Blocket: A Swedish Franchise

Blocket – Some Background

Blocket was founded in 1996 in Fjälkinge, a small Swedish town, by Henrik Nordström. It started out as a small local market place in the region of Skåne (the southernmost region in Sweden), from where it grew and started offering buy and sell ads for the whole country to become what it is today, Sweden’s biggest marketplace for for selling and buying stuff you need or want to get rid off. 

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In 2003 Blocket was acquired for 183 MSEK by the Norwegian media company Schibsted. Already back in 2001 Schibsted had been negotiating with the founders to buy Blocket, but decided not to since the asking price of 90 MSEK was deemed to be too high. Instead Schibsted started their own version of Blocket, but it turned out to be a failure. Having had this experience Schibsted kind of adopted the motto “If you can’t beat them, join them.” In hindsight, the initial 90 MSEK looks superb, but at the same time the 183 MSEK still turned out to be a great deal too. Operating profits during 2008 to 2013 totaled approximately SEK 2 billion. 

At the time of the acquisition Blocket had revenues of 34 MSEK and a profit of 13 MSEK. Using these numbers to get some rough measure of the purchase price paid by Schibsted and by assuming a 28% tax rate, no interest-bearing debt and also no excess cash results in a P/E multiple of 14 and EV/EBIT multiple of 10.

eBay also wanted to grab a share of Blocket’s ever growing profits and most certainly came to the same conclusion as Schibsted. Unfortunately, eBay wasn’t able to “join them,” instead they acquired Tradera, a swedish business not really as good as Blocket—at least from looking at the earnings and profitability. 

Let’s have a look at a few more stats provided by Blocket.se.

Blocket vs. Tradera

To get a quick summary of Tradera and its business, let’s turn to Wikipedia: 

Tradera.com is one of the leading online commerce services in Sweden, with over 2,5 million members and about one million listings (2011). Although Tradera welcomes members from all over the world, most are Swedish. Tradera was founded in 1999 but was acquired by eBay Inc. in 2006. Tradera was originally based completely on private auctions but today visitors can purchase both new and second hand items through auctions as well as fixed price listings.

On 24 April 2006, Tradera.com, along with its sister site Traderamotor.com, was acquired by eBay for 365 million SEK (about 50 million US dollars)

The table below summarizes some financial metrics for Tradera and Blocket. From looking at the change in net sales, earnings and profitability we see that Blocket seems to be the more solid business. At least this has was the case during 2011-2013.

At the same time as Tradera posted an accumulated negative EBIT for this three year period, Blocket managed to earn an accumulated EBIT of SEK 1 128 billion. When looking at ROE in the table below, keep in mind that it may not tell the whole truth about the underlying profitability due to the capital structure and inter-company receivables and liabilities. At least this seems to be the case for Blocket. 

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Blocket’s relative share of total net sales for both businesses has been slowly rising during 2011 to 2013, from 80% to 85%. Looking at EBIT, Blocket has posted great earnings at the same time as Tradera has had a hard time avoiding red numbers. 

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The growth in Blocket’s net sales and profit before tax has been pretty consistent during the last ten years (Source: allabolag.se). Net sales for Tradera grew at a high speed between 2004 up until 2010, showing some decline from 2011 to 2013 and profit before tax has not been that impressive. 

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A Profitable Growth Story

The financial statements speak for themselves and reveals a great growing business with high returns on capital. Net sales grew from 409 MSEK in 2008 to 786 MSEK in 2013, a compounded annual growth rate (CAGR) of 14%. Accumulated operating earnings during 2008 to 2013 approximated roughly SEK 2 billion, growing from 239 MSEK to 398 MSEK, a CAGR of 10.7%.

The question then is: How much investments were required to achieve this growth in sales and earnings? The answer: None. Net investments, that is investments in working capital and capital expenditures (both tangibles and intangibles) totaled a positive of 10 MSEK. Sound pretty good right? Earning SEK 2 billion in accumulated EBIT in a period of six years without having to invest anything in the business to make it happen, instead you get an additional 10 MSEK for doing it.  

Without exaggeration, Blocket seems like a pretty decent little business. A fair question to ask then is: What competitive advantages does Blocket enjoy (at least during the last decade)? If someone else had been able to do it, I’m pretty sure they would have liked to take away some of Blocket’s earnings. 

To keep it short, it seems reasonable to assume that Blocket probably enjoy some combination of local economies of scale coupled with habit and switching costs from the network effect. If you are going to sell something you want to go where the buyers are. The same is true the other way around. As buyer you want to go where there’s a lot of sellers. Sellers and buyers seem to like Blocket, and most likely Schibsted love the business. And who would not, one just have to look at free cash flow margin, averaging almost 53% during 2008-2013. 

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Free cash flow grew from 191 MSEK in 2008 to 417 MSEK in 2013, a CAGR of 17%. During 2008 to 2013 Blocket’s average operating margin was 55% and profit before tax margin 56% (the corporate income tax rate in Sweden during these years was reduced from 28% to 22%). In the same period the free cash flow margin was about 53%. 

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Profitability has been great with pre-tax return on equity (ROE) and pre-tax return on assets (ROA) averaging 166% and 60% respectively.

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If one was to account for the inter-company receivables and liabilities and adjusting for excess cash, it most likely would be the case that business doesn’t really require any invested capital (as measured by net fixes assets plus net working capital). But the point is already pretty clear. Blocket during the last decade has turned out to be a pretty good investment for Schibsted.

Schibsted has also used its ownership of Aftonbladet and its large number of unique visitors (number one of all media sites in week 9 according to http://www.kiaindex.se/), and by placing ads on Aftonbladet’s site driving traffic to Blocket. A great advantage when it comes to achieving the scale of Blocket’s network of sellers and buyers, that when achieved is pretty hard to overcome for any competitor.

Blocket has also expanded at the edges of its business, adding Blocket Jobb (in 2011, with the goal of becoming the biggest site for job ads) and Blocket Bostad (in 2014 with the goal of becoming the biggest housing site in Sweden).

Annual reports

All financial statement data taken from Blocket AB’s annual reports (click link to read PDF): 

Sources

Disclosure: I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it. I have no business relationship with any company or individual mentioned in this article. I have no positions in any stocks mentioned.

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Q&A: Case Study of See’s Candy

“There was something special. Every person in California has something in mind about See’s Candies and overwhelmingly it was favorable. They had taken a box on Valentine’s Day to some girl and she had kissed him… See’s Candies means getting kissed. If we can get that in the minds of people, we can raise prices.” —Warren Buffett

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This post contains my answers to the questions posted at CSInvesting.org as part of the DEEP VALUE course and the case study on See’s Candy. Feel free to comment and share your own views, reflections and take-aways.

Company Overview

A brief description of See’s Candy as of today:

See’s Candy Shops, Inc. produces boxed chocolates and candies. The company offers chocolate assortments, nuts and chews, decadent chocolate truffles, milk and dark chocolates, brittles and toffees, truffles, lollypops, candy bars, gift cards, and kosher categories. It offers products online, as well as through its shops in the United Sates, Hong Kong, Japan, and Macau. The company was founded in 1921 and is headquartered in Carson, California. (Source: Bloomberg)

Financial Data and Operating Metrics

From the current description of the business, let’s turn back to the time when Buffett and Munger purchased See’s, that is in the beginning of the 70’s.

From the financials disclosed by Warren in his shareholder letters we can see that See’s development has been excellent. Growing sales revenues translating into higher operating profits. See’s excellence is, to a great extent, derived from its ability to raise prices along with and also above the rate of inflation and at the same time requiring very limited investment in tangible assets.

A look at the development in the number of pounds of candy sold shows that during the same time period (1972 to 1984) as revenues more than quadrupled, operating profit after taxes increased more than tenfold, the number of pounds of candy sold increased only 46%. That’s right, just 46% during this 12 year period, or at an average growth rate per year of 3.2%. So, the great growth rate shown by sales revenues, was not due to volume growth, but to price.

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If we take a look at sales revenues, operating expenses (OPEX) and operating profit after taxes (OPAT) on a per-pound basis, it’s clear that at the same time as sales revenue grew, operating expenses were managed in a good way which resulted in great growth in operating profit after taxes.

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Looking at the data broken down on a per store level the same can be seen even here. Rising revenues per store, rising OPEX (even though at a lower rate than the growth in revenues), which contributed to the great growth rate in OPAT per store. At the same time the number of pounds of candy sold per store was growing real slow, and even turned negative for three of the four periods for which averages are calculated (see table below).

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And finally, from where can any support for the pricing power of See’s be derived? If growth in sales revenues is compared to volume growth from the number of pounds of candy sold, we get a rough measure of the price increase each year (before inflation, i.e., nominal amounts). Taking inflation into account in the next step then gives the real price increases, that is any amount of the total price increase each year that remains when inflation for the same period is taken into account.

A year-to-year comparison does not always show any clear signs, growth between single years can go in opposite ways even when the underlying trend during a couple of years tells another tale. Instead, from looking at longer time periods it can be seen that See’s has not just been able to raise prices to match inflation, See’s also was able to raise prices at a rate higher than inflation, i.e., in real terms. (Any input regarding the pricing power issue of See’s and how to derive it would be greatly appreciated. Does my thinking make sense, or should something maybe be reconsidered here in my attempt to try to find the key to the “untapped pricing power” of See’s (both in nominal and real terms) Feel free to comment!)

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Describe the competitive advantages of See’s.

In our primary marketing area, the West, our candy is preferred by an enormous margin to that of any competitor. In fact, we believe most lovers of chocolate prefer it to candy costing two or three times as much. (In candy, as in stocks, price and value can differ; price is what you give, value is what you get.)

—Warren Buffett, 1983 Letter to Shareholders

See’s moat most likely stems from:

  • CAPTIVE CUSTOMERS through habit formation and maybe even some kind of emotional switching costs due to psychological reasons coming from the influence from mere-association tendency and the social proof tendency (both discussed by Charlie Munger in his speech The Psychology of Human Misjudgment), and
  • LOCAL ECONOMIES OF SCALE in advertising and distribution.

For a hint on why it seems likely to assume the presence of LOCAL ECONOMIES OF SCALE even some decades ago, take a quick look at the map below showing some 186 See’s stores in California AS OF TODAY (Source: ca.sees.com). This concentration reminds me of the Walmart map that I posted in another post (see here).

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Could this be a faster growing business if See’s sold through other marketing channels?

See’s most likely would be able to increase its growth rate (in volume) if it was sold through other marketing channels. But, would it still be as profitable? Probably not. But as we can see from an analysis of See’s moat and its sources, the moat sources are most favorable in California, and thus probably less so in other parts of the U.S.

How does Buffett analyze this business?

  • Poundage volume
  • Units sold per store

The poundage volume in our retail stores has been virtually unchanged each year for the past four, despite small increases every year in the number of shops (and in distribution expense as well). Of course, dollar volume has increased because we have raised prices significantly. But we regard the most important measure of retail trends to be units sold per store rather than dollar volume. On a same-store basis (counting only shops open throughout both years) with all figures adjusted to a 52-week year, poundage was down .8 of 1% during 1983.

—Warren Buffett, 1983 Letter to Shareholders

  • Per-pound realization
  • Per-pound costs
  • Same store-volume

During 1984 we increased prices considerably less than has been our practice in recent years: per-pound realization was $5.49, up only 1.4% from 1983. Fortunately, we made good progress on cost control, an area that has caused us problems in recent years. Per-pound costs – other than those for raw materials, a segment of expense largely outside of our control – increased by only 2.2% last year.

Our cost-control problem has been exacerbated by the problem of modestly declining volume (measured by pounds, not dollars) on a same-store basis. Total pounds sold through shops in recent years has been maintained at a roughly constant level only by the net addition of a few shops annually. This more-shops-to-get-the-same-volume situation naturally puts heavy pressure on per-pound selling costs.

In 1984, same-store volume declined 1.1%. Total shop volume, however, grew 0.6% because of an increase in stores. (Both percentages are adjusted to compensate for a 53-week fiscal year in 1983.)

—Warren Buffett, 1984 Letter to Shareholders

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What price did Buffett pay and why?

See’s is a slow grower, but its growth is steady and reliable—and best of all, it doesn’t take additional infusions of capital.

—Damn Right! Behind the Scenes with Berkshire Hathaway Billionaire Charlie Munger

Purchase price for See’s amounted to $25 million, a business earning $4 million pre-tax and $2 million after-tax, from $8 million in tangible assets (25% after-tax ROC or 50% pre-tax ROC), which translates into these key ratios:

  • 12,5 times after-tax earnings (8% yield)
  • 6,3 times pre-tax earnings (16% yield)
  • 3 times invested capital

In comparison, the 10-year treasury rate in January 1972 was 5.95 percent.

Harry See’s asked for $30 million, but Buffett and Munger weren’t willing to pay more than $25 million, since this was a lot higher than the capital invested in the business. Harry See’s finally accepted the price of $25 million and Buffett and Munger, through Blue Ship Stamps, acquired a great franchise.

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