01 - Greenlea Lane Capital - VALUEx Vail 2011 - Pricing Power
01 - Greenlea Lane Capital - VALUEx Vail 2011 - Pricing Power
THIS DOCUMENT SHALL NOT CONSTITUTE AN OFFER TO SELL OR THE SOLICITATION OF ANY OFFER TO BUY. NO PART OF THIS DOCUMENT IS A RECOMMENDATION OR A SOLICITATION. THE INFORMATION AND BELIEFS CONTAINED HEREIN ARE BELIEVED TO BE CORRECT, BUT THERE IS NO GUARANTEE.
However, it is unusual to find a company with the ability to raise prices in excess of inflation for a sustained period of time
Necessary Conditions
Favorable competitive dynamics are necessary for above-inflation pricing power
Brand franchise Customer captivity Rational competitive behavior
Underpriced products are rare because markets are efficient: companies are generally good at taking what they can get for their products Therefore, there is a parallel between looking for a value investment and looking for above-inflation pricing power
We are looking for a mispriced product in the same sense that a security analyst looks for a mispriced security We are trying to find inefficiencies in markets that are generally efficient
Ideally, what we want is a company at the beginning (not the end!) of the finite period during which it exploits its latent pricing power
Recap
TWO KINDS OF PRICING POWER Inflationary Prevalence Importance Yields margin expansion Historical demonstrability Common Pre-requisite No Provides confidence Above-inflation Rare Most valuble attribute Yes Engenders skepticism
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The combination of improving conditions and awful pricing trends produced enormous latent pricing power
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US Railroads (continued)
UNION PACIFIC - Selected Statistics 2001 Revenue Y/y growth Rev. / thousand RTM* (ex-fuel surcharges) Y/y growth Opex / thousand RTM (ex-fuel surcharges) Y/y growth Pricing less cost inflation Operating income % of revenue Y/y growth 1,750 19.0% 10,830 2002 11,159 3.0% 2003 11,551 3.5% 2004 12,215 5.7% 2005 13,578 11.2% 2006 15,578 14.7% 2007 16,283 4.5% 2008 17,970 10.4% 2009 14,143 -21.3% 2010 16,965 20.0% '04 - '10 CAGR 5.6%
$20.63
$20.54 -0.4%
$20.54 0.0%
$20.87 1.6%
$21.86 4.7%
$23.43 7.2%
$24.89 6.3%
$26.34 5.8%
$26.65 1.2%
$28.50 7.0%
5.3%
$17.49
1.0%
17.8%
* RTM = revenue ton-mile = a ton of goods transported one mile Revenue per RTM is what customers pay to transport one ton of goods one mile
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Recently, there was an episode that may have revealed untapped pricing power
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2.
Management is newly aware of SMGs untapped pricing power, but it is unclear what they do with that information
Managements are generally reticent about pricing!
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VRSK (continued)
Some relevant history:
1866: National Board of Fire Underwriters established by 75 leading insurers to pool claims and policy data to help analyze risk and set rates 1869: US Supreme Court rules the insurance industry is not subject to antitrust law Subsequently, hundreds of regional ratings bureaus formed 1942: Justice Department sues rating bureau Southeastern Underwriters Association for anti-trust violations 1944: Southeastern case reaches Supreme Court, which reverses course: the industry is subject to antitrust law State regulation is preserved and by the 1960s most states had adopted open competition 1971: The Insurance Services Office (ISO) is formed through the merger of the major ratings bureaus
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VRSK (continued)
The ISO possessed unique policy and claim databases that had been accumulated by ratings bureaus over decades The ISO was non-profit corporation owned by the major P&C insurers and run for their benefit, by offering data and analytics that aided in the estimation of prospective losses, as well as providing standardized policy language and forms and essential regulatory compliance services In 1988, insurance companies relinquished control of ISOs board as part of a settlement of antitrust litigation ISOs management began to shift the strategic direction of the company to include broaden its activities, culminating with the conversion to a forprofit corporation in 1997
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VRSK (continued)
As part of the conversion senior management was given 5% ownership of ISO and the Employee Stock Ownership Plan 10% ($75 million of total value) Quoting an insurance industry trade publication:
One person familiar with the voting told us that some of the larger companies that might have opposed the plan were nervous about doing so because they were dependent on ISOs information and didnt want to incur its wrath. --Schiffs Insurance Observer, April 1997 ISO went public in 2009 with a new name: Verisk Analytics (VRSK) The offering was 100% secondary; the only shareholder that did not sell any of its stake: Berkshire Hathaway
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VRSK (continued)
Favorable competitive dynamics:
Unique position based on proprietary, non-replicable data sets, analytic capabilities, regulatory status Provides mission-critical services that are highly integrated to customers businesses
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VRSK (continued)
Despite its market power, VRSKs prices are low on an absolute basis
1. VRSKs revenue as percentage of customers premiums is only 20 basis points (0.2%) Enormous gap between the price and value of VRSK services
For most basic industry-standard services, the company estimates it would cost insurers at least 5x more to provide functions themselves For higher value-add services, VRSK estimates 20-37x ROI for customers
2.
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VRSK (continued)
Management is relatively reticent about pricing Quoting from 2011 investor day:
Questioner: Now with a different constituency, no longer 70% owned by the customers but owned 50% by public shareholders, how do you look at the bargain that the customers are getting? Frank Coyne (CEO): I agree with you that its a good value proposition and it would be a good value proposition to the property casualty industry if we raised our prices. We think that the best interest for all of our shareholders today, and before, was that we maintain this kind of unique position that we have within the property casualty industry by treating that position with a high degree of respect.
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VRSK (continued)
I think I've been in the top 5% of my age cohort all my life in understanding the power of incentives, and all my life I've underestimated it.
--Charlie Munger
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VRSK (continued)
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VRSK (continued)
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Thank You
Josh Tarasoff General Partner [email protected] (646) 450-9248
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