Uncrowded corners: investing
in near-monopolies

In most industries, unusually high profits attract competition. New entrants emerge, prices come under pressure and returns are gradually eroded. This helps explain why businesses in highly competitive sectors such as airlines, retail, construction, banking and manufacturing often have to work exceptionally hard simply to maintain their position. Over time, that competitive pressure tends to show up in their returns on capital.

This brings us to two concepts at the heart of our investment process. A sustainable competitive advantage is what allows a company to protect its position and profitability from competitors over time. In investment terms, this is often described as a competitive ‘moat’ – the barriers that make it difficult for rivals to replicate a company’s success or erode its returns. The wider and more durable that moat, the stronger the competitive advantage.

But competitive advantage is only one of the characteristics that make a business desirable. Among other things, we consider the attractiveness of the industry in which it operates, the quality and long-term growth potential of the business itself, its unit economics and how efficiently it uses capital. Together, these factors help determine whether a company has the potential to generate attractive returns over the long term.

This is where monopolies and near-monopolies become particularly interesting from an investment perspective – they can represent the strongest expression of both these concepts.

Advantages of dominance

A business that dominates its market can enjoy advantages that are much harder to achieve in a highly competitive industry:

• Pricing power. When customers have few credible alternatives, a company has greater scope to raise prices without significantly affecting demand.
• High returns. Near-monopolies can earn high returns on capital and, crucially, reinvest at similarly attractive rates. Over time, that combination can create a powerful compounding effect, particularly when the business can continue deploying capital into profitable growth opportunities.
• Consistency. The real value of a strong market position lies not simply in producing exceptional returns in any one year, but in sustaining returns over long periods. A 15% return on capital maintained for 20 years can create considerably more value than a spectacular 40% return that lasts for three years before competition erodes it.

The key word throughout is durability. Monopolies are rarely permanent, and history is littered with businesses that once appeared unassailable. De Beers, for example, once controlled roughly 90% of the world’s rough-diamond market – today, its share is closer to a quarter. For investors, the challenge is not simply to identify dominance, but to assess how long it can endure – and what it is worth paying for that durability.

The case for Verisign

We recently added Verisign to our global direct equity portfolios. The company operates the registry for .com, giving it a contractually protected monopoly over one of the internet’s most important pieces of infrastructure. It sells nothing directly to consumers and has virtually no customer-acquisition costs, while its ability to increase prices is governed by an agreement with the US government rather than by negotiation with customers.

For an annual fee of just US$10.26 per domain name, Verisign ensures that .com and .net domain names remain accessible. It has maintained 100% operational availability for 29 years – .com has never gone down. Whether the address belongs to Amazon or a small single-page website, Verisign receives the same fee for every .com or .net name on its registry. With almost 180 million domain names under management and more than 675 billion Domain Name System (DNS) queries processed each day, the scale is considerable.

There are many other top-level domains, including country-specific domains such as .co.za and .co.uk, but .com remains the internet’s prime real estate, accounting for around 46% of websites globally.

Verisign’s pricing is regulated by the US government, with its current agreement allowing prices to increase by up to 4.6% a year. This equates to roughly 2% above inflation, providing a predictable source of revenue growth. We also expect domain volumes to grow by just under 2% a year, which together should support annual revenue growth of around 6%.

The economics become particularly attractive beyond the top line. Verisign has an operating margin of almost 68%, while tight cost control provides scope for modest, but consistent operating leverage as revenue grows. As a result, we expect earnings to compound faster than revenue.

The company also converts almost all its accounting earnings into cash, which it returns to shareholders through dividends and share buybacks. By reducing the number of shares in issue, these buybacks can then help earnings per share grow faster than the company’s overall profits.

This combination of durability and market dominance comes at a price. However, we believe Verisign offers one of the more predictable earnings streams available in global equity markets, supported by modest but highly visible growth.

Listed near-monopolies

Local monopolies exist across the world, but relatively few are accessible to global equity investors. Among those that are, several stand out for the strength and durability of their competitive positions.

Near-monopolies we own

• TSMC dominates the manufacture of the world’s most advanced semiconductors. Its technological lead, enormous capital requirements and manufacturing expertise make it exceptionally difficult for competitors to replicate its capabilities at the leading edge.
• Nvidia dominates the market for high-end graphics processing units (GPUs) used in artificial intelligence. Its advantage extends beyond the chips themselves to CUDA, its widely adopted software platform, which creates powerful switching costs for developers.
• Alphabet (Google) remains dominant in internet search. Its vast scale, data, network effects and brand reinforce one another, making its position extremely difficult to challenge.
• Microsoft has an entrenched position in enterprise software and cloud computing. Its products are deeply embedded in the operations of businesses around the world, creating significant switching costs.
• Visa operates one of the world’s largest payment networks, connecting consumers, merchants and financial institutions. The more participants that use the network, the more valuable it becomes, creating a formidable barrier to potential competitors.

Near-monopolies we're watching

These are some of the exceptional businesses we would consider owning at the right price:

• ASML is the only company capable of producing the extreme ultraviolet lithography machines required to manufacture the most advanced semiconductors. Replicating its technology and expertise could take a potential competitor many years.
• Intuitive Surgical is the leader in robotic surgery. Its large installed base of surgical systems, together with the instruments and other consumables required for procedures, creates a powerful and recurring ecosystem.
• Booking Holdings has a particularly strong position in online travel. Its two-sided marketplace benefits from scale: travellers are attracted by the breadth of accommodation available, while accommodation providers want access to its large customer base.
• Meta Platforms benefits from the network effects created by billions of users across its social media platforms. That enormous audience, in turn, underpins the strength of its advertising business.
• Moody’s is one of a handful of dominant global credit-rating agencies. High barriers to entry, including regulatory requirements and the widespread acceptance of its ratings by investors and issuers, make its position particularly difficult to replicate.

Valuation and risk

Identifying an exceptional near-monopoly is one thing – deciding when to own it is another. Valuation matters. Even the best business can be a poor investment if too high a price is paid for it. Periods of broader market weakness, temporary company setbacks or negative sentiment towards a sector can provide opportunities to acquire such businesses at more attractive prices.

Dominance also brings its own risks. Market power can attract regulatory scrutiny, while technological disruption or changing customer behaviour can gradually weaken what once appeared to be an impregnable position. The important question is therefore not simply how wide a company’s competitive moat is today, but whether it is likely to widen or narrow over time.

Finding these uncrowded corners of the market is only the starting point. Our aim is to identify businesses with enduring competitive advantages, buy them at a sensible price and allow the strength of their underlying economics to compound over the long term.