We have noted of late, increased commentary about particular ASX listed companies that are perceived to be expensive on traditional measures without regard for their actual business models. We will focus specifically on those companies that utilise scalable business models, and examine the nature of what a scalable business model actually is.
In it's simplest definition, a scalable business model increases profits over time by growing revenue whilst mitigating a proportionate increase in costs. The least scalable businesses are typified by: high cost of human capital and low scale. Businesses such as consulting and professional services we consider to possess linear business models. We generally find scalable business models in industry segments such as software, online travel agents, digital finance and goods, online advertisements.
Scalable businesses can grow exponentially, due to a range of factors, including but not restricted to: low capital intensity and human capital requirements, quick and low cost deployment, fast iteration of product and business processes to fulfill customer needs.
We consider a the key elements of a scalable business model to be:
The scalability of a business model we consider to be driven by the following factors:
Concept - Inputs
A couple of ASX listed companies that we consider to possess scalable business models are Altium and Afterpay. Both operate and are leaders in 'winner takes all' markets, possess novel products and intellectual property, as well as holding customer-centric visions of the future.
Altium is a software company whose software assists in the design of electronic components critical to the operation of the technology that is ubiquitous today. In 2012, company revenue was $55 million and the EBITDA margin was only 0.5%. By 2018 the company had grown to revenues of $140 million and had achieved an EBITDA margin of 32%; with consistent increases in both revenues and EBITDA margins year on year. To me this typifies a scalable business model.
Afterpay is a payment solution platform, that has been growing extremely fast over the past couple of years driven by consumer and merchant demand. We feel the company has just reached it's tipping point, in the 2018 financial year gross sales were achieved of $2.2 billion, while it's EBITDA margin was circa 1.6%. We believe the company can achieve gross sales of $10 billion within 2 years, whilst increasing it's EBITDA margin to close to 3% or circa $300 million.
Investing in scalable businesses is an attractive proposition, and can lead to outsized returns over time. Investors should keep in mind, that investing in a scalable business in not a panacea as they can be disrupted themselves as well as being subject to market forces like all other businesses.
Disclaimer: This article does not take into account your investment objectives, particular needs or financial situation; and should not be construed as advice in any way
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