Idea Generation: International Diffusion of Secular Change
One consistent source of idea generation for Somar is the diffusion of secular change across borders. We study the winners and losers in the area where the change originated and leverage those learnings to other geographies giving us an early read into opportunities for longs and shorts there.
We believe Somar is uniquely positioned to identify these opportunities given our on-site business work and investing experience in several countries in the US and Europe.
In this letter we will provide a few illustrations of this process:
Shift from Defined Benefit to Defined Contribution pension plans
Starting in the 80’s, the United States initiated a generational transition from Defined Benefit (DB) to Defined Contribution (DC) pension plans. DB plans led to high and growing liabilities for employers due to beneficiaries growing life expectancy. This led to massive switch from DB to DC (see Fig. 1).
In Europe, the UK was the first country to initiate the transition from DB to DC. That said it is still very
early days for the transition (see Fig. 2).
Somar analyzed the roots of the success that retail oriented discount brokers had in the US on the back of
the DB to DC secular shift. In the UK, we looked for similarly positioned companies. Companies with bestin-
class consumer value proposition. Companies that grew share and took a leadership position in the DC
consumer market. Through onsite visits, customer surveys and competitor interviews we determined that
Hargreaves Lansdown had the best consumer offer: combining the widest assortment of funds, with
attractive prices and best service (Fig. 3).
While Hargreaves has been a profitable position, we believe it is still early days. According to our estimation
Hargreaves and the industry have only captured about 1/10th of the DC opportunity. Based on the US
experience, Hargreaves is in the pole position to continue leading the transition, take market share and
benefit from this multi-year secular change to continue creating value for its customers and its shareholders.
The risk reward at current valuations is attractive. In addition to the secular opportunity, Hargreaves benefits
from the added attractions as an investment:
- Operating leverage – most of the operating costs are fixed so as volume increases margins tend to expand
- High Return on Invested Capital (low working capital and Capex requirements)
- Strong alignment with founders
The shift to high value-added industry-specialist online classified providers has been led by the UK and
Australia where pioneers Rightmove and REA respectively built highly successful businesses serving the
Real Estate market. They successfully fended off attacks from more generalist players (for example Google
and eBay). Overtime they built strong leadership positions in their countries bringing multiples of the traffic
of their competitors and becoming the place where buyers and sellers meet. Offering a best in class product
and partnering with the major sources of real estate supply they were able to unleash a virtuous circle of
liquidity that allowed them to build and expand a powerful moat (Fig. 4).
Once leadership is achieved, online classified providers are able to significantly increase their revenue per
user (both through additional services and price increases) and deliver very attractive margins (Fig. 5).
After carefully studying the long track record of these businesses Somar was able to identify other
investment opportunities in the space by following the careers of two pioneers (Ed Williams and Greg Ellis)
and also by identifying other entrepreneurs that are following similar strategies to those employed by
Rightmove and REA. This has led us to attractive investments opportunities in France, Germany and
Scandinavia (Fig 6).
A good example of a secular change that originated in Europe and is currently diffusing to the US is the
emergence of Fast Fashion. In last month’s letter we illustrated a short idea originated from this change, on
our GAP write-up and we encourage you to re-read it in this context.