Below is an article shared from one of our previous monthly Portfolio Updates sent to our investor clients.
On the final few days of a trip along the coast of far north Queensland, I am writing this article from the balcony of my hotel room in Cairns overlooking the marina.
Looking out on the world; thinking about the businesses and of course the share market, I cannot help but become very intrigued by the activities that I see playing out in the marina below. Why? Because of the parallel they offer with how we analyse businesses and construct portfolios.
Down below, several boats are returning after a day out on the Great Barrier Reef. At a rough count, I can see at least seven different companies servicing this market and my first instinct is to ask myself:
- How do these companies differentiate themselves from one another?
- Do any of them have a distinct competitive advantage?
My mind continues to ponder…
…I notice that the boats returning seem to be able to take about 75 people each. That means that there is a ceiling on the amount of revenue each business can generate in a day. Assuming it costs say $200 per passenger, that ceiling is $15,000.
At the same time as I ponder these dynamics, I cannot help but continually fix my eyes on a monstrous mega yacht on the outer part of the marina (in the background of the picture above that I took on my iPad). This thing is massive! It dwarfs every other boat in the marina (including the Reef Cruising boats) and from where I sit I can count seven stories above the water level and how many below, I imagine a few more.
Out of curiosity, I googled the name on the side (“Octopus”) and it turns out to be owned by the co-founder of Microsoft, Paul Allen. As I am reading through the specs of the boat; $200 million cost, two helicopters, seven boats, a permanent crew of 60 (including several former Navy Seals), a remote control vehicle for crawling the ocean floor, oh and a submarine that can sleep eight for up to two weeks underwater (just to mention a few), I ponder the parallels between the activities of this businessman, with those that own the reef cruising businesses.
On my ballpark figures above, a reef cruise boat generates approximately $5.5 million in revenue a year (assuming it is hired at capacity every day for 365 days – highly unlikely!). I am not sure of the margins on this type of business but with staff, insurance, boat maintenance, equipment, fuel and taxes, I dare say profit margins would be below the 20% mark. Not necessarily a bad figure but on revenues that hit a low lying ceiling, the upside can be limited.
In order to increase the revenue and profits beyond this point, the owners must add significant inputs e.g. a new boat, which means capital is highly intensive in a growth scenario and this is even without considering how the extra demand could be captured in a market where differentiation is difficult and demand limited.
Let’s compare this to Paul Allen’s Microsoft.
Where a reef company has a ceiling of say 75 customers per day per boat, Microsoft’s ceiling is substantially higher. Broadly speaking, Microsoft spends the same amount of inputs creating/maintaining their operating system and other products if they had 75 customers as they would with 100 million customers.
Largely, there is no limit to the number of people that can use Microsoft’s products, they are sold to the masses and is why they have significantly larger profits.
It is important to note that I am not dismissing the merits of owning a business with model characteristics similar to the reef cruising businesses, nor am I belittling their owners, far from it. I am sure they are all successful in their own right but what I am saying is that I would not want a portfolio made up of businesses that had such limitations on growth.
In general, we seek businesses with scale! If boat sizes were a proxy of successful business models, the Cairns marina displays the benefits of such a focus.
CEO and Portfolio Manager