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Small cap moats


RichardGibbons
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When you talk about moats, they're almost always associated with large-cap companies.  I think this is partly because moats help a company become large, and partly because economies of scale and networking effects both cause moats and become more powerful with size.

 

However, moats don't always need to be associated with large companies.  So, which small-cap companies do you think have the largest moats?  Which small cap companies do you think are almost certain to exist and maintain their pricing power 15 years from today?

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Try UK-based Aggreko (AGK.L)

 

Benefits from large network of service centers that are unlikely to be duplicated unless one

wants to spend several billion dollars. This gives them significant advantage in service

and deployment. (kind of like Caterpillar).

 

Company still small, but operates in 130 countries, and has steady 20-30% ROE for 10 yrs.

Plenty of opportunity for growth and reinvestment.

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VRSN....they are a legal monopoly and owns 100% of the market share for .COM and .NET website registration. A small cut but hen there are quite a handful of websites. They have great pricing power for .NET and limited pricing power for .COM although practically they can also raise rates for .COM.

 

There is the threat of unknown impact of generic top level domains about to appear (.CAR, .DENTIST, etc)

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VRSN....they are a legal monopoly and owns 100% of the market share for .COM and .NET website registration. A small cut but hen there are quite a handful of websites. They have great pricing power for .NET and limited pricing power for .COM although practically they can also raise rates for .COM.

 

There is the threat of unknown impact of generic top level domains about to appear (.CAR, .DENTIST, etc)

 

Can you explain this more?  I've registered domain names with namecheap and godaddy, I don't think either used Verisign.  I registered a SSL cert with RapidSSL recently as well.  It cost me $10.95 for an SSL cert from RapidSSL, a trusted registrar, Verisign's lowest price was $400.  As you know there is nothing differentiating between the certs. 

 

It also appears that Symantec owns Verisign now, is that accurate?

 

Two questions about this, the first is what happens with the .Dentist etc, and second what happens with IPv6?

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VRSN....they are a legal monopoly and owns 100% of the market share for .COM and .NET website registration. A small cut but hen there are quite a handful of websites. They have great pricing power for .NET and limited pricing power for .COM although practically they can also raise rates for .COM.

 

There is the threat of unknown impact of generic top level domains about to appear (.CAR, .DENTIST, etc)

 

Can you explain this more?  I've registered domain names with namecheap and godaddy, I don't think either used Verisign.

Verisign operates the authoritative registry for .com and .net, so namecheap and godaddy have to go through Verisign.

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VRSN....they are a legal monopoly and owns 100% of the market share for .COM and .NET website registration. A small cut but hen there are quite a handful of websites. They have great pricing power for .NET and limited pricing power for .COM although practically they can also raise rates for .COM.

 

There is the threat of unknown impact of generic top level domains about to appear (.CAR, .DENTIST, etc)

 

Can you explain this more?  I've registered domain names with namecheap and godaddy, I don't think either used Verisign.

Verisign operates the authoritative registry for .com and .net, so namecheap and godaddy have to go through Verisign.

 

That's what I was wondering.  In that case Verisign has an enviable position, a moat for sure!

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north media, A danish company. Owns the largest danish online housing platform. Like the danish rightmove.co.uk. It is sort of hidden tho. They also own the 2 largest handyman (if you want to havw something rebuilt in your house, you can find experts to do it for you through this site) websites in denmark. They are trying to do the same with a swedish housing platform. They also deliver advertising folders for supermarkets. It recently shot up, and was v cheap in 2013. You basicly got that housing platform for free. Market cap is like 40 million euros I think. Should be worth 60 I think. Their advertising folder and newspaper (also the largest free newspaper in denmark) business is dying. But they can pretty easily adjust by cutting in their part time work force. Which is a pretty large cost.

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VRSN....they are a legal monopoly and owns 100% of the market share for .COM and .NET website registration. A small cut but hen there are quite a handful of websites. They have great pricing power for .NET and limited pricing power for .COM although practically they can also raise rates for .COM.

 

There is the threat of unknown impact of generic top level domains about to appear (.CAR, .DENTIST, etc)

 

 

Can you explain this more?  I've registered domain names with namecheap and godaddy, I don't think either used Verisign.

Verisign operates the authoritative registry for .com and .net, so namecheap and godaddy have to go through Verisign.

 

That's what I was wondering.  In that case Verisign has an enviable position, a moat for sure!

 

Verisign has this monopoly only through a contract with the Dept of Commerce and in their most recent contract there were limits placed on price increases for domain name registration.

 

There's a similar company called Neustar.  They've bid on the dot com registry contract in the past and hold various country TLDs and .biz registry.  I think with all the various TLD registries you will see some very competitive bidding.  Neustar runs the number portability database.  Similarly, the telcoms aren't stupid and put in restrictions on how much price increase Neustar can pass on.

 

So why there is a moat it's not permanent and the depth (pricing) is controlled by someone other than the company (govt).

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True small cap cutoff is at less than 2B so not a small cap (I had to look it up - although at today's rate it might just get there).  It recently won the renewal contract for the 100% market with the ICANN, a private US non-profit that oversees the internet infrastructure on behalf of the US government (i've always thought it was interesting it is the US not an international organization). The term for this renewal is 6 years starting end of 2012. The ICANN does have increased competition as one of its goals. So in 2003, VRSN agreed to give up .ORG and the iCANN has now established the generic top level domain names.

 

Roger, do you follow Neustar? Do you think they pose a threat? My understanding is VRSN has been able to keep its contract since 2000 because of support from large companies like Microsoft.

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north media, A danish company. Owns the largest danish online housing platform. Like the danish rightmove.co.uk. It is sort of hidden tho. They also own the 2 largest handyman (if you want to havw something rebuilt in your house, you can find experts to do it for you through this site) websites in denmark. They are trying to do the same with a swedish housing platform. They also deliver advertising folders for supermarkets. It recently shot up, and was v cheap in 2013. You basicly got that housing platform for free. Market cap is like 40 million euros I think. Should be worth 60 I think. Their advertising folder and newspaper (also the largest free newspaper in denmark) business is dying. But they can pretty easily adjust by cutting in their part time work force. Which is a pretty large cost.

I don't quite get how that's a moat since the online businesses are still loss-making.

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They are pouring lots of money into marketing. Their housing platform and builder platform would be profitmaking already if it wasn't for that. Also it seems their new swedish housing platform and their job application website take up most of the costs now. I hope they shutdown the jobs website tho. They cannot really effectively compete with that one.

 

If you look at their UK housing counterpart, they do 50% net profit margins after tax. And once you are the largest, marketing costs are pretty small. Id say that 20-30% net profit margins for their housing platform would be reasonable. The founder is a very large shareholder and is involved, so I think shareholder interests are aligned.

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Perhaps we should talk about what kind of moats really exist. Right of my head i see only two kind of moats

 

1) Size (KO/PEP control nearly every bottler in the world, if one new pops up they simply buy it)

2) Monopolies (MSFT with Windows for a long time or any other type of monopoly)

 

For a small cap these are hard to reach, because big contracts go normally to big companies, so that leaves local monopolies for small caps.

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There is another kind of moat - Geoff Gannon calls it demon dust, but basically this is the one in which your product is a small, but critical component of a larger entity, but since their portion in the cost structure is small, they have pricing power, and maybe only you have the scale and expertise to manufacture or design it. The firm I mentioned - IPHS is like that, their phosphate products are important ingredients in food and other products but only form a portion of the cost structure.

 

VIFL had something similar, but it got acquired.

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That sounds like a part of the product that got outsourced, but what if the main company simply insources it again or changes the process that this part is not necessary anymore? I have seen this a lot with car parts suppliers. That can only be a moat when its patent protected. And patents are more like temporary moats.

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Perhaps we should talk about what kind of moats really exist.

 

I think I'd go with the following:

1. Low cost advantage/economies of scale

2. Network effects

3. Regulatory advantage (e.g. patents)

4. High switching costs (e.g. Fiserv)

5. Intangible advantage (such as brand etc.)

6. Dominates niche market that cannot support two producers

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Here are some other ideas....not all of these are exactly small caps, some are small large caps or large small caps. I need to invest in companies with growing moats, I own mostly undervalued commodity-like or differentiated companies.

 

1. Autodesk - I've mentioned this before. They control more than 50% of architecture and engineering industries and this has been true since 1980s. There is no close #2 spot, The rest 50% is shared by 3 or 4 other companies

 

2. FICO - try applying for a loan at a bank using Bob's credit company instead. Last time I looked about two years ago their market cap was about 1 Billion. Their name is like google, it is synonymous with credit score.

 

3. Intel - large company but an obvious one. I think they hold about 80% market share and have dominated for decades. Bruce Greenwald talked about this in his value investing class, video available on YouTube (speaking of moats)

 

4. Luxxotica - I didn't believe it when I first read about them but apparently every single eyeglass in existence is made by them regardless of brand (Oakley, target glasses, dkny, etc). OK so I exaggerate, they only make 80% of all the world's eye and sunglasses.

 

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dpetrescu - I followed NSR but not so much of late.  There is a stickiness to these TLD registry contracts.  NSR has bid on the .com TLD but has not been awarded.  There is a tendency to favor the incumbent vendor in these things.

 

NSR itself is dealing with a perceived slap on the wrist from its customers for the Number Portability database.  The contract expires in 2015 and NSR submitted a bid that the vendors did not like.  They returned it unopened.  Some analysts are calling it a disaster whereas others are saying its procedural.

 

 

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Morningstar has a wide moat index. The take companies with highest ROIC less cost of investment, from that take the lowest valued 20 (by their own means - not sure how), and reweigh once every year. Its fared a bit better than the market since early 2000. Although I don't see how Amazon and St Joe should be there.

 

http://lcchong.files.wordpress.com/2013/09/economic-moats-sources-and-outcomes.pdf

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