August 10, 2023
It has been the experience of the Fairlight investment team that online classifieds (e.g. property, used cars or jobs) are generally great businesses. Once a portal has reached the #1 competitive position, they have proven to be difficult to displace. As a platform attracts more participants on both sides, it becomes more valuable for each group (buyer and seller), creating network effects. These effects can contribute to a virtuous cycle where more users attract more users, reinforcing the platform's dominance.
This has resulted in wonderful business models in many developed countries, such as Australia (REA Group), the UK (Rightmove), Sweden (Hemnet) and Germany (Scout24) along with developing countries such as the Baltics (Baltics Classifieds Group). Generally, the #1 portal enjoys a sticky customer base and attractive economics due to its capital light, network style business. Often these portals are destination sites and not dependent on Google Ads to drive traffic, therefore enhancing margins. On average the companies listed above generate operating margins >50%, return on capital >100%, cash conversion of >100% and in aggregate are expected to grow earnings per share 20% during the next financial year.
Examples of the #1 portal being displaced by a competitor are rare, with nuance involved in the nature of the local markets. For example, French property portal Seloger.com has largely been disintermediated in regional areas by Leboncoin.fr and in Russia Cian.ru was superseded by Avito.ru. Interestingly in both instances the (property focused) vertical incumbents were outcompeted by horizontal (i.e. generalist) sites who focused on consumer-to-consumer transactions.
More commonly however, assaults on established vertical property portals are typically rebuffed with the #2 relegated to a fraction of the profitability of the leader. In most cases the dominance of the leader is stark in terms of market shares (Figure 1). For our Australian readers this will be quite intuitive. When selling a house in Australia, a seller would sack their real estate agent if they didn’t engage REA, but to ensure you didn’t miss a potential buyer you might also reluctantly consider Domain.com as an added expense.
Outside of the rare event of disintermediation by a competing site, the major risk to these sites is the demise of the independent real estate agent in favour of a scaled digital alternative. Whilst this is an ongoing threat, the failure of online estate agent Purplebricks may act as a cautionary tale for potential entrepreneurs tackling the challenge. Founded in 2012, and with a peak valuation of £1.3 billion the company failed across three continents. Originally founded in the UK, Purplebricks expanded to Australia, Canada and the US where its fixed fee model (rather than success based) failed to gain meaningful market share. Its assets were sold for £1 in May 2023.
Competitive advantages in a historical context
The luxury of investing globally allows for the comparison of quality businesses operating in similar niches, but across different geographic borders. Often the opportunity is nuanced; for instance both REA Group in Australia and Hemnet in Sweden are blessed in having the end consumer foot the bill for the advertising. Generally, this results in a greater spend per property as compared to the more common “agent pay” model (via subscription). Essentially, under this model, the agent encourages the seller to spend generously on advertising to increase the prospects of a seller’s commission. The seller typically obliges as the overall cost of the advertising is a fraction of the total asset price.
The history of these portals can also be handy clues for understanding growth opportunities. For example in the UK, Rightmove was formed in 2000 by the top four corporate estate agencies at the time: Countrywide, Connells, Halifax and Royal and Sun Alliance, and was initially free to list with charging introduced in 2002. Due to the B2B and critical nature of the product to its clients, take rates (the percentage of agent’s fee kept by the portal) grew steadily as the business developed. Steadily increasing prices have been achieved partially due to the “premiumization” of the subscription base, essentially marching agents up the product tier ladder over time.
Hemnet shares a strikingly similar history to Rightmove in so far as it also originated as an industry initiative to consolidate most agencies’ listings into one digital platform. However, if the REA Group experience is to be repeated, Hemnet may have a stronger revenue opportunity given the “seller pays” model. Whilst average revenue per listing is currently 20% above Rightmove’s, it’s some 70% less than REA’s, despite Hemnet’s dominance in user monthly visits (Figure 1). Given the high operating leverage of platform businesses, executing on a modest portion of this pricing opportunity (Figure 2) should see Hemnet’s operating margin expand from its currently already impressive 50% towards the 65% level REA’s Australian operations enjoy and perhaps even the eyewatering 75% level achieved at Rightmove.
The Fairlight View
The Fairlight Global Small and Mid Cap Fund has held a variety of leading portal businesses across the property, auto and classifieds markets. These businesses often operate in cosy duopolies with low customer acquisitions costs, high customer switching costs and strong pricing power. Portals are particularly attractive during periods of high inflation as costs can generally be passed onto customers whilst concurrently having low working capital and capital expenditure requirements. Pleasingly, we’ve also found that most portal management teams understand the rarity of their market dominance and instead of driving risky M&A strategies, they typically use excess capital to pay dividends and repurchase shares. This algorithm of strong organic growth, margin expansion, growing dividends and a shrinking share count often results in wonderful investment outcomes for our clients.