On The Beach is the UK’s leading retailer of packaged short-haul beach holidays. Their business model is a hybrid between a Tour Operator (think Thomas Cook or TIU Travel) and an Online Travel Agent (think Hays Travel or Trip Advisor). The business has a market cap of £630m. Last year it generated £84m of revenue, almost all of which came from selling European package holidays to UK consumers.

A traditional tour operator, such as Thomas Cook or TUI, typically own their own aeroplanes, shuttle buses and have long running contracts with hotels & resorts. The drawback of this business model is that tour operators typically promote only their own hotels as well as restrict customers to flying at inflexible and anti-social times. These businesses typically have set aircraft and bed commitments that must be hit, meaning that in the event of significant geopolitical events (which do occur in this industry) tour operators are exposed. Additionally, due to the significantly lower cost base, the average cost per booking for a traditional tour operator can be as much as 5x that of OTB. This lower cost base means OTB should be able to offer sustainably cheaper packages than tour operators.

Online Travel Agents do not have their own assets however they typically do not source their inventory directly. The key disadvantage here being the commission payable to third parties, as well as not having a direct relationship with suppliers.

Where On The Beach differ is in their business model. They are a hybrid between the above two models. They do not have their own assets such as planes or hotels but source their accommodation directly with a group of BDM’s. Their size allows them to get good deals (averaging 20% on accommodation and 50% on shuttle buses) with 25% on exclusivity deals. Over 65% of OTB’s accommodation is contracted directly with suppliers. This generates a cost saving for OTB as well as increases their ability to work with the hotel in order to improve yield. They can get these contracts over other OTA’s due to their size (for European Beach Holidays they’re the second biggest seller to the UK consumer, behind TUI with roughly 20% market share) as accommodation providers are reassured that OTB can provide volumes due to their web traffic.

The overall package holiday industry in the UK is forecast to grow at a moderate 6% pa between now and 2022. Within this, prices are expected to make up 2% pa with volumes expected to make up 4% pa. This alone doesn’t sound like an industry we’d like to invest in, however, when you consider OTB is stealing market share from the incumbents at a high rate, it makes it interesting.

OTB have managed to increase the volume of packages sold at 15% pa over the last 5 years while UK Tour Operators volumes have declined by 7% pa since 2008.
Although OTB doesn’t have the resources of a TUI or Thomas Cook, because they are focusing on a specific segment of the market (European Beach Holidays) they can excel. This approach has resulted in them stealing market share consistently each year until they have now carved out 20% of their target market.

Its main edge vs the competition lies in their in-house purpose built marketing function. They have over 100 developers and digital marketers continuously testing conversion rates, optimising PPC bidding strategies and AB testing personalised site layouts for user accounts. This efficiency has meant their marketing spend has dropped from 53% of revenues to less than 48% in the last two years, despite revenues going from £60m to over £80m.A large effect of their efficient marketing is a higher percentage of “branded (free) traffic”. 59% of traffic is direct. Their website receives 70m daily visitors who convert at an average rate of 0.7%.

All of this combined has resulted in a very attractive consumer proposition. Repeat customers’ makeup 40% of their sales volumes. This tailored marketing strategy, coupled with their lower than Tour Operator costs and more product range than Online Travel Agents are the main reasons why the business has grown so fast in a mature industry.

Risks

Travel companies have always faced inherent risks to do with geopolitical events, terrorism, currency swings, or a general economic recession (beach holidays are a luxury item for most). As such, most travel companies’ trade on low PE’s. OTB is priced as a tech company, at an average PE of around 20.Any significant geopolitical shock could see the shares fall quite significantly.

OTB heavily relies on Google for traffic. A significant change in Googles algorithms could have a short-term impact on volumes but also a longer term impact on OTB’s algorithm which is used to spend AdWords budgets efficiently (a large part of its edge).

Our View

We like this business. The incumbents have been complacent for too long and OTB are doing a good job at providing a better service. They are the market leader in their sector. It’s a simple business doing what it does, well. They are the only operator running with this business model in the European Beach Holiday space and they have many other verticals that they can easily move into.

Disclaimer

This document and all is contents remain the property of Middleton Enterprises Ltd and should not be copied or passed to any third party without prior permission. The contents of this document are for general information and use only and are not intended to address the particular investment or other requirements of any recipient. In particular, the information provided does not constitute any form of advice, representation or recommendation regarding any investments and does not constitute an offer to buy or sell the securities of any company. This document is confidential and is intended solely for the person or entity to which it was addressed. Further Middleton Enterprises Ltd does not warrant or guarantee the accuracy of the information provided and cannot be held responsible for any use of the document in whole or in part or the information it contains.

CTS Eventim is an online ticketing marketplace. They promote live sports and music events, selling tickets via its websites and licencing their software. CTS operates in 23 countries and is the market leader in Germany with 85% share. The company has delivered 11% revenue CAGR and 16% profit CAGR over the last 10 years. The business model is very cash generative, with a conversion rate of 140-150%. The shares are listed in Germany with a market cap of £3.8bn.

CTS core business is selling tickets to live events from its Eventim websites. An artist or promotor will appoint CTS to be an exclusive primary vendor of tickets.CTS charges the booker a fee of 12-15%. This is high margin business as CTS is the exclusive vendor so the cost of acquiring web traffic is minimal. They have price elasticity of demand as buying tickets to an event is an emotional purchase and there is a limited supply available.

The company also licences its software for brands to use on their own websites. For example, Bayern Munich and Real Madrid use CTS software to sell tickets to their games. They run a single Saas platform which generates high margins (90% EBITDA), recurring revenue, on 3-5 year contracts.

CTS also owns the promoters of various live events. This division makes strategic investments in promotion companies, which guarantees the ticketing division exclusive content. This is a low margin business (7% EBITDA) where revenue growth can vary from year to year depending on the events schedule. CTS has a competitive advantage due to its scale. They have 35m client profiles which are starting to be monetised. For example, they could facilitate the marketing of travel and accommodation for people that have bought event tickets.

CTS operates in 23 countries, primarily in EU. Their core markets are;

• Germany – 85% market share – with small regional operators have 15% share.
• Austria – 65% market share
• Italy – 60% market share – Ticketmaster is the no. 2.
• Switzerland – 60% market share

This is a digital marketplace which has strong network effects, like Rightmove or Just Eat. Event promoters want to use the largest platform where they are most likely to sell their tickets. Buyers want to attend a particular event and will use the website which sells tickets to that event.Live Nation is the largest international competitor. They own Ticketmaster, operate in 40 countries and are the market leader in the US and UK. Live Nation sold 206m tickets in 2017 compared 49m sold by CTS. They are listed in the US with $11bn market cap and $10bn revenue.

Event tickets are also available on secondary sites such as Viagogo, Ticketline and StubHub. These companies will use software to buy tickets from primary sites (such as Eventim) and then resell them at a marked-up price. When a primary site has sold out or crashes then secondary sites can be the only place to buy tickets.Secondary sites have been scrutinised by the press, politicians and artists for extorting fans. On Ed Sheeran’s tour fans have been denied entry with tickets from secondary sites. Viagogo was fined €1m by the Italian Competition Authority for not displaying the face value of tickets and declaring its fees. Ticketmaster recently announced that it is closing its resale sites, Seatwave and Get Me In. Clamping down on secondary sites will further push supply/demand dynamics in favour of primary sites.

The business is very cash generative as customers buy tickets online and pay upfront. Event promoters are paid at a later date. Cash flow to EBITDA conversion has averaged 146%. The balance sheet shows €736m net cash.  The key driver of the ticketing division has been the number of tickets sold growing by 20% pa reaching 49m in 2017. The EBITDA margin in this division is 42%.Revenue growth in the live events division is more volatile, swinging from -10% to +40% pa, depending on the schedule. This is a lower margin business, although it has been consistently profitable with an average EBITDA margin of 7%.

CTS is acquisitive. They have spent €108m in the last 6 years on acquisitions and investments (average €18m pa). The ticketing division will enter a new territory through joint ventures and acquire more of these businesses if they are successful. The live events division will acquire small event promoters. There were 18 such transactions in 2017.

CTS is a good quality business which has demonstrated strong growth and is very cash generative. They are the market leader in multiple territories which constitutes a competitive moat. I think that it is likely that the company will continue to deliver 12-13% growth in the medium term.

Disclaimer

This document and all is contents remain the property of Middleton Enterprises Ltd and should not be copied or passed to any third party without prior permission. The contents of this document are for general information and use only and are not intended to address the particular investment or other requirements of any recipient. In particular, the information provided does not constitute any form of advice, representation or recommendation regarding any investments and does not constitute an offer to buy or sell the securities of any company. This document is confidential and is intended solely for the person or entity to which it was addressed. Further Middleton Enterprises Ltd does not warrant or guarantee the accuracy of the information provided and cannot be held responsible for any use of the document in whole or in part or the information it contains.

The team attended the annual Saastr 2018 in San Francisco last week. This conference is attended by 10,000 Execs, Founders and VC’s. It is a great forum to learn about software companies from a venture capital perspective.

Our key takeaways from the Saastr conference were;

1. A lead indicator for a company missing its sales budget is if they miss their recruitment targets.
2. Product development is a key part of the growth plan. New features/products can deliver a higher ROI and sales & marketing investment.
3. It takes 10-15 years for SaaS businesses to reach scale. They all have issues and growth is not linear (just like all businesses).

Our notes from specific seminars are below. 

David Skok – General Partner of Matrix

It can be misleading to look at total customer numbers. There can be a lot going on within that. Looking at a cohort of data and tracking it over several years can be more insightful. E.g. Take all of the customers acquired in a single year and analyse their churn and upsell in the subsequent years.

The biggest indicator that a company will miss its sales forecast is if they fail to hit their recruitment targets. If a budget model is based on a number of sales recruits and the actual number of salespeople is lower it is likely that sales will be lower than budget.

You cannot calculate an addressable market by looking at global revenue and assuming that a company wins X%. You need to look at the number of serviceable customers, make an assumption for market penetration and average selling price.

Karen Peacock – COO of Intercom

Intercom is an in app/website messaging layer. It helps websites to convert customers. As COO, Karen is responsible for; sale, marketing, admin support, product and data.

She advised not to drive the business based on ARR milestones. Creating value for customers is the most important thing. Tracking users per day, customer engagement or conversion rates give more insight than ARR.

When asked how to get a quick win when working with a new business, she said to look carefully at the customer onboarding process and make sure that you give them a wow moment. If you can give customers something really useful in their first experience they will remain customers for longer.

Stewart Butterfield – CEO of Slack

The company is an internal messaging and file sharing programme. It can be incorporated via API into website and intranets.

The company has raised $800m. In the last 4 years, their staff headcount has increased from 80, 320, 600 to 1000. It has 6m users

Slack has 150 software vendors. They estimate that large enterprises buy in software from 1000 suppliers. This gives an indication of the scope of opportunities for SaaS companies.

Roman Stanek – CEO of Good Data

Customer lifetime value = ARR x gross margin / customer churn rate

Review each component and think about how to improve it on a monthly basis.

The average SaaS churn rate is 10% pa. If LTV is less than 3x CAC then the business model does not work.

Stephanie Schatz – SVP Sales at Xamarin

You can find very good salespeople within your customers’ organisations. Former users will have the most insight on benefits and objections.

Don’t use probabilities to forecast sales (5 prospects with 20% probability of closing may not equal 1sale). Make sure there is some contingency.

Ryan Smith – CEO of Qualtrics

Qualtrics provides stakeholder experience management services. They have 4 modules; product, customer, employee and brand. The company has $250m ARR.

They boot strapped until a $3m series A. Their model was for renewal revenue to cover overheads. While new customer revenue funded expansion.

They created the SaaS category of experience management. To create a category, you need to be the winner and it takes a long time (10-12 years).

Kathy Lord – SVP Sales at Intacct

The company provides accounting software. They were acquired by Sage for $850m (9.8x ARR). It took 8 years to get from 0 to $2m ARR in 2007 and a further 10 years to reach $80m.

To progress from a product to a platform you need to provide API’s, original data and/or an eco-system. That is how a competitive edge is created.

In addition to analysing the sales funnel, they also monitored qualitative measures such as tech/product awards and staff reviews on Glass Door.

Eric Gundersen – CEO of Mapbox

Mapbox software is used by developers to build map-based features into apps. They have 1m registered developers and their tech features in apps such as Snapchat. Mapbox harvests location data from 300m end users. This gives is dynamic, live, location data.

They estimate that Google Maps generates $1.5bln revenue. 30% of people who see an ad in Google Maps then visit that store.

Mapbox raised $164m from Softbank last year.

Autumn Manning – CEO of YouEarnedIt

When raising a series A round the company met 30 VC’s and received 5 terms sheets. They accepted an offer with a valuation 25% lower than the top offer because the VC was the best fit.

Disclaimer

This document and all is contents remain the property of Middleton Enterprises Ltd and should not be copied or passed to any third party without prior permission. The contents of this document are for general information and use only and are not intended to address the particular investment or other requirements of any recipient. In particular, the information provided does not constitute any form of advice, representation or recommendation regarding any investments and does not constitute an offer to buy or sell the securities of any company. This document is confidential and is intended solely for the person or entity to which it was addressed. Further Middleton Enterprises Ltd does not warrant or guarantee the accuracy of the information provided and cannot be held responsible for any use of the document in whole or in part or the information it contains.

We are entering the 10^th year of a bull market, with Brexit and a global trade war escalating. So which stocks would you buy today?

We have bought DotDigital and On The Beach in recent weeks. These are both disruptive technology businesses, with strong organic growth and high profit margins.

The tech sector has seen a significant sell of in recent months. The NASDAQ is down 12% since September. We have welcomed this volatility which has presented some buying opportunities.

There is a lot of talk about the valuation of tech stocks, FAANG’s and another Dotcom Bubble. But we are focusing on individual companies which leverage technology to benefit their customers and disrupt traditional business models.

DotDigital is valued on a PE ratio of 22, which appears reasonable for a company that is growing earnings by 26% pa. The company provides marketing automation software. It is expanding internationally and has predictable recurring revenue.

On The Beach is valued on a PE ratio of 16, with earnings growing at 19% pa. Their online only business model allows OTB to provide more flexibility and lower costs to consumers. While traditional travel agents are struggling with high fixed costs, OTB’s asset light model is allowing them to build market share.

The stock market is undoubtedly expensive. The Cyclically Adjusted PE Ratio for the S&P500 stands at 30. Markets have only ever been this expensive in 1930 and 1999. This may or may not predicate an imminent market crash. It does mean that the probability of generating positive returns in the stock market is lower now than it has been in the recent past.

Howard Marks said earlier in 2018 that “the S&P500 has roughly quadrupled, including income, from its low in 2009. It was certainly easier for the p/e ratio to go from low teens in 2011-12 to 25 than it would be for it to double again from here.”

Some investors are rotating out of growth stocks into defensive names. On several occasions recently, the biggest risers on the FTSE100 have been tobacco and utility companies and the biggest fallers are miners and financials. However, taking a very long-term view, we believe that the risk/reward profile is better for quality growth companies than it is for defensives.

We analysed a basket of defensive UK blue chips (including Diageo, Unilever, National Grid). On average this portfolio declined by 29% from 2007 to 2009. The portfolio has generated 110% return in the period from 2009 to 2018.

In comparison a basket of growth companies (including Rightmove, Hargreaves Lansdown, Dominos Pizza) declined by 54% in the financial crisis. They have returned 1037% in the bull market that followed.

We cannot predict where the stock market will go next. We do not know when or if a market crash will happen. But we are happy to run the risk of circa 50% downside in the short term in exchange for 1000% upside in the long term.

Neil Woodford said that “timing a market reversal, or pinpointing a specific event that will trigger it, is not possible but neither is it necessary. It is an inevitable consequence of the way that free financial markets work and have always worked – in the end however, fundamentals always reassert themselves and therefore, they are the only thing matters in the long run.”

So, we will continue to focus on finding great companies. If we can buy a business that has demonstrated consistent double-digit growth with a PEG ratio of less than 1, then we are very happy.

Disclaimer

This document and all is contents remain the property of Middleton Enterprises Ltd and should not be copied or passed to any third party without prior permission. The contents of this document are for general information and use only and are not intended to address the particular investment or other requirements of any recipient. In particular, the information provided does not constitute any form of advice, representation or recommendation regarding any investments and does not constitute an offer to buy or sell the securities of any company. This document is confidential and is intended solely for the person or entity to which it was addressed. Further Middleton Enterprises Ltd does not warrant or guarantee the accuracy of the information provided and cannot be held responsible for any use of the document in whole or in part or the information it contains.

FDM sources, trains and places IT & business consultants, known internally as “Mounties”. The FTSE 250 company operates in the UK, North America, EMEA and APAC. Founded in 1991 the business floated on AIM in 2005 but was taken private in the wake of the financial crisis. The company was re-floated in 2014. 

FDM specialises in a range of business & IT disciplines including development testing, IT service management, Project Management, Data Services, Business Analysis, Business Intelligence and Cyber Security.  The company hires graduates or ex-forces personnel and, via a training period of up to 16 weeks, seeks to bridge the required gap between academia and real-life work. They have training academies in London, Leeds, Glasgow, New York, Virginia, Toronto, Frankfurt, Singapore and Hong Kong with a combined training capacity of over 800 seats.

Strategy

FDM has a strong reputation as a graduate employer, consistently winning recruitment awards every year. They have partnerships with hundreds of universities providing a link to graduates. During 2017, FDM held over 600 graduate recruitment events at over 400 universities. This attracted 81,000 applications in the year. Of these, FDM accepted and trained 1,626 – a 2% acceptance rate. This abundance of applications allows FDM to choose graduates that fill the roles best & take on additional staff when demand warrants.

The standard training programme involves a 3-month training period and looks to combine technical education with industry standard certificates. Almost all training material IP is owned by FDM having been developed in-house over its nearly 30 years of operating.

Once training is completed, Mounties are selected by clients via an interview, and work on site for the client until they are no longer needed. Clients have to give a 1 week notice period before returning a Mountie to FDM. An impressive part about FDM’s model is their ability to consistently place a growing number of Mounties with blue-chip clients, and for those individual clients to take on an increasing number of mounties – shown in the below image. This has been a trend for almost 30 years.

Economics of a Mountie

As mentioned above, mounties receive free training from FDM. In return, they are required to work for a minimum of 24 months or repay their training costs. They are paid between £20k and £25k pa, depending on location, and are charged out at an average of £60k per year.

The average time spend on a client’s site is 19 months. FDM has averaged a utilisation rate of 97.8% since 2007, including following the months after the financial crisis. The lowest utilisation ever reported was 96.7%, in 2009.

Typically, mounties end up being employed by clients in a more senior role having gained company-specific knowledge. Frequently, their previous roles are filled by new mounties which helps sustain growth for FDM.

FDM has expanded its training academies to a capacity of over 800 seats. These seats can be used up to 3x pa meaning FDM has the capacity to train and place 2,400 mounties pa. In 2017, FDM had 3,170 mounties on placement with clients. New training centres are built on a client demand basis, with a focus in recent years on pop-up training centres. These centres utilise flexible working spaces and allow for far greater economics.

Financials & KPI’s

Revenue has grown at a fairly consistent 20% CAGR over the last 5 years. Margins have slightly contracted but are healthy at 19%. The company did have a significant amount of debt when it was taken private by a PE house in 2009, but this was repaid in its 2014 float and is currently debt free. Its cash generation is healthy at a conversion ratio of 80%.

These financials alone aren’t amazing, although there’s nothing that stands out as a red flag. However, if we look at their longer track record, we can see why the business has grown from a market cap of £20m to £1bn in 10 years. Revenues have grown from £50m to £230m at a rate of 15% CAGR and profits from £4m to £32m at a CAGR of 25%. Each year, including 2008 & 2009, has shown revenue and profit growth (although the business only grew 2% in 2009).

Taking all this into account, the business ranks 20^th on the MEL Quality Rank above On The Beach, Just Eat and CTS Eventim. 

Over the long term, margins have expanded from 8%. This is mostly due to the change in business mix. When the business first started, it was more of a traditional IT consultancy which placed experienced & expensive IT personnel with clients. The Mountie division was small but grew fast to make up 90% of revenues in 2017. The margins on mounties are much higher due to their low cost, resulting in the business deciding to focus solely on this area and is now phasing out the traditional consultancy business. This has resulted in overall revenue growth taking a hit in FY18, but mountie revenue growth was still healthy at 14%.

Mounties placed on site have grown at a CAGR of 30% over the last 5 years, and grown every year since 2007 (earliest records I can find). As mentioned previously, the mountie utilisation rate has averaged 97% and revenue per mountie has averaged £60k pa – although this differs significantly based on geography.

Over half of all mounties are based in the UK, while North America has a third and the rest are split between APAC and EMEA. The UK has grown at an average rate of 20%, North America by 50% and APAC by 70% over the last 5 years.

FDM’s reputation, training academies and relationships with banks are all very difficult to replicate. Their knowledge and ability to supply labour in niche areas of technology development mean the company has a defendable edge. They give plenty of KPI’s and have a global structural driver in terms of IT spend. The financial performance has been excellent and, as long as IT spending continues to increase at a modest rate, they should do well. We feel this is will be a good long term investment.

Disclaimer

This document and all is contents remain the property of Middleton Enterprises Ltd and should not be copied or passed to any third party without prior permission. The contents of this document are for general information and use only and are not intended to address the particular investment or other requirements of any recipient. In particular, the information provided does not constitute any form of advice, representation or recommendation regarding any investments and does not constitute an offer to buy or sell the securities of any company. This document is confidential and is intended solely for the person or entity to which it was addressed. Further Middleton Enterprises Ltd does not warrant or guarantee the accuracy of the information provided and cannot be held responsible for any use of the document in whole or in part or the information it contains.

Match Group are a leading global provider of online dating products through applications and websites. Match operate a portfolio of brands including; Tinder, Match.com, PlentyOfFish, Meetic, Ok Cupid, OurTime, Pairs, Hinge and 30+ more. The apps are designed to increase user’s likelihood of finding a meaningful connection and the different products are tailored to meet varying preferences of users such as age, gender, geography, religion, and sensibility.

Match Group initially entered the online dating market through Match.com which was targeted towards a niche older demographic, strictly through desktop products with a paid subscription model. Match’s acquisition of Tinder in 2014 propelled the business into a new, fast growing, underpenetrated dating market targeting a wider demographic.

Strategy

Match Group had a first-mover advantage in the mobile ‘Swipe based’ dating market and used a freemium business model to attract many customers to their platform. This generated little revenue but the strategy enabled the core business of the group, Tinder to gain a platform effect.

The huge active user base, which is estimated to be in excess of 50m, has resulted in significant barriers to entry for other businesses attempting to compete. Moreover, as more users are on Tinder, it has created a stronger user experience as the more people on the platform has increased the chance of a customer successfully finding a partner.  The platform effect has also created consumer stickiness as the cost-to-benefit of switching to a similar product may not be worthwhile for customers.

Match group have taken a portfolio approach by acquiring competitors in different geographies and market segments at an early stage. This has enabled Match to gain new market share in other countries, reduce the reliance on a single product, reduce competition, and gain upside on switching trends in the industry.

Economics

Tinder has translated its freemium model into a premium model where customers can subscribe to access premium features. Features include unlimited restrictions on the app and boosting of an individual’s profile, so it is more visible to others. Tinder has seen extremely strong growth in the number of paying subscribers since they launched their premium product in 2015 with more than 6 million paying users having grown at 69% CAGR. Match have also demonstrated the ability to upsell and price up over time with ARPU growing at 31% and low levels of customer churn.

Middleton Enterprises (MEL) perceive the customer stickiness and economics of a customer and the high levels of cash conversion of the business model to be very attractive. As a software business Match can scale quickly, and a large portion of costs will be fixed and unaffected by increasing customer numbers which is well suiting with MEL’s core investment philosophy.

There is still significant runway for Match to grow. Current customers can convert to paying customers and structural drivers including internet penetration and normalisation of online dating will enable continued growth of new customers. MEL have also highlighted a potential increase in the pace of penetration in light of COVID-19.

Financials/KPI’s

Match have extremely consistent and fast growing KPI’s which has translated to strong financial performance, placing Match in the top quartile on the MEL Quality rank.

The graph below illustrates how Match have consistently gained subscribers and increased ARPU over time.

Match Group have competitive edges in a fast-growing market estimated to be worth in excess of $6bn annually and growing at 6% CAGR. Much like MEL’s other investments this company has taken advantage of technology to revolutionise an industry. The product has replaced an outdated dating method of dating, stigma has reduced, and declining marriage pressure is increasing the LTV of a customer.

The market is still underpenetrated, monetization is still in its infancy and innovation within the industry may lead to more value-added, in turn increasing ARPU.  The subscription-based revenue model allows for consistent, measurable performance and their software-based products will allow for expanding margins as they scale larger.

Middleton Enterprises perceive Match as a strong long opportunity for growth investors.

This document and all is contents remain the property of Middleton Enterprises Ltd and should not be copied or passed to any third party without prior permission. The contents of this document are for general information and use only and are not intended to address the particular investment or other requirements of any recipient. In particular, the information provided does not constitute any form of advice, representation or recommendation regarding any investments and does not constitute an offer to buy or sell the securities of any company. This document is confidential and is intended solely for the person or entity to which it was addressed. Further Middleton Enterprises Ltd does not warrant or guarantee the accuracy of the information provided and cannot be held responsible for any use of the document in whole or in part or the information it contains.

LiveChat (LVC) is a global provider and developer of ‘Live Chat’ related software that is sold in the SaaS model for B2C and B2B communications. The company has a portfolio of products that are designed to improve the quality and efficiency communication between the customer and the business.

LVC have 4 products, the core product being ‘Live Chat’. Live Chat is a chat application that is white labelled for a company’s website allowing them to manage customer support and sales online.

LVC’s products are designed to replace incumbent, expensive and inefficient methods of sales and support, currently provided by telephone or email. According to Forester, live chat services are 17-30% cheaper than a phone call (Forrester Research, 2019) and can drive 3-5x more conversions than tele-sales. In some cases, ROI’s can exceed 6000% for the client.

LVC have over 27,000 customers ranging from SME’s to large enterprise clients such as McDonalds, PayPal and Samsung.

Strategy

LVC have a business model and roadmap designed to outperform an already fast-growing market. MEL believes their business model is favourable. Their products are highly scalable as businesses can be onboarded quickly, and their SaaS sales model creates a high level of visibility and predictability. Their diversified client base means they do not have a reliance on a specific sector or large client.

LVC use a simple marketing strategy that comprises of only SEO, affiliate marketing and partnership programs. The strategy is designed to be low cost as the business pays for marketing on a ‘success only’ basis. Live Chat also owns the domain Livechat.com which allows for efficient search engine rankings. This marketing strategy has helped LVC achieve industry leading operating margins of 67% with marketing spend representing only 9% of sales as an average over the past 5 years.

The business plans to grow through several verticals including;

1. Increasing customers numbers through building more partnerships, developing the affiliate program, improving brand presence, and increasing penetration globally.  Tele-sales/services remain the most widely used method of support as penetration of Live Chat services is still in its infancy. This provides an opportunity for significant long-term growth.
2. Upselling/Cross-selling. LVC have demonstrated an ability to consistently develop and sell new products to their existing clients. This has been a driver of consistent increases in ARPU.
3. Increasing prices. LVC have improved clients ROI’s, which has allowed for price increases without increasing churn.

Financials/KPI’s

LiveChat provide two KPI’s; Clients and average revenue per client (ARPC). LVC have achieved healthy growth in both categories over an extended period.

This has correlated to extremely strong and robust financial performance, placing it in the top decile on the MEL Quality rank. Their strong operational performance has generated 42% Revenue CAGR, 43% PBT CAGR, 105% ROA and 2-3% dividend yield over the past 5 years. MEL expect strong future performance due to low penetration in the market, effective marketing, and failings in the incumbent tele/email support industry.

Amongst the top 1 million largest websites, LVC has 11% market share. The largest competitor is ZenDesk who holds a 27% market share, followed by several other companies with 7-15% market shares. Many of LVC’s competitors are large USA businesses with significant financial backing from investors. These businesses tend to also be growing strongly, but have live chat products as a product within a larger CRM offering rather than a sole focus.

Due to the structural drivers, several of the businesses in this category have achieved high double-digit growth, meaning the market is unlikely to be a zero-sum game. Unlike other competitors, LVC are growing their revenues while generating profits.  Most competitors are focussed on growing their top line at the expense of generating profit, often meaning persistent share issuance, diluting investor returns.

LVC have taken an approach to minimise the external costs of acquiring new customers and focus on maintained profitability of operations. This business model has allowed sustainable growth, high levels of cash generation, no debt, no share issuance, and the ability to pay a healthy dividend. MEL believe this is a safer business model and gives management levers to pull if the market environment changes due to their healthy balance sheet.

Middleton Enterprises believes this is a strong long opportunity for growth investors.

This document and all is contents remain the property of Middleton Enterprises Ltd and should not be copied or passed to any third party without prior permission. The contents of this document are for general information and use only and are not intended to address the particular investment or other requirements of any recipient. In particular, the information provided does not constitute any form of advice, representation or recommendation regarding any investments and does not constitute an offer to buy or sell the securities of any company. This document is confidential and is intended solely for the person or entity to which it was addressed. Further Middleton Enterprises Ltd does not warrant or guarantee the accuracy of the information provided and cannot be held responsible for any use of the document in whole or in part or the information it contains.

Facebook build products that enable people to connect and share with friends and family through mobile devices, personal computers, reality headsets, and in-home devices. Facebook generate almost all revenue from selling advertising placements to marketers across Facebook, Instagram, Messenger and third-party applications and websites. Facebook Ads enable marketers to reach people based on a variety of factors including age, gender, location, interests, and behaviours. Facebook sell ad space mainly through pay-per-click but can also charge on impressions, video views and other metrics.

Facebook have over 2.7bn monthly active users (MAU’s) worldwide who generate an average of $31 per user annually.

Investment Thesis

The global market for advertising spending is estimated at estimated to be valued at $578bn, and is projected to grow at 7% CAGR to 2024. Social media only represents 17% of this ad spend and is forecast to outstrip global advertising spend, growing at a 10% CAGR to 2024.

Social media advertising is gaining market share over traditional forms of advertising as it generates a higher ROI for businesses because:

• Success is easier to measure – Digital advertising can track click through rates, bounce rates, engagement and conversion easier than traditional forms of advertising.
• It has more precise targeting – Advertisements can be targeted to specific users based on customer data, whereas TV advertising is a far broader category.
• It’s lower cost and has lower barriers to entry. Small businesses are able to run ad campaigns for the fraction of a cost of using traditional advertising methods.

Facebook are the market leader in social media controlling 6 of the top 12 networks, placing them in a prime position to gain from the switch to social media advertising.

The business benefits from a network effect. Although there were previous social media networks in the early 2000’s FB was the first to gain significant scale. Now that Facebook has over 2bn users and has built up years of data, connections, photos and videos, the cost/effort of a user to join another platform is high. This has created significant barriers to entry into the market, that even one of the more well-resourced businesses in the world, Google, failed to make a success out of their social network, Google+.

Financials/KPI’s

Facebook’s financials are phenomenal. They have achieved 37% revenue CAGR, 39% Operating profit CAGR and 51% Net Profit CAGR over the past 5 years. Facebook have consistently high gross and operating margins at 80%+ and 40%+ respectively.

Performance is underpinned by 2 KPI’s; Monthly Active Users and Revenue per user.

Facebook are growing users and revenue per user across all geographies in a consistent manner. The US is the most lucrative area with the $163 per MAU, compared to the RoW which generates only $8 per user signalling the potential for further monetization in other regions.

Middleton Enterprises believe Facebook is an extremely high-quality business with a significant runway for growth. Facebook have demonstrated the ability to continually attract more MAU’s to the platform, whilst increasing their engagement and time spent on the platform, in turn generating a higher revenue per user. Social Media marketing represents only ~12% of global marketing spend, despite its clear superiorities in generating ROI for businesses. There are likely to be several winners in this category, but as the owner of most of the top brands and the strong network effects, Facebook is likely to maintain its position as the leader in the category.

This document and all is contents remain the property of Middleton Enterprises Ltd and should not be copied or passed to any third party without prior permission. The contents of this document are for general information and use only and are not intended to address the particular investment or other requirements of any recipient. In particular, the information provided does not constitute any form of advice, representation or recommendation regarding any investments and does not constitute an offer to buy or sell the securities of any company. This document is confidential and is intended solely for the person or entity to which it was addressed. Further Middleton Enterprises Ltd does not warrant or guarantee the accuracy of the information provided and cannot be held responsible for any use of the document in whole or in part or the information it contains.

MJ Gleeson is a £500m market cap UK housebuilder that redevelop brownfield land in low socioeconomic areas in the North and Midlands of England. Their low-cost properties give young and low-income families the opportunity to own a home for weekly mortgage payments less than the price of a similar rental. MJ Gleeson also operate a strategic land division in the South of England, aimed to increase group margins. This division utilises managements experience in the industry to efficiently attain planning permission on land which is then sold to external developers.

Investment Thesis

The UK is currently experiencing a housing shortage –The UK government estimates, to offset previous undersupply and keep up with a rising population, 300k new homes need to be constructed annually by 2025. This would represent a 10% CAGR from 2019’s production of 170k new homes.

Government schemes have been introduced to increase construction of affordable housing – Schemes such as Help-to-Buy are incentivising families to buy, and increasing the affordability of, new build homes. Over 99% of MJ Gleeson homes will be eligible for the reduced-price cap which remains until 2023. The government has also introduced investments such as the affordable homes project and brownfield land fund which are estimated to produce an additional 200k new homes over the next 5 years in key regions MJ Gleeson operate.

Young people and low-income families want to get on the property ladder, but high prices are preventing them – Since 1995, the average price of a UK house has risen c.150%. Significantly higher than the c.20% increase in average household income for families aged between 25-34. With young families finding it harder to enter the property ladder, the number of UK households in rented accommodation increased from 2.8m to 4.5m over the last decade. A recent Ipsos MORI survey found that 79% of rental tenants aged between 16-34 would rather own a home than rent.

MJ Gleeson’s model of redeveloping brownfield land provides a cost advantage– As brownfield land requires the removal of existing infrastructure, it is more difficult to develop and less profitable for the standard housebuilder. This reduces the competition MJ Gleeson face in the land bidding process. The business’s bids also contain intangible positives, such as committing to using local materials/labour where available and a strong reputation built by over 100 years of experience of development in partnership with local authorities. This means MJ Gleeson are often able to acquire plots at a discount to market value. Note below how this strategy of brownfield land in low-cost areas results in MJ Gleeson having a significantly lower average sales price than other listed housebuilders.

KPI’s/Finances

In the 4 years between 2015-2019, MJ Gleeson grew revenues at a CAGR of 21%, had relatively consistent operating margins averaging 19% and increased EPS at a CAGR of 28%. Through the period the group increased its dividend pay-out ratio from 31% to 56% and on average yielded a 3.5% dividend.

In 2019, the last undisrupted year of trading, MJ Gleeson’s housebuilders division sold 1,529 houses at an average sales price (ASP) of £129k. Management’s strategy is to keep ASP low and focus on growing unit sales. You will note below that ASP has remained relatively flat, growing at a 2% CAGR between 2015-2019, while houses sold increased at a CAGR of 28% over the same period of time. Management guide for 2,000 annual completions by 2022, with a short-term rise in ASP as an unusual proportion of larger homes are sold through covid.

While growth in the strategic land division is more varied, plot sales have averaged a CAGR of 30% between 2015-2019. By generating operating margins in excess of 25%, the division continues to add high margin revenue to the group’s operations, indicating potential group margin expansion in the future.

In the opinion of Middleton Enterprise, MJ Gleeson are a high-quality, socially responsible business whose niche operating model will benefit from the increased demand of affordable housing in the medium term.

While COVID-19 reduced the group’s performance in FY20, the desire to swap city life for gardens has provided a short-term tailwind to the businesses in FY21. The government’s commitment to ‘build, build, build’ the UK out of a recession, with a particular focus on ‘levelling up’ the regions, makes MJ Gleeson a prime candidate to benefit from government support through the next cycle. MJ Gleeson’s focus on affordable housing also minimises their exposure to the standard business cycle. When lending restrictions tighten and incomes fall, the business sees resilient demand as consumers seek to reduce weekly housing costs/are pushed into their price bracket.

Middleton Enterprises believe that managements strong track record, backed by the aforementioned trends, will allow the business to perform through the next cycle and beyond.

This document and all is contents remain the property of Middleton Enterprises Ltd and should not be copied or passed to any third party without prior permission. The contents of this document are for general information and use only and are not intended to address the particular investment or other requirements of any recipient. In particular, the information provided does not constitute any form of advice, representation or recommendation regarding any investments and does not constitute an offer to buy or sell the securities of any company. This document is confidential and is intended solely for the person or entity to which it was addressed. Further Middleton Enterprises Ltd does not warrant or guarantee the accuracy of the information provided and cannot be held responsible for any use of the document in whole or in part or the information it contains.

Align Technology is market leading provider of clear aligner trays, listed on the NASDAQ. The business is known as the inventor of Invisalign, but also provide digital dental solutions via their intraoral scanners, iTero, and dental software, ClinCheck and Exocad. [1]

Investment Thesis

• Population growth and rising middle classes are driving growth in the orthodontic industry.
• Clear aligners are stealing market share from traditional metal braces.
• Invisalign holds a dominant position as the premium operator in the clear aligner market, due to their IP developed over the last 25 years in the industry.
• Align Technology’s ancillary digitalproducts will furtherdevelop a moat around Invisalign and add another fast-growing revenue stream.

Products

Align Technology split their portfolio into two divisions: Clear Aligners and Scanners & Services. Clear aligners make up 85% of group revenue via the Invisalign product. Invisalign trays are a premium alternative to traditional metal braces and differ from in that they can be fitted by dentists (not just orthodontists), are removable, are more aesthetic/comfortable and require less consultations/maintenance.

Clear Aligner brands vary in the complexityof malocclusion cases (misaligned teeth) that they can correct. Invisalign, as the most advanced solution, dominates the clear aligner market with 81% market share. This isbecause each case is overseen by a dentist or orthodontist (referred to here on out as doctors) allowing Invisalign to solve 90% of malocclusion cases.Invisalign is sold directly to doctors who pay an upfront ‘lab fee’ per patient of c.$1,200.

Align Technology generate 15% of group revenue through the scanners & services (S&S) division. 10% of group revenue is derived through the sale of iTero scanners and 5% through recurring sources such as software subscriptions, PPE disposables, device rentals and pay-per-scan contracts.

The iTero is a handheld oral scanner that creates 3D images of a patient’s mouth. Scanners are a cheaper and more efficient way of making moulds and their images are used to identify areas of decay, design templates for restorative items (such as crowns, veneers, etc) and submit clear aligner cases for Invisalign. The iTero is the most common scanner amongst dental practises in the USA, with c.40% market share, andwill only submit clear aligner cases for Invisalign, not rivals.

KPI’s

The business provides the total number of cases (split into the Americas and RoW) and the number of active doctors (prescribed at least one case of Invisalign in the 12-month period).

Total Invisalign case numbers have increased at a 5-year CAGR of 23%, driven by international expansion. Revenue per case, or the lab fee,hasdeclined as doctors receive discountsdepending on the number of cases submitted.

The active doctor base has expanded at a 5-year CAGR of 16%, while also generating 7% more revenue per doctor. Revenue per doctor has increased due toadditional cases per doctor and iTero sales/software subscriptions.

Route to Market

To prescribe Invisalign, doctors must attend a one-day course. To-date, the business has trained over 190k doctors, 102k of which were active in 2020. Doctors are ranked on the MyInvisalign App depending on the number of cases submitted in a 6-month basis. Top ranked doctors receive the highest customer traffic and discounts on lab fees/iTero machines of up to 46%.

Align Tech’s current focus is on partnering with Dental Service Organizations (DSO’s). DSO’s are large collections of dental practises that are consolidating the market. In 2018, UBS estimated that DSO’s represented 14% of all dental practises in the US but was expanding at a CAGR of 15%. DSO’s are generally more profit focused than individual practises, so Aligns ability to offer bulk discounts on an end-to-end digital platform makes for an appealing exclusive partnership. So as DSO’s expand, so does Invisalign’s monopoly.

Align Technology has partnered with LendingPoint, a digital direct lender.This gives doctors the ability to offer patients finance plans for Invisalign. These plansincrease sales and TAM by bringing in users who previously were offput by the large upfront cost. It also makes Invisalign more appealing to doctors by removing the hassle of collecting payments from patients and reducing the time needed to re-coup the costs of the upfront lab fee.

Doctors

The WHO list the total number of dentists worldwide as 2.5m with 900k in OECD countries.[2]With 190k trained as of FY20, the business has trained 7.6% of their global TAM. 

Clear Aligners

The clear aligner market was estimated to generate $2.6bn of revenue in 2020 and grow at a CAGR of 27.3% until 2028.[3] Invisalign generated $2.1bn from clear aligners in 2020, suggesting a revenue market share of 81%.

Management estimate that15m people start orthodontic work annually. 11m, or 73%, of these starts are teenagers and 4m, or 27%, are adults. Management estimate that their current market share amongst annual starts is 6% for teens and 30% for adults. The expansion into the teen market is key area of growth for the business.

Currently Invisalign can be used in 90% of malocclusion cases, suggesting a TAM of 13.5m annually.As clear aligner technology improves to handle increasingly complex cases, its TAM will expand stealing market share from traditional metal braces. With 1.65m cases achieved in 2020, Invisalign sells to 12.2% of current applicable annual starts.

60-75% of the world’s population, or c.5bn people, currently suffer from malocclusions. However, most live-in places where orthodontic work is unavailable/too expensive or they are put off by the idea of traditional metal braces. Management estimate that beyond the 15m starts annually, there is an additional pipeline of 500m potential customers in developed countries who can afford clear aligners but would not use braces.To date the business has sold trays to 10.9m patients, suggesting 2% penetration of their maximum market. 

Unit Economics

ASP has declined at a CAGR of -1%. Gross Cost per case increased in 2018-2020 due to an upgrade in material used and additional trays per patient. This is in line with the businesses plan to expand TAM by fixing more complex malocclusion cases. On averagefixed costs have been 34% of revenue, though have trended downwards from 2016 due to economies of scale. The rise in 2020 is a result of lower-than-expected volume sales.

Finances

Going forward management have guided for 3-5 year growth targets of:

• Revenue Growth 20-30%
• Operating Margin 25%-30%.
• Free Cash Flow Margin 20%-25%.

The balance sheet is relatively clean with $5.4bn of total assets and $2bn of liabilities. The business has no long-term debt instruments and $1bn of cash. The business does not pay dividends but engages in share buybacks.

Conclusion

In our opinion, Align Technology is a high-quality business with a strong defensive edge that operates in a fast-growing, underpenetrated industry.

As the innovator of clear dental aligners, the business utilized their first mover advantage to achieve scale and, in the process,become the largest 3D printing operation and highest valued dental business in the world. This monopoly allowed investment into ancillary products, so the business is now pivoting from an orthodontic device manufacturer to anend-to-end digital dental platform that monetises patients at every stage of their restoration treatment.

While Invisalign is dominant in the clear aligner market, the majority of malocclusion cases are still handled by traditional metal brackets. Hence, there is significant room to expand both amongst the 500m potential customer pipeline andthe 15m recurring annual starts.   

[1]Quick video overview of the business at the bottom of the page here https://www.aligntech.com/about

[2]https://www.who.int/data/gho/data/indicators/indicator-details/GHO/dentists-(per-10-000-population)

[3]https://www.grandviewresearch.com/industry-analysis/clear-aligners-market

Disclaimer

This document and all is contents remain the property of Middleton Enterprises Ltd and should not be copied or passed to any third party without prior permission. The contents of this document are for general information and use only and are not intended to address the particular investment or other requirements of any recipient. In particular, the information provided does not constitute any form of advice, representation or recommendation regarding any investments and does not constitute an offer to buy or sell the securities of any company. This document is confidential and is intended solely for the person or entity to which it was addressed. Further Middleton Enterprises Ltd does not warrant or guarantee the accuracy of the information provided and cannot be held responsible for any use of the document in whole or in part or the information it contains.