Jumbo Interactive (ASX:JIN) is an Australian online lottery seller. It has a simple enough business model, yet it was the complete opposite of BPF in terms of its moat and the impact to my portfolio. It is (still) one of my best investments. The reason why it was misjudged by the market was due to 2 main reasons: internal short-term woes AND a misunderstanding of the strength of its business model.

Back in late 2015, JIN was essentially the same business as it was today. The Australian business was doing well as always, however its overseas division was dragging its whole business down. Its Germany and Mexican division were losing $3.9m that year, overwhelming the other aspect of the business. If you say it’s the classic case of a hidden valuable asset, then you are completely right! However, “good” comes in a spectrum and it was not readily observable in late 2015 that this was indeed a “good” business. It was not in small part thanks to Steve Johnson at Forager  who shed light and assured me of how “good” JIN’s business was.

Lottery’s lollapalooza effect

Now, I must digress from Jumbo and talk about mental models and its importance in my development as an investor; more importantly of a particular talk by Charlie Munger. I have listened to his “Psychology of Human Misjudgement” talk more than 50 times, yet it seems that every time I listen to it, I am still amazed at his insights and how far ahead of his time he really was. (Note: the revised copy that he wrote for Poor Charlie’s Almanack is also worth reading. Actually, anything by Charlie is well worth your time)  In that particular talk, he talks about “bias from mis-gambling compulsion.” Then he talks about how powerful that bias is, especially if people pick their own number for the lottery. I would like to expand that in a lottery there is a lollapalooza effect from envy and jealousy from seeing other people winning obscene amount of money, very strong financial incentives, commitment tendency in that once you buy lottery every week then it is almost automatic and it becomes your routine, sunk cost bias from all the money you have been putting down. There are probably more, but as you can see, the draw of lottery is very strong (so naturally, I tend to avoid it as a consumer). However, it makes for a highly predictable and regular cashflow. Some circles has come understand this, evidenced by Sandon Capital’s investment thesis on Tatts in Feb 2016 and when the private equity players wanted to take over Tatts.*

Hidden treasures

So lottery is a very strong business. That JIN had, at that time, 2m customer accounts (with ~330k actively purchasing lottery) is not a thing to sniff at. That customer database has value from the fact that people are a creature of habit and a certain percentage of that 2m customers (~15%-my estimation) don’t think when they buy lottery. I have experienced it first hand when my friends tell me they just buy lottery every week. No thoughts given. That is a very powerful thing. Furthermore, Jumbo benefited from another moat, government regulations. If you have tried to sign on to those new gambling websites, you would have realised that there are certain hurdles that you have to go through. It is almost like opening a bank account, due to the money laundering risks. Therefore, it makes customer acquisition costs for new entrance very high. There was (and is) a hidden asset in those 2m customers and JIN would be a mouth-watering acquisition for a new lottery/gambling entrant.

That hidden asset became very valuable to JIN and provided a safety to its biggest flaw: it did not have a formal contract stipulating it can sell VIC and NSW lotteries and can be barred by Tatts from selling on 30 days’ notice. The Australian lotteries were basically a Tatts group monopoly (in almost all states). This flaw would be the biggest stumbling block for many investors looking at JIN.

The amazing thing about JIN was how it charged a premium for exactly the same lottery. You could buy it at a newsagent or tatts website OR you could buy on JIN’s website for ~24% more! (Note: the price difference has lowered to ~13% now). I believe this was because JIN had to buy the lotteries at the same price as any regular punter would down at the newsagent. When I saw that, I realised that it would be a very difficult choice for Tatts to cut JIN off, as JIN was providing them a steady stream of income with little to no downside. The draw of lottery is just awesomely powerful.

Present time

Fast forward 2 years on and JIN’s stock has gone on a tear. A mispricing like JIN was not an everyday occurrence and I am thankful that I reached for a bucket, not a thimble. They have shuttered the German and Mexican loss making businesses. They have negotiated a long term contract with Tatts and Tatts have become a strategic investor in JIN. This was due to the wave of new online lottery provider like Lottoland, Crownlotto, neds.com, etc. The new kids on the block will take some market share from the old guards, but I think customer acquisition cost will be high for them. As to the current valuation of the stock, I think they are almost fully valued. There is some room for next year to be a more profitable one due to the small jackpots this financial year.

Disclosure: I still own JIN shares and I am an investor in one of Forager’s funds. Nothing here is advice

*Charlie probably would not approve of an investment in JIN due to its nature as a gambling product and the negative impact it has in society.