Over the next few weeks, I plan to write about metaphors, like this one, and how they have helped me identify ideas. 

Cornelius Vanderbilt was an American tycoon who lived between 1794 and 1877. He built his wealth first with shipping and then with railroads and at one point of time, he was the richest man in America having a net worth of about $ 75 Billion in today’s terms. 

After the civil war, when his negotiations failed with rival railroad companies, he came up with a brilliant master plan to beat them into submission. He owned the Hudson River Bridge which was the only railroad bridge into New York City and blocked its use by all rival companies. As a result, all other companies lost access to the biggest port of the country at that time – the New York City port. This hurt his competitors badly and their share prices started to drop precipitously at which point he went and bought all the shares of at least one rival company. Though many of the acts he did would be deemed illegal today, yet I was inspired by the power that comes from owning the only railroad bridge into New York City.

This article is about metaphorical toll bridges and why it makes sense to own them. These are like the Hudson River Bridge that everyone is forced to use and therefore owning an asset like that would be equivalent to owning a money printing machine. 

So let’s look at the physical toll bridges and then their metaphorical equivalents. 

We have all used toll bridges and so we are familiar with their working. What are some of the business attributes of a Toll bridge:

• It’s usually a monopoly. Because it costs a lot to build, there is usually not much competition and therefore the toll bridge becomes a monopoly of sorts.
• Doesn’t have a substitute. The alternate to a toll bridge is probably a free but a long and inconvenient route. Users therefore prefer using the toll bridge to the alternative.
• It costs a lot to build, but very little to maintain. A real world toll bridge would usually need minimal maintenance on a yearly basis. Also, most of the costs needed to operate the bridge like employee salaries, repair and maintenance etc. tend to be fixed in nature. Therefore with the same fixed costs, the bridge can cater to a large traffic. As the traffic increases, revenue increases, but the costs don’t increase which leads to profits and tons of free cash flows. 
• Customers need to use it more than once. Repeat usage ensures cash flows for the future as well.

The mind map below breaks down illustrates how the business strengths get translated to high returns for its owners.

Now let’s look at some similar examples in the business world. Think of Visa and MasterCard. Over the years, they have built large information networks involving various banks and merchants like grocery stores, gas stations, restaurants, hotels etc. Customers like you and me use our credit cards for their convenience and the reward points. Every time you swipe your card using the Visa/MasterCard terminal, there is an exchange of information and money that happens using the Visa/ MasterCard network. And for using this network, Visa/MasterCard charges the merchant a toll. 

For the merchant, saying no to Visa/MasterCard would be like saying no to a lot of business. To the merchants, Visa and MasterCard are a toll bridge on the road to more business. 

Likewise, Google and Facebook are toll bridges on the highway of digital advertising. App Store and Google Play Store are toll bridges for the app developers. Stock exchanges like NSE/ BSE and depositories like NSDL/ CDSL are various toll booths on the highway of stock investing. IRCTC is the toll bridge to book railway tickets. LinkedIn and Naukri.com are the toll bridges for job seekers and recruiters. There are no close substitutes to these monopolies or duopolies. 

In the table above, we can see that some of the toll bridges have very gross margins because they incur almost no cost while serving customers. They all have a lot of cash and equivalents therefore actual Return on Equity adjusted for cash is much higher. 

A word of caution. While analyzing toll bridges, do make sure that the financials of the company such as return on capital, return on equity and quality of earnings (high profit margins, low debt, lots of free cash flows etc.) validate the story. There are numerous toll bridges and therefore you can reject the ones that don’t meet the financial criteria. 

So, why do Toll bridges matter? Toll bridges usually produce fantastic returns for their owners and therefore we would do well to spend time looking for them and studying them. For example, in the last 5 years, the shareholders of Alphabet (Google) have seen a return of 21% CAGR and those of Visa a return of 25% CAGR! 

Oh yes, and when you do find them, hold onto them! 

 

Disclaimer: Prof. Sanjay Bakshi had first blogged about Toll Bridges in 2012 and it left quite an impression on me. All the wisdom is his and errors if any are mine. The companies mentioned are only to illustrate the concept and should not be regarded as buy or hold or sell recommendations. I may have invested in some of the companies mentioned above and therefore my views may be biased.

 

Featured photo by Ryan Barron on Unsplash