The Facebook – Google Duopoly — Where They Differ?
Summary:
Facebook and Google differ fundamentally in the degree of adtech vertical integration. Facebook only has a significant internal supply side platform (SSP). Google has a significant SSP, ad exchange, and a demand side platform (DSP).
Facebook recognizes that its supply of ad impressions has reached a ceiling due to user annoyance of ads in their feeds. With supply now inelastic within Facebook, there are three options open to increasing revenue — quantity times unit price.
- Get into selling impressions outside its “walled garden” which it has done through a retargeting business.
- Assert its pricing power as a duopolist and just “shift up the supply curve” (i.e. limit ad impressions).
- Work to “shift up the demand curve” of advertisers by sharing user data with independent DSPs to improve ad buy ROI resulting in a willingness to pay higher prices.
Option 2 exposes Facebook to antitrust lawsuits. Option 1 and 3 are promising, but it relies on a sharing of user data with independent demand side platforms (DSPs) which has become problematic due to the Cambridge Analytica debacle.
We make the case for Option 3.
The Facebook – Google Duopoly
The intermediate market for digital ad impressions is now dominated by the Google – Facebook duopoly. In 2017, the duopoly’s total share of ad impression sales was estimated at 60.4% (see below).
In the fast growing digital native ad subset market, the duopoly’s share rose to 91.9%.
The data above largely reflects ads embedded in mobile and PC content. The market for real time ad impressions embedded in ad-supported streaming TV — as opposed to subscription-supported Netflix and Amazon Prime — is just beginning.
The Intermediate Market for Digital Ad Impressions
On the extreme demand-side of the digital ad impression market are advertisers wishing to buy ad impressions and on the extreme sell-side are content publishers selling ad impressions.
Between advertisers and publishers is an adtech intermediate market. It consists of supply-side platforms (SSPs) also dominated by Google and Facebook with Amazon being a fast riser in the SSP space.
Next comes ad exchanges where transactions and pricing takes place increasingly via real-time auctions. Google dominates with DoubleClick AdExchange. Facebook launched its own FBX in 2011 but let it slowly die over the next three years.
Next comes demand side platforms (DSPs), which is the most competitive segment. Google has its own internal DSP called DoubleClick Bid Manager which dominates ad buying both on Google’s “walled garden” of search and on its own subsidiary YouTube.
Facebook has an internal DSP called Facebook Ad Manager useful to small and medium business wishing to buy ads within its eponymous “walled garden.” But, Facebook seems to be holding back from customizing its internal DSP to cater to large advertisers with unique needs.
Because of the publicity surrounding Cambridge Analytica, Facebook is under enormous pressure to pull back all the ways its allows third parties to access its user data. We think it would be “throwing out the baby with the bathwater” if Facebook were to pullback of all adtech — SSP, AdEx, and DSP — within its “walled garden”.
Rather, it needs all the help it can in filtering out “lemons” ala George Akerlof’s iconic economics paper “A Market for Lemons”. It is in Facebook’s own interest to foster independent DSP’s with “clean room” access to data (see below).
The Focus of Antitrust Concerns
The sheer scale of the Google – Facebook duopoly is the current focus of antitrust concerns. But, the extent of the duopoly’s vertical integration — owning the full vertical stack of businesses from content publishing to a SSP to an ad exchange to a DSP — needs to be analyzed in much greater detail by adtech experts for potential antitrust violations.
Antitrust concerns so far has focused on the supply side with the most recent flare-up being Facebook’s decision to limit third-party news feeds inserted into the social graphs of Facebook users.
This supply-side focus on content is understandable as such developments hurt the job prospects of the very paid tech and business writers [ not us 😉 ] who write about Google and Facebook.
In contrast, we think a recent development on the demand-side deserves more attention. This is because it signals that Facebook is seeking to deflect antitrust concerns by actively assisting in the development of strong, independent DSPs.
Facebook’s Effort to Foster Strong Independent DSPs
In December 2017, TechCrunch published an article describing how an internal Facebook team of 100 engineers has been working with big advertisers to develop their own customized DSPs.
Right off the bat, this revelation is a clear sign that Facebook today does not intend on repeating the anticompetitive tactics used by Microsoft in the mid 1990s. Back then, Microsoft used its control over the dominant Windows PC operating system to throttle the ability of users to replace Microsoft’s own default browser with a popular third-party browser developed by Netscape.
Notwithstanding the antitrust motivation for supporting independent DSPs, Facebook’s initiative is good from a pure business perspective. Facebook realizes that improving ROI on purchased ad impressions via reduced information asymmetry translates into a willingness by advertisers to make higher bids for “peaches” instead of “lemons” ala George Akerlof’s iconic economics paper “The Market for Lemons”.
Indeed, we see the current digital ad impression market as the “mother of all markets for lemons” including the following list of extreme conditions for markets with information asymmetry between sellers and buyers:
- zero marginal cost on both sides creating lemons and traps
- dueling artificial intelligence (AI) on both sides morphing sell-side lemons and buy-side traps
- real-time auctions
- low latency rendering and fill of ad after purchase of impression
- double interrelated information asymmetry (see below)
Facebook’s Options For Increasing Revenue
Facebook recognizes that its supply of ad impressions has reached a ceiling due to user annoyance of ads in their feeds. With supply now inelastic within Facebook, there are three options open to increasing revenue — quantity times unit price.
- Get into selling impressions outside its “walled garden” which it has done through a retargeting business.
- Assert its pricing power as a duopolist and just “shift up the supply curve” (i.e. limit ad impressions) which it in effect has done by limiting outside news feeds.
Facebook Option 2: Shift up the Supply Curve
- Work to “shift up the demand curve” of advertisers by working with independent DSPs to improve ad buy ROI resulting in a willingness to pay higher prices.
Facebook Option 3: Shift up the Demand Curve
Facebook is signaling that it is giving option 3 a try.
Here is a great quote from an April 2017 adExchanger article on digital ad prices as a reflection of quality and the opportunity for Facebook to receive higher prices — shift up the demand curve — from advertisers and agencies using more discriminating DSPs.:
We buy it cheaper” used to be the lead differentiator in a pitch. Today, agencies that lead with “We can buy digital cheaper” have a sign taped to their back that says, “We buy lots of fraud.” Low prices in digital media are not only no longer a badge of honor, they’re a warning sign.
Here is a quote from the TechCrunch article on the ROI improvement coming from DSPs built with the assistance of the Facebook engineering team:
Facebook says that on average, clients working with the solutions engineering team see their return on ad spend improve by 100 percent.
The article mentioned that after working with the Facebook team to improve the performance of its own internal DSP, the mobile game company MZ (formerly Machine Zone), has spun off its internal DSP as an independent business called Cognant ®.
It should be noted that even before the spin-off, MZ was already the largest “direct response” advertiser in the world and likely on Facebook itself.
As Facebook’s largest direct response advertiser, MZ was the likely first recipient of access to Facebook user data located in “clean rooms” on Facebook servers. Here is a February 28, 2017 description by AdExchanger of the linkage:
Google and Facebook are each responding to advertiser demands for more data. Facebook does data-sharing deals on the DL with large marketers that push for it.
In so-called “clean rooms,” for example, advertisers can compare their first-party data with impression-level Facebook campaign delivery data using laptops that have never touched the internet. Facebook also allows certain large advertisers to create a private instance on its server to run advanced analytics.
We would expect Google to lag behind Facebook as Google’s supply of ad impressions is more elastic. Google can increase revenue via increasing the supply of impressions especially on its YouTube subsidiary.
Facebook has no room in its “wall-garden” for more ad impressions. It will be interesting to see how much Facebook derives revenue from its retargeting business outside its “walled garden.” Otherwise, the only way Facebook can increase revenue is by working to improve ROI on the demand side and “shift up the demand curve.”
Facebook antitrust lawsuits will inevitably dwell on ad price trends as measured by cost-per-click (CPC). Consider the following graph showing that Facebook’s CPC rose 136% in the first six months of 2017.
How much of the above trend was due to Facebook asserting it’s pricing power and how much of that trend was due to other factors?
For example, the upward trend could be due in part to a secular improvement in ad ROI delivered by independent DSPs with help of Facebook supplied application programming interfaces (APIs), thus reducing information asymmetry on the part of buyers.
Of course, it takes more than API hooks for a DSP to deliver significant improvements in ad ROI. It takes a DSP that can build a sophisticated real-time programmatic bid engine and a real-time predictive analytics platform that feeds off Facebook-supplied user data and spits out bids with improved click-through rates.
In sum, Facebook has deflected the antitrust case against it by assisting independent demand side platforms (DSPs) like MZ’s (Machine Zone’s) Cognant ® to build strong countervailing platforms.
At the same time, working with independent DSPs to improve ad buy ROI and a willingness to pay higher price is a way out of its conundrum of growing revenue while limiting ad impressions in its “walled garden”.
OnDeck Capital IPO: A Treadmill Lender
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Summary:
OnDeck Capital (ONDK) has engineered a treadmill lending platform for small businesses resulting in 49.2% of 2014 originations from repeat customers.
This is a risky way to grow the business as ending the refinance of any repeat customer risks default. OnDeck is on the treadmill too and cannot get off.
OnDeck also has substantial balance sheet risk and should not be seen nor valued in the same terms as LendingClub (LC). We recommend not investing in OnDeck.
OnDeck Capital (Pending:ONDK) is an online originator of short-term loans for small businesses.
It has priced its IPO between $16 and $18 a share which places its valuation north of $1B despite being unprofitable.
It will get this valuation when its stock opens for trade on the NYSE on Wednesday, December 17, 2014 because investors view the company as “fintech” and a “marketplace lender” like LendingClub (NYSE:LC) which had a very successful IPO a week earlier.
But, we would avoid investing in OnDeck’s stock as the company’s business is dependent on “treadmill” leading practices that binds borrowers to ongoing refinance.
OnDeck is not LendingClub. It has substantial balance sheet risk as it books most of its originations with offsetting liability.
Furthermore, as a non-bank, it does not have the backstops of a bank in the event of a liquidity crisis caused by requirements to repurchase excessive loan defaults that back its securitization facility.
Unlike LendingClub or alternative student-loan originator SoFi (which uses alma mater as a key risk variable), OnDeck does not tout its ability to offer substantially lower interest rates than banks through curation (a/k/a risk-based pricing).
OnDeck suggests that it creates value for small businesses and distinguishes itself from traditional financial institutions by offering quick-approval, 3 to 24 month term loans. The company suggests that these types of loans are sought by small businesses to fund money-making opportunities with quick paybacks.
For example, a Christmas ornament store with seasonal inventory buildup or a custom yacht dealer that needs some upfront payment from the manufacturer would be ideal candidates for an OnDeck term loan.
But, this is not the case. A near majority of OnDeck’s small business customers have chronic cash flow problems and seem to get stuck on a treadmill of term loan refinance. Furthermore, the churn is growing.
“We believe the behavior of our repeat customers will be important to our future growth. For the year ended December 31, 2013 and the nine months ended September 30, 2014, total originations from our repeat customers was 43.5% and 49.2%.”
When OnDeck says that its nine month YoY growth in loan originations is 171%, a fair portion of this is repetitive refinance of term loans from existing customers.
OnDeck has “engineered” a treadmill lending platform through the following practices:
(1) originating brief term loans of 3 to 24 months quoted in “cent-on-the dollar” averaging around $1.17, but amortized and paid DAILY via automatic ACH such that the ARP is 60%;
(2) requiring the same origination fee of around 2.5% of principal for refinance from existing customers even though the incremental cost of qualifying repeat customers is substantially less than new customers;
(3) half-heartedly offering a revolving line of credit alternative, which would have spared repeat customers repetitive origination fees, by limiting the revolving line to “a maximum line size of $25,000, repayable within SIX months of the date of the latest funds draw.
The problem is that OnDeck has become as dependent on repeat customers as they have become dependent on it. The consequences of OnDeck turning off treadmill borrowing of a repeat customer could be loan default.
We recommend against investing in OnDeck.
Disclosure: The author is long LC. The author wrote this article themselves, and it expresses their own opinions. The author is not receiving compensation for it. The author has no business relationship with any company whose stock is mentioned in this article.
LendingClub: The First Big FinTech IPO
LendingClub (Pending:LC) is a San Francisco-based online peer-to-peer lender. On Wednesday, December 10th, 2014, it is scheduled to price 57.7 million shares for between $12 and $14 a share and will begin trading on the NYSE the next day.
This IPO will raise $900 Million for the company, be the second largest IPO of the year behind Alibaba’s (NYSE:BABA) whopping $21 Billion offering and be one of the top 10 technology IPOs of all time.
Based on the upper range price of $14/share and about 370 million shares outstanding after the IPO, which includes a 8.7 million share option likely to be picked up by underwriters, LC will have a market value of $5.18 Billion. Yet, the company currently is GAAP and EBITDA unprofitable and will remain so for the next year or two.
Despite its short-term profitability prospects, what makes LC so valuable today is its proprietary, innovative and, last but not least, value-creating “FinTech” – applications of computer and software technology to financial services that, for whatever reason, traditional financial institutions have failed to adopt.
We rate LC a buy generally on the basis of its FinTech to drive future deal flow, rather than any current financial metrics. We also rate it a buy based on the size of its target market – $882 billion (with a ‘B’) in outstanding revolving consumer credit, which many consumers seek to refinance.
The purpose of this paper is to pinpoint where and how LC’s FinTech creates value.
If this IPO is successful, and all indications are that it will be, it will open up a floodgate of other IPOs from companies touting their FinTech and claiming enormous valuations despite no profits. For stock market investors, it is important early on to distinguish between proprietary, value-creating FinTech and easy-to-replicate and/or whiz-bang, fluff FinTech.
In its Amendment 3 to Form S-1, LendingClub lists six different areas that it applies FinTech: (numbers added are mine)
Our proprietary technology automates key aspects of our operations, including the (1) borrower application process, (2) data gathering, (3) credit decisioning and scoring, (4) loan funding, (5) investing and servicing, (6) regulatory compliance and fraud detection.
The purpose of this article is to present the case that LC’s most value-creating application of FinTech is at the intersection of scoring and loan funding.
The second is the speed at which the whole intermediation process takes place. Beginning-to-end speed enables LC to avoid balance sheet risk, so deadly in the past to traditional financial institutions, who were slow to tranch, securitize and sell bought mortgages in the prior decade. Indeed, isolating the value of beginning-to-end speed may be impossible as there would be no viable business here in first place without it.
Specifically, the core of LC’s value-creation is a more granular scoring than banks (“Base Risk Grade” A to G) of credit card and other debt refinancing applications based on a proprietary algorithm, and a more granular array of refinancing rates based on these scores.
LC bundles these loans into tranches based on scores and offer lenders, via securitized notes or directly, more granular investing options than previously.
Based on S-1 data, the following table represents the core of LC’s FinTech innovation:
LendingClub – Interest Rates on Standard Loans as a Function of Base Risk Grade, October 2014
Basically, LC is doing a better job than banks at matching credit card rates to consumer risk profiles and cherry-picking the A-to-D consumers by offering, according to its S-1, an average of 680 basis points (6.8 percentage points) below existing rates. E-to-G consumers, if they qualify at all, are offered refinancing rates above their current rates and are likely to decline LC’s loan offer.
At the same time, investors, lately financial institutions more than individuals, eagerly buy A-to-D tranches even though the loans are 680 basis lower than what consumers previously paid. This is because the risk profile has been granularized by LC to such an extent that the risk-adjusted rate of return for these A-to-D tranches has proven to be favorable relative to other offerings in the marketplace.
The following table is derived from a LendingClub information sheet for prospective investors found on their website:
LendingClub – Investor Nominal and Net Adjusted Rate of Return as a Function of Base Risk Grade, October 2014 for loans made in last 18 months
We complete the article with our case against other areas identified by LC as sources of FinTech innovation and value creation. These areas are loan origination, data gathering, scoring and loan servicing.
LC’s online loan application process significantly reduces origination costs and is quantifiable. According to its S-1, its “adjusted contribution margin” was a very healthy 44% of trailing 9 month revenue. Adjusted contribution margin is revenue less origination and sales and marketing costs. It excludes engineering and G&A and stock-based compensation, which is substantial especially in the quarter before this IPO.
Origination and sales and marketing costs, net of stock-based compensation, as a percent of total loan flow was a mere 2.14% for 9 months trailing. This compares with a reportedly 5%-7% for traditional brick-and-mortar loan origination operations.
While impressive, the real source of LC’s current valuation is the expectation for rapid scaling of deal flow, not unit margins. Deal flow is a function of LC’s ability to offer consumers significantly lower loan rates.
LC’s customers are, by and large, refinancing credit card debt. Origination fees are a one-time negative and a minor portion of the total financing costs. Cutting origination costs in half through FinTech is not the source of LC’s current and future deal flow.
Nominally, there is nothing very innovative or FinTech about LC’s data gathering. They start with FICO scores purchased from traditional agencies. According to their S-1, they supplement FICO scores with “behavioral data, transactional data and employment information.” But LC is vague (intentionally?) about what this data is, how it obtained it, and how it enhances credit decisions.
Does LC data mine customer Facebook (NASDAQ:FB), Twitter (NYSE:TWTR), LinkedIn (NYSE:LNKD), eBay (NASDAQ:EBAY), Netflix (NASDAQ:NFLX), and Amazon.com (NASDAQ:AMZN) accounts? Can they get at customer cookies? Do they feed this data into a proprietary “spendthrift” algorithm? If so, we would be impressed. But, we just don’t know the extent of LC’s use of FinTech data gathering.
In addition, according to their S-1, LC does little to no independent verification of data supplied on applications.
LC definitely has a proprietary FinTech algorithm that spits out loan scores. But it is not the scoring algorithm per se that is innovative. It is the granularity of scores and related interest offerings that sets it apart from traditional banks issuing credit cards and making unsecured, small denomination consumer loans.
And it is the more granular tranching of consumer loans by score that is the innovative and value creator on the investor side.
Finally, there is nothing very innovative or FinTech about LC’s loan servicing, other than insisting that all loan repayments be remitted via ACH to avoid the more costly paper check in the mail approach that banks lazily accept.
LC has its own in-house collection teams that work delinquent loans for the first 30 days, but according to its S-1, it outsources subsequent servicing efforts to tradition collection agencies.
The is no mention of any FinTech way of dealing with delinquent accounts, such as automated text messages or use of social networks to shame. (How about @bobsmith is #LCdelinquent tweets?) Or offering 100 basis point credits on loans in return for being able to post on your Facebook page that you are delinquent?
Seriously though, LC has left many opportunities out there for start-ups to apply value-creating FinTech in the area of data mining and verification relevant to credit scoring and decisioning and use of texting and social media to improve collections.
Markit IPO: Buy the Moat and Be Better than Buffett
Click here for version published by Seeking Alpha
Summary:
• Markit’s IPO is set for Wednesday, June 18th. It is a buy. Its core product are prices and indices that facilitate the buying and selling of credit default swaps.
• Its biggest threat is its own Board of Directors – a bank cartel which wears multiple hats as supplier, customer, dominant shareholder, and underwriter.
• We use a game theoretic approach to analyze Markit’s prospects, suggesting that this moat’s moat is a doomsday machine defense.
• Even at our estimated trailing P/E ratio of 30, it is a buy.
• In doing so, you will be able to brag that you outdid Buffett because you are buying the moat instead of a company with a moat.
“In business, I look for economic castles protected by unbreachable moats.” – Warren Buffett
Markit’s (MRKT) core product are prices that facilitate the buying and selling of credit default swaps (CDS) – insurance on complex heterogeneous debt called asset-backed securities (ABS) and collateralized debt obligations (CDO).
They also have created a series of branded indices, representing particular classes of ABSs and CDOs, much like the S&P index, that are traded. This includes the well- known brands Markit CDX™, iTraxx®, and iBoxx®
Their business is impenetrable, with both definitions of this adjective applicable: (1) impossible to enter; (2) impossible to understand.
So, don’t spend too much time trying to figure out what Markit does or poring over their financials, which I will summarize below. Just buy it. (Swoosh)
For those financial wonks that want a deeper dive, I recommend a paper by Robert E. Litan called “Derivatives Dealers Club” published by The Brookings Institute. Needless to say of a Brookings-sponsored publication, the conclusions are anti-laissez faire.
By adding Markit to your portfolio, you will be able to tell friends you outdid Warren Buffett’s mantra of buying companies with moats, because you just bought the moat.
Indeed you will be buying the mother of all moats, as Markit protects a cartel of twelve of the most powerful banks in the world who make lucrative commissions brokering over-the-counter [OTC] two party trades with an estimated yearly value of $57 TRILLION DOLLARS in 2011.
Markit acts as a moat for the bank cartel by refusing to sell its data to entities who wish to start up a CDS exchange as an alternative to the banks’ less transparent, more lucrative OTC way of doing business. The reason Markit refuses is…guess?
The bank cartel owns a dominant share of Markit’s stock and sits on its Board of Directors.
Another reason to add Markit to your portfolio is that you will be adding a rare buy-and-hold stock that will around three decades from now and still be appreciating.
You can have confidence in a buy-and-hold strategy for Markit that you can’t have for tech stocks with alleged moats as evidenced by the performance of the likes of Intel, Microsoft, Cisco, and Oracle.
In some ways, Markit is similar to bond rating companies. A 30 year buy-and-hold strategy seems reasonable given these founding dates: Standard & Poor’s (1860), Moody’s (1909) and Fitch (1913). CDS will last as long as bonds and so too will the data analytics companies that first rate these financial instruments.
We wish to address now the threats to Markit’s financials. In other words, what is this moat’s moat? We think the primary threat is not the government, or potential competitors, but its own Board of Directors.
As we will summarize below, Markit is profitable with the latest FY2013 GAAP profit margin of 15.5% and an adjusted EBITDA margin of 44.4% (See F-1 filed with the SEC in conjunction with its IPO).
But, we ask ourselves, given its critical role in the smooth functioning of a $57+ Trillion market, why is Markit not more profitable?
The answer starts with the fact that a dominant share of Markit’s stock is owned by twelve of the largest banks in the world who both broker CDS trades and supply Markit with ongoing trade data.
Markit’s financial engineers then slice and dice this data creating synthetic prices and indices, whose value is in reducing the price discovery costs of those who buy and sell CDS. Markit then licenses its products back to banks and other financial institutions including hedge funds.
The banks wear an unprecedented 4 different hats when relating to Markit: Supplier / Customer / Stockholder and Board Member / Underwriter.
From Markit’s F-1 on reducing the banks’ rights to sit on its Board:
“Reduced engagement from these financial institution customers after this offering due to their loss of a right to designate a member of our Board of Directors, or the reduction in the level of their equity ownership in us in connection with or following the completion of this offering, may cause them to reduce or discontinue their use of our products and services, their desire to work with us on new product developments or their willingness to supply data and information services to us..”
From Markit’s F-1 on customers as shareholders as underwriters:
“We have historically earned a substantial portion of our revenue from and have worked on new product and service offerings with financial institution customers that are also our shareholders. For the years ended December 31, 2011, 2012 and 2013, 43.8%, 44.7% and 42.6% of our total revenue, respectively, was generated by payments from financial institutions or their affiliates that are also our shareholders, some of which are underwriters of this offering.”
There are 3 groups who are a threat to Markit: (1) its own Board of Directors; (2) government antitrust regulators; and (3) data analytics competitors. We have no real insight into Markit’s strategy for (3).
But, Markit’s defense for threat (1) and (2) comes straight out of game-theory whose foundation is based on the work of John von Neumann and John F. Nash (A Beautiful Mind).
The defense is known as “the doomsday machine” defense, a form of Nash equilibrium in which neither side, once armed, has any incentive to initiate a conflict or to disarm.
What Markit can do is let potential threats know that if attacked, Markit will trigger a “doomsday machine” with mutual assured destruction [MAD], an acronym first coined by the great John von Neumann and made popular by the movie Dr. Strangelove.
We have become familiar with a particular application of this defense called the “too big to fail” defense that these same banks used to persuade the Federal Reserve Bank to buy its distressed ABSs and CDOs back in 2008.
Markit can turn the tables this time and use this defense against its Board of Directors.
For example, in response to a Board (bank cartel) refusal to approve a large price increase to customers (same bank cartel), Markit CEO could respond by having its systems engineers delay transmission of data, halting multi-billions of dollars of CDS trades.
The same doomsday defense is available both to Markit and its Board should governments try open up CDS trades to any newly formed, more transparent exchange as an alternative to the opaque, more lucrative, OTC trading favored by the banks.
The threat comes as a suggestion that, while imperfect, OTC trading is a known quantity. Moving CDS trading to a transparent exchange might wreak havoc on world financial markets with resulting MAD.
Compared to a game-theoretic approach to Markit’s prospects, a financial analysis of its IPO is downright dull.
Markit is very profitable, but not insanely so given its “mother of all moats” position. Its top line growth has slowed since the crisis of 2008. But, as a believer in the Minsky theory of the inherent instability of capitalism, I am confident that Markit can look forward to a “Minsky moment” every 10 years or so.
Some analysts have said that Markit’s profit levels and margins are in decline. But they are looking at GAAP figures, not EBITDA, which is on the rise.
Markit has been doing a lot of investing lately in businesses outside its core. This has resulted in poor cash flow and substantial amortization that cut GAAP numbers. Markit explicitly states that it does not intend to pay a dividend in the foreseeable future.
There is also the question of its incorporation in Bermuda, but the implications of this are beyond our expertise.
The IPO will not yield any cash for Markit as it consists totally of stock of existing shareholders. If successful, there is likely to be follow-on offerings of new stock because Markit needs cash to continue diversification through more acquisitions.
It could also be part of its doomsday machine defense as by expanding its shareholder base, it can point to more innocent bystanders that will be destroyed if attacked.
For example, it has reported that the Canadian Pension Plan Investment Board plans to invest up to $450M in this IPO. Markit could use more civic-minded stockholders like this as they could rally them in defense should anti-trust regulators encroach.
The IPO is slated for Wednesday, June 18, 2014 and is expected to be priced between $23 and $25 a share. At the mid-point price of $24, we have estimated that Markit’s trailing price-earnings ratio will be 30. The IPO price is not cheap.
But, how often do you get an opportunity to one-up Buffett by buying a moat instead of a company with a moat?
The following graphs based on its F-1 summarize Markit’s financials for the last five years.
