Looking for the ‘network effect’
One of the key steps in our Investment Framework is to look for companies that possess sustainable, long term competitive advantages. We believe that these advantages are often underestimated by the market, which is typically focused on short-term returns while sustainable, long-term competitive advantages endure for many years. There are also many different types of advantages, and some may be more important than others depending on the industry and company.
One of the sustainable, long-term competitive advantages that we seek is the ‘network effect’ in a company. This is where the addition of every new customer or user increases the value proposition for every other customer or user. In the Australian context, REA Group (REA) – the owner of property site realestate.com.au – possesses a network effect, where it has successfully captured effectively all buyers and sellers of property in Australia. More property buyers bring more sellers to the website (and vice versa). This makes it incredibly difficult for new platforms to succeed, as they would immediately have to bring all buyers and sellers to their platform in order to compete.
The Australian Stock Exchange (ASX), and all other leading exchanges, is also another example of a company that possesses the network effect. Most domestic stock trades go through the ASX, and traders are therefore unlikely to start trading through a start-up exchange. Any discount on the transaction offered by a start-up exchange will be immaterial when compared to the better price for the underlying asset that is available at the largest and most liquid exchange.
Although we own both REA and ASX in the Fund, we think that the most interesting opportunity is with a company called Megaport (MP1). MP1 is a leading global network as a service provider, where it effectively aggregates the capacities of different data centres and cloud services providers, and offers access to enterprises in a low-cost and user-friendly manner. So, what does this actually mean? Most companies use multiple cloud services for different purposes and MP1 allows them to connect the data stored by each cloud service provider. For example, a company may have its marketing and CRM data on Salesforce and its accounting data on Amazon Web Services. MP1 enables the efficient transfer and usage of data across the two cloud service providers. As MP1 adds more and more cloud service providers to their platform, it increases the value proposition to companies as it increases the options available to them. Cloud service providers are compelled to join the MP1 platform as it helps them embed into their clients’ operations. MP1 is the current leader in this space, and if it continues to connect the data centres globally at the current pace, it will eventually possess a network that will be incredibly difficult to recreate, and deliver value for customers. We think that in the short-term, the stock trades on near term growth rates, but we are invested in the company as we see it has potential to become the global leader in cloud services, without the capital intensity of owning a single data centre.
This note has been prepared by ELM Responsible Investments (‘ELMRI’) ABN 70 607 177 711 AFSL 520428, for Australian wholesale clients for the purposes of section 761G of the Corporations Act 2001 (Cth).
The information is not intended for general distribution or publication and must be retained in a confidential manner. Information contained herein consists of confidential proprietary information constituting the sole property of ELMRI and its investment activities; its use is restricted accordingly.
This note is for general informational purposes only and does not purport to be comprehensive or to give advice. The views expressed are the views of the writer at the time of preparation and presenting and all forecasts, assumptions, opinions, data and other information are not warranted as to accuracy or completeness and are subject to change without notice. This is not an offer document and does not constitute an offer or invitation of investment recommendation to distribute or purchase securities, shares, units or other interests to enter into an investment agreement. No person should rely on the content and/or act on the basis of any material contained in this note. Any potential investor should consider their own circumstances and seek professional advice.
ELMRI funds, its directors, employees, representatives and associates may have an interest in the named securities.
Past performance is for illustrative purposes only and is not indicative of future performance.