We Study Billionaires - The Investor’s Podcast Network - TIP549: 2 High-Quality Compounders

Starting point is 00:00:00 You're listening to TIP. Hey, everyone, welcome to the Investors podcast. I'm your host, Clay Fink. I have a very exciting episode for you today because I'm going to be doing a bit of a deep dive on two companies that I've really caught my attention lately and deserved further research. Recently, I released an episode with Chris Mayer, who is the author of 100 Baggers. This is one of my very favorite investing books because it touches on some of the things that makes so much sense and looking for great.

Starting point is 00:00:30 businesses that aren't always mentioned in other places. So at the beginning of this episode, I'll be touching on many of my biggest takeaways from Chris's book. If you missed my conversation with Chris, I recommend you go check that out as well. That was episode 543. After I go through my biggest takeaways, then I'll be doing some analysis on Topicus.com and Copart. Topicus is a spinoff of Constellation Software, which is one of my very favorite businesses.

Starting point is 00:00:57 recently went public and is a smaller company, while Copart is already a top performer over the past 10 plus years. Both of these companies fall in line with my strategy of looking for high-quality compounders. Full disclosure, I do not own shares in either of these companies. I do own shares in Constellation Software, which I do reference in my analysis of Topicus. Of course, nothing in this podcast should be used as financial advice. Please consult a professional before making any financial decisions. Everything in this podcast is solely my opinion and should be used for informational purposes only. I hope you enjoy today's episode covering two wonderful businesses, Topicus and Copart.

Starting point is 00:01:43 You are listening to The Investors Podcast, where we study the financial markets and read the books that influence self-made billionaires the most. We keep you informed and prepared for the unexpected. All right, so like I said at the top, in today's episode, I'm going to be covering, two quality compounders. But first, let's talk about Chris Mayer's book. Chris Mayer's book, 100 baggers, really attracted me to these kinds of businesses that are high-quality compounders. Before we dive into the two companies, I'd like to summarize some of the key lessons I personally learned from reading this book and from interviewing Chris on the show. The two primary lessons for a company to compound capital and reach 100-bagger or multi-bagger status is first, the company

Starting point is 00:02:35 needs to be deploying capital effectively so that earnings can grow year after year. If a stock is trading at a PE of, say, 20, and earnings grow by 15%, assuming that that multiple of 20 stays the same and the earnings increase by that 15%, your stock price should also go up by 15% as well because your earnings multiple has stayed the same. So the first thing you need is for a company to grow its earnings. You want companies that are able to reinvest back into the business. If a company is paying out a dividend or doing large share repurchases, then that may indicate that the business does not have a lot of opportunities for reinvestment. I'd much rather own a company that can reinvest back into it at 20 or 30% than a company

Starting point is 00:03:21 that pays me dividends. Chris mentioned the quote in our interview that dividends are an expensive luxury, and that quote really hit home for me. It doesn't mean that dividends are bad or share repurchases are bad. is that if you want a compounder, it needs those high rates of free investment back into the business. Now, the second criteria for a company to reach multi-bagger status is that it needs to grow its earnings for a long period of time. Or in other words, it needs to have a really long runway. You can't buy Apple stock today, assuming it's going to go from a $2 trillion to a $20 or $200 trillion

Starting point is 00:03:56 company. It just isn't feasible. If you're wanting to buy a company that can grow for a really a long time, you want to find something that is in its earlier stages of its growth. Chris shared some of his portfolio holdings on Twitter and his fund, which I'm very grateful for. And every company he owns has a market cap below $50 billion. Almost half of his portfolio is below $10 billion market caps. So he's looking for smaller companies, not companies that have a market cap in the hundreds of billions of dollars or in the trillions of dollars. Another thing I picked up from Chris that many people don't talk about is looking for businesses with high insider ownership. If the managers own a lot of stock, then their incentives are aligned with shareholders, and they're much more likely to think

Starting point is 00:04:41 long-term and make decisions that are in the interest of long-term shareholders. Chris also mentioned that he spends a lot of time analyzing a company's competitive advantage. If a business is able to grow over a really long time, other companies are going to try to come in and eat their lunch. If the business doesn't have a strong competitive advantage, then we probably shouldn't own that company. We should always be mindful of valuation as well. If you're starting from a very high valuation, then you really need those earnings to grow substantially in the future in order for the company to grow into that valuation.

Starting point is 00:05:15 So once you've determined the businesses that you like, you need to ensure that you're paying a reasonable price for them in order to get a decent return going forward. Chris also talks about this idea in his book of the Twin Engines, where you could benefit from both the growth of the business, but also benefit from the company trading at a higher multiple after you purchase it. If you manage to get in early when a business is out of multiple, say, 15, and the business does well and then the market better appreciates it, if it ends up eventually trading at a multiple of 30, then that's 100% appreciation in the stock just from the multiple re-rating.

Starting point is 00:05:52 In my mind, it's really important to get the business right, and if you're willing to hold for a really long time and you're right about the business, many times the valuation will really just take care of itself, assuming you aren't paying a ridiculous price like 50 times sales or 100 or 200 times earnings. Chris also references the work of Chuck Akri, who also falls in this line with this philosophy of purchasing long-term compounders. Ackery has what is known as his three-legged stool approach, where he's primarily looking for three things. First, businesses that have historically compounded at a high rate of return. Second, businesses with highly skilled managers who have a long history of treating shareholders like partners. And third, businesses that can reinvest cash flows at an above average rate of return. So, very similar to Chris Mayer. If a business has $100 invested in it, it manages to earn 20% per year, the business will grow to $120 at the end of year one.

Starting point is 00:06:51 When you compound that 20% over a number of years is when the magic really starts to happen. At the end of four years, the business has doubled. At the end of 10, you have a six bagger. And after 25 years, you'll have a hundred bagger. Now, very few businesses, of course, are going to be able to achieve this, but there's still that really powerful lesson of recognizing the power of long-term compounding. Lastly, I also wanted to mention that Chris is also very strict. on investing in companies with a rock solid balance sheet.

Starting point is 00:07:21 This ensures that the company won't have any issues during a recession. They don't have a lot of leverage in order to generate high returns, and management is conservative and holds a lot of cash. Filters on these types of things just tend to point to a quality business that helps us narrow down the giant universe of thousands of companies just to those very few really good businesses that have relatively low risk of permanent loss of capital. All right, so let's talk about the first company, which is Topicus.com, which I'm going to refer to here as Topicus during this discussion.

Starting point is 00:07:57 If you tuned into my episode on Constellation Software, then you're probably familiar with Topicus as well. That was episode 531 where I touched on Constellation Software. Full disclosure, I do own shares in Constellation Software that were acquired in February of 2023 at just under $2,400 Canadian dollars. Topicus was a result of a spin-off. off from Constellation Software back in early 2020, the company trades under the ticker, T-O-I.V. Topicus is practically a carbon copy of Constellation Software, and they have a very similar business bottle. Topicus specializes in the European market specifically, and it looks to me that Constellation owns roughly 30% of the shares of Topicus. So for those shareholders

Starting point is 00:08:41 in Constellation, they're already getting exposure to Topicus. The company trades on the Canadian in stock market, and at the time of this recording, has a market cap of around $5 billion US dollars. Like Constellation Software, Topicus is a serial acquirer of vertical market software businesses, which are very high-quality businesses that tend to demonstrate characteristics such as sticky revenues, strong customer relationships, and their services provided at customers are really critical to the operations of their business. These VMS businesses tend to offer their services in a very niche,

Starting point is 00:09:17 market, and these businesses tend to sell for around $5 to $10 million to Topicus. So they're in these very small markets, which means that the competition in such markets tends to be low, and these businesses are too small for a private equity firm to be interested in purchasing them. I find Topicus to be a company that is worth diving into for a number of reasons. First is that they are simply taking the approach that Constellation took into other markets, and they're applying it to the European market. Constellation is a lot of the world. Constellation has shown that this strategy of being a niche serial acquirer can be very successful as long as you have the right managers and you're doing the right approach.

Starting point is 00:09:56 Because Topicus is smaller and has a $5 billion market cap relative to Constellations $41 billion, it's been said that buying Topicus today could be similar to buying Constellation back in 2010. Of course, there are no certainties in this, and just because Constellation has been so successful doesn't mean that Topicus will replicate that success in the years to come. But I find it exciting to have a company that may have the potential to do even half as well as Constellation has to date. The reason that Constellation Software has been so successful is because they have a world-class management team that is exceptional capital allocators. They have a decentralized culture that allows for autonomy among the managers. They have a reputation of being great perpetual owners of VMS businesses.

Starting point is 00:10:41 and they have perfected the formula of making VMS acquisitions that are value accretive to their shareholders. Now let's turn to talk more about Topicus specifically. Topicus started around the same time as Constellation back in the late 90s and they had pretty similar beginnings. A family out of the Netherlands had a nest egg of capital from selling their business and they wanted to use that capital to start acquiring VMS businesses. For years, they operated under the name Total Specific Solutions. Essentially, the pitch to businesses was, if you sell your company to us, we'll let you continue to run your business.

Starting point is 00:11:19 In addition to that, they'll also provide you capital should you need it, as well as administrative services such as HR, accounting, or legal support. Then the businesses can focus more on what they do best, which is serving their customers. From 2006 through 2012, TSS completed eight acquisitions, and from 2008 to 2012, revenues increased from 67 million euros to 201 million euros, which is a 31% compounded annual growth rate. Quite impressive. The businesses that TSS acquired provided highly customized services to their customers, which led to very sticky revenues because it was such a headache for these businesses

Starting point is 00:12:00 to switch. In 2010, Robin Van Polge, I'm going to butcher this name, he became the CEO in TSS, and he is the CEO of Topicus today. In 2013, Constellation Software wanted to purchase TSS, to which they came to an agreement on as long as the founding family of TSS remained 33% minority interest, and Robin could remain CEO. So at the end of 2013, Constellation officially acquired TSS, which is Topicus today. Constellation was happy to have TSS under their ownership, as they had a dominant position in certain Dutch verticals, highly customized products,

Starting point is 00:12:40 a decentralized business model, managers who think long-term, and very similar to Constellations managers, and of course they had a great reputation as a serial acquirer. It took a couple of years for TSS to become 100% aligned with Constellation and get the right people on the management team, but once they did, acquisitions for TSS just started to take off. Like I mentioned, from 2006 through 2012, Topicus completed eight acquisitions. In 2015, they completed two. 2016, they completed 10, and then by 2020, they had completed 17 acquisitions. So from 2006 to 2012, they'd completed a total of eight, and in 2020 alone, they completed 17. Looking at the geography a little bit here, in 2018, 80% of their revenues came from

Starting point is 00:13:30 the Netherlands, and by 2020, that had declined to 62% as they started to make more acquisitions in other countries in Europe. While under the ownership of Constellation, TSS increased revenues by 20% annually and grew their EBITDA margins from 18% to 33%. Then in 2020, Constellation announced that they would be spinning off TSS in conjunction with a large acquisition of another Netherlands-based VMS business called Topicus.com. Topicus.com, the business that merged to become what is the separate spinoff entity, it took a slightly different approach than TSS and Constellation in that they were willing to spend more money internally to achieve organic growth and they encouraged innovation in the development

Starting point is 00:14:16 of new products. But at the end of the day, their overall revenue growth and return on capital is similar to that of TSS before the two merged together. I suspect that the topic is operating group will eventually become more acquainted with being open to doing more acquisitions, rather than putting focus on internal organic revenue growth. With the spinoff, Topicus would then have essentially three shareholder groups. There was Constellation, which owned 30.35% of shares. The original founding family's investment vehicle owned 39.3% of shares. And then public shareholders would own the other 30.35% of fully diluted shares.

Starting point is 00:14:58 I'm sure public shareholders sleep well at night knowing two-thirds of the shareholder base thinks very, very long term. Mark Leonard and his team at Constellation have a long history of being great stewards of shareholder capital. The investment firm that owns the other portion is very similar in their mindset of how they think about their ownership in Topicus. Now Topicus has the head office which oversees their three operating groups. Each operating group has a number of business units under them that have full autonomy,

Starting point is 00:15:29 but it's the operating groups in the head office that end up making the capital allocation decisions. The majority of the free cash flows end up getting redeployed into acquisitions. And since Topicus is a smaller company, they should have a much easier time at deploying all of their free cash flow through acquisitions. In 2022, they had revenues of $1.3 billion Canadian dollars. For reference, one Canadian dollar is about three-fourths of a U.S. dollar. So $1.3 billion Canadian dollars in revenue translates to around $960 million U.S. dollars. Revenues for 2022 were up over 22% year over year. Since I love Constellation so much, I really like that Topicus is essentially an extension of Constellation.

Starting point is 00:16:15 Constellation owns 30% of the shares. They used to be a part of Constellation, so they know the formula really well. And they've learned from some of Constellation's mistakes, such as paying out special dividends, instead of using that capital to make larger acquisitions at slightly lower hurdle rates. I see it as a benefit that Topicus is in the European market. The European VMS market is more fragmented than, say, the U.S., and there's less competition with private equity firms for getting deals. The reason the VMS market is more fragmented is because there are barriers between countries

Starting point is 00:16:50 that make it difficult to expand from one country to another. There may be a language barrier. There are different regulations in different countries, different payment systems, and so on. So the European market is more fragmented than the U.S., which means that there's a lot more opportunities for businesses to acquire that have a dominant share of their specific niche. Let's take a quick break and hear from today's sponsors. All right, I want you guys to imagine spending three days in Oslo at the height of the summer. You've got long days of daylight, incredible food, floating saunas on the Oslo Fjord.

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Starting point is 00:21:21 To foster that future growth, I envision Topicus acquiring companies in similar niches in other countries and then sharing best practices between companies or potentially even expanding existing businesses into new markets. The other positive with the European market is what seems to be much less interest from private equity firms, as I mentioned. research from McKinsey indicates that most of the growth in private equity is in the U.S. while Europe is still fairly stagnant. Even when you look at Europe, it's more developed in the U.K., which means that Topicus

Starting point is 00:21:55 probably won't have too much competition from private equity in continental Europe. This creates a ton of opportunity for Topagus. While a lot of money flows to the U.S., this means that there's a plethora of small businesses in Europe because they haven't received that capital that would have been received had they been in the U.S. Another critical piece to consider with Topicus is their organic revenue growth. Historically, Constellation's organic growth of their existing businesses has been under 2%, while Topicus's organic growth has historically been over 10%, which is quite impressive

Starting point is 00:22:30 given that the majority of the cash flow is used for acquisitions rather than reinvesting internally. Topicus may have many opportunities to acquire small VMS businesses and offer them capital to grow organically at really high rates because the company didn't have access to much capital prior. This is a win-win for both Topicus and the acquired companies. These structural advantages in the European market may mean that Topicus may have a chance at growing potentially even faster than Constellation did over the past decade. When you look at the data within Constellation, you'll see that these structural advantages also exist within Constellation when you're looking

Starting point is 00:23:10 at Europe specifically. The revenue growth. rate within Constellation for the European market was just over 20% annually from 2015 through 2020, while the revenue growth rate in Canada was only 17%, the U.S., 12%, and then other regions actually was over 30%, but it's a smaller portion of their business. Remember that roughly half of Constellations revenue comes from the U.S., so I see Topicus operating in Europe as a really good advantage to have from a shareholder's perspective and in the business's perspective as well. A lot of the competitive advantages that apply to Constellation also apply to Topicus as well.

Starting point is 00:23:46 The products within their businesses have that high switching costs, sticky revenues, and there's little incentives for their customers to want to switch to a competitor. Their decentralized business structure allows them to continue to grow at a rapid rate with the right incentives put in place and then continue to scale the number of acquisitions they do year after year after year. And then they have the reputation and culture, as I've mentioned before, to continue to attract those deals from businesses that are looking to sell. And then similar to Constellation again, their high earners are paid cash bonuses that have

Starting point is 00:24:19 to be invested in shares and invested for a minimum of four years. This is great for two reasons in my mind. First is, existing shareholders aren't diluted from the bonuses that are paid out. They're paid out in cash. And then second is that managers are incentivized to act in the best interest of shareholders. And then since Constellation is a 30% owner in Topicus, Mark Leonard and the brilliant managers at Constellation are likely going to ensure that operations are run well within Topicus. Shareholders of Topicus have their wealth tied to Mark Leonard, who I personally see as one of the best capital allocators I've ever come across. As I mentioned in the episode on Constellation, the company thrives during recessions. Their revenues from existing businesses are sticky,

Starting point is 00:25:04 and they don't decline too much, if at all, during a recession. And then second, during recessions, there's more potential to make really attractive acquisitions, as companies may become desperate to sell, and then during recessions, there isn't really too much competition from firms looking to make acquisitions. Back during the Great Financial Crisis, for example, constellations organic revenue declined by 3% in 2009 and then 2% in 2010, and then it increased by 7% in 2011, which shows the resilience of the businesses' businesses.

Starting point is 00:25:34 Constellation owns, as well as Topicus. Finally, turning to the valuation, I pulled some data from a website called QuickFS. The market cap shows around $7.2 billion Canadian dollars, which equates to around $5.3 billion USD. QuickFS shows they produce cash flows of $282 million Canadian dollars for 2022, which means that the price to free cash flow is roughly 25, which is lower than constellations. The price of Topicus shares in Canadian dollars as of recording are around 88. This is a slightly more attractive valuation than Constellation software. During my episode on Constellation, the price to free cash flow was around 30. Constellation is also much more well-known and it has a longer track record of being a public

Starting point is 00:26:20 company. And given the specific advantages for Topicus, I would say their valuation is definitely more attractive, but there may be more risks and more unknowns with their long-term success. solely operating in Europe and maybe just things I'm not seeing in the business. I believe a multiple of 25 is a fair valuation for a company that's this early in its growth cycle. Over the past three years, revenues have grown by 29% annually, and then with the increase in 2022 being over 22%. If free cash flows grow by 20% over the next three years, then paying a price to free cash flow multiple of 25 today is equivalent to paying 14.4 times the free cash flow for 2025, three years

Starting point is 00:27:04 from now. And if that growth continues through 2027, then you're paying 10 times 2027's free cash flows. Of course, it's going to be really tough for them to continue to grow at this really high rate. None of this, of course, is a recommendation to buy or sell Topicus. I'm just sharing some of the information I'm seeing. There are, of course, risks. There's the possibility that Topicus simply can't do what Constellation has done so well for many years, and that the strategy isn't successfully implemented in Europe, or there's the possibility that Constellation maybe sells their shares of Topicus, and then they lose that really valuable connection that they've built over the years.

Starting point is 00:27:43 Transitioning to the second compounder I wanted to talk about today, it is Copart. C-P-R-T is the ticker. Copart is another business that is owned by Chris Mayer and his fund. and he mentioned a few times during my conversation with him, John Huber is another really great investor. I look up to a lot that owns Copart as well. Before I get into my analysis, I wanted to share a clip here of my interview with John Huber on our millennial investing show back in May of 2022. I was specifically asking John about the types of competitive advantages he looks for in a business, and he brought up Copart as a prime example of a company with a strong competitive advantage

Starting point is 00:28:24 in a number of different ways. Here's the clip with John. Barriers to entry is really important. That's something I spend a lot of time thinking about. Copart is a company that I really love. And Copart actually is a business that exhibits all three of those advantages, economies of scale, network effects, and barriers to entry. And it's got a network effect because what Copart does,

Starting point is 00:28:46 most people don't know it's not a household name. What they do is essentially they operate junkyards. That's the easiest way to think about it. So if you can visualize a junkyard, That's what Copart does. And they run salvage auctions. And so if you crash your car and you total your car, GEICO will take the car and send it to Copart to sell on GEICO's behalf.

Starting point is 00:29:05 And so Copart works with insurance companies to sell these salvage vehicles to dismantlers and other dealers and in some cases the general public that might want to buy these cars. And oftentimes these cars get shipped overseas to different buyers. And they get repaired and they go back on the road. But Copart is a great business because it owns. the land. And so there's economies of scale because it can spread its growing revenue over a fixed cost of the land. And that leads to attractive unit economics that increase over time as the business grows. And it also has a network effect of buyers and sellers. And insurance companies go there

Starting point is 00:29:39 because it has the most buyers and buyers go there because there's the most sellers. And then most importantly, I think with Copart is the barrier to entry. And that's because no one wants another junkyard in their backyard, right? So it's sort of a nimbie, not in my backyard concept there. And it's very difficult for a competitor to develop the relationships. It's not just the fact that no one wants it in their backyard. It's very difficult to get the zoning permits to set up, even if you wanted to, to set this up. And so Copart has, I think, some natural advantages there. And it's a business that enjoys relatively low competition. There's one other main competitor, but it's not a business that gets a lot of attention from VCs. You know,

Starting point is 00:30:20 There's not a lot of people that want to go into the junkyard business. And so there's just some natural advantages that I think a business like Copart enjoys. And so those are three things that I spend a lot of time thinking about. All right. So as John Huber mentioned, Copart provides online auction services to sell and remarket used, wholesale and salvaged title vehicles. And they operate in a number of different countries, including the U.S., Canada, UK, Brazil, Ireland, Germany, Finland, among others.

Starting point is 00:30:48 On their site, they also offer a number of different services, including salvage estimation, end-of-life vehicle processing, vehicle inspections, dealer services, as well as membership services that give you access to their network. Now, this is anything but a sexy business, but when I look at the numbers and I look at the advantages this company has, it really gets me excited. So on their site, I see that they have a free tier, a basic tier that they offer members, which is 99 per year, and then a premium. tier for 249 per year.

Starting point is 00:31:22 Kopar started back in 1982 with a single salvage yard, and it's grown to become a global leader in the online auction space for vehicles. The company IPOed back in 1994, and it's been a really strong performer as the stock has risen from a split-adjusted price of 30 cents in 1994 to $77 today. The business has two main revenue streams, which includes their service revenue, and then their purchased vehicles revenue. Service revenue is essentially when someone lists a car on their site and then they collect a fee on the sale for being the intermediary. Pretty simple. In this case, they're not taking ownership of the vehicle. Purchased vehicles refers to vehicle sales where

Starting point is 00:32:03 Copart has taken ownership of the vehicle and then sells it at a higher price and then pocketing the difference. Service revenue was up 24% in 2022 at $2.8 billion, while purchased vehicles revenue was up 61% at $648 million, quite impressive. So service revenue accounts for over 80% of total revenue for fiscal year 2022. When thinking about this business, the point that John Huber made on their network effects really resonated with me. You want to go to the largest network with the largest number of buyers so that you can get the best price you can. Pretty simple. When I look at the financials for Copart, I see a ton of good things. Over the past decade, revenues have grown by 14% annually, and free cash flows have grown by 17% annually, so the company

Starting point is 00:32:50 has operating leverage, meaning that their earnings are outpacing their revenues. And this is because they're buying the land, which has relatively fixed costs, while their revenue and their market share increases year after year. Their debt to equity ratio is only 0.3, so they have a really strong balance sheet. They've been profitable each of the last 20 years, and their return on invested capital tended to be in the mid-teens, but it really jumped back in 2017 and ever since it's been in the mid-20% range, really strong return on capital. As a testament to the quality of the management team, Chris Mayer shared this data on Twitter that compared Copart to their primary competitor Insurance Auto Auctions, which I'll refer to here as IAA. Co-part invested four

Starting point is 00:33:36 times more back into their business since 2016. Despite during that time period, they paid down $700 million in debt and their competitor issued $1.3 billion in debt. And on top of all of this, Copart produced $1.4 billion in free cash flow over that period since 2016, and their competitor produced no cash flow, and they paid out these substantial dividends to their shareholders of $1.8 billion. So Copart, very clearly is all about reinvesting back into the business. And Copart actually doesn't pay a dividend because they have so many investment opportunities that they're capitalizing on. And I think this is a really important piece that I picked up from Chris Mayer.

Starting point is 00:34:20 He referenced that quote from Thomas Phelps in my interview with him that dividends are an expensive luxury, meaning that it might be nice to see a company paying out a dividend, but if the dividend could have been used to reinvest back into the business at say 20%, then you're missing out on that substantial compounding over the years ahead. Chris had this other quote from our conversation that Copart seems to get better with age, since they're continually reinvesting back into the business, and the lead over their competitors just gets larger and larger. And at this point, they've reinvested so much back into the business

Starting point is 00:34:54 that their advantage is insurmountable because it's cost of them billions and billions of dollars. And then you compare the market share between Copart and IAA. Copart's market share has marched upward year after year, and then IAA is losing market share. Chris shared this data that was pulled from a presentation by Luxor Capital that I'll be sure to link in the show notes for those interested. Luxor Capital was an advisory firm that highly, highly recommended that Richie Bros. not acquire IAA because Copart was such a better business, and you don't want to be competing with them, essentially when IAA's business is already determined.

Starting point is 00:35:32 There's a headline from March 20, 2023 that Richie Brough's acquired IAA for $7 billion weeks after two proxy advisory firms urged shareholders to reject the deal. They have this slide here in their long and in-depth presentation that is titled, Copart versus IAA is not a fair fight. And it says, Copart has more buyers, more sellers, a stronger network effect, a stronger balance sheet, far more EBITA to invest out of an advantaged cost structure from owning their land and an experienced management team, end quote. And then just looking at Copart here at the time of the presentation, it had a market cap of $33 billion, almost $1.5 billion in EBITDA, 9,500 employees, 17,000 acres of land, $1.5 billion in net cash, $425 million in CAPX in the trailing 12 months,

Starting point is 00:36:31 and their co-CEO is the founder. All of these statistics I just listed trumps their competitor. Let's take a quick break and hear from today's sponsors. No, it's not your imagination. Risk and regulation are ramping up, and customers now expect proof of security just to do business. That's why VANTA is a game changer. VANTA automates your compliance process

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Starting point is 00:39:51 other information can be found in the income funds prospectus at fundrise.com slash income. This is a paid advertisement. All right. Back to the show. Another slide shows that Copart has three times the number of unique visitors globally. A big issue with IAA, according to this presentation, is that they lease their land and have largely neglected reinvestment, while Copart has heavily reinvested in Cappex since 2016. so IAA has just fallen further and further behind on all fronts, and they need to invest

Starting point is 00:40:24 billions of dollars just to try to compete and regain that market share. The situation IAA is in with them paying these big dividends to their parent company puts copart in such an advantageous position where they just continue to get further and further ahead with their continued competitive advantage. There's one slide here that I feel is such a good business lesson here. it's titled RBA Management is in denial on why IAA will not be the exception to the laws of nature. It states, quote, The history of marketplace businesses contains numerous examples of number two players burning enormous amounts of cash to catch up,

Starting point is 00:41:04 with no sustainable share gains to show for it, end quote. Then it shows brands such as Amazon versus Walmart, Uber versus Lyft, Spotify versus Pandora, and then Airbnb versus Verbo. And then, of course, we have Copart versus IAA, with Copart having a market cap 5.6 times the size of IAA. The point they're making here is that the first mover gets a sizable head start over all of their competitors, and it becomes exponentially harder for the other players to catch up,

Starting point is 00:41:35 meaning that you just can't simply invest the same amount of money that the first mover did. You're going to have to invest much more than the first mover, just to even have a shot because there are many different aspects that are difficult, if not impossible to capture, such as the customer mindshare that the first mover got. Once someone is so used to shopping on Amazon and it works really well for them, why would they all of a sudden want to switch over to shop on Walmart online for all of their online shopping? The same concept applies to Copart with their online platform. It's also really nice as shareholders to really only have one real competitor.

Starting point is 00:42:11 80% of the market they're in is split between Copart and IAA. In the U.S., Copart has a 40% market share, so there's still room for them to grow and continue to capture share from their competitors, as well as just the overall industry growing and expanding itself. So they're growing in terms of stealing market share, and then they're also growing from the overall industry growing as well. The competitive landscape is not really a situation where there's dozens of players, and You don't really know who the clear winner is going to be.

Starting point is 00:42:42 I listened to another podcast that Chris Mayer was on, and he was talking about his research and how he had spoke with someone who worked at IAA. And he asked this person that worked there how difficult it is to compete with Copart. And the guy evidently told him that you would be crazy to compete with Copart. You'd have to get all these physical yards all over the country in places that are really tough to get land. And then from a physical perspective, it's just not the type of business. that people really get attracted to. And then there's the regulatory aspect and the zoning laws as well

Starting point is 00:43:15 where only certain pieces of land can become a lot for salvage cars. So essentially in order to get the land, you need to be buying a lot of these lots from Copart themselves that were able to get these back in the 1990s when the laws were different. The zoning and regulatory aspect in that landscape was totally different. Copart's advantage seems to be especially shining in the past couple of years, as their revenue in 2021 increased by 22%, then 2022 increased by 30%. It's just really amazing. One piece I really like about Copart's business is that there's both the physical and the online presence.

Starting point is 00:43:52 So they're benefiting from both. The online piece enables the network effects where anyone can go online and purchase the vehicle, and then the physical piece is all the land they've purchased to support that online network and make it incredibly expensive for. a competitor to work its way into their business and industry. And it took a ton of time and a ton of effort for them to build this out. It's not like they're just a pure technology company that might be disrupted by a new technology.

Starting point is 00:44:20 So I definitely think that sort of industry dynamic and that dynamic with Copart is definitely worth considering. Taking a look at insider ownership, I found some data on this site called SEC Form 4. Willis Johnson, the founder, owns almost 25 million shares, which today's were. roughly $1.9 billion, so he has substantial alignment of interest with shareholders. The CEO Jay Adair owns 5 million shares, and the co-CEO Jeff Leow owns 325,000 shares. The CEO, Jay Adair, is Willis Johnson, the founder's son-in-law. Jay started with Copart all the way back in 1989 at the age of 19, and he became the CEO in 2010.

Starting point is 00:45:03 Willis Johnson is no longer with the company, the founder, but he's started with the company. still has significant ownership in Copart. So the insider ownership seems to look really, really good. Copart's managers really are best in class, as they always think really long term and they're always looking to allocate capital effectively. Their return on invested capital has increased in recent years, like I mentioned earlier, and year after year, it's just been really strong and consistent. Here's a line from their co-CEO Jeff Leow during their Q4 earnings call that I wanted to read here. The priority certainly is always to invest in, and this is what any good steward of capital would, I think, is the framework they would approach the question with, which is how do we

Starting point is 00:45:45 maximize those returns over 30, 40, 50-year time horizons? And if that is your framework, we would always elect to invest productively in the business long term. There is power in the network. There's power in physical capacity. There's power, as you heard me say, in owning it and controlling it into perpetuity. We generate cash, of course, net of those investments as well. As you know, from our history, we buy shares back. We do so aggressively in real volume. We also do so periodically as opposed to predictable routine buyback program. But at some point, we will be buying back more shares, end quote. As Jeff stated, management is very opportunistic about performing share repurchases. Buffett taught us that you only want to perform share buybacks when the intrinsic

Starting point is 00:46:34 value of the shares is more than the share price. If buybacks are performed, when the stock is overpriced, then shareholder value is being destroyed as a result. Very few management teams truly act in shareholders' best interest in this way. Since copart has a really strong balance sheet, they're also well prepared to serve their largest customers, such as insurance companies during these times when they need copart most. This could be during something like a natural disaster, such as a hurricane, insurance companies want to partner with a business they can trust, which management really understands and really wants to take care of their customers. Back in 2019, Copart partnered with GEICO to take on more of their business over time.

Starting point is 00:47:17 A big reason they did this was because after Hurricane Harvey, IAA wasn't able to meet GEICO's immense needs during that time. Sometimes it literally takes a disaster for a business to make a change, and insurance definitely isn't a industry where players are moving really quickly. They're really slow to change. And while Copart focuses on having these long-term relationships with their customers, they continue to attract business from their competitors because they've built that trust and that reputation relative to their competitors. In fact, since I mentioned GEICO, when IAA would report their results, they would exclude one of their large customers when they would present these pieces of

Starting point is 00:47:56 the results to their shareholders. And that company that they excluded was GEICO. GEICO was transitioning away from IAA to Copart, and IAA, rather than presenting the facts to shareholders, they would try and cover up that information to say, hey, if you ignore this one customer, then we're actually growing, which that alone is a tell of managers I personally don't want to be partnering with. I want managers that are being honest, they're being transparent, and they're being, you know, just straight up with their results and taking ownership of their results rather than trying to hide or manipulate them. And then the other reason Copart holds so much cash is because they want to be in a position

Starting point is 00:48:34 to opportunistically buy back their shares. It's no wonder that management thinks and acts like owners and acts in the best interests of long-term shareholders. If you were to own hundreds of thousands of shares, you wouldn't want to be destroying shareholder value by overpaying on buybacks or incurring unnecessary taxes by paying out large dividends to their investors. Copart doesn't even pay a dividend, and that's because Copart's managers have skin in the game while IAA's managers do not.

Starting point is 00:49:03 Transitioning to cover the risks. One risk with Copart is the eventual transition to autonomous driving. Hypothetically, if autonomous driving is really good and many people are using it, then in theory there will be less accidents and less inventory for Copart. Autonomous driving is not here yet, as we all know, and we don't know when that will really be widespread. The kicker with Copart is that since there is so much technology involved, with cars nowadays, this has actually been a tail win for their business because a lot of times

Starting point is 00:49:35 when you have these minor accidents, it essentially totals the car because it's so expensive to fix. So for now, it seems that the rise of technology and vehicles is more of a tail win rather than a headwin for Copart, which is another interesting dynamic in my mind. Another piece to consider here is that Copart is continuing to expand internationally. So while there may be autonomous vehicles rolling out in the U.S. and Europe, there won't be in a lot of other places they're expanding in. Over the near term, say five, 10 years, autonomous driving shouldn't be a big risk for Copart, in my opinion. Management also has discussed electric vehicles in their Q4 earnings call. The EV market is still very small, but as it grows, it will actually benefit

Starting point is 00:50:20 Copart as well because they're easier to total because of that more advanced technology that's in them, and then there's just an absence of repair networks for these vehicles. Just given the sheer change that can happen in society over the long run, it's really hard to tell what Copart's business will look like way down the line. So turning to valuation here, Copart is definitely not a cheap company when looking at the multiples. I'm looking at the EV to EBIT, for example. It's currently around 26. And over the past five years, this multiple has trended from 17 to around 35 in late 2020. So today's EV to EBIT is roughly in the middle of where it's been historically over the past five years. And then the PE tells a similar story, which sits around 31 today. For fiscal year

Starting point is 00:51:05 2022, again, they grew revenues by 30% year over year, which is partly due to the tailwind of rising used car prices during the year. Co-part shouldn't be too dependent on high use car prices, I don't think. On the one hand, their average selling price on their services revenues increases as the price of cars increased. But on the other hand, as the price of cars increased, more people would be willing to repair their cars rather than sell it to Copart. So it's kind of a give and take either way. It's clear that Copart has seen really strong growth internationally, and it's been continuing to steal market share from their competitors, such as IAA. Copart's units in Q4 were up 5% year over year, while IAA's units were down 3%. And they operate in a really large and a really growing

Starting point is 00:51:50 market as the U.S. has roughly 285 million cars in operation, which is growing at around 2 million cars per year after you consider what's added and then what ends up getting totaled. So Copart's market cap is around $37 billion. They have a rock solid balance sheet with $1.4 billion in cash. And then running a bit of math on the valuation here just based on their net income numbers, which I will take at face value as their owner's earnings before making any of their internal investments. Net income has grown by 21% annualized over the past five years, which is really high because we've seen a big boost in their business since COVID. With a market cap of

Starting point is 00:52:30 37 billion and a net income for the trailing 12 months of 1.1 billion, that puts their multiple at 34. When I project that out over the next five years, for example, and then I assume a multiple of 25 at the end of five years. Right now, the market is currently pricing and earnings growth of around 13 to 14% over that five-year period. So essentially, if Copart grows their earnings at around 13% over the next five years, and you see some multiple compression down to a multiple of 25, then I would expect this stock to return around 10%. If you're a long-term buy-and-hold investor, then today's price is probably a fair price. It's not super overheated, and it's definitely not a screaming bargain. If you're more opportunistic about your purchases

Starting point is 00:53:16 and being selective when you buy like my co-host, Stig Bruterson is, then you'd probably want to put Copart on your watch list and keep an eye on it to see if it has another drawdown like it did in late 2022. It seems that the more I read about Copart, the more I really like their business. I don't believe I'm one to say whether it's far overvalued or undervalued at today's price, but I do believe that over the long run, this business will continue to do really well.

Starting point is 00:53:42 One of the things I almost always look for in a company as well is to see how it did during the great financial crisis, to see how resilient it is to weather through big economic storms. Copart's revenue was up 40% in 2008 just before the crisis, and then it was down 5% in 2009, so definitely didn't do too bad considering it had such a boost in 2008. Then during the crisis, they still remained profitable, so there was really no real detrimental threat to the underlying business. Remember that Copart is ultimately tied to the automobile market. It might not be a surprise to you, but during a recession, people still drive their cars and they do what they need to do, and inevitably, accidents still happen. I saw one write-up on the company

Starting point is 00:54:27 mentioned that this is very much like a Peter Lynch-type stock. Since they're in the junkyard industry, it's just not a sexy business. It's not like Tesla with its cool cars and outspoken CEO and fun things always happening. It's really the complete opposite. So simply because of that, it probably won't get a lot of attention from everyday retail investors. If you'd like to learn more about Copart, Chris Mayer recommended reading the book, Junk to Gold. I haven't gotten the chance to read this, but if he recommends it, I'm sure it's a really great story talking about the rise of Copart. As always, nothing stated on this podcast is intended to be investment advice. Please consult a professional before making financial decisions.

Starting point is 00:55:09 If you're like me and enjoy learning about individual stocks and maybe what types of companies other people are researching, then you may consider joining our TIP Mastermind community. Here soon I'm going to be chatting with Stig Broderson and do a Q&A session with him. Stig is meeting with the management team of a small company that's only around $300 million in size, so I'm really interested to hear Stig's thoughts around why he's so interested in learning more about such a small company. I have another call booked with Lance, who is a member of our community, and he has aspirations of starting his own fund.

Starting point is 00:55:42 And I have another call booked at the end of May to chat with a gentleman who specializes in researching potential multi-baggers, which I absolutely love chatting about. I really enjoy being a part of this community because I think it's just a great way to source ideas from others, as well as stress test your own ideas. I'm well aware that I have blind spots, so I'm always interested to hear the opinions of others who are like-minded value investors. Community members also get access to a community forum to collaborate and share ideas, as well as our paid tier of our TIPP finance tool.

Starting point is 00:56:14 Anyways, if you'd like access to these exclusive conversations, then you can check out the community by visiting theinvestorspodcast.com slash mastermind. That is theinvestorspodcast.com slash mastermind to check it out today. That wraps up today's episode. I really hope you enjoyed this one. I really enjoyed putting it together. I always love researching high-quality compounders. If you're on Twitter and enjoyed this episode,

Starting point is 00:56:40 I'd really appreciate it if you shared it and tagged me at Clay underscore Fink, C-L-A-Y-U-S-I-N-C-K. That would be very much appreciated. Thanks again for tuning in, and I hope to see you again next week. Thank you for listening to T-I-P. Make sure to subscribe to Millennial Investing by the Investors Podcast Network and learn how to achieve financial independence.

Starting point is 00:57:05 To access our show notes, transcripts or courses, go to theinvestorspodcast.com. This show is for entertainment purposes only, before making any decision consult a professional. This show is copyrighted by the Investors Podcast Network. Written permission must be granted before syndication or rebroadcasting.

We Study Billionaires - The Investor’s Podcast Network - TIP549: 2 High-Quality Compounders

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