I like simple businesses. Complicated ones make my head hurt. Auctions are about as simple as you can get. You bring together people who want to buy stuff with people who want to sell stuff. You confine them in a space and have some guy who talks fast take bids. The stuff gets sold, both parties are happy, and the auctioneer gets a cut.
Today, when you think of auctions, you think of eBay (NASDAQ:EBAY) and Google (NASDAQ:GOOG). eBay revolutionized the "garage sale" business by creating an auction site that uses the Internet to bring together millions of buyers and sellers. Google used a Dutch auction to thumb its nose at Wall Street and sell its shares to the public.
The two auctioneers that I'll present could not be more different. They are old-fashioned auctions (yes, I know that the Dutch auction is an old concept). One sells toys that allow big boys to play in the dirt. The other is all about the finer things in life. And unless you are in the market for used heavy machinery or collectible stamps and coins, you probably have never heard of Ritchie Bros. Auctioneers (NYSE:RBA) or Greg Manning Auctions (NASDAQ:GMAI). But they both have a long history and are very good at what they do.
In order to break these investment ideas down for you, I'll take you through what they do and show you how well they do it. I'll make estimates about their value and share my concerns with you. But as always, you Fools are required to make up your own minds.
Ritchie Bros. Auctioneers
I'll let the Ritchie Brothers' website tell you what they do.
"Ritchie Bros. sells, through unreserved public auctions, a broad range of used industrial equipment, including equipment utilized in the construction, transportation, mining, forestry, petroleum, marine, and agricultural industries."
Ritchie Brothers started auctioning construction equipment in 1963. After years of successful growth, it went public in 1998. Since then, its stock has appreciated at a rate of 20% per year. Not bad for an old-fashioned business.
Before I crunch any numbers, I always look to see if I can spot a competitive advantage, which I define as a unique position plus the right supporting capabilities. Ritchie Bros. is an intermediary. That's notalwaysgood, but it's the life of an auctioneer. But Ritchie Bros. chooses to use the unreserved auction method to establish its competitive position.
So why would Ritchie Bros. choose to use such a risky method, as it's easy to upset both sides of the transaction? Like the group of managers at Berkshire Hathaway's (NYSE:BRK.A) (NYSE:BRK.B) insurance businesses, Ritchie's strength lies in its people. They know how to keep both the buyers and the sellers happy. And the proof is in the profitable growth of their business. And the coolest thing is, when buyers and sellers are happy, shareholders are happy because Ritchie Bros. gets paid to make buyers and sellers happy.
Speaking of profitable growth, let's look at some numbers to how well they do what it is they do. Dollars are in millions.
| 2002 | 2003 | TTM* | |
|---|---|---|---|
| Revenues | $134 | $162 | $172 |
| Gross margins | 85% | 86% | 87% |
| Flow ratio | 0.50 | 0.51 | 0.51 |
| SFCF | $8.6 | $32.0 | $32.4 |
| EV/SFCF | 27.3 |
* Trailing 12 months.
From the numbers, revenues continue to grow. Gross margins are very high, and Foolish Flow ratios are very low because Ritchie Bros. does not usually buy inventory from a consignor to sell. This leads to better working capital management. And we see that Ritchie generates lots of owner's earnings. As I said, its people know how to run an auction business.
Unfortunately, given that the enterprise value-to-structural free cash flow (EV/SFCF) ratio is 27.3, it appears the market has already bid up the price. That's probably because cash flow from operations jumped up almost 2 times over 2003 because of how well they manage receivables and payables. But it's been said before: You pay up for a cheery consensus. Fools would be advised to let this lot pass and be ready to bid should shares decline 15% to 20% from current levels.
Greg Manning Auctions
Greg Manning competes in a different lot (nothing like a little auction humor, huh?). It specializes in bringing together philatelic and numismatic buyers and sellers. For those who aren't down with the lingo, those are fancy words for stamp and coin collectors.
Greg Manning Auctions was founded by none other than CEO Greg Manning in 1981. Despite its experience, things have not been so smooth for Greg Manning Auctions, especially a few years back. Nothing like taking shareholders on a roller-coaster ride from $1 in 1998 to about $25 in 1999, and then back down to $1.50 in 2003 and up to $14 today.
Greg Manning Auctions' competitive advantage may come from an outside source. In September 2003, Afinsa Bienes Tangibles, a Spanish collectable company, bought about 72% of the company. In return, Afinsa agreed to purchase $250 million worth of merchandise over five years. And then, because things were going so well, Afinsa upped it to $1 billion over 10 years. You think that's sweet, get this: Greg Manning gets the gross margin (sales minus cost of goods sold) plus 10% of the purchased prices.
Here are the numbers before and after the deal.
| 2002 | 2003 | 2004 | |
|---|---|---|---|
| Revenues | $81 | $101 | $213 |
| Gross margins | 11% | 14% | 29% |
| Flow ratio | 2.31 | 1.93 | 1.94 |
| SFCF | -$7.0 | $3.2 | $29.6 |
| EV/SFCF | 12.2 |
Having a guaranteed buyer is great for an auctioneer. Revenues grow (remember that Afinsa agreed to purchase about $100 million a year of collectibles, which is almost the entire difference between 2003 and 2004). Margins increase, which gives management more opportunities to go out and buy more collectibles to sell. Note that gross margins are lower and Foolish Flow ratios are higher than Ritchie Bros. That is because Greg Manning Auctions buys a greater percentage of merchandise from consignors for inventory.
We see that owner's earnings have grown considerably and that the stock price has risen in proportion. And looking at the EV/SFCF ratio of 12.2, Greg Manning Auctions looks like a buy at these levels.
Sorry to rain on your parade, but despite the recent success and the clear impact the controlling parent has, two questions come to mind. First, are there $1 billion of stamps and coins available for purchase that can be auctioned profitably? Second, at what point will Afinsa start selling shares and cause a whole bunch of dilution given it purchased its shares for less than $2 per share? Basically, I am not sure how sustainable its competitive position really is.
OK, maybe three questions. Does something seem strange about the supply agreement? While I can't argue with the economics and I am sure there's plenty of disclosure, my gut is warning me that not all shareholders stand to benefit as much as Afinsa. These concerns are real and are likely built into today's price.
Well, my goal was to give you some investment ideas that you might not have otherwise considered. Always remember that Fools are required to dig more and think critically before plunking down their hard-earned cash.
Tom Gardner loves to hunt for undervalued companies in his Hidden Gems newsletter. Take a free trial and discover what he finds.
Fool contributor David Meier is the first Fool to write anything about Ritchie Brothers, and he loves to look for stock ideas where others might not. He does not own shares in any of the companies mentioned. The Motley Fool has a disclosure policy.
