Category Archives: 2019

Q4’2019 Investment Commentary – 2019 in Review

2019 saw the S&P register a 30% total return. In isolation, this looks like a banner year, and it sure was; however, when we take a step back and look at the market’s two-year stack the reality is far more normal. Thus is the nature of markets: moves happen in lumps and one must zoom out to find some semblance of an orderly trend. Instead of thinking about the 30% return, we can look at the annualized return since the start of Q4 in 2018. From that lens, the S&P has returned an annualized 10.82% since the first day of Q4 2018. This level of return is consistent with the long-term price trend of the index. All that truly changed along the way was sentiment.

Markets across the world looked awful heading into 2019, despite a brief reprieve that commenced promptly on Christmas Eve 2018. At one point, the S&P was within one fifth of one percent of a “Bear Market.” Alas, those who live on proclamations such as “this is the longest bull market in history” can still make the claim because of a mere twenty basis points.[1] This is the second time in the Bull Market that started in March of 2009 where the S&P came within one percent of hitting “Bear Market” territory (the first having been 2011’s -19.4% peak to trough move). Just imagine how different today’s narratives would be had things moved slightly further in the wrong direction one random afternoon.

Labels, as such, are great for selling headlines but have little value for us investors. Does the longevity of the Bull Market mean anything in and of itself? Had we registered a 20% correction in 2018 instead of a 19.8% correction would prognosticators bemoan the “maturity” of this Bull Market? Another common refrain is about how expensive stocks look today. We concluded our end of 2018 introductory section with the following point that is worth repeating today:

In the end, 2018 marks one of the biggest one-year declines in the forward P/E in the past few decades fueled by a combination of strong realized earnings growth and a decline in the stock market. Some of the earnings growth was the sugar rush from tax cuts, though a healthy amount was realized via higher revenue growth. While one might call the early 2018 levels “the upper end of fair value,” today is on the lower end of the fair value range. Yes, we have been below these levels, but they were in far different environments. This makes now a compelling time for long-term investors to put money to work.[2]

While last year ended at the low-end of the valuation range, 2019 saw the pendulum swing back to the high side when looking just at the market’s P/E (what we have lovingly called “Mr. Market’s mood indicator” in the past). Even looking at P/Es can be a little misleading however, given the following visual which is especially helpful in contextualizing where things stand:


Yes, when we look at traditional valuation metrics (like P/E), stocks do appear expensive on an absolute basis. However, pay attention to the bottom two lines in the above table for the one relative (in contrast to absolute) valuation metric: stocks are on the historically cheap end of the spectrum relative to the 10-year Treasury yield. Importantly, stocks are exactly in the middle of the long-term range with respect to “free cash flow yield.” The contrast between P/E ratios checking in at the 88th percentile and free cash flow yield at the 53rd percentile is one of the most interesting realities of markets today. This contrast speaks far more to the nature of today’s leading businesses and the composition of earnings than it does what the market itself is doing. Over the past decade, companies like Circuit Cities, Countrywide Financial, Lehman Brothers, RadioShack and KB Home have been replaced in the S&P by the likes of MasterCard, Intuitive Surgical, Salesforce, Booking and Blackrock. Is it any wonder that while earnings might appear lower on a per share basis overall that cash flows are much better? The S&P is built to evolve with the times. As older industries struggle, shrink and inevitably perish they get replaced by the younger upstarts, with better growth dynamics and different business models. These compositional changes tend to happen gradually; however, the financial crisis accelerated the pace of change. Today we are witnessing the consequences.

New Business Models, New Opportunities

The last time we called out a group of companies who shared similar traits was in our January 2016 commentary entitled “Robust Networks for the Long Term.”[4] We see something similar developing today. On the one hand, the market has been enthusiastic about new business models, rewarding them with rich valuations, while on the other hand, a certain subset of companies with distinct properties seem neglected. Two kinds of companies stand out for stellar performance last year:

  1. Companies with no earnings and rapid growth.
  2. Companies with low growth, high free cash flow and high repurchase yield alongside perceived “safety.”

In the middle is a third type of company that got left in the dust. In some respects, the Dow Jones Internet Composite Index holds many companies evincing these traits. In 2019, the composite as represented by the First Trust Dow Jones Internet Index (FDN) returned 19%, well less than the market’s 30% returns. This index includes 40 holdings listed below:


Some of these companies have unique problems, while others are strong. By and large, the traits that bind these companies together beyond the “internet” being core to their business model are as follows:

  • Descent though not other-worldly growth rates (think high single digits up to 20%)
  • High and growing operating margins (>15%)
  • High free cash flow yield (the consolidated index boasts a 4.5% free cash flow yield, greater than the S&P at 4.1%)[6]
  • Over-capitalized balance sheets

Taken all together, you have an index with faster growth than the market and lower valuations, operating in the new economy, yet with somewhat extreme underperformance. Clearly this space looks like fertile hunting grounds for investors with a growth at a reasonable price (GARP) bias. Several companies in the FDN ETF have been in our portfolios for years, though we added a few more of these kinds of companies in the last quarter (most are in the actual holdings list above, the exception we are adding boasts all of the same traits but cannot be included due to its low float). Here are the companies in alphabetical order:

  • Alphabet (GOOGL)
  • ANGI Homeservices (ANGI)
  • Dropbox (DBX)
  • eBay (EBAY)
  • Grubhub (GRUB)
  • PayPal (PYPL)
  • Twitter (TWTR)

For the remainder of this letter we will dive into four of these positions, two of which because they are new to our portfolio and two because they suffered especially poor returns in the fourth quarter, deserving some attention and reflection.

ANGI: The House Isn’t The Only Thing Getting Fixed

Barry Diller and IAC have an incredible history of nurturing and growing companies who are digitizing the offline world including stalwarts like Ticketmaster,, and Expedia.[7] In 2004, IAC acquired ServiceMagic before rebranding the company to HomeAdvisors in 2012. In May 2017, HomeAdvisor acquired Angie’s List and the company (“ANGI”) was listed publicly with IAC retaining ownership of over 80% of the combined company. ANGI provides digital marketplaces for home services. It connects service providers (“SP”s) with homeowners in need of service requests (“SR”s).

Each marketplace match performed by ANGI throughout the years has provided a datapoint for a price on a specific job in a specific geography. ANGI currently has the largest database for job pricing in the United States. Although ANGI was not initially sure what the benefits of this database would be, the company is now deploying this information to offer transparency and in some cases, a fixed, fair price for projects in 133 specific verticals in certain zip codes, leveraging a strong data moat into a unique offering for homeowners. ANGI’s CEO William Ridenour explains:

So one of the opportunities I see, and this is a huge area of concern for homeowners and consumers, be — the fear of not getting a fair price. … And the difficult part is nobody knows what a fair price is. … So we think that there’s an opportunity to actually, as a brand and as a service, become this reference point for home services pricing, with the idea that before you buy, check to make sure you’re getting a fair price, an easy, fast, digital way to see what you can get that service for.[8]

This strategy is a key building block for ANGI’s efforts to increase mobile app usage, create a fixed price booking platform, and ultimately increase the number of service requests per customer. As the product improves, customer loyalty improves, adding to ANGI’s already lush cash flow generating capabilities. ANGI is currently investing significant cash flow into customer acquisition and earning slightly above a 10% free cash flow margin despite these considerable investments. If ANGI can use improved loyalty to migrate customers onto the mobile app and away from the rising toll Google charges for traffic, the company could generate considerable leverage on the over 50% of revenue it invests in sales in marketing (40% of that S&M expense goes directly to customer acquisition).

In addition to customer acquisition, sales and marketing investments are funding the growth of the SP network. As ANGI evolves from lead generation, to a managed marketplace, to a fixed price platform, the importance of growing SP supply only increases. ANGI currently has the largest supply of SPs in the market which creates a challenging barrier for competitors to overcome. A fixed price platform with price transparency should catalyze SP engagement since it would lower barriers for SPs to land jobs in a cost-effective, time-saving way.

Platforms provide network effects as they grow, and network effects would grow margins meaningfully.  Even if margins only expand by 200 basis points per year and sales growth is less than half of what management expects over the next five years, ANGI should be valued at $12.60 a share based on a DCF, 60% above the price at which we made ANGI a position in our portfolio independent of our holding in IAC. ANGI is at least a couple years away from an adoption inflection in the fixed price platform given the early stages of implementation. As such, the exciting benefits of the fixed price platform were not baked into the base case and left as an asymmetric source of upside. In our base case DCF for ANGI, we use a 16% CAGR on the top line for 6 years (well below the company’s 20-25% target range) and a terminal EBITDA margin of 26% (decently below the company’s 35% long-term target). These assumptions result in a value for ANGI of $16.00 per share, over twice the price we initiated the position at.

Dropbox-Storing Files and Saving Time

We have long admired Dropbox for how it facilitated the operations side of our business at RGAIA. As many of you have experienced, we can securely share files, with HIPAA/HITECH compliant encryption,  password protection and links that expire, without ever attaching sensitive documents to an actual email. Many people were first exposed to Dropbox through the free, limited space offering that spread virally amongst certain peer groups. Through virality alone, Dropbox has built up a universe of 600 million users, 360 million of whom are “potentially monetizable” in either their personal or business capacities. The virality of the product affords Dropbox a major advantage in customer acquisition.

Dropbox is a classic example of a company that stayed private for too long only to come public when growth was slowing and questions about competition intensifying. Some contend that the cloud storage space has been commoditized by Google, Microsoft, Apple and Amazon offering competing services to Dropbox, bundled into broader suites and as such, “free” to the customer. Although there is some merit, especially in the retail photo-sharing and saving market, these concerns miss how valuable Dropbox’ suite of services with greater power and flexibility have become in the workflow of small and mid-size businesses. We have often expressed an affinity for pure-plays against large, well-capitalized competitors due to the contrast of having a product be one’s essence versus one’s unit. This further helps Dropbox vis-à-vis the technology giants as the company’s engineering-centric culture further iterates and improves its product suite while competitors rely on free being “good enough” for the customers who use it. In the storage market, there is room for both.

There is a misperception due to the viral origins of the product that most users are individuals, when in fact 80% of Dropbox users deploy the product primarily for work, with the remainder personal. On the surface, competing with free looks like a losing battle; however, in reality,Dropbox’ suite ends up priced as a tiny cost in a typical business’ operating budget and its better UI/UX as a product saves time in quantifiable ways. Its robust tools for control are crucial to businesses in regulated industries and its fluidity in sharing is a true differentiator from mere “storage” in collaborative industries like architecture, sales, engineering and inventory management. In the third quarter, Dropbox reported that the average user paid $123.15. While this number is clearly more expensive than free, it can be contextualized as follows: according to the BLS, the average worker in the US earns $28.32 per hour of work, while the average information worker earns $42.34 an hour.[9] If the advantages of Dropbox over the competition save the average worker 4.3 hours in an entire year or the average information worker 2.9 hours in a year, Dropbox pays for itself. With a better product suite, the bar is not too high for Dropbox to deliver a demonstrable benefit over the large scale, unfocused challengers.

The greatest evidence that Dropbox is meeting the needs of its customers stems from both its ability to raise prices as a growth lever alongside declining churn in aggregate. Dropbox recently raised the price of its Plus plan by 20% and while the company suggested it might slow net new customer additions for the next several quarters, there has only been a modest uptick in churn.[10] Customers already onboard clearly recognize the value. To make the price increase more palatable, they executed the price hike intelligently, along with doubling storage capacity and adding functionality like restoring folders and/or files to past dates. Dropbox benefits from multiple growth levers, including the aforementioned pricing power, along with opportunities to lower churn, improved conversion of free to paid and more products like Paper and New Dropbox.

With net revenue retention in the mid-90s and customer retention in the mid-to-upper 80s (probably higher but think mid-90s less mid single digits ARPU lift), at today’s $6.6 billion enterprise  value, assuming a 7 year average customer lifespan, you are buying the value of the existing customer base with any growth essentially free on top. If that lifespan drops to five years, there would be 15% downside; however, given that the company will have grown its user base in the low teens in 2019 and users will grow base case in the high single digits in 2020, we see a margin of safety in the churn assumption. Dropbox is a Rule of 40 SaaS company[11], with a commitment to the market of expanding margins as growth moderates. If growth reaccelerates, they will be able to maintain margin. When adjusting free cash flow for duplicative headquarter expenses that will end in 2020, the trailing free cash flow yield here is over 5.4%. Rarely does one find companies growing so much faster than the market with a higher free cash flow yield. Founder Drew Huston showed what he thinks of the stock this fall, buying $10 million worth on the open market.With an over-capitalized balance sheet and some clear frustration with the stock’s performance, perhaps the company considers commencing a largescale repurchase program in the coming year.

Grubhub-Eat or be Eaten, The Story of an Upset Stomach

We revisited our thesis on Grubhub in our Q1 2019 commentary and events have not played out as hoped. We want to take this as an opportunity to share some lessons learned and our reassessment of the thesis from here. We simplified our thesis in Grubhub with an intense focus on “economic parity” which we explained as follows: “ Grubhub could reach what they call “economic parity” between marketplace and delivery orders as measured by EBITDA per order, leaving the platform agnostic, the diner indifferent and the restaurant empowered to choose the model that best fit its own needs.” Unfortunately while Grubhub did achieve a number nearing economic parity in Q3 2019, the level of parity was well below where the marketplace had been trending largely a consequence of growth slowing well below management’s and our expectation. Such is the nature of businesses with serious operating leverage. In the future, we will focus our simplification efforts on situations where there is a distinct qualitative tie-in to the customer relationship. This means we will either isolate on a revenue driver (as we did with engagement on PayPal) or a margin item with a direct customer nexus.[12]

Alongside the disappointing results, management issued a unique shareholder letter analyzing the history of the nascent online delivery industry and the competitive landscape today, blaming increasingly “promiscuous” behavior from diners due to promotional activity at competitors for the problems. In response, management made the case to shareholders for pursuing a “scorched Earth” strategy whereby Grubhub would spend (invest?) its own cash flows just at the moment when competitors like UberEats and Doordash were attempting to delivery on promises to its current and prospective investors for a path to profitability. It is difficult to determine whether the Grubhub move is offensive or defensive in nature. It is offensive insofar as the company is attempting aggressively to win diners; however, it is defensive for how it aims to keep competitors in a grinding battle defending their core markets instead of spending more aggressively to fight Grub on its own turf. Essentially the battleground in this delivery war has been primarily second and third tier cities—the new frontiers of growth—while marketshares in the Northeast have remained largely stable for Grubhub.


Upon hitting “send” on this letter, whether they knew it or not, management commenced a tectonic shift in the food delivery landscape. In Europe and around the world, a wave of consolidation is taking place in the industry, while the US has thus far been mostly immune (Doordash taking over Caviar aside). With the sharp reset in Grubhub’s stock price, the economic accretion available to those with larger market caps in the industry looks increasingly attractive. Taking a glance at the city-by-city breakdown shows the clearest opportunity in Grubhub’s stock today: With 67% of New York City marketshare (with an over-representation to Manhattan itself), whoever acquires Grubhub between Uber and Doordash will own 80% of the single most valuable delivery marketplace in the country. 80% is a magic number first noted by Italian economist Vilfredo Pareto in what is now known as the “Pareto Principle.” If one player achieves 80% share in NYC they will likely generate over 100% of the EBITDA in that one key geography. At the October 30th closing price of $34/share, Grubhub was trading for a discount to the standalone NYC value. NYC alone generates upwards of $250m in EBITDA which gets reinvested within the company to other growth initiatives. What choice do those with broad aspirations in the sector have but to give an acquisition a look?

The list of potential acquirers is deeper than just the two main US competitors. Prosus, a Naspers carve-out with a focus on the food delivery space has large, global ambitions.[14] Strategic acquirers range from big tech companies to super market companies. Most logically we think someone already in the industry, who is bleeding cash but wants to grow, will find the ridiculously high cash flow margins of the core marketplace business a crucial piece in achieving their own aspirations for profitable, cash flowing growth. While the recent path in this stock has been turbulent, we still remain sanguine on a constructive outcome.

Twitter: Will this bird finally set sail?

In many respects, Q3 2019 should have been cause for a chest-thumping victory lap at TWTR.  Account growth, as measured by year-over-year monetizable daily active usage (mDAUs) slowed to the single digits in the second-half of 2018. In Q3 2019 this number registered 17% year-over-year growth, the fastest rate of mDAU growth in at least three years. With pure inertia it will end the year closer to 20%. Notably, this acceleration happened without any major events or catalysts to spark engagement, on top of a tough comp with the World Cup having occurred in the same quarter, last year. Historically, the stock has moved based on the trend in mDAUs; however, this past quarter’s report came with a new problem. Twitter was inappropriately using data for personalization on accounts who had opted out of data collection and Twitter shared data with mobile application promotion (MAP) advertisers it should not have shared.[15] These problems collectively stem from a lack of investment in revenue product while the company was laser-focused on enhancing the user experience.

MAP in particular is a big revenue product in Japan, which is Twitter’s second largest market after the US. ARPU in Japan was thus down meaningfully, dampening the impact of the mDAU acceleration. Our analysis shows that while the US ARPU will actually be up somewhere around 5% in 2019, International will be down 3.4% and Japan in particular will be down over 12%. In a loose sense, it might be fair to suggest these problems are isolated and they open up intriguing possibilities. Improving the demand response product is a major opportunity that will now get the attention it deserves:

But what can we do around direct response and bringing more advertisers to the service? So our MAP work should lead to more direct response-type opportunities over time. And in terms of bringing more advertisers to the service, we have a nice business where we help smaller advertisers in reaching their customers on Twitter, but that’s not an area that we have prioritized improvements around in the recent past. It’s a place where we know that there’s millions of small businesses throughout the service, where we could help them more in reaching their customers on Twitter. But we’ve got to do the engineering work and make the case to them better than we are today. And right now we’ve chosen to prioritize other things first.[16]

Twitter has a fair reason for putting off the redevelopment of direct response revenue products. The platform is well-established for brand building and product launches; however, that might have been at risk had the company not achieved measurable progress on safety and user growth first. If they put demand response ahead of user experience as a priority, they might have lost this crucial support (and budget) in the advertising community and considerable revenue, which would have rendered any progress futile. Now that the company has a growing user-base story once again, we think it is only a matter of time for revenue to follow.

From a valuation perspective, the Twitter only needs modest ARPU growth in order to support today’s prices. We like backing into the market’s implied expectations and using 2.7% ARPU up-lift per year, for eight years (well below the trend of the last three years) Twitter’s user growth would need to track the yellow line in the following chart in order to justify today’s market cap:

Importantly, the yellow line today is in the process of accelerating and it is rare that these things so swiftly reverse. This is especially so with 2020 being an Olympic and a US election year.

Meanwhile, the opportunity on ARPU remains relatively untapped. We think one of the single biggest opportunities for Twitter is launching paid feeds whereby instead of merely “following” another user, someone could “subscribe” to a feed and Twitter could take their cut for building the infrastructure to make it all work.  There are companies who do this over Twitter’s rails, like Premo Social, for an all-in take rate of about 13%.[17] This would be an intriguing revenue opportunity considering most Internet revenue at the giant Internet companies comes from advertising. A subscription-based take rate would be far less volatile, far more consistent and open the door to all kinds of serendipity for the platform.

The hurdle for success on the existing business here is set very low. Should the acceleration in mDAUs persist, the stock would be worth upwards of $60 without any ARPU recovery. If ARPU recovers its swoon and returns to a 5% growth trend, this is upwards of a $70 stock. New paths to monetization are pure optionality. Taken as a whole, Twitter is one of the most compelling risk/reward opportunities we have seen.

Where it all goes from here:

It is impossible to know what the market will do from year-to-year and what kinds of stocks the market will take a liking to. What is knowable is that over the long run, stocks are worth the discount of their future cash flows. These companies we discussed today all share many common traits that lend themselves to good future returns including: 1) low starting valuation; 2) high margins and 3) good growth tailwinds. While these companies in many respects share a lot of similarities, importantly, the key drivers of their revenues are all unique. ANGI connects homeowners and service professionals, Dropbox is a service for small and mid-sized businesses, Grubhub connects diners and restaurants and Twitter is the modern associated press and interest network for the masses. In other words, none of these companies will be reliant on the same macro forces to drive their profitability, while all are in advantaged areas ready to move key offline processes to the digital world.

These companies also share another important trait with respect to their institutional imperative. Companies with no profits and rapid growth are incentivized to pull the growth lever and gear their organizations accordingly. In effect, one can say the objective of such companies is to grow. These companies we are highlighting do exhibit growth; however, their institutional imperative is far more balanced: they are incentivized to deliver both growth and profitability. Companies that understand the tradeoff between growth and profitability gear their organizations towards achieving profitable growth. Growth then becomes about scaling proven unit economics instead of goosing the top line at all costs. It is important for management teams to effectively communicate how they think about these tradeoffs to their shareholder base.

One reason Grubhub has been so volatile is how poorly the company has managed communication with a shareholder base focused on margin, in a competitive landscape dominated by companies whose owners are pushing for growth at all costs. Grubhub’s institutional mandate put the company at odds with the demands of its industry; however, the company’s profitability in core markets provides the financial lifeline necessary to know life will persist even when the regime shifts. Market regimes will inevitably shift the extent to which they reward growth and that will be painful for companies who have not yet created pathways to profitability with talent and staff who understand the precise balance between the underlying levers that drive the tradeoff.

Growth-at-all-cost companies can prove their ability to grow, though they cannot explain, nor can investors determine whether they are merely growing, or scaling proven unit economics. When companies exhibit both growth and profitability, there is implicit evidence the unit economics do work and that scale can deliver more profit long-term. Further, profitable growth companies have the added financial flexibility and runway necessary to experiment with ways to improve their offerings and accelerate their growth in out-years while profitless growth companies will spend their time figuring out how to turn $1 of revenue into some degree of margin.

Thank you for your trust and confidence, and for selecting us to be your advisor of choice.  Please call us directly to discuss this commentary in more detail – we are always happy to address any specific questions you may have.  You can reach Jason or Elliot directly at 516-665-1945.  Alternatively, we’ve included our direct dial numbers with our names, below.

Warm personal regards,

Jason Gilbert, CPA/PFS, CFF, CGMA
Managing Partner, President
O: (516) 665-1940
M: (917) 536-3066

Elliot Turner, CFA
Managing Partner, Chief Investment Officer
O: (516) 665-1942
M: (516) 729-5174





[3] Eye on the Market Outlook 2020, JP Morgan Private Bank.


[5] Bloomberg

[6] Free cash flow yield as of 12/31/19

[7] is a link to a presentation on IAC we gave in 2018

[8] ANGI HomeServices Inc at Credit Suisse Technology, Media & Telecom Conference



[11] Rule of 40 in SaaS is defined as Sales Growth + EBITDA margin exceeds 40%.

[12], Slide 12.




[16] Ned Segal, Twitter Q3 Earnings Call, 10/24/19, Sentieo.



Past performance is not necessarily indicative of future results.  The views expressed above are those of RGA Investment Advisors LLC (RGA).  These views are subject to change at any time based on market and other conditions, and RGA disclaims any responsibility to update such views.  Past performance is no guarantee of future results. No forecasts can be guaranteed. These views may not be relied upon as investment advice.   The investment process may change over time. The characteristics set forth above are intended as a general illustration of some of the criteria the team considers in selecting securities for the portfolio. Not all investments meet such criteria.  In the event that a recommendation for the purchase or sale of any security is presented herein, RGA shall furnish to any person upon request a tabular presentation of:
(i) The total number of shares or other units of the security held by RGA or its investment adviser representatives for its own account or for the account of officers, directors, trustees, partners or affiliates of RGA or for discretionary accounts of RGA or its investment adviser representatives, as maintained for clients. (ii) The price or price range at which the securities listed.

Q3’2019 Investment Commentary – Kambi

2018 was a watershed year for turning this formerly illegal activity into a regulated, legal activity. Many regular people cheered and entrepreneurs greeted the news with enthusiasm. Meanwhile, the stock market hardly noticed. From the first two sentences, you may have thought we were writing a prelude to a marijuana company pitch, but you need not worry, we have yet to find an investment even tangentially related to marijuana that is not inflated with hot air. Instead, we will use this space to present to you our investment in sports betting.

On May 14, 2018 the Supreme Court of the United States ruled 6-3 in favor of striking down The Professional and Amateur Sports Provision Act of 1992 (PASPA). PASPA effectively made sports betting illegal in any state who had not already commenced a sports betting system (the four grandfathered in states were Nevada, Oregon, Delaware and Montana, though only Nevada actually had a single-game betting regime in place).[1] [2] The case was commenced in 2011 following a New Jersey referendum in favor of legalizing sports betting in Atlantic City. Consequently, once SCOTUS overturned PASPA, New Jersey was the first new state ready to take a legal bet in a decades. On August 1, 2018, in New Jersey, DraftKings became the first company in the United States to take a legal sports bet through a mobile app ever.[3] That historic bet was powered by a company named Kambi Group PLC, the subject of this writeup.

Rarely can one find companies like Kambi that are well-positioned in an industry undergoing dramatic change, while also reasonably valued in the market. There are a few reasons this opportunity exists as it does. First, Kambi’s ownership base is predominantly European and the European sports betting market is far more mature on the regulatory and technology fronts. Familiarity with the US market and the regulatory regime is complicated and challenging for some Europeans to fully grasp. Second, US investors intrigued by sports betting hardly have Kambi on their radar. In our informal survey of other investors on the space, we have yet to encounter anyone who has heard of the name before, even those who have invested in companies premised on their exposure to the sports betting opportunity. Good evidence of this is a Bloomberg article boasting how “Draftkings’ Legal Betting Shows How Big Gambling Can Be.”[4] There is not a single mention of Kambi, though there is much excitement about the scale of the opportunity. In the hundreds of articles we have scoured from mainstream sources like Bloomberg and the Wall Street Journal, there is hardly a mention of Kambi anywhere. We are quite fond of this setup.

In gold rush industries, the saying goes: “invest in the picks-and-shovels, not the gold miners” and we think the sports betting industry is no different. Kambi is the “picks-and-shovels” in the form of a SaaS provider of the tools the “gold miners” (aka the sports books) need in order to conduct their business. We have always been fond of the SaaS business model for its recurring revenue nature and high customer-level margin profile; however, given the market shares this infatuation multiples have become incredibly stretched at US-listed SaaS companies. Worse yet, many of these high valuation SaaS companies have yet to prove their business models can be profitable over the long-run. Kambi is different. They are both profitable and valued at a fraction of the sales multiple of the more glamorous SaaS names.

Kambi has a $430 million market cap and a $402 million enterprise value. The company is headquartered in Malta, and listed in Sweden on the NASDAQ OMX under the symbol KAMBI, with a pink sheet ADR in the US under the symbol KMBIF. Kambi boasts many of the qualities we often espouse in our commentaries: the people operating the business own meaningful equity, have a history of innovating in product and business model in their sector, are applying technology to old industries, benefit from strong secular tailwinds, boasts high margins and even higher incremental margins, and multiples that are downright reasonable. In fact, while Kambi’s stock has compounded at around 32% since its June 2014 IPO, its EV to Forward Sales (EV/S) multiple has contracted from about 4.5x to 3.25x. In other words, the returns in Kambi’s stock since inception have come from increasing the value of the business itself.

Kambi’s origins:

Kambi was founded in 2010 as part of a larger company formerly known as Unibet (today Kindred Gaming). Kambi CEO Kristian Nylen and his cofounders at Unibet saw an opportunity to take the prowess they had developed in setting lines and managing risk for the Unibet sports book and packaging it as a full service, business-to-business backend for both established and aspiring sports book operators. Founding essentially meant bringing in a customer who was willing to pay for the services other than Unibet and giving 80 employees a seat in the new division. By 2014, Kambi had established meaningful relationships with growing sports book operators, demonstrating robust top line growth and a scalable cost structure. The concept was thus proven and in 2014, Unibet decided that Kambi would need independence in order to achieve its highest ambitions. Independence from Unibet would be instrumental in Kambi’s go-to-market strategy of trying to win business with operators who may be competitors of Unibet in some or all jurisdictions. It would also afford Kambi its own institutional imperative and opportunity to forge its own unique identity separate and apart from a parent, while aligning incentive structures for employees. As such, on May 20, 2014, shares of Kambi were spun off to Unibet shareholders and Kambi became an independent public company.

Kambi’s business model is smart and aligned with their front-end partners. Partners who use Kambi have a better menu of possible wagers, can offer more lines in more situations, and are ultimately more profitable. The company charges a take rate in the low to mid-teens percent of net gaming revenue in exchange for providing their services. Net gaming revenue is the revenue an operator earns after deducting all regional and federal taxes and promotional activity offered by the operator from gross gaming revenue (GGR). Kambi’s revenue can be calculated as follows

 Kambi Revenue = (GGR – promotions) * (1-tax) * (take rate)

The Industry Landscape:

Stated simply, the industry is highly complex. The complexity itself is multi-faceted. This is an industry with black, gray and legal markets. In places where sports betting is legal, investors and operators must contend with a highly fragmented regulatory regime, where each domicile has different rules and taxes. Plus, there are multiple layers of companies operating in the industry who in some respects look like competitors, while in other respects they may be partners. Establishing an addressable market for the industry, let alone a given company focusing in a niche is thus a complex endeavor itself.

Essentially there are three ways sports books make lines (the following three are paraphrased from The Logic of Sports Betting by Ed Miller and Matthew Davidow)[5]:

  1. Algorithms that rely on troves of data to estimate probabilities.
  2. Scraping lines from publicly available betting sites on the Internet.
  3. The market making price discovery function.

None of these are mutually exclusive and the best bookies rely to some degree of all three. For bookies where the algorithms drive the lines, human traders add an overlay and reassess changes in model inputs that a computer simply cannot see on its own.

A recent example illustrates why this is so important:


When Andrew Luck announced his sudden retirement on August 24, 2019, the Borgata sports book, (run by GVC) held its lines related to the Colts for extended periods of time. Any time a quarterback will miss time, especially one with the skill of Andrew Luck, betting lines related to the team should change. This mistake at the Borgata afforded the opportunity for some sharp bettors to place action on stale lines, reflecting imperfect information. The bettors gain in this case is the book’s loss.

The landscape in the United States offers a nice microcosm for the challenges the entire industry faces. While the repeal of PASPA opened the door for legalized betting on the state level, the Interstate Wire Act of 1961 (The WIRE Act) effectively makes interstate sports betting efforts illegal.[7] As a result, even if sports betting were legalized in each and every state individually, there would be challenges in operating a national sports betting business.

Here is a good map that as of the time of this writing, shows where each state stands:


Even if every state does eventually legalize sports betting, each state has taken its own approach to creating an industry structure. Effectively there are three distinct market structures states can choose from:

  1. Open competition. Allowing any and all worthy operators with a license the opportunity to compete.
  2. Monopolistic/oligopolistic licensing structure. So far this typically evolves in states with an existing, but limited brick-and-mortar betting industry, where operators are given the right to launch their own sports books.
  3. The lottery structure whereby the state owns and operates the book itself.

Each state has approached the distinction between brick-and-mortar and mobile licensing differently. Some have only legalized brick-and-mortar, some have fully legalized mobile, while others have legalized mobile with the requirement that either funding or withdrawal be done at a brick-and-mortar location. As for the parties that actually take bets, there are two basic business models: those who are fully integrated and make their own menu and betting lines, and those who rely on an outsourced provider for the menu and lines. No two operators in either bucket are exactly alike.

The front-end, in general (whether it be for integrated operators or pure front-ends) is a low margin, highly competitive business, while the back-end is structurally higher margin with considerable operating leverage and meaningful points of differentiation between offerings. While front-ends primarily invest in customer acquisition, back-ends invest in research & development in order to build out their capabilities and enhance their offerings.

Scale is incredibly important in making good lines; however, the balkanized regulatory regime makes scale a complex challenge. With greater scale, a book can take less “proprietary trading” risk and end up with better matched markets. A scale operator sees more flow and has insight into whether their lines are priced appropriately. An important value in seeing this kind of scaled flow is how the operator can build customer files and know who is a “sharp” bettor. If all the “sharps” are coming in on one side, it becomes a strong tell that a line is mispriced. Pulling this all together, scaled operators have less variance in their daily, weekly and monthly profitability. Further, scaled operators can offer a bigger menu because the costs to build out each pillar of the betting business are largely fixed. The quest for scale is even more important insofar as in-game betting is concerned (discussed more below), where lines must be priced every second, requiring distinct technology for both the estimation of probabilities and the acquisition, incorporation and delivery of the information.

One of the big distinctions industry people talk about in sports betting is the “European vs Vegas model.” The Europeans tends to focus on user experience and the entertainment angle to sports betting, whereas Vegas is far more interested in the skill and quantification thereof.  Kambi put this rather succinctly: “So from the end-users’ perspective, we believe that we are in the entertainment business. We help our customers to provide a service to our end users — or not a service but an experience to our end users. And if the end users do not find that experience compelling, they will easily move to another sports book and put their bets there.”[9] Vegas is more purist and idealistic in the “American” way, thinking the “best odds” (aka lowest vig) are what win customers at a book. These differences in perspective have consequence, because in the early stages of regulation in the US market, the European companies have had a considerable advantage getting to market. European companies are already profitable, with scalable technology infrastructures. In contrast, American ones (represented colloquially as “Vegas”) were never built for scale and never had the opportunity to open up for in-play betting.

Kambi’s solution:

Kambi offers its partners two essential services that are related to one another—1) they build the menu and set the lines, and 2) they manage the risk. Here is Kambi’s explanation for how the process works:

What you do when you deliver this end-user product called sports betting? You can look at it this way, somewhere in the world 300,000 events per year is played in all various types of sports. They may have some relevance to some end users to bet on. We buy data from all these events in realtime. And this date then streams into our system and our organization. So there we work with a mix of specialist traders and algorithms. So we use that data to — for any really type of occurrence of what can happen here to predict the outcome. So I think we heard before, we — today, we do in a month 480 million predictions like that, which is what we call odds spin. That’s about 100 predictions per second.

And we actually don’t think that we get this right every time. It is impossible to, at that scale with a quite small margin, get that probability right every time. And that leads us onto the third part here, which is really a core part of what we do, and that’s the risk management. So in the lifecycle of an odd as we publish it on the site, a lot of new information comes. You have bets being placed, you have market movements, you may have injury news, you may have a really big bet or you may have really a high accumulated risk for one operator. And our risk management is about really optimizing at all times the price given this new information that we get.

At the heart, really, of risk management for us comes what we call player profiling. So this is about for every end user really that does something with our product, we build a profile of future profitability of that player. In around 98% of the cases here, we don’t really act on the information from end users from a risk management perspective. But around 2% of the players, they actually come with new information to us that we use in the trading. So adapt the price.

Further, Kambi gives their partners great latitude in how they want to use the platform for their own differentiation:

“How Kambi differs from its competitors is that it offers this freedom, this flexibility, to innovate, to create and to build a sportsbook as desired. Kambi takes all the heavy lifting through the provision of sophisticated technology, a powerful sportsbook core and an experienced trading and risk team to deliver exciting sports betting experiences, while the operators, if they so wish, can work with us to co-create how those experiences are packaged and presented, as well as what levels of vig are applied per sports and per market.”[10]

Kambi’s edge stems from their ability to offer large scale, leading partners, across geographies:

  • Easy integration using Kambi’s APIs
  • A scalable software platform with little down time
  • Integrity
  • Quick access to markets following regulatory change.
  • A broad menu of diverse betting options, priced appropriately
  • A fair operator margin

Key partners (in no particular order) include Kindred, 888 Sports, BetPlay, Draftkings, Rush Street, Penn Gamin and more adding up to about 25 total relationships.

Back-end is the SaaS end:

“I think the biggest change that has happened for us here — the last 4 years is when we really moved over from delivering a service including a front-end client. We then started also delivering a service where you don’t need to take our client, you can work directly on our APIs. You have our full product either end to end with a mobile and web client or you can work directly on our APIs and create this yourself.”[11] – Erik Logdberg, Deputy CEO & Chief Business Development Officer

In the call following the announcement of Flutter Entertainment’s merger with The Stars Group (TSG), there was an insightful exchange on the lack of synergy between a front-end and back-end in sports betting:

Edward Young, Morgan Stanley, Research Division – Equity Analyst

 I’ll ask 2 genuine questions. The first one is could you just elaborate a little bit what you meant on the conservative API approach to tech integration? And does that affect your capacity to generate additional synergies above that GBP 140 million target? And the second one is, are there any gray markets that TSG operates in that you or the Flutter Board would consider exiting?

 Jeremy Peter Jackson, Flutter Entertainment PLC – CEO & Director

 Okay. Thanks, Ed. Look, in terms of the first question about a conservative API approach, if I look at how we manage the Paddy Power Betfair integration work, we effectively had to turn the Betfair technology stack into something that could operate on a certain multi-brand, multi-jurisdictional basis. And we then migrated all of Paddy Power onto its back, and it’s a big, complex thing to do.

 Since then, we’ve actually been able to separate our front-end and back-end platforms such that our front-end platforms communicated our back-end platforms by APIs. And that will allow us under this transaction — this proposed transaction to effectively allow teams with their own front-end platforms to maintain those product road maps, but then just to fit into a back-end betting platform and our global risk and trading capability, which we think will allow us to maintain momentum into the business, maintain individual identities associated with the brands but still deliver some considerable cost savings.

Jonathan Stanley Hill, Flutter Entertainment PLC – CFO & Executive Director [4]

 The only thing I’d add there is it also — we feel is a much better customer proposition for enabling the front — the local teams and the brand teams to maintain their own identity and deliver really what the customers are after. [emphasis added][12]

Following the completion of the Flutter and TSG merger, the combined entity will be the largest sports betting company in the world. The foremost synergies in the deal come from “API based technology integration” though that effectively means that TSG will no longer run its own platform and all incremental investment to improve the product will be foregone and narrowed. The entirety of the synergies add up to 7.3% of TSG’s revenue run-rate (and even less so on the 3 year forward revenue guide, in the year in which synergies are actually meant to be achieved) and 3.7% of the combined company’s revenues. Simply put, the synergies are a fraction of the rationale behind the deal, with cross-selling the customer file serving as the primary motivation.[13]

The fact that the back-end’s relationship with the front-end, even at the largest sports book in the world, is so “complex” is the ultimate validation of Kambi’s raison d’etre and strategy. In effect, within Flutter, you have two separate companies with little vertical synergy, relationship or cross pollination between the teams. Front-ends have fundamentally distinct skill sets from back-ends. Front-ends have customer files and marketing prowess, whereas the back-ends are the technology. The Flutter team makes it abundantly clear that the front-end and back-end are essentially two entirely different businesses. Meanwhile in the industry there is only one other back-end who can adequately service both retail and mobile needs (SBTech) and a few others who do well at retail but suffer mightily online (William Hill/IGT, Don Best, NYX). If you want the best multi-jurisdiction sports book, Kambi is essentially the only option for a high quality operator.

A look at the common-sized income statement of Kambi (a pure back-end) versus Kindred (a pure front-end) paints a clear picture of the distinct differences in the two business models:

Note the higher EBIT and EBITDA margins at Kambi, despite boasting well over double the top line growth rate, in an investment phase. The two highlighted lines are the big points where Kambi must spend more than Kindred, but importantly, these are the two lines with the most leverage on the income statement. As Kambi grows, the highlighted expenses will shrink, while Kindred will remain in steady state in aggregate. The clear difference between the front and back-end here is how the back-end invests in its human and technological capital (human capital is captured in “Administrative Expenses” where just less than half of the line is covered by personnel and personnel related expenses), while the front-end invests in marketing. This is the skill divide between the two: back-ends are competent in technology, while front-ends are competent in customer acquisition. Flutter’s emphasis on “cross-selling” with 18 references littered throughout their merger call hammers home this distinction in competency.

The beauty of the SaaS model from Kambi’s perspective is how it translates to very high incremental margins. There is very little incremental cost to onboard a new partner. Instead of charging customers a fixed fee per month, Kambi charges a take-rate on NGR of approximately 15%. We do think there will be some modest atrophy to somewhere around 13% over time as some larger customers achieve their scale ambitions, while remaining on Kambi in order to protect the front-end’s own profitability. Meanwhile, Kambi can continue to invest in product development and share the benefits of that investment with their partners. Kambi has 700 employees today, which includes 250 traders and 200 developers. The trading team is the non-SaaS piece; however, that is already at its mature size. Meanwhile, the company is recruiting more developers in order to continue enhancing the technology side. A key area within technology is risk management, where you need a higher degree of control to make sure no one has better information and better stakes. The infrastructure to aggregate, analyze and apply data is also a key area of investment. As of today, Kambi makes 450 million odds changes per month. In order to accomplish this feat, you need exceptional technology and people behind it. The investment is considerable and few, if any front-ends have the scale in order to do it on their own.

Partner with Integrity, Build Industry Knowledge:

“And the reason why is because we have that one solution and what it includes in it is about challenging mindsets, it’s about educating. And what we focus on is that second point there. Don’t turn up for meeting with the CEO or a Chairman or Board member or anyone if you haven’t got something insightful for them to take away from it. They may not buy from Kambi then, they might not buy in the next 3 years, but if they come to see Kambi, they’re coming to some get information and insight because they know Kambi really understands what they are doing. And that’s the difference. That opens doors. That’s what makes us stand out. We’re not there to just try and sell from — straight from the beginning. They will understand through our insights, “You know what Kambi knows something that we have don’t.” So even if they’ve got full trading solutions themselves internally, you go, “Hey, I really understand that Kambi could help us here, maybe we should consider things, maybe we should take more meetings, maybe we should meet the CEO of Kambi, let’s have more conversations.”[14]—Max Meltzer, Chief Commercial Officer.

“First of all, our unwavering commitment to integrity and corporate probity. Kambi is a [NASDAQ] listed company and therefore holds itself up to the highest of standards. For example, since our inception we have been careful to avoid markets where gambling is prohibited. This was a conscious and long-term decision as, not only is it the right thing to do, but we realized it was likely to be looked favorably on by regulators when moving into new territories in the future – particularly in the U.S. which has always been a key part of our long-term business strategy.”[15] –Max Meltzer, Chief Commercial Officer.

Kambi is discriminant about who they are willing to partner with and will only partner in regulated markets. This is important for both regulators and prospective partners, as their primary competitor in the pure-play back-end is not nearly as discriminant. SBTech is the company’s foremost competitor and was recently rumored to be in late stage talks to be acquired by Draftkings.  Nylen has pointed out that he “think[s] it’s positive rather than negative that we have a good competitor nowadays, and I think the market is definitely large enough for both (SBTech) of us. But so far I am very pleased that we have been able to win our top targets.” Competition offers Kambi the opportunity for differentiation and one of the key pillars has been on integrity. While some of this can change, it is notable how Kambi received an actual license as a “Sports Information Services Limited…For A Gaming Related Casino Services Industry License” whereas SBTech settled for a temporary “Qualification Waiver.”



Pennsylvania, the other large, early legalizer of sports betting on the state level gave SBTech conditional approval and cited concerns with the company’s partnership relationships that enable betting in Iran.[18] While SBTech is insistent they do not facilitate operators in Iran, their response perhaps implicitly acknowledged they know some of their operators function in what the betting world calls “gray markets”: “To be very clear, SBTech does not operate in any black markets.”[19]

Scale + Time = Compounding Advantages

The two outside lines illustrate the upside and downside tracking error representing a 95% confidence interval. The selected confidence interval indicates that on average, for 19 months out of 20, the actual return should be between the two tracking error lines.

Over time the tracking error band has become narrower, indicating that the monthly margins have become more stable. The increased stability is primarily due to a relative increase of live betting, which is less volatile than pre-match betting, and a stabilizing effect resulting from Kambi’s risk management tools becoming increasingly sophisticated in identifying and managing different customer segments.

While Kambi has not revisited this specific chart, they have shown what the daily, weekly, monthly, quarterly and annual distribution of operator margins looks like:


This is the nature of a business relying on assessment of probabilities. You can set the right probability for an outcome to happen, yet still lose. Without skill, the longer time-frames would also be random; however, with skill the longer timeframe would smooth the outcomes. That is clearly the case here. While the day-to-day can be volatile, the range of outcomes narrows as the timeframe is extended. We have spoken to industry experts, including employees at Draftkings involved in onboarding Kambi and at Kambi involved in managing the Draftkings relationship. One fundamental truth we have seen acknowledged on both sides is that Draftkings would be less profitable at their sports book and would take a period of three years before they can get their models up to Kambi’s skill and stability today. Meanwhile Kambi will continue improving, such that Draftkings would be trying to catch a moving target.

This risk management side is especially compelling. Kambi is phenomenally good at using anonymized information in order to hunt down people who are sharp betters and have figured out ways to whittle down the book’s edge. Sharp bettors find this especially frustrating and have come to facetiously call the company “Kan’tBet” for how little action they are willing to take from the experts; however, this is exactly why front-ends use Kambi. Notably, Kambi will take action from these people, but in small amounts, because learning their intents help in the process of refining their own line making.

Vegas as often been more willing to take this kind of action and the sharp bettors claim this is the fundamental flaw in the European model. Kambi brings their distinctly European model to the front-end operators they work with, even in the US. On their capital markets day, they pointed out how:

Ever since I started in 2005, we have looked at this chain being about one thing. And that’s not about margin, that’s not about accuracy and probability predictions. In the end, it is about user experience, it is about delivering entertainment. So our quant analyst, for instance, they’re not tasked with the sort of theoretical challenge of only predicting probability, they’re tasked with a challenge of delivering a fantastic experience. —Erik Logdberg, Deputy CEO & Chief Business Development Officer

Handicapping the probabilities is obviously an important endeavor, but so too is managing the user experience. Kambi does not exist to serve as a counterparty for sharp bettors. If a book consistently provides opportunity to those with an edge, the book will lose money. There are hedge funds and advanced quant strategies launching in an attempt to take advantage of inefficiencies in betting and the beauty of it from Kambi’s perspective is how the adverse selection bias of skill in risk management will ensure that those books who are not good at identifying sharp bettors will ultimately perish before the harvests of the industry landgrab are reaped.

Kambi is not resting on its laurels as a European Model innovator. Instead, the company is opening its first US office in Philadelphia, a strategic location given both Pennsylvania and New Jersey are the large, early-adopter states.[21] In keeping with management’s culture of shareholder value, Philadelphia was strategically selected for its lower costs than New York City or other technology hubs, its passionate sports fanbase and its many high quality universities offering a good opportunity set on the hiring front. The company is “ hoping to take people who have a passion for sports — maybe they’re in another business like finance or whatever — and convert that into what we need from an operational perspective — trading, risk management, sales, partner success.”[22] To date, Kambi’s progress in US markets has come without an on-the-ground premise here. The US office opened in Q2 and is in the process of staffing up. This will only help as more states legalize and regulate betting.

Adding it all up to shareholder value:

Kambi boasts large insider ownership and is operated by its founders, with a shareholder friendly management team and aligned interests. They both say and do the right things:

“Moving on to our shareholders. On top of what I’ve talked before, which is naturally also important for our shareholders, is to have a return on their investments. And one of the absolutely most important task for us, as the management team, is to have a very stringent and sophisticated approach to our capital and resource allocation with the ambition of securing a high return on investments for our shareholders.”[23] –Cecilia Wachtmeister EVP of Business & Group Functions

The company has a mandate to think long-term in capturing the large opportunity, while remaining anchored in establishing measurable, deliverable goals:

“and we have further evolved it during the last year, a very established strategy process where we set our long-term strategy on the 3 years horizon. We break that down to company performance target on a yearly basis, which in turn gets broken down into quarterly key objectives. And that gets actually broken down to departmental and team level within the company. And in that way, we’re really having the connection between what we want to achieve as a company and what is expected from each and every one of the employees. It’s a very, very solid and thought-through process. And we, as the management, we monitor this on a monthly basis how the progress is and where we are.”[24] –Cecilia Wachtmeister, EVP of Business & Group Functions

This will help innovate Kambi develop and tailor products that are more sanguine for the US sporting environment and create a local salesforce in the pursuit of partnerships.

Sizing up the TAM:

In Kambi’s 2018 annual report they offered the following estimate for global sports betting GGR in 2018 and five-year forward forecast:


Historically, Kambi has operated primarily in Europe, which is about a €20b plus GGR market. 2018 was the first year where online betting exceeded retail in Europe and this trend of growth coming from online will only continue to accelerate:


The repeal of PASPA makes the US perhaps the most compelling market and largest opportunity the industry has ever encountered. Shortly after the SCOTUS ruling, Morgan Stanley pegged their base case 2025 revenue opportunity (in this case, revenue is a proxy for GGR) by 2025 at $5 billion:


(Please note, while the above chart is in US Dollars, much of the below conversation on TAM is covered in euros given that is the reporting currency for Kambi. Pay attention to the currency, for we change from euros to dollars depending on the source). The entire regulated market globally generated €5.4b in GGR in 2018 and is expected to grow to €11.5b by 2023 (a 16% CAGR). In order to translate that into a revenue opportunity for Kambi we need to know both the average tax rate across all their regimes and the company’s take rate; however, neither is precisely knowable. We will visit the assumptions later, but for now let us work with a 20% all-in tax rate (arguably on the high side) and a 13% take rate in order to translate GGR into Kambi’s revenue TAM.

Today at €5.4b, Kambi’s revenue TAM is approximately €562m, while in 2023 that number jumps up to €1.196b. Inevitably TAM will be highly sensitive to the cadence of regions legalizing sports betting. And thus far there are pieces of evidence that show regulated market GGR could exceed expectations. We think there is a degree of conservatism embedded in these numbers and that is a good thing insofar as planning corporate strategy and analyzing risk/reward in investments goes. For example, the American Gaming Association believes the illegal sports betting market size in the US to be “at least $150 billion annually.”[28] It is incredibly challenging to size up an illegal market.

When we think about addressable market, the upside of converting a black market to a regulated market is intriguing. This is true for several important reasons, mainly built around the idea that establishing trust in a regulated market is far easier than in an illegal bookie scheme. Some people simply won’t engage in an illegal activity even if the general idea is appealing. Some people may just hold back on the actual volume they would like to play. Most importantly though is the innovation and creativity that legalizing these markets unleashes for the industry. In Europe, it is said that over 70% of all sports betting occurs “in-game” versus less than 5% of US-based action occurring in-game pre-PASPA repeal.[29] In-game creates novel experiences and relies heavily on technology ranging from challenges in data and speed to building sharp algorithms to price probabilities in real-time and managing risk, while adding a human overlay in order to adjust to rapidly changing circumstances. For example, were a starting QB to leave the game with injury, the odds of the next play being a completed pass would be drastically different than immediately before the injury. It’s simply impossible for an illegal bookie to even contemplate offering in-game betting, meanwhile in many respects, this is Kambi’s specialty. In-game betting is basically entirely novel to American sports bettors, yet in some respects, our favorite sports are perfectly suited for this opportunity.

As a result of these unknowns, the range of potential TAMs is incredibly wide. Most US analysts expect somewhere between a $7.5-12b TAM in the US, base-case, while the American Gaming Association pegs the US market size at $150b total wagers (or the equivalent of $75b in GGR).[30] We do our work based on the low end of these estimates, while viewing any upside as incremental to our expectations.


Our valuation process starts with working backward to solve for the embedded assumptions in Kambi’s stock price. At todays price of around $14.50 USD, the market is pricing top line growth to slow down to a 9% 5 year CAGR and a 10x terminal EBITDA multiple all discounted at a 12% WACC. We think these results are highly achievable, even with the loss of Draftkings as a customer. Before the US market even legalized sports betting, Kambi was growing its top line at a 13.8% rate. That growth was lumpy and was slowing in the later periods; however, its core markets in Europe as of today are still growing at ~8% GGR. Meanwhile its partners are taking share with a combination of organic and inorganic growth, supporting base rate growth assumptions of around 12%. By our estimates, the US business has contributed nearly half of 2019’s 22%+ growth rate. Draftkings has accounted for a little less than half of the US contribution.

One thing to consider in valuation is the asset value and replacement value. Kambi is a truly unique asset and management and ownership recognizes this. As such, they have a convertible note held at Kindred which is effectively a poison pill to prevent a hostile takeover attempt. Draftkings perhaps would prefer to acquire Kambi than SBTech, but no way management is selling. Meanwhile, the rumored Draftkings acquisition of SBTech quoted the prospective price tag as between $300-500 million, essentially bracketing Kambi’s market cap today.[31] SBTech is not public, so their financials are not disclosed though it is well established that they are smaller than Kambi and revenue estimates peg the run-rate at approximately $24 million USD (less than 1/3rd that of Kambi’s).[32] One other point of reference for replacement value is the price Scientific Games paid for NYX and Don Best in order to accelerate their own attempt to get into the sports betting industry. Scientific Games spent $632 million for NYX and around $40 million for Don Best, meanwhile they have no key partnerships to show for it, are suffering from employee exodus and an offering that is sub-par at best.[33]

To value Kambi directly, we rely predominantly on DCF. While Kambi does not disclose the GGR or NGR metrics for their operators, we can back into a rough approximation of the historical numbers and forecast them going forward. The key assumptions that we need to make in doing so are on the tax rate, the level of promotional activity and Kambi’s tax rate. Tax rates are the most challenging assumption here because we do not know the geographical distribution of GGR and tax regimes vary widely. Even within the US there is a high degree of variance. For example, Delaware and Rhode Island are lottos with the state getting a direct revenue share equivalent to a 50% tax rate, while New Jersey has an 8.5% tax at land-based sports books, 13% for casino-operated online sports books and 14.25% for racetrack operated online sports books.[34] Pennsylvania, another early adopter, has a 36% tax rate.[35] The UK recently raised their betting tax rate (which includes sports books) from 15% to 21%.[36] We cite these numbers here as illustrative examples. For the backwards numbers we apply a 15% tax rate to build up to our GGR estimate and for 2019 on, we use a 20% tax rate. Our purpose with this analysis is not to precisely nail down the GGR that Kambi’s partners generate, but rather to estimate roughly how much total GGR Kambi needs to capture over the coming five year period in order to rationalize our financial estimates for the company.

As for take rate, we know from triangulating around industry sources and company conversations that today they are in the mid-teens and take rates have come down modestly in the past few years. With some smaller operators, early on, take rates have been as high as the low 20s. Kambi has cited SBTech’s emergence on the competitive front as putting pressure on take rates, though the market is now approaching a degree of stability. Some of the US operators were more insistent on joint venture relationships which have an even higher implicit cost than a take rate, for even lower quality. In a lot of respects, we think of Kambi’s value much like programmatic DSPs for advertising and we would note that the highest quality operator in that sector (The Trade Desk) earns a 20% take rate. Long-term, we expect some modest degradation, though think working with an approximate 15% rate today makes sense. We take that down to 14% in 2021 and 13% thereafter under the assumption that some of the larger operators with long-term deals and little volume as of yet (like Penn Gaming) have come on with more favorable rates than the existing book of business. Here is where we think GGR has come from and where it will go:

The most important takeaway from this chart should be how much incremental GGR Kambi’s partners need to receive in order to underwrite out-year earnings expectations. In order for Kambi to compound top line at a rate just above 20% for the next five years, their partners need an incremental €1.7b, or $1.9b of GGR. That $1.9b of GGR can come from the US and Kambi’s operators. With the more mature, European online business expected to grow at ~8% annualized (5% tailwind in global GGR w/ excess capture in transition from black/gray markets to regulated) , that means Kambi partners need to capture about $1.2 billion of the US opportunity over the next five years. Given most industry estimates peg the opportunity between $7.5-12 billion in GGR over that time, that means Kambi partners need to capture anywhere from 10-16% of the US opportunity. As of today, Kambi’s market share is well above these levels. Here is how Kambi’s suite of partners stacks up in revenue share in the more mature New Jersey and Pennsylvania markets:


While we hardly expect these market shares to remain constant over time, we think with its crop of partnerships Kambi has cemented its place as a key provider in the US sports betting industry. Importantly, we see upside not just for the base case market shares, but also for the potential size of the US market. Rather than incorporating that into our estimates, we will leave any upside for optionality on top of our base expectations. Plus in effect, this “US” number we are using here is the rest of the world outside of Europe. Kambi sees great potential in Latin America and APAC though given we are less familiar with those markets and the sporting industry in general is far less mature there, we are not willing to incorporate that into our expectations.

In the investment phase of US market launches, Kambi had formerly guided to 4-6% quarter over quarter growth in operating expenses. That has been taken down this year to 3-5% growth given “in some states, it’s actually going to be slightly lighter-touch application and therefore, by implication, a slightly lower cost for us.”[39] By and large, the operating cost structure is fixed once Kambi launches in a state. As of today, the company need not hire more traders (as discussed above), with incremental investments flowing predominantly into state-by-state launches and technology. The launch costs will roll off and incremental technology investments will continue, though with benefits of scale affording more overall technology investment at a lower percent of revenues. Incremental EBITDA margins are in the mid-40 percents. We expect a low 30 percent EBITDA margin in 2019 that gradually walks up to a low 40% margin in out-years. This adds up to about 200 bps of EBITDA margin leverage per year.


For our purposes here, beyond EBITDA, we assume fairly modest leverage on technology expense (which is not incorporated into EBITDA) to the tune of 100 bps over the next five years. Pulling it all together, this is how we think about the value in Kambi:

We see a path to a 275 krona stock in Kambi, based on today’s value, which would represent 95% upside to recent closing prices. It is important to emphasize that while the model is close to a straight-line CAGR, the reality for Kambi will be very different. Embedded in here are assumptions on future states legalizing and then regulating betting, including California. Consequently, there will be considerable lumpiness to the actual path. Additionally, sports betting itself is cyclical, with notable spikes around major events like the World Cup and varying degrees of interest in events like the Super Bowl depending on the teams involved. The key takeaway is what the company will likely look like in 2024 once more states have had the opportunity to legalize and regulate sports betting and the United States becomes the most important global market for sports betting. In order to achieve the run-rate we would apply our 15x EBIT multiple (equivalent to 10x EBITDA), Kambi would need to capture the $1.9b of incremental GGR, $1.2b of which comes from the US.

If the US market does not develop as contemplated, the stock today trades at reasonable values. Growth will still register low double-digit levels, on near all-time low multiples at 3.25x EV/2020 S (see chart below) and EBITDA margins registering in the mid-30s. Multiple expansion is unnecessary for a good return, for the company’s top line and cash flow generation would support where the stock is trading today:

The adverse scenario in the US market would still result in a stock that is undervalued on DCF, cruising along as a rule of 40s SaaS operator with long-term margin leverage. The core sports betting market globally continues to grow at about 5%, with the dual uplifts of regulatory acceptance and digitization enabling a better, more engaging experience.

Risk factors:

  1. Competition. This can come either from new entrants in B2B or more large suppliers buying or building their own backend. SBTech in particular competes with a broader suite of services including marketing services and digital casino games, while Kambi operates as a pure sports operator.[41] IGT in the US packages in their sports offering with slot machines. Neither boasts the quality of Kambi; however, both use other levers to try and capture their share of the sports business.
  2. Regulation. This can manifest in several ways. States can be slower to legalize sports betting than expected. States (and countries) can also be more aggressive on the tax front. The impact of taxes hits twice. Taxes factor directly into the calculation of odds, so higher tax rates make odds less favorable, which translates to lower betting volumes, plus operators must give up more of that volume.
  3. Integrity fees. Leagues are strategizing on how they can monetize betting and while no outright integrity fees have been demanded from US leagues there are intimations that leagues will use data in order to grab their cut.[42] Kambi passes these costs on to front-end operators; however, this could negatively impact aggregate GGR.
  4. Customer concentration. Kindred Group is an especially large partner globally while Draftkings is a large US partner. Kindred risk is mitigated by virtue of the corporate history, a shared concentrated owner in Anders Ström and a long-term partnership agreement.

Thank you for your trust and confidence, and for selecting us to be your advisor of choice.  Please call us directly to discuss this commentary in more detail – we are always happy to address any specific questions you may have.  You can reach Jason or Elliot directly at 516-665-1945.  Alternatively, we’ve included our direct dial numbers with our names, below.

Warm personal regards,

Jason Gilbert, CPA/PFS, CFF, CGMA
Managing Partner, President
O: (516) 665-1940
M: (917) 536-3066

Elliot Turner, CFA
Managing Partner, Chief Investment Officer
O: (516) 665-1942
M: (516) 729-5174





[5] We strongly recommend reading The Logic of Sports Betting by Miller and Davidow for anyone looking of a detailed overview for how sports betting itself works, what kind of bets are possible and how sports books make their lines.




[9] Kambi Capital Markets Day, Sentieo.


[11] Kambi Group PLC Capital Markets Day, May 20, 2019. Sentieo.

[12] Edited Transcript of Flutter Entertainment PLC M&A conference call presentation, October 2, 2019, Sentieo.


[14] Kambi Group PLC Capital Markets Day, May 20, 2019. Sentieo.


[16], page 8.

[17], page 4.



[20] Kambi Capital Markets Day – May 20, 2019


[22] Ibid.

[23] Kambi Capital Markets Day, May 20, 2019. Sentieo.

[24] Kambi Capital Markets Day, May 20, 2019. Sentieo.

[25] page, 19.

[26] page 19

[27] “US Sports Betting: Who Could be the Winners?” Morgan Stanley Research. June 26, 2018. Page 6.








[35] Ibid.




[39] Kambi Q2 2019 Earnings Call, Sentieo.

[40] Sentieo for historical financial data and RGA Investment Advisors for estimates.




Past performance is not necessarily indicative of future results.  The views expressed above are those of RGA Investment Advisors LLC (RGA).  These views are subject to change at any time based on market and other conditions, and RGA disclaims any responsibility to update such views.  Past performance is no guarantee of future results. No forecasts can be guaranteed. These views may not be relied upon as investment advice.   The investment process may change over time. The characteristics set forth above are intended as a general illustration of some of the criteria the team considers in selecting securities for the portfolio. Not all investments meet such criteria.  In the event that a recommendation for the purchase or sale of any security is presented herein, RGA shall furnish to any person upon request a tabular presentation of:
(i) The total number of shares or other units of the security held by RGA or its investment adviser representatives for its own account or for the account of officers, directors, trustees, partners or affiliates of RGA or for discretionary accounts of RGA or its investment adviser representatives, as maintained for clients. (ii) The price or price range at which the securities listed.

Q2’2019 Investment Commentary

The second quarter was a little choppier than the first quarter, with an upward bias in the end. Markets largely spent time digesting the magnitude of the moves from the fourth quarter of 2018 and first quarter of 2019.  Amidst the choppiness there was indeed one notable happening of market consequence:

The chart above shows the spread between the S&P’s equity risk premium as measured by the S&P’s current earnings yield (in other words, E/P, the inverse of the market’s P/E ratio) minus the 10-year Treasury Yield. Although “the market” as measured by the S&P traded pretty sideways during the quarter, during the brief June selloff, the market’s equity risk premium hit its second highest level in the past three years and reached levels seen mainly in the wake of the Great Recession. As the third quarter is now underway, this rise in the equity risk premium has only gotten more extreme, measuring near the highest levels in the past five years.

With the market trading sideways, it is clear that one variable alone drove the majority of the rise in the equity risk premium: The 10 Year Treasury Yield. The 10 Year Treasury yield started the quarter at around 2.4% and reached a low of 1.95% in June.  As Charlie Munger once observed: “Finding a single investment that will return 20% per year for 40 years tends to happen only in dreamland. In the real world, you uncover an opportunity, and then you compare other opportunities with that. And you only invest in the most attractive opportunities. That’s your opportunity cost. That’s what you learn in freshman economics.” Since all of us investors exist and operate in the real world, we constantly must weigh various investment options. When the equity risk premium is high, the opportunity cost of bonds relative to stocks is high and thus investors in aggregate are incentivized to put money to work in equities. This will be especially notable come quarterly rebalance when the huge pool of assets in 60/40 strategies kick in the self-calibrating trade of selling bonds to buy equities and restore equilibrium. Approximately 7% of bond exposure in such strategies must be sold in order to buy 4% more stocks.

It is important to emphasize that our investment decisions are made on a bottoms-up basis. In other words, we do not look at the market on the whole and say “are stocks in aggregate cheap? If so, let’s invest.” Our process is on a security-by-security basis, whereby we deeply analyze a business’ management, industry, moat and valuation in order to come up with an investment thesis. That said, we always like being conscious of our environment. When the equity risk premium is high, we are far more sanguine on the broader opportunity set than when it is low.

A thought from Elliot:

With baseball season in full swing now seems like an opportune time to visit one of my favorite setups in the market. In fantasy baseball there is this category of player called “the post-hype sleeper” that I find appealing. A post hype sleeper is defined as a “player with minor league pedigree who [has] failed in limited major league time.”[1] When the player is called up, fantasy baseball players draft him with enthusiasm, paying for value that is expected to be realized instantly. Instead, as often happens, there is a developmental curve and many players take a little extra time to mature into big league readiness. In a rut (whether an instant slump or a “sophomore slump”) the player’s value in the eyes of the fantasy baseball community erodes.

While some players ultimately never live up to their pedigree, there are others who make meaningful improvements in their true skill level and build a foundation for enduring success in the Major Leagues. Fantasy baseball players can draft these truly skilled players for far less in the wake up the slump than beforehand and are thus called sleepers for how the new Major Leaguer holds the potential to surprise expectations to the upside. There is an analogous setup we look for in equity markets that takes shape in an individual asset, as follows:

  1. A big following and a lot of momentum based on what could be in the future.
  2. Internal metrics of the company’s performance all continue to move in a positive direction.
  3. Despite the company’s intrinsic value rising, the pace of advance is slower than what investors were looking for, or some kind of headwind emerges.
  4. Momentum evaporates and leads to a sharp, rapid plunge in the company’s share price.
  5. The momentum overshoots to the downside, while business performance continues moving forward.
  6. The stock is not cheap enough to be a deep value investment, and it too recently burnt momentum/growth investors to regain their interest.
  7. The stock price has leveled off into a range of apathy for an extended period of time.

A good friend loves explaining how “the market has a problem with accelerating revenue” because people simply do not know how to value such companies. This is why Mr. Market tends to overshoot to the upside when things are giddy. The post-hype sleeper is a corollary of this idea, because accelerating revenue does not level off at a plateau, but rather drops off and must find a new range or equilibrium. The process is sloppy and just as the market overshoots to the upside, so too does it overshoot to the downside.

Post-hype sleepers come in many forms in the stock market, but busted IPOs are perhaps the most fertile hunting grounds to seek out such opportunities. IPOs tend to be sold to the market amidst a drumbeat of positive momentum and news that results in a high multiple on the stock. The problem with a high multiple is how challenging it becomes for the company to meet expectations. When an inevitable disappointment hits the market, the stock drops considerably and the multiple contracts accordingly.

Just like in fantasy baseball, it is important to figure out which of these busted stocks has the potential to forge a sustainable future of value creation. To that point, we look to operate in situations that are nuanced in contrast to those that are binary. In other words, we are not looking for situations where the company will either be wildly successful or flame out, but instead we want situations where the question the market is grappling with is “to what extent will this company succeed?” This is a key distinction and part of what we rely on as our “margin of safety” alongside our qualitative analysis of the business, the industry and the management team.

Number three in our list above is thus crucial and what could be called the essence of the entire setup. If intrinsic value is not increasing, we will not give the company our time of day—such a company would be a turnaround, not a post-hype sleeper. The ideal company in this setup also tends to be an asset in its own right, whereby at least a portion of the value can be attributable to strategic value in an industry or vertical. From the perspective of analyzing the distribution of possible returns, strategic asset value provides both a put option and call option to the holder. If the nuanced question about growth rate is not answered quickly and the stock price drops, strategic buyers might step in quickly. Should the market experience a drawdown with little change to the company’s specific fortune, opportunistic buyers would enthusiastically swoop in. Therein lies the put. On the call side, strategic buyers are often willing to pay a significant premium to the outright earnings power of the asset. This can pull forward returns and enhance IRRs in the process. We do not bank on M&A and often prefer the opportunity to hold such companies for the long run; however, we appreciate the role that the M&A option plays in assessing the range of possible outcomes.

Often the pivotal question in such companies is surrounding the mid-term growth outlook, as a company’s 20+% revenue growth rate heading into IPO slows to the high single digits or low teens. We can apply our suite of valuation tools and triangulate what we think is a fair price for the company, analyze the likelihood of a growth re-acceleration and think about what a worst case would look like amidst a longer-term stagnation in the growth outlook. If a growth re-acceleration does not arrive, we should have a decent IRR; however, if it does we might end up owning something very special. To date, all our five best returns have emerged from this exact stock market setup.

Elliot recently had the privilege to present at the MOI Global Wide Moat Investing Summit. This year’s presentation was on Grubhub and introduced with the post-hype sleeper setup. You can watch the presentation here ( and see the slides at this link ( As of this writing, we own nine positions that we regarded as post-hype sleepers at the time of our entry. Several on this list are no longer sleepers with the market appropriately recognizing the value, while for the rest the verdict remains out.

Thank you for your trust and confidence, and for selecting us to be your advisor of choice.  Please call us directly to discuss this commentary in more detail – we are always happy to address any specific questions you may have.  You can reach Jason or Elliot directly at 516-665-1945.  Alternatively, we’ve included our direct dial numbers with our names, below.

Warm personal regards,

Jason Gilbert, CPA/PFS, CFF, CGMA
Managing Partner, President
O: (516) 665-1940
M: (917) 536-3066

Elliot Turner, CFA
Managing Partner, Chief Investment Officer
O: (516) 665-1942
M: (516) 729-5174

Past performance is not necessarily indicative of future results.  The views expressed above are those of RGA Investment Advisors LLC (RGA).  These views are subject to change at any time based on market and other conditions, and RGA disclaims any responsibility to update such views.  Past performance is no guarantee of future results. No forecasts can be guaranteed. These views may not be relied upon as investment advice.   The investment process may change over time. The characteristics set forth above are intended as a general illustration of some of the criteria the team considers in selecting securities for the portfolio. Not all investments meet such criteria.  In the event that a recommendation for the purchase or sale of any security is presented herein, RGA shall furnish to any person upon request a tabular presentation of:
(i) The total number of shares or other units of the security held by RGA or its investment adviser representatives for its own account or for the account of officers, directors, trustees, partners or affiliates of RGA or for discretionary accounts of RGA or its investment adviser representatives, as maintained for clients. (ii) The price or price range at which the securities listed.


Q1’2019 Investment Commentary

We’d like to take a moment, ahead of our investment commentary, to share some exciting happenings within our investment practice. Our firm has come a long way since its inception a decade ago with our deliberate effort to improve on every aspect of our business, from our technological infrastructure to our research capabilities and investment process.

Our commitment to continuous improvement runs deep in our DNA and we consistently strive to be the best investment managers possible, while knowing that tomorrow we will be better than we are today. Over the past five years we have invested heavily in our research capabilities by accessing financial data terminals, joining industry round tables and adding to our already robust roster of investment research publications. One of our financial data platforms put together a case-study on our firm which provides a window into how we leverage technology to create efficient workflows to analyze large amounts of company data. Sentieo’s write-up on us can be viewed here.

In 2015 we chose to become a GIPS verified firm. This enormous undertaking stress-tested every aspect of our business, from our compliance requirements to investment policies and procedures. Adherence to these standards, which are widely regarded as the gold standard in fair representation and full disclosure of a firm’s investment performance, afford us the ability to operate a truly world-class asset management firm. You can review our firm-wide verification letter and annual disclosure presentation results here.

This year, after considerable searching, we are excited to announce the first expansion our team with the addition of Ari Lazar. Ari comes to us from Lincoln International in Chicago where he worked as an Analyst in the firm’s Valuation and Opinions Group. In his previous role, Ari provided valuation coverage for the investment bank’s clients across a variety of industries and in doing so, developed a robust set of industry knowledge and equity analysis skills. Ari is a CFA Level II candidate with deep rooted intellectual curiosity and a passion for investing — his new role with us is what he has dreamed of doing since learning about the stock market as a child. He will be right at home here at RGA. Ari has already contributed considerably to our research endeavors since his March 1st start date. Ari works primarily out of our Stamford, CT office. He can be reached at 516-600-0200 or at

As we look back in awe at the progress we’ve made over the past ten years, we couldn’t be more excited to embark on this next leg of growth. Our first hire is crucially important to us as it sets a precedent and perpetuates a culture of integrity, inquisitiveness, and collaboration. We couldn’t be more pleased with our new addition and we are confident that you will agree.

What a difference a quarter makes:

It is hard to put into words the contrast in action between the fourth quarter of 2018 and the first quarter of 2019. As 2018 drew to a close, markets were searching for a bottom to three months of selling pressure that drew parallels to some of the worst episodes of market history, including the 1987 crash. While we concluded our macro overview in our year-end commentary with a “what if we go into a recession in 2019” section, as of today, two key catalysts have lessened the perception of that risk. First, and most important, the Federal Reserve Bank shifted its rate path from hiking to an extended pause, and second, earnings reports and guidance for the full year 2019 were fair with modest weakness in the first half outlook offset by strong expectations for the second half of the year.

When the Fed hiked interest rates in December of 2018, many were left wondering whether they were intentionally trying to invert the yield curve and tip the economy into a recession to ease some of the tension in labor markets and prevent the economy from overheating. This was a fair question since the typical recession in the post-Depression US Economy was the result of Fed tightening in the face of rising inflation. Between the end of December and the Fed’s meeting in late January, it became clear that the Fed did not explicitly want to bring on such a recession. Fed members immediately commenced their public relations efforts to ease these concerns when the market reacted harshly to the December hike decision and these concerns were put to rest with the Fed’s (in)action in January to keep rates unchanged while removing their language about more rate hikes being necessary and adopting a more flexible stance on the balance sheet wind-down.

During the first quarter, as stocks rose and earnings reports came in largely in line with expectations, the analyst consensus for first quarter earnings kept dropping lower. Per FactSet, “the first quarter marked the largest percentage decline in the bottom-up EPS estimate over the first two months of a quarter since Q1 2016 (-8.4%).”[1]

Source: FactSet[2]

This trend left many frustrated. In hindsight, what becomes obvious is that heading into the quarter, markets “discounted” the impact lower earnings would have on stocks in aggregate and priced that in. Outsized moves in markets (whether it be individual securities, indices, currencies, etc) never result from one catalyst alone. There is however one behavioral constant: the path of incremental information becomes disconnected from the state of expectations. This is the Mr. Market in Benjamin Graham’s famous parable. When the direction of the news is increasingly good, Mr. Market’s enthusiasm grows. Conversely, when the flow of information gets worse, Mr. Market’s enthusiasm turns into despair. Typically, Mr. Market is most euphoric at peaks and most depressed at bottoms, where the incremental information can only surprise insofar as it’s “less bad” than before.

A Thought from Elliot

Of the many powerful lessons learned from reading “The Snowball: Warren Buffett and the Business of Life” by Alice Schroeder in 2016, one subtle takeaway continues to emerge in my semi-regular musings. Warren Buffett’s grandfather owned and operated Buffett & Son, a grocery store where a young Charlie Munger had worked as a clerk. Schroeder wrote about it within the following context:

Buffett & Son was a direct descendant of the oldest grocery store in Omaha and Ernest’s demanding ways were all in pursuit of an ideal vision of service to his customers. He felt certain the discount national chain stores that were encroaching on the neighborhoods were a fad that would disappear because they could never provide a comparable level of service. Sometime during this period, he wrote confidently to one of his relatives: “The day of the chain store is over.”[3]

Today’s supermarkets all build around a layout which was introduced around this time, where you enter the store in the produce section, travel through the packaged goods aisles and finish collecting items in the dairy and egg shelves. In the pre-WWII America, a grocery store was completely different. As a fascinating blog post about “Grocery Shopping in the 1920s” explains, instead of walking through the aisles and selecting produce for oneself, “In the early 1920s, the customer approached the counter, made a request, and the clerk selected the merchandise for the shopper. Much of the merchandise was kept behind the counter.”[4]

In fact, the customer rarely, if ever handled any product until they were in the comfort of their own home.


Ever since the rise of the Internet, people have mused about the eventuality for Internet-driven delivery, but interestingly the grocery delivery model is an old idea that worked incredibly well within a certain model. The key technology facilitator for delivery in groceries was the telephone. When competition emerged from the early incarnation of the modern supermarket, the town grocer, as Ernest Buffett lays bare, relied on their relationship and customer service as key points of differentiation. As we now know today, lower prices ultimately won out over personal touch and convenience.

Although the town grocer lost out to the scaled supermarket, embedded in the old model is an interesting concept worth exploring. The grocery, as a customer-service centric model conferred a high degree of trust on the grocer himself (back then they were mostly men). The customer service principle included the job of curator. It was the grocer’s responsibility to select the products that checked off the everyday needs of his customer. When a customer called in an order the ask would be for “bread, cheese, soda, a can of beans and toilet paper” in reference to the generic.

The transition to a grocery shopping experience that empowered customers to walk the aisles and select their own products would not have been as simple without the concurrent emergence of brands like Coca-Cola, Kellogg’s and Kraft in the supermarket. The rise of the supermarket aisle saw bottled Coca-Cola overtake fountain sales fueled by the six-bottle carton, the introduction of ready-to-eat cereals from Kellogg and the launch of a powdered beverage named Kool-Aid from Kraft. Given Mr. Buffett’s proximity and familiarity with the fall of the local grocer and rise of the mass supermarket, we perhaps have an explanation for his infatuation in branded CPG like Coca-Cola and Kraft, two names which populate Mr. Buffett’s portfolio today. Brands were the most important shortcut in helping customers navigate the aisles of the supermarket. In other words, there would have been no empowerment absent the power of brand. To that end, brands subsidized the very existence of the supermarket and the resulting relationship was thus symbiotic.

Many have observed that often what’s old becomes new again, and new old. While the Internet has yet to unleash scaled grocery delivery, we can muse about the effects that the online world already hath wrought on brands and one of the biggest consequences is the reemergence of a layer of curation which dilutes the value of brand. There are many great writings on the impact the Internet has had on brands, but we find the history in thinking about this story interesting for analyzing who will win and lose today. To that end, there is one kind of company we are increasingly enamored by for how it fills a vital role in today’s ecommerce landscape: the app that owns the customer. An abundance of really high-quality companies are emerging to help consumers navigate a fragmented ecosystem, full of friction with little differentiation.

A few verticals where we have specific investments include payments (PayPal), content (Roku, and Disney going DTC), home services (IAC, specifically the HomeAdvisor vertical) and food delivery (Grubhub) which we will cover for the remainder of this letter. Each of these referenced companies owns the customer in some way, where customer’s decision-making process starts effectively in-app and leads to a kind of transaction. It is interesting to contemplate the economic reality of a food delivery order placed by searching “Pizza hut delivery” with explicit intent versus an experience that starts with a hungry diner opening up the Grubhub app, given some of the limited screen real estate anyone has on their phone, and browsing through a list of restaurants organized by a combination of proximity, paid targeting (the restaurant giving up a higher take rate) and a diner’s historical preferences. Explicit intent brings little value to the restaurant with no likelihood of incrementality, while owning the customer in app and sending them to a restaurant premised on curated taste is uniquely valuable. Keep this in mind as a point of context while we discuss our investment in Grubhub.

Mr. Market Delivers Time and Again

One of the best positions in our firm’s history, which inadvertently has neither been written up nor presented, though has been discussed in depth with many of you is Grubhub. While our portfolio had a great start to 2019, Grubhub also happens to have been our worst stock in the first quarter. From the first day we bought shares in the company, it has been one of our most controversial positions. We bought our first shares in January of 2016 and from there the returns look stellar; however, over the past six months, shares have shed over 50% of their value.

Grubhub and its SeamlessWeb division (hereinafter we will simply refer to Grubhub) are collectively the patriarchs of the Online Delivery Provider business model. The two brands started as pure online marketplaces, built to connect diners with restaurants for a fee (the take rate). Diners place their orders online at Grubhub, after which restaurants receive a fax detailing the order, manually enter their acknowledgment of receipt of said order, then deliver the food to the diner’s door. As a pure marketplace, Grubhub was just a middleman, collecting its generous take rate in exchange for connecting restaurants to incremental sources of demand and simplifying the process for consumers.

Own the customer, build your TAM:

In building its business, Grubhub removed two crucial pain-points in the food delivery process for consumers. First, consumers often didn’t know all the delivery options in their area and what each had to offer. Grubhub gave a platform through which restaurants could share this information and strategically purchased Menupages in order to improve their own access and awareness to this crucial piece of the puzzle in an effort to drive its salesforce in the right direction. Second, calling in an order was prone to error and in high-volume restaurants, subject to repeated busy signals. For a diner to painlessly click in their order online and know reliably that it will arrive without error was a big change. Grubhub’s success on these two fronts conferred important power on the company as a source of demand generation for restaurants. The site became a hub through which hungry diners commenced their search for food delivery and consequently, while most expected Grubhub’s take rate to compress over time, it actually rose as the company added in the capability for restaurants to offer more take rate in exchange for a higher listing in a diner’s search.

So successful was Grubhub in removing key delivery frictions that in the process, the diner appetite for delivery grew alongside the company itself. When Grubhub started, its opportunity was converting phone orders to online and the total addressable market was clearly defined in that sense; however, as Grubhub proved tremendously successful, the opportunity grew to include shifting a bigger portion of restaurant consumption generally to the online ordering world.

This is all amidst the backdrop of a huge shift from “food at home” to “food away from home,” best demonstrated by this chart shared with us by a sharp analyst:

Source: BLS CPI data, Bloomberg

Making a S***** Business Yummy:

When we first commenced this position, Grubhub shares were weighed down by the emergence of the turnkey delivery business and well-capitalized competitors with no imminent profit mandate like Uber and Amazon entering the delivery business. Pure marketplaces are phenomenal businesses, with high profits and little capital necessary to support the business. With well-capitalized competitors offering to do delivery for restaurants in exchange for a higher take rate, Grubhub was hit with a tough dilemma: do you stick with the marketplace and subsist on your lush economics or do you build your own turnkey operation and expand the platform’s offering?

Grubhub, led by CEO/founder Matt Maloney and CFO Adam DeWitt chose the harder, but more ambitious path of launching their own delivery business. At the time, Maloney called delivery a “s***** business” and lamented that “I’m running my delivery-based business with the explicit goal to break even. That’s not fun for me, and normally I’d say that’s the dumbest business you could ever be in. Why run a break-even business? That’s a pain in the butt.”[6] Grubhub was all-in on this plan in 2015 with the acquisition of three regional delivery services (RDS), commencing its own investment plan and the hire of Stan Chia from Amazon to run operations and logistics for delivery. While Maloney did indeed call delivery a “s***** business” what he meant is that on delivery itself, there would not be much room to generate a margin, even with Grubhub’s scale advantage over both venture-backed and well-capitalized competitors.

It just might be that delivery when added to a marketplace is a better business. Delivery is effectively a three-sided marketplace, which connects diners (first side) to restaurants (second side) via an independent contractor driver (third side). Maloney’s vision was that if delivery could run at break-even, then Grubhub could continue to earn its marketplace margin on the “demand generation” piece. The take rate for a restaurant on the pure marketplace side is around 15%, while the take rate for one who uses Grubhub’s fleet of driver’s is 30% plus a$2 delivery free. Think of this 30% as two separate pieces—15% for the demand generation piece, 15% for delivery. It thus became Grubhub’s imperative to squeeze the cost structure of its delivery service into 15% of the average order. In doing so, Grubhub could reach what they call “economic parity” between marketplace and delivery orders as measured by EBITDA per order, leaving the platform agnostic, the diner indifferent and the restaurant empowered to choose the model that best fit its own needs.

The introduction of EBITDA per order parity was important in setting expectations, because as delivery increases as a percent of gross food sales (GFS), revenue grows faster than before (due to the 2x take rate), while margin is suppressed. EBITDA per order thus gave us analysts a way to track the company’s progress on monetizing orders, in contrast to modeling out revenue and margin assumptions that would now be dis-anchored from past trends. The economics break down as follows:

We note that Grubhub’s delivery take rate of over 30% is far superior to UberEats’ comparable take rate of under 20%, due to UberEats over reliance on McDonald’s as a source of demand at extremely low take rates. Per Uber’s S-1: “the large chain relationship we charge a lower service fee to certain of our largest chain restaurant partners on our Uber Eats offering to grow the number of Uber Eats consumers, which may at times result in a negative take rate with respect to those transactions after considering amounts collected from consumers and paid to Drivers.

In Grubhub’s Q4 2017 earnings report in February 2018, management declared its achievement of “economic parity” between marketplace and delivery alongside its most important strategic partnership to date: Yum! Brands, owner of KFC, Pizza Hut and Taco Bell invested $200m in exchange for a ~3% equity stake with the two set to rollout a nationwide partnership with Grubhub providing delivery services to Yum’s subsidiaries and its franchisees. The relationship with Yum was about more than just bringing Yum on platform. With proven economic parity in their existing model, Grubhub was able to use their lessons learned along the way, leveraged with the Yum platform in order to expand their delivery business from what had been exclusively first tier cities to second and third tier cities. As Maloney explained, “by leveraging our chain partnerships, where they[Yum] have a lot of footprint and a lot of excitement where they can see your [sic] more growth, we can kind of create those anchor tenants and then we fill out the mom-and-pops as we continue to expand our market coverage in these nascent markets.”[7]

For any new delivery market launch, Grubhub had to foot certain overhead expenses (like driver subsidies) in order to ensure enough scale is in place for where delivery volume would go, even before the demand is evident in the market. Yum’s national footprint of brands helps bring the demand necessary in order to justify the cost of starting in these less dense markets. This leaves open a key question: if Grubhub has been a “demand generation” platform historically, what would the economics with Yum look like? CFO Adam Dewitt explained as follows:

“It’s impossible to think about just the economics of the Yum! deal without thinking about the value of the advertising that we’re getting, the value of the cobranding that’s not explicit, that’s more implicit, the new diners that we’re getting, the value of the — the value of just having the brands on the platform and driving new diners. And so you need to take all that into consideration, and we still think that — we still feel really good that over time, even in the kind of short to medium term, you’re not going to see a detrimental impact to EBITA per order related to the Yum! deal or other deals.”[8]

Yum, with its big brands and marketing prowess accomplish the following for Grubhub:

  1. Help with customer acquisition by introducing new diners to the platform
  2. Support brand marketing for Grubhub alongside the Yum brand names with paid marketing on TV and a branded presence in each of the restaurants.
  3. Bring enough demand in order to justify the cost of operating a delivery network in cities that don’t have the same scale and density of New York and Chicago.

Yum effectively introduced a third key pillar of the Grubhub business model beyond marketplace and delivery—a white labeled, outsourced delivery and technology partner. Whereas Grubhub gets compensated for “demand generation” in marketplace or delivery, with a large chain partner Grubhub gets a take rate but also builds the website, the app and handles delivery in addition to the benefits of scale and awareness that come with a large chain’s marketing prowess. As Dewitt explains, “in aggregate, that we get to an EBITDA per order that is not significantly accretive or dilutive, and instead, just adds a lot of growth.”[9] If Grubhub could support Yum “at cost” with its take rate (a secret between the two parties), then the company’s insistence that the deal would be “EBITDA per order neutral impact” would require the scale benefits provided by chains to drive down its “operations and support” costs per order and the halo of the Yum brand portfolio to lower customer acquisition costs and boost lifetime values for Grubhub diners.[10]

Despite the vague economics, investors were initially enthusiastic. Enthusiasm gave way to doubt in the fourth quarter of 2018 when the rollout of the new delivery markets was slower than hoped and with a series of large funding transactions for Doordash on the heels of its reemergence from near demise. With a huge influx of cash, a growth mandate blessed by Softbank with profitability an afterthought and a series of aggressive tactics, like selling non-partner restaurant food, skimming tips from drivers and positioning smartly in Google’s new “delivery” console Doordash was able to quickly take share.[11] [12] This raised concern about Grubhub’s first mover and scale advantages and the captivity of customers to any of the delivery platforms. By some accounts, Doordash overtook Grubhub in aggregate US market share during the month of March in 2019.[13] While this may be the case, there are four important reasons why aggregate market share is misleading:

  1. The market is growing rapidly and even in seemingly losing share, Grubhub is growing alongside the delivery market itself.
  2. A lot of the growth is coming from Tier 2 and 3 cities, where Doordash launched first, meanwhile core existing markets remain far more stable than aggregate market share data would have one think.
  3. Doordash services “non-partner” restaurants whereby the company earns no take rate and marks up menu prices at the diner’s expense in order to cover the cost of the delivery. Many of these restaurants don’t know they are listed on Doordash nor do some of them want to be.
  4. An unknown but meaningful portion of Doordash’s “market share” comes from non-restaurant deliveries, most notably their Walmart This is a good “last mile logistics” business, but is not comparable to GFS at Grubhub.

Competition puts opportunity on our plate once again:

We must confess that the rise of Doordash caught us by surprise; however, we think the fears surrounding Grubhub are as much about the swinging of Mr. Market’s pendulum from euphoria to despair as they are about Doordash or Grubhub itself. The market took the Yum partnership and subsequent acquisition of LevelUp (which we could spill much ink on, but will spare you for now) to such an optimistic extreme that the stock became setup to fail. The launch in tier two and three cities happened alongside Doordash’s ascent and analysts were challenged to figure out whether the EBITDA per order decline across the business was the result of operating nascent markets sub-scale or the influence of competition driving down core economics. In the Q4 2018 earnings call, management shaped expectations as follows:

“We expect adjusted EBITDA and EBITDA per order to increase throughout the year as we gain efficiencies in the newer delivery markets, start to get increasing leverage from the recent marketing and technology investments and achieve general operating leverage as we continue to grow.

As a result, we expect to exit the year generating EBITDA per order much closer to our third quarter 2018 rate of $1.57 than our fourth quarter ’18 rate of $0.98. If you take our 2019 order volume and apply the third quarter of 2018 level of EBITDA per order, it implies that the business would generate $40 million to $50 million in EBITDA above our full year guidance for 2019. So when considering 2020 and beyond, we believe the base EBITDA from where we’ll continue to grow should be closer to that figure than our full year 2019 guidance.”

With sentiment now squarely reset, the risk reward in the stock is as good as it has been since November 2016. There have been several key catalysts since then that have enhanced the company’s advantaged position and some setbacks. They key variables to follow on this thesis are the rate of net new diner additions and operations and support as a percent of delivery revenues. Net new diner adds continue at a robust rate and while competition is forcing customer acquisition costs upwards, the lifetime value to customer acquisition costs remain robust for the company. Further, Yum’s co-branded marketing efforts with Grubhub only kicked in during the first quarter. Consequently, we have so far only seen the impact of the costs associated with supporting the Yum partnership (sub-scale utilization in nascent markets) without seeing any of the benefits. We think management’s perspective here is smart. Maloney summarized it as follows:

“If we wanted to grow at a slower pace, if we wanted to grow similar to what we are doing in the first quarter or the second quarter last year, we could add $20 million to $30 million EBITDA right now, but this is the right choice for the business long term, right. We have — as I mentioned in the call, we’ve accelerated our DAG growth every quarter for the last 5 quarters with a couple hundred basis points consecutively for the third quarter and fourth quarter.”[14]

With this stock trading at 4.40x consensus 2019 sales estimates, the market is implying that growth will slow and future margins will be well below the “economic parity” margins the company generated just one year ago. In fact, this is the lowest price to estimated sales in the company’s history since going public. The Q4 2015 P/S dip below 5x coincided with skepticism surrounding the initial launch of the delivery business.

As Maloney and team executed on achieving profitability goals, the multiple expanded. We see many parallels to late 2015 when looking at the following chart:

Source: Bloomberg

We find market cap to forward GFS an especially insightful and important valuation metric:

Source: Sentieo, RGAIA

EBITDA to gross food sales has hovered around 4.5% historically and as such, a consistent market capto forward GFS is an expression that the economic value Grubhub extracts per dollar of GFS will remain consistent over the long-term. At today’s market cap of around $6b and expected GFS of around $6.4 billion in 2019, the stock is trading below a 1:1 ratio. At around a one ratio, an investor could reasonably expect to earn a return commensurate with the growth of GFS over a holding period, assuming economics stay consistent. In our fairly conservative estimate for GFS, which notably excludes any economic benefit from LevelUp, we expect a 15% compound annual growth rate (CAGR) over the next three years and around 14% over the next five years, with exit growth beyond that period expected to maintain growth rates into the double digits. We think there is the reasonable opportunity for EBITDA/GFS to improve over this time period, which would be accretive to returns, though we are not underwriting the position under the presumption this happens. The biggest opportunities in improving EBITDA/GFS stem from leveraging the Sales & Marketing. Technology the Operations and Support expense lines over time.

In many respects, we view this situation as analogous to buying Booking Holdings (Priceline Corp) when it was at a similar revenue run-rate in 2006, only better (for added color, consensus expects 36% top line growth for Grubhub this year, vs 17% growth for Booking in 2006). Grubhub is similar to Booking back then, in how there are questions about competition from well capitalized players and industry incumbents and general frustration with the high fees the platform was able to generate their respective merchant bases. The similarities are deeper in how Grubhub and Booking each earn the majority of their economics off of an incredibly fragmented customer base (in Booking it’s the largely independently owned European boutique hotels, while with Grubhub it’s the independent restaurant landscape). Grubhub is superior is how the company owns the customer with its presence at the top of funnel where search and discovery commence, while operating in an area where the frequency of interaction with the company is far more regular. Booking unfortunately must reacquire customers each time someone plans travel, which for many customers happens only once or twice a year. Booking merely offers both parties the removal of friction, Grubhub offers demand generation as an added layer and thus should earn superior economics in the very long run. Notably, Booking was able to grow its top line at a near 24% CAGR since 2006—a span of twelve years. If Grubhub’s high growth time period could meet Bookings, even if at a much lower rate, the returns to long-term holders would be incredibly attractive. In our DCF, we think the mid-$80s per share is justified today. Each year we increase our forecast period beyond year five adds upwards of $30 in expected value. This goes to demonstrate just how important the company’s ability to extend its high growth period before reaching terminal value will be in driving long-term returns.

Thank you for your trust and confidence, and for selecting us to be your advisor of choice.  Please call us directly to discuss this commentary in more detail – we are always happy to address any specific questions you may have.  You can reach Jason or Elliot directly at 516-665-1945.  Alternatively, we’ve included our direct dial numbers with our names, below.

Warm personal regards,

Jason Gilbert, CPA/PFS, CFF, CGMA
Managing Partner, President
O: (516) 665-1940
M: (917) 536-3066

Elliot Turner, CFA
Managing Partner, Chief Investment Officer
O: (516) 665-1942
M: (516) 729-5174




[3] Schroeder, A. (2008, 2009). The Snowball: Warren Buffett and the Business of Life. New York, NY: Bantam Books. Page 69.




[7] Grubhub Q1 2018 Earnings Call Transcript.

[8] Grubhub Q2 2018 Earnings Call Transcript.

[9] Grubhub Q1 2018 Earnings Call Transcript.

[10] Grubhub Q1 2018 Earnings Call Transcript.




[14] Grubhub Q4 2018 Earnings Conference Call


Past performance is not necessarily indicative of future results.  The views expressed above are those of RGA Investment Advisors LLC (RGA).  These views are subject to change at any time based on market and other conditions, and RGA disclaims any responsibility to update such views.  Past performance is no guarantee of future results. No forecasts can be guaranteed. These views may not be relied upon as investment advice.   The investment process may change over time. The characteristics set forth above are intended as a general illustration of some of the criteria the team considers in selecting securities for the portfolio. Not all investments meet such criteria.  In the event that a recommendation for the purchase or sale of any security is presented herein, RGA shall furnish to any person upon request a tabular presentation of:
(i) The total number of shares or other units of the security held by RGA or its investment adviser representatives for its own account or for the account of officers, directors, trustees, partners or affiliates of RGA or for discretionary accounts of RGA or its investment adviser representatives, as maintained for clients. (ii) The price or price range at which the securities listed.