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OPINION

Wonderful toll gates

Wonderful toll gates
April 10, 2014
Wonderful toll gates

Still, it's also a stock market newcomer with an instant value of £1.5bn despite generating less than £100m of revenue in 2013, so it's a relevant question. To understand why Just Eat could be outstanding, we have to start with a story about the great Warren Buffett that may be apocryphal. When he was still in short trousers - and after a hard day making nickels and dimes carrying golf clubs for members at the Omaha Country Club - young Warren would relax on the front porch of his friend Bob 'Russ' Russell's house and watch the cars heading out of Omaha to all parts of the Midwest. According to Russ's mum, Evelyn - and as told in Roger Lowenstein's biography, Buffett, The Making of an American Capitalist - the young Buffett would opine: "Gee, Mrs Russell, all that traffic. What a pity you aren't making money from all the cars going by."

The point is that, even aged less than nothing, the young Buffett instinctively understood the merits of a toll gate - that whoever controls it generates a stream of income just by being there; anyone who wants to use the road must pay the toll. True, there would be costs incurred in building and maintenance, acquiring the franchise and so on. But, once established, controlling a toll gate is about the nearest it gets to making money for nothing and still being legal.

Yet characteristics of the toll gate extend throughout the business world. When Mr Buffett graduated to long trousers, he recognised 'toll gate' companies and made big money from them throughout his career. Slightly more portentously, he called them 'gross profits royalty' businesses, which gives a clue to the ability of some exceptional companies effectively to charge a royalty on the gross profits of other firms. Put another way - if ordinary companies want to do business, they have no choice but to pay a slice of their income as a royalty to the exceptional toll keepers.

In his early days, Mr Buffett spotted newspapers and television franchises as natural toll bridge businesses. Especially in the US, dominant regional newspapers had a de-facto monopoly, which meant that consumer-facing firms had no choice but to peel off a slice of their revenue and hand it to the publisher in exchange for advertising coverage. Pretty much the same was the case for regional independent television franchises in the UK, which were state-approved, loosely-regulated monopolies.

More recently, some gate keepers of the internet are formidable gross-profits-royalty firms that either have - in the case of Microsoft (Nasdaq:MSFT) - or may well - in the case of Google (Nasdaq:GOOG), Facebook (Nasdaq:FB) and Amazon.com (Nasdaq:AMZN) - attract the attention of trade regulators. True, technology may get to them first, as it did (eventually) with newspaper and TV operators and (pretty quickly) with Microsoft. Still, as things stand currently, if you want to know why Amazon has a stock market value of £88bn - slightly more than GlaxoSmithKline (GSK) - despite making next-to-no profit, you simply have to think of it as the ultimate gross-profits-royalty business. Any independent retailer of anything anywhere in the developed world that wants to trade online has no choice but to pay its tribute to Amazon and join its market place.

Obviously, I exaggerate, but you get the idea. Elsewhere, toll road style businesses come in various guises. Employment agencies such as Hays (HAS) are one and the very fact that Hays is a former constituent of the FTSE 100 index and has a current stock market value of over £2bn tells us that their model can build big companies even if their revenues will always be cyclical. Much the same could be said of Intertek (ITRK), whose product-testing services piggyback on the growth both of international trade and product regulation. Advertising agencies are archetypal gross-profits-royalty firms and for years Mr Buffett's Berkshire Hathaway (NYSE:BRK.B) holding company had a big stake in Ogilvy & Mather, which was eventually swallowed by the UK's WPP (WPP). Specialist public relations firms such as Huntsworth (HNT) also fit the mould.

Nearest to Just Eat's business model are website operators Moneysupermarket.com (MONY) and - especially - estate agents' portal Rightmove (RMV). Indeed, the success of Rightmove may offer the best hope that Just Eat will be both a successful company and a good investment. For years some investors - and this magazine - feared that Rightmove would be crushed if Google decided to throw what in its terms would have been small change at developing a rival portal. As it is, Google did not really bother and Rightmove now dominates a niche.

Bulls of Just Eat must hope for something similar; that, despite the absence of clever technology or any worthwhile barriers to entry, Just Eat will end up the winner. Maybe. Yet you only have to type 'takeaway' into a search engine to know that Just Eat's competition is fierce, so buying its shares might be much like ordering a chicken tikka masala from an unfamiliar 'Indian' - you're taking pot luck. But that's not this week's point. The main message is to understand the gross-profits-royalty model - it can make a brilliant investment.