position has created an opportunity to increase price and mix, resulting in >20% revenue growth in the recent half in their ANZ and ANZ Private Vehicle businesses respectively.
A virtuous cycle emerges, with their ability to keep reinvesting further deepening the moat; there is literally a graveyard full of local and global competitors that have tried (and failed) to dismantle what are entrenched positions. Interestingly both SEK and CAR have taken proven models and exported them into Asia, in some instances creating ‘near monopolies’ which we feel aren’t yet fully appreciated by the market.
Monopolies are less of a gamble
Michael Maughan - Tyndall Asset Management
SkyCity Entertainment (ASX: SKC) has monopoly positions in both Auckland and Adelaide. Together more than NZ$1 billion has been invested in the venues, and the group is essentially ex-CAPEX. The catalyst for realising that value in the share price should simply be getting the clear air to trade after two years of intermittent lockdowns.
We are conscious of the regulatory scrutiny on the sector - it comes with the monopoly position - but what stands them apart from the problems that exist with Crown (ASX: CRN) and Star (ASX: SGR) casinos is that they have a much smaller exposure to international VIP customers.
Revenues are down 50% due to lockdowns, making it a prime candidate to benefit from the world reopening, and it has been quick to bounce back from each hiatus. These irreplicable property assets are also likely to attract the attention of private equity and super funds in the same way that Sydney Airport, Ramsay and Crown have.
In addition to SkyCity, we think investors could also look at Transurban, Carsales, Aurizon, and APA Group.
A special spin-off
Leon de Wet - Elston Asset Management
With the S&P ASX 100 Index representing our investable universe, I suspect most investors would be aware of the monopoly assets we could invest in. Companies like Transurban (ASX: TCL) with its stakes in almost every toll road in Sydney as well as long-term concessions in Brisbane and Melbourne, or PEXA (ASX: PXA) (via Link Group’s 42.8% equity interest), the digital property settlement platform that is estimated to have handled more than 80% of the property transactions in Australia for the 6 months to December 2021. And of course Tabcorp (ASX: TAH), or more specifically The Lottery Corporation (“TLC”), that will soon start trading as a separate listed entity following court approval of the demerger last week.
While admittedly not a unique idea, following shareholder approval for the demerger we bought Tabcorp with the intention of being long-term holders of TLC. Given the increasingly challenging macro backdrop which is likely to see slowing economic growth going forward, we view TLC as attractive for the following reasons:
- While seemingly a discretionary purchase, lotteries have historically proven to be defensive with revenue resilient regardless of the economic environment driven by a loyal customer base (in the past 12 months an estimated 46% of the adult population had purchased a lottery product) and strong brand;
- It is an infrastructure like business with both the Lotteries & Keno licenses typically long-dated, with the only material license up for renewal being the Victorian Lotteries license in 2028. While by no means inevitable, given the very substantial tax revenue generated from lottery sales for state governments, TLC as the incumbent with an existing retail network, established customer base and proven track record of growing revenue will likely be in pole position when it comes time for license renewal. While admittedly separate, we note that Victoria’s Keno license was recently renewed until 2042;
- With digital sales representing approximately 37% of total turnover in 1H22, scope certainly exists for increasing digital penetration which should lead to margin expansion as it negates the need to pay a commission of c.10.3% to newsagents. Every 1% increase in digital penetration is estimated to add $4-5m in EBITDA. This margin expansion will further be supplemented by the increasing ‘service fee’ that Jumbo Interactive, its largest lottery re-seller, needs to pay on ticket sales – it scales from 2.5% in 2022 to 4.65% in 2024 and beyond; and finally
- TLC is a highly cash generative but capital-light business, which provides scope for management to reinvest in the business or consider returns to shareholders.
As for New Tabcorp which includes wagering, media and gaming services, we are not long-term holders given extremely high levels of competition within digital wagering where corporate bookmakers, typically licensed in the Northern Territory, enjoy structural advantages notwithstanding the introduction of point of consumption tax due to lower racing industry funding requirements and state tax obligations. Multiple bids in the past 12 months however clearly illustrate that industry players and private equity at least see the potential value, and further bids post demerger can obviously not be ruled out especially since the wagering division is expected to rebound following Covid restriction impacts.
Looking ahead, these CAPEX headwinds should however start easing because of:
Reduced inventories being held as rising cost-of-living pressures combined with a switch in spending to services as Covid induced distortions roll-off lead to lower demand for goods
Looking at the non-obvious end of the monopoly spectrum is an important process when trying to find interesting companies with strong economic moats. But sometimes, it is the companies in front of you that may actually be the most dominant. In either case, once identified it is all about deciding whether that competitive advantage is here to stay. Finishing the Buffett quote used at the beginning of the piece:
"We are trying to figure out why that that castle still standing. And what's going to keep it standing or cause it not to be standing five, 10, 20 years from now. What are the key factors? And how permanent are they? How much do they depend on the genius of the lord in the castle?"
The sheer spread of stocks that have dominant shares in their respective niches presents an exciting prospect accross all corners of every industry - I know I'll be closely tracking the grain storage market after Graincorp's meteoric rise.
In the previous part of this collection, I explored stocks with high levels of pricing power. These are the perfect candidates to maintain margins against the threat of rampant inflation.
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