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  • Chris Mayer

Online Brokers, NYC REITs, Music Industry & More

Some short notes below – on the online brokers and zero commissions, on the music industry’s mid-year report, on the value in New York City property REITs and a bit of trivia on a very important invention.


I hope you enjoy today’s post.


Online Brokers and Zero Commissions


It’s been interesting to watch the reactions of people to the online brokers going to zero commissions. I think the online broker world has bifurcated into two business models.


The first model is the Schwab model of zero commissions but offering additional services (and imposing other costs, including selling order flow) that more than make up for the loss of commissions.


And there is the classic Interactive Brokers model, which charges commissions, but generally offers the lowest all-in trading costs (doesn’t sell order flow), high interest on cash balances, the ability to trade foreign markets easily, etc. I say “classic” because IB now offers IBKR Lite, which offers zero commissions (and sells order flow).


I’ve written about Interactive Brokers here before. We own in the stock in the Woodlock House portfolio. The stock has not been a good performer this year, down about 10%. But the business is doing well enough and I don’t see any reason why it shouldn’t continue to do well.


Yes, the growth rate seems to be slowing, but IB should still be able to grow earnings by a double-digit percentage annually for years to come. The stock trades for 18x this year’s earning guess. And that for a business with no net debt and excess capital. In five year’s time, I suspect the business will be a lot larger and more valuable.


In some ways, IB disproves the old adage about building a better mousetrap. IB has the best mousetrap in the business in my view. When you think about all-in trading costs, interest on cash and the ability to trade in markets all over the world, IB is unmatched. But not everyone wants or needs all of that. Somebody who makes five trades a year and otherwise sits on their stocks, doesn’t really need the powerful platform IB provides in the same way that somebody who is just looking to tool around town and run errands doesn’t need a Ferrari.


That’s all fine. I think the world is big enough for both models to prosper. Schwab seems to be in the driver’s seat for dominating the retail business. And IB is in the best position to dominate the so-called power users.


One telling statistic about the online brokers – which tells you how different they are – is to look at the number of accounts they have and compare it to DARTs (or daily average revenue trades).


Schwab, for example, has 12 million accounts. (Ameritrade has nearly 12 million; E*TRADE, about 5 million). IB has just 655K. And yet, in the second quarter, IB handled 739K DARTs to Schwab’s 392K – nearly twice as many with 5% of the accounts Schwab has. That may tell you all you need to know about how different their customers are.

Q3 earnings come out soon and we’ll see what IB has to say.


The Music Industry – Streaming Dominates


Earlier last month, the Recording Industry Association of America (RIAA) released its mid-year report. It shows that total industry revenue increased 18% in the first half of the year. Revenues from streaming alone increased 26%. Streaming now accounts for 80% of industry revenues. And paid subscribers to streaming services topped 60 million for the first time:


The report paints a picture of a healthy, growing industry.


We own Vivendi (and also the parent Bolloré SA). The crown jewel at Vivendi is Universal Music Group (UMG), which is one of the big three labels that supplies most of the music for the streaming services.


There are different ways to invest in the music industry. Vivendi is my favorite.


The business is on fire: UMG’s EBITA was up 47% in the first half of the year. And it’s a great value: Vivendi is in the process of selling at 10% interest in this business, which values UMG at ~$34 billion. The entire market cap of Vivendi is about $33 billion. (Net debt is about $2 billion). Vivendi owns other businesses (most importantly Canal+ and Havas), which generated $260 million in EBITA in the first half.


Meanwhile, Vivendi has a massive buyback in place for 25% of the shares. The max buyback price is 25 euros. So perhaps the market is anchoring on that price, as Vivendi has not traded far off it since. Overall, Vivendi seems a low-risk way to invest in the music industry.


Earnings are due out on October 17. I expect another strong report.


New York City Office Property – Time for Buybacks


Talk about unpopular assets, New York City real estate must be one. Just take a look at the chart of Empire State Realty Trust (ESRT), which owns the Empire State Building. It’s about 36% off its high from February of 2017.


I am always interested in own so-called “trophy assets” and the Empire State Building would certainly seem like one of those. I remember looking at ESRT when it went public in 2013. There were a couple of things that turned me off about it and I passed, though I kept an eye on it anyway. Well, here it is all the way back near its offering price.


I read the transcript of the last earnings call. There was a lot of talk about the share price and a discussion around ESRT doing a buyback. It was an interesting call overall. During the call, another New York REIT came up: SL Green.


SL Green’s chart looks a lot like ESRT’s: Down. But here is a company doing a very interesting thing about that: It’s selling assets for a healthy premium to its share price and using the proceeds to buy back stock. On SeekingAlpha, there is an excellent write-up from August by Dane Bowler on SL Green.


He writes:


“SLG is selling its assets at the equivalent of about $120 a share on average. Its recent sale of 521 Fifth Avenue was at a 4.6% cap rate, which is closer to $130 a share equivalent.


Buying back its stock is literally buying its remaining pool of office assets, but they are buying those assets at about $80 a share. It is basically an arbitrage that creates value for shareholders every time it is executed.”


I love that. Bowler also makes the case that cap rates in public markets have not adjusted to the new lower ten-year Treasury rate. Cap rates generally follow the ten-year. He shows what would happen to SL Green’s share price at various lower cap rates. Remember, the stock is $80:


Now, as Bowler says, getting cap rates that low depends on a healthy NYC real estate market. And right now it’s softening and maybe will get softer. But this seems a cyclical issue. Longer-term, it’s hard to see how this idea doesn’t work out well.


I have no position in either of these stocks. (Though, Woodlock House does have a position in a firm that owns one of NYC’s “trophy assets.”)


The Non-Event as Triumph


I am currently reading an architectural history of New York City, titled Delirious New York by Rem Koolhaas, a famous architect, first published in 1978. I find it fascinating so far.


One bit of trivia from the book: If you had to think about what invention, above all others, changed the skyline of New York City (and to a lesser degree other cities around the word), what would it be?


Here’s Koolhass:


“[The elevator] is presented to the public as a theatrical spectacle.


Elisha Otis, the inventor, mounts a platform that ascends – the major part, it seems, of the demonstration. But when it has reached its highest level, an assistant presents Otis with a dagger on a velvet cushion. The inventor takes the knife, seemingly to attack the crucial element of his own invention: the cable that has hoisted the platform upward and that now prevents its fall. Otis cuts the cable; it snaps.


Nothing happens, to platform or inventor.


Invisible safety catches – the essence of Otis’ brilliance – prevent the platform from rejoining the surface of the earth.


Thus Otis introduces an invention in urban theatricality: the anticlimax as denouement, the non-event as triumph.”


Not the invention of the elevator itself, but the safety device that prevents disaster. That leads people to overcome their fears of using elevators. And it makes possible the skyscraper.


Thanks for reading.


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Published October 8, 2019

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