Friday, April 25, 2014

When quality and moat are on sale

Most people know CeBIT and CES, the annual trade shows for hi-tech products. Imagine now I challenge you to start an exhibition organiser (EO) to run a new trade show to compete with CeBIT and CES. Will you take up my challenge?

This will probably be your phone conversation with a potential exhibitor on one of the cool calls:
You: Would you like to book a booth at our new MobileTrend 2014 exhibition which will be held at Vegas this summer?

: No thanks. I will be at CES in January. I don't think I have the resource and energy to exhibit twice a year.

You: I can give you irresistible discount. I think you are paying $7,000 for your CES booth? You see, I can offer you the same 3-sided booth at MobileTrend for only $3,500.

: That's very kind of you and it definitely sounds very attractive. But I have no idea what foot traffic and what kind of visitors your exhibition will attract.


: How about this. You call back in 2 years. If your show turns out to be successful, I will drop CES and take up yours.
EOs are in very interesting businesses. Can you distill their businesses into a simple mental model? Can you see which another familiar business it resembles?

It's eBay.

Although eBay works at a much larger global scale and an EO works in very local vertical markets, both exhibit network effect. At eBay, you need buyers in order attract have sellers; and you need sellers in order to attract buyers. Similarly, in exhibitions, you need visitors in order to attract exhibitors; and you need exhibitors in order to attract visitors. Mature markets are dominantly by one or two big EOs. Once an EO incumbent has established its market position, it's virtually impossible to displace it. This is kind of first mover advantage that drove people nuts in the dot-com days.

So, here you are. EO businesses have moat.

Now, imagine I have this EO which owns a portfolio of exhibitions for various industries. They are not as big or as prominent as CES or CeBIT. Nevertheless, these exhibitions are profitable and are the market leaders. How much are you willing to pay for such business? What multiple will you pay?

How profitable, you ask. You see, EO businesses are asset-light businesses. There is no expensive machinery or significant hard assets. The ROE of this particular EO is north of 30%. And it is achieved without debt.

Got a valuation in mind yet? Great.

Let me reveal a bit more about this business. Its exhibitions are operated primarily in emerging markets with high GDP growth. To take advantage of the growing markets, it spends about 50% of its profit on bolt-on acquisitions, 15% on organic growth and it pays out the remaining 35% as dividends. Essentially, its strategy is to take its existing operations as a template and clone it across different industries, different locations and different countries.

Are you revising your valuation?

What if I tell you can buy this company at 15x ttm after-tax profit? Will you buy it? Take a pause and think about it.

Let me reveal yet a bit more about this business. Since it has been acquiring businesses over the years, it has to amortise certain acquired intangibles like customer relationship. Such amortisation is pure accounting treatment which doesn't reflect the actual economics of the business. As long as the exhibitions are well organised, the economical value of the acquired customer relationship won't fade away. There is no extra maintenance capex you have to spend to maintain this asset.

Adding back the amortisation, this company is actual available at 11x after-tax earning.

Will you buy it?

Wait, there is more! Since exhibitors prepay for their bookings, this company runs with negative working capitals. In other words, it has float. Net float makes up 20% of its assets. When the business expands, this float grows too. This company's expansion and operation are partially funded by its customers.

Where can you find such an attractive investment?!

The company in question is UK company ITE Group (ITE.L).

Too good to be true? What's the catch?

Here is the catch. Remember I said "emerging markets"? More the 60% of ITE's business is in Russia. ITE also operates in Ukraine and other East European countries. Since the outbreak of the crisis in Crimea and Ukraine, ITE's market cap has fallen more than 30%.

But the market's fixation on this crisis is our opportunity. It's time to be greedy when others are fearful.

ITE has been around since 1991. It has prospered through the 1998 Russian financial crisis, the 2008 Russian financial crisis and the 2008 Russo-Georgian war. Its bullet-proof balance sheet and the strength of its business model will give it the staying power to weather this political hurricane just like how it did it in the past.

ITE has the characteristics of the holy grail of Buffett-style value investing. It has moat. It has high ROE. It is asset light. It has float. It has a big enough untapped market in front of it to redeploy its cash flow and float, to recycle its business model. It is a compounding machine.

The real risk of this business is losing its key personnel on the ground in Russia. But this risk is forever  present for ITE and has nothing to do with the current political uncertainty. (This will probably be the topic of another post.) Besides, growing by acquisition is risky; expanding into other countries is also risky. There is no guarantee this business won't stumble.

However, the current price offers enough margin of safety to overcome all these risks. With a time horizon of 5-10 years, we are in for a double-dip. When the fear of the war subsides, we will firstly be rewarded with a proper P/E expansion. But a quality business is still a quality business. It will continue to compound internally. We can sit back and be rewarded with satisfying return for many years to come.

p.s. Thankyou to Richard Beddard (@RichardBeddard) for the lead.

(Disclosure: Long ITE.L)


  1. Interesting write-up. Have you heard of Key3Media? It used to be the holding company for COMDEX, the major computer expo in the US (this, incidentally, is how Sheldon Adelson got his start before moving into the casino business).

    Anyway, Key3Media ended up going bankrupt in 2003 due to the fixed-cost deleveraging which occurred post the tech bust. If there's one "watch out" here, it's understanding that these events tend to be highly procyclical -- i.e. if belts need to be tightened, many small companies will cut back on attending industry events... even if it is THE main event for that particular industry). And since incremental revenues translate to ~100% incremental EBITDA, profitability can see fierce -- nay deadly -- whipsaws during downturns.

    1. Hi Sam,

      Thanks. I have a superficial understanding of COMDEX from Wikipedia. :-)

      It looks like the primary problem with Key3Media was debt. No?

  2. I have been looking at this very closely as well. Reading the above, it would appear that key3Media had one main asset - Comdex. ITE has a large portfolio of exhibitions, which provide protection from that idiosyncratic risk.

    What I am trying to work out is the barrier to entry. If this is the great business it appears, what is to stop a large media group or similar following a similar strategy of just buying existing exhibitions?

    1. I looked at a few EOs in the mature markets. All of them are part of larger media groups. M&A was once very active in the mature markets.

      Operating in emerging markets require very different skills. If you take a look at ITE's annual reports, you will see there are these recurring related party transactions. My theory is, this shows ITE understands how to operate in places like Russia.

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