Websites that have taken the place of classified newspaper ads can earn extraordinary EBITDA margins of 50% to 70%. Think of eBay (used items), StubHub (market for ticket exchange and resale), or Apartments.com (property listings for renters). Each platform's ability to generate extraordinary profitability, however, depends strongly on the level of market share it has relative to its next closest competitor.
Schibsted, a Nordic media group that owns a variety of classified websites, illustrated the unique relationship between market share and profitability in their 2009 Classified Media report.*
The graphic tells us a lot about the skewed distribution of rewards in these types of systems. If the top two companies in an online marketplace are equal in size, then both will have equal margins below 30%. Once a company gets to 3–5 times the size of the second player, the EBITDA margins grow above 30%. When a company is 8–10x the size of the second player, margins can be enormous.
We typically like this space for a reason. Online marketplaces or websites that have replaced a classified section of a newspaper can be highly profitable once they establish a dominant position in their specific vertical.
The process of establishing dominance takes time and aggressive investment, a deliberate strategy we have written about. A company must invest heavily to create a superior product and experience. The company must invest in sales and marketing to attract users to their website. In the short-term, this spending can translate into a company with subdued margins and expensive-looking earnings multiples.
Given Andvari’s focus on the qualitative aspects of businesses and our long-term focus, we rarely disregard a company that looks pricey in the short-term. Andvari is willing and able to research and invest in a marketplace company that we think can dominate its particular niche and ultimately wind up with the kind of earnings profile depicted above.
* We originally and incorrectly referenced Schibsted's 2009 annual report as the original source and inspiration for this blog post. It is actually the Schibsted Classified Media 2009 report from the CBS Case Competition.
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