I discuss grading a lot on this blog, since it’s a big part and often controversial topic in the hobby. I also discuss the concept of investing in vintage baseball cards. Thus, I figured it might make sense to take a closer look at Collectors Universe, the company, which is traded under the symbol CLCT on the stock exchanges. Of important note, Collectors Universe is the parent company of Professional Sports Authenticator (or PSA as many of us are most familiar).
In this piece, I’ll examine the operations of the company, how they make money and how successful they’ve been in doing so, along with what the future prospects of the company look like. This is by no means investment advice and I do not own any shares of CLCT nor am I being compensated by anyone to write this article. This is all being done for my own enjoyment and to give collectors some future insight in the big business behind sports card grading.
Background on The Company
Collector’s Universe got its roots back in 1986, although it didn’t become a publicly traded company until November of 1999. It was in 1986 that several coin dealers, including then President David Hall launched Professional Coin Grading Service (PCGS), a company focused on the authentication and grading of coins. Hall would go on to launch a sports card offshoot of his coin grading company (PSA), which would commence operations with the grading of the famed ‘Gretzky’ Wagner T206 card. Of course, there was much controversy surrounding the Gretzky Wagner, much of which we covered in this piece here.
In 1999, Hall formed Collector’s Universe, combining the operations of PSA, PSA/DNA and PCGS in order to take the company public. In its initial public offering documents, Collector’s Universe noted that its intentions in becoming a public company were as follows:
To expand into authentication and grading of additional collectibles and to create additional service offerings to collectibles markets, to acquire or invest in complementary businesses, technologies, services or products and for other general corporate purposes.
At the time of its IPO in 1999, the company in it’s last completed fiscal year had generated $22.5 Million in Revenues. Hall was the Chairman of the Board at Collectors’s Universe while Louis Crain was its CEO. Crain would only last a year as CEO of the company starting what would become a bit of a revolving door at the top executive seat. Here’s a list of CLCT’s CEO’s over time. Note that Hall even gave it a shot for a little wile.
Joe Orlando – CEO from 2017 – Present
Robert Deuster – CEO from 2012-2017
Michael McConnell – CEO from 2009-2012
Michael Haynes – CEO from 2003-2009
Roger Johnson CEO from 2001-2002
David Hall CEO from 2000-2001
Louis Crain – CEO from 1999-2000
One of the more interesting executive developments occurred in 2018, when CLCT terminated David Hall from his position as COO and President of the company. I’ve dug around and can’t find any concrete information as to why Hall was let go from the company he founded.
Yet again it is important to note, that Hall was FIRED, not that he retired or accepted some other position at another company. Thus, Hall must have done something that CLCT and executive management didn’t quite like. Now I’m not going to speculate on what might have happened but it is important to point out that there were inherent conflicts of interest between Hall and CLCT.
As pointed out in a popular investing forum, Hall was renting out space at CLCT headquarters, while at the same time running David Hall’s Rare Coins (DHRC). It seems that there most certainly could be a conflict at a company where a professional coin grader is operating under the same roof as the founder of a company that is also buying and selling rare coins.
Hall actually just sold off a big collection of T206 cards via Heritage Auctions:
Thus, a new era at CLCT has been ushered, with the founder of the company (Hall) out of the picture and the present operations under the guide of Joe Orlando who has been at the helm since 2017, and with the company since 1999.
How Does Collector’s Universe Make Money
Collector’s Universe generates the bulk of its revenues from card, memorabilia and coin grading. They do have some ancillary businesses which bring in some sales, including their sports and coins magazines (which also generate advertising revenues) along with a coin and collectibles trade show that is run three times per year, a Collector’s Club subscription service and a Certified Coin Exchange (CCE) dealer-to-dealer Internet bid-ask market for certified coins.
However grading revenues are the primary focus and generate roughly 94% of overall company revenues. The fact that CLCT has diversity between coins and cards is a strength in my opinion; the health of these two markets don’t necessarily run in tandem. Card grading revenues have been much stronger than coins over the past several years due to the increased interest in cards and card grading in general.
Coin prices and demand for grading have proven to be much more volatile over time and are subject to the health of the overall economy. Coin grading demand and overall pricing is also impacted by the the level of interest rates along with the value of precious metals and short term changes in the price of gold.
Orlando has even noted on recent calls that they are fortunate for the strength in PSA grading, leading them to be less reliant on coin grading revenues as they were in the past
We can see below that the revenues for cards and sports autographs has been on a steady climb whereas the coin grading revenues have been more volatile and somewhat stagnant over the past five years.
We can also see in the chart below that from a percentage of overall grading revenues, coins are still the leader at roughly 61%, but this gap is narrowing quite quickly. At the current trajectory, cards would surpass coin grading revenues in a little over two years.
CLCT generates fees for grading, with the most recent average at about $13.40 per item. Coins actually generate more revenue per item at $17.18 per item while cards generate on average about $9.36 per card. Note that vintage collectibles on average generate higher fees since collectors tend to request faster turnaround times and pay higher fees versus modern collectibles. (Note that PSA is quite transparent in regards to expected turnaround times)
The grading business is quite simple when we think about sales and overall profitability. The revenue is the fee for grading the card. The costs involved include:the plastic holder in which the cards or coins are encapsulated, the labor for the grading employees (note CLCT has a total of 71 grading professionals), credit card fees, warranty on submissions and overhead expenses (or occupancy costs).
Thus as far as businesses go, this is a pretty easy one to understand. This table below is really helpful when we analyze the overall profitability for CLCT. We can see that the company's gross profit for 2019 ---which in the simplest of terms is just the grading fees minus all of the costs I've outlined above --- is 58.4%. Meaning if they graded $1 Million worth of cards and coins, they would generate $584,000 before all other expenses are paid.
Now we also have to account for business expenses that will take away from that Gross Profit. We can see from the above table, the Operating Expenses which include 'Selling and Marketing Expenses' and 'General and Administrative Expenses'. These are fairly variable, the former more so since it involves the company's expenditures on marketing the business. The General and Administrative costs involve non-grading employees and executive compensation among other items.
Overall we can see that in 2019, the total operating expenses were 38.6% of overall revenues meaning that from our 58.4% Gross Profit we will subtract that 38.6% of Operating Expenses to get to a 19.8% Operating Income. Now that operating Income is reduced by income taxes but overall the Operating Income is a good gauge as to the overall health of the business.
Thus, in 2019, CLCT generating an 'operating margin' of 19.8% which is a pretty good margin for any business. In the simplest of terms, for every $1 in revenues that CLCT generates, if we account for all costs before taxes, they are earning 20 cents.
Some important notes are that operating Income improved in 2019, due to generating higher average service fees, some of which was from higher pricing and some due to leverage that the company gets from getting more cards to grade. Ultimately CLCT is more profitable with an increase in card submissions.
Important to again note that card grading demand has been robust -- card grading revenues were up 25% in 2019 and 17% in 2018. They have a record backlog while continuing to add grading capacity while at the same time not experiencing any slowdown in service.
The Competitive Landscape
With cards, there are only two other major competitors – SGC and Beckett (BGS and BVG). PSA is the clear leader in the grading space and I don’t honestly see either of the other two companies encroaching on PSA’s territory any time soon. I think there is certainly room for the three companies to co-exist with one another, but I would also expect that PSA retains its market lead over time, barring any unforeseen circumstances.
In coins, PCCG competes with Numismatic Guaranty (NGC), Indepedent Coin Grading (ICG) and ANACS. As with cards, PCCG is in a leading market position along with NGC. Thus, I would say that they have a fairly wide moat in both coins and card grading.
If a major competitor wanted to take significant market share from PCCG and PSA it would be challenging. However given some of the concerns from collectors in regards to grading companies, I do think there is a level of risk in the fact that any internal wrongdoing could obviously lead to some severe mistrust of third party graders, leading to an opening for more competitive opportunities.
Ultimately, I also believe that all of the grading companies are missing out on investing in newer forms of grading technologies that would help alleviate the issues we’ve seen in regards to trimming and inconsistency with grading.
How Do They Grow From Here?
PSA claims in investor materials that it believes that ‘less than 10% of vintage coins and less than 10% of vintage trading cards have been authenticated and graded by independent providers of authentication and grading services’. Also they believe that they have graded less than 10% of the potential market for autographs in the US’.
I’m not sure how they calculate this, but if it includes all of the available population of all vintage cards (which I suspect it may) then the numbers would be really far off the mark. The reason being is that it might possibly include some common cards that sell for say $5-$10. No one is going to get those graded when the average cost to grade a card is up over $17.
I do think that vintage grading still likely has some decent runway–I know that there are still plenty of ungraded cards out there, but ultimately there does become a point when grading in vintage has probably reached its peak. Maybe not there yet, but I think that maybe ten years out it might finally reach a point where there is limited growth in grading of vintage cards.
The good thing is that collectors are spending money to get new cards graded, often in search of that perfect 10 Gem Mint card pulled directly from a pack. I would say that as long as collectors remain interested in card collecting as a whole, the grading for new cards should remain robust.
CEO Joe Orlando noted this on the most recent quarterly conference call
" Turning to PSA, the division keeps growing as renewed interest in modern card collecting has been driving our submission volumes to new levels. As much of a contributor as Pokémon has been to PSA, it hasn't been the main driver of the business. That driver is the market for PSA-graded modern sports cards. This rejuvenated segment of the market is more robust that at any point in our Company's history as younger generations of collectors are becoming more active. In fact, around 80% of our approximately 1 million count backlog are of the modern variety at PSA and the vast majority of that 80% are sports cards. This is extremely encouraging not only for PSA but for the industry at large."
What Are The Risks to Investing in CLCT
I see three risks to an investment in CLCT.
One, is trust. Collectors have lost some trust in the third party graders. Can they restore that trust? My guess is that PSA likely wasn't negligent in the recent card trimming scandal, but if there is any word that they were aware of the trimmed cards that they graded, there will be some significant trouble.
In addition, PSA has a stated warranty on cards (and coins) that it grades. There is an outsized chance that authorities require PSA to compensate collectors for the cards that they failed to acknowledge were trimmed.
PSA Grading Warranty
Under the terms of the warranty, in general, if a coin or trading card that was authenticated or graded by us later receives a lower grade upon resubmission to us for grading, or is determined not to be authentic, based on our opinion, we will offer either to purchase the coin or trading card at the current market value at the originally assigned grade or, instead, at the customer’s option, to pay the difference in the current market value of the item between its original assigned grade and its lower grade.
A second risk to an investment in CLCT is the health of the economy. A recession of sorts would likely lead to lower expenditure on cards and coins and ultimately less demand for third party grading. As noted prior, the diversity between cards and coins is a strength as the two markets don't necessarily move in tandem. Coin grading has been much more volatile whereas card grading has been showing good consistency in growth.
The last risk I see is any increase in competition. I would say that PSA could be disrupted by a new grader that provided some sort of image recognition technology that almost takes a human grader nearly out of the equation all together. Still a longshot, but the potential risk is something to think about.
What Is The Company's Valuation?
CLCT currently has a market capitalization of $263 Million. As I noted earlier they generated about $73 Million in Revenues last year, earning $15 Million before taxes, thus we could say that the stock trades at around 18x operating earnings.
They also have around $20 Million in cash with zero debt so we would say that CLCT has a 'strong' balance sheet. Often some investors will subtract the cash from the market cap to get a better picture of the multiple, so at $263 Million - $20 Million = $243 Million, the multiple is more like 16x earnings.
That's a reasonable multiple to pay for a company that has been growing revenues and improving margins like CLCT has. The coin business has held back growth in recent years but showed some signs of life in the recent quarter with a 21% year/year increase. Card grading revenues continued to show momentum with a 35% year/year increase.
Thus, if this can keep up, the current multiple for CLCT would appear reasonable. Note that the entire S&P 500 trades at around 19x. Oh, I also forgot to mention that CLCT also pays a dividend, earning investors about a 2.5% yield per year.
Note that if you had invested into CLCT stock 10 years ago, you'd be in roughly the same position as if you had invested in the S&P 500. So, it has been an OK investment, however with a lot more volatility, as shown below.
The Future Investment Potential For CLCT
Collector's Universe had a bumpy ride to where we are today, but yet the company's current growth trajectory looks sustainable as the need for continued authentication and grading should remain robust. The company will likely remain volatile as coin grading revenues are often lumpy from year to year, but card and autograph grading growth should ultimately overtake coin revenues in future years.
Global expansion is a growth wildcard and the company appears well capitalized. There are risks as with any investment and trust is a concern, especially given some of the latest card trimming scandals. The current business looks solid and fairly valued, likely a good investment for anyone that believes PSA will have a continued leadership position in the grading space for the coming years.