I often worry for the future of Australia's economy because we have so many low-quality commodity-based businesses and relatively few innovative and moat-protected businesses to drive the economy through the commodity cycle. The commodity cycle has already sent the value of our mining companies plummeting, but it's easy to avoid the carnage if you pick the right companies.
I shudder when I read someone recommend a low-quality business like Fortescue Metals Group Limited (ASX: FMG) based on a historic dividend yield, because earnings can be so unpredictable from year to year. It's simply not a business that can or will reliably grow in value over time. It's cyclical, and beholden to forces outside of the company's control.
Not so with top-class internet businesses such as jobs website SEEK Limited (ASX: SEK), second-hand car market place Carsales.com Ltd (ASX: CRZ) and crowd favourite, online real estate advertiser, REA Group Limited (ASX: REA). While these businesses are priced for growth, their underlying economics also provide some protection to the downside, because they don't require a lot of working capital for their operations.
In order to make more money, a company like Fortescue must either cut costs, produce more, or fetch a higher price for iron ore. The latter is out of the company's control, and increased production requires significant capital investment. Far from boosting the business, cost-cutting is actually required for survival.
In comparison, the internet market places for cars, homes and jobs are so essential to car sellers, real estate agents and hirers that as opposed to cutting costs, the companies that own the market place can boost profits simply by putting up prices. Indeed, that's what REA Group has done in recent years, and despite squeals of discomfort from real estate agents, there's little they can do about it. Can you imagine hiring a real estate agent to sell your house, only to find they had not advertised your property on Australia's number one real estate website? You would rightly fire them.
Pricing power is a symptom of a business with a durable competitive advantage, and Carsales, Seek and REA Group all have it, at least to an extent. In comparison, Fortescue has no pricing power and no long-term competitive advantage. Long-term investors should seek companies with long-term advantages. So which of these three ASX internet giants is the best buy today?
By my calculations, Carsales.com is much more attractively priced than Seek or REA Group. As the table below demonstrates, it is trading on a cheaper 2014 multiple than REA Group and Seek, and its rolling five-year return on investment has remained impressively high.
| Company | EV/EBITDA | 5 Year average ROI | 5 year Revenue CAGR |
| Carsales.com | 18.5 | 52.8 | 14.7% |
| Seek | 19.5 | 23.9 | 13.8% |
| REA Group | 25.6 | 35.7 | 17.6% |
Data from Morningstar and company materials. The author's calculations are only approximate.
Although return on investment and annual revenue growth rates will almost certainly decline over time, I expect Carsales.com to grow at least as fast as Seek and REA Group over the next few years. I believe Carsales.com is the best value of the three, largely because it is earlier in its development.
The company is pursuing an expansion strategy similar to the one Seek has used, by buying interests in similar overseas websites. Notably, REA Group has over $250 million in cash which it is not deploying for growth. This figure distorts the EV/EBITDA, making it look lower than it would otherwise be and makes the ROI look higher than it probably would be if the company deployed more capital. In my view the cash is essentially trapped in the company, but perhaps it will be one day be used for a major acquisition.
