The price of a New York City (NYC) taxi medallion, or a “tin”’ as the industry has taken to calling them, has risen from $10 when originally issued in the 1930s to well over $1 million today.
That’s about a 15.5% annualized return over the last 80 years, a solid five points better than the S&P 500’s total return (including dividends) over the same period.
And that’s just on face value. Rented to a driver, the return is even higher. According to NYC’s Taxi and Limousine commissioner in a recent Bloomberg interview, the rental rates are around 3 or 4% of face value these days. Those combined returns are enough to make even Warren Buffett blush.
Source: 2014 New York City Taxicab Fact Book
Does that mean we’ve all been doing everything wrong with stocks and bonds? Is the taxi medallion really the perfect investment?
In the back of a cab on the way to JFK airport Monday night after a busy day hustling around the city meeting with start-ups and industry partners, I got to chatting about taxi medallions—a subject about which I knew far less than I realized until my wife started asking lots of questions. That quickly evolved into a discussion about the characteristics of a great investment.
Why invest in biotech start-ups? Why risk money on 100-gigabit fiber-optic equipment providers? Why buy venture debt when I could just buy a taxi medallion or two instead?
Her ability to get right to the center of things is one of the reasons I love her… but it drives me up a wall too. So, I got to explaining… making such decisions involves understanding that any investment is only as good or bad as your alternatives.
So how does the medallion do, comparatively? Let’s check a few of the criteria we look for in any investment and see how it stacks up against another of my favorite investments in the current climate of weakening stock returns (the average S&P 500 company was down 9.3% this year as of last week, even though the Index has been buoyed by three or four mega-caps) and less-certain interest rates: venture debt.
The growth capital market, as it’s also called, is just a twist on the classic game of mezzanine financing, where you lend money to businesses stuck between the worlds of smallish bank loans and having enough of a presence to make the public bond or stock markets work. These mid-tier companies are often most in need of working capital and yet have the hardest time getting it, which opens up an opportunity for mezzanine lenders to provide money on very lender-friendly terms (usually on a variable rate basis with equity kickers or convertibility). The problem is, these particular mezzanine lenders focus very specifically on the technology markets, where their detailed understanding of the industry and close connection to venture capital firms provide them with an advantage in finding good quality borrowers.
Both of our prospective investments obviously have a compelling economic value. The medallion is an option on running a constrained business with high built-in demand. Venture debt is a promissory note against the revenues of a fast-growing company, with its equity as collateral. But just how easy would it be for us investors to get involved with either game?
Scarcity: One of the reasons that taxi medallions have proven so valuable is that right at a time when demand escalated as New York’s business economy and tourism draw were both increasing, the supply of taxi medallions has been relatively static. There are only 13,473 medallions authorized in the city, a number that has barely changed since inception eight decades ago, and is actually down from the original 16,900 issued. (Interestingly, the population of NYC itself has edged up only 1.2 million since 1930.)
However, a taxi medallion isn’t like a bar of palladium. Its scarcity isn’t determined by a random collision of celestial bodies a few billion years ago, but is largely controlled by artificial constraints, namely government regulation. The New York state government, which issues the licenses to the city, has had to resist the urge to increase the volume of taxis as a way of raising revenues—remember that it gets a percentage of all taxi fares in the form of taxes—for over 80 years now. Very easily during that time, regulations could have changed to make the medallions far less valuable.
But it hasn’t happened… yet. So far, the supply of taxi medallions has badly trailed demand, and thus prices and yields have remained strong.
In contrast, venture debt is more driven by market forces than the medallion industry. For many years now, deterred by their own cascading series of bubble blunders, banks have been getting progressively less aggressive in their loan portfolios. That means many companies in many industries have had a harder and harder time borrowing money to grow their businesses. As that has happened, the demand for mezzanine lending has steadily grown. A cottage industry that once only served really obscure and risky markets has morphed into dozens of sector-specific companies with a deep understanding of their customer bases.
But when you closely examine any one sector, as we’ve done with technology, you find what is still a very small market, with only half a dozen companies serving only a few hundred customers every year. And the demand always far outstrips the supply, just like with medallions. So, the lenders have the ability to be very choosy about the terms they offer and whom they offer them to. This has allowed the industry to command high interest rates—well above 10% on average—even in today’s low-rate climate. Not only that, in most portfolios the notes are 95% or more in senior secured positions and often have convertibility to equity at preferred prices if the stock of the borrower takes off. Those kinds of terms are available because what’s on offer is scarce in a high-demand environment.
So we have to call this first category a draw, methinks:
- Taxi Medallion +1
- Venture Debt +1
Scale and Diversification: When I was about 13, I wanted to get a new video game, so I sold one of my baseball cards—a Jose Canseco rookie card—for about 100x the dollar I paid for it just a short time earlier. Unfortunately, the rest of my cards were worth exactly zip. Apparently no one was interested in a Jim Palmer rookie card at the time; if only I’d waited until he ran out of money and starting flogging loans on TV, so someone would have known who he was… So there I was, flush with $100 in cash and no other options to raise the balance. Dreams dashed. That’s because there was a limited market for my inventory.
Taxi medallions are similar. Yes, the prices are high, but there are only so many investable areas, and only so much quantity. Cities like San Francisco charge a fixed price for their medallions, and haven’t changed it in years. If you had significant money to invest, it would take a lot of time to gain any level of diversification.
Venture debt, on the other hand, is pretty global. Most companies in the business have hundreds or thousands of different loans in their portfolios, and are always out looking for more. There are choices for multiple managers to invest in, and within their portfolios, there’s a good deal of diversification. Plus, the industry has the ability to absorb tens of millions in fresh money at a time, which it frequently does with new capital raises.
Altogether, the opportunity for scale is much larger in venture debt:
- Taxi Medallion 0 = 1
- Venture Debt +1 = 2
Cost of Access/Barrier to Entry: Buying taxi medallions is a pretty simple process, at least in New York, since they all must be sold through the central intermediary of the New York City Taxi and Limousine Commission. When there’s enough inventory, it schedules an auction and posts the details online. Interested parties submit bids in advance and await the auction result. (In order for a bid to be valid, it has to include financing or asset verification for at least 80% of the purchase price from a NY licensed bank or credit union.) In the last auction of mini-fleet medallions (which are sold only in pairs), the lowest winning bid was over $2.2 million. (The individual medallions go for less, as most have a restriction that the owner must be the operator, which makes them worthless for an investor.)
So, unless you have access to a multimillion-dollar credit facility, it can be tough to get into this market. But there’s at least one way for the average investor to get to it: Medallion Financial (TAXI), a publicly traded company whose primary business is lending money for the purchase of taxi medallions. However, the company has been diversifying of late and only 56% of its managed loan portfolio is in medallions these days, down from 63% at the end of the previous year.
Medallion Financial is organized as a business development company (BDC), which is a corporate-tax-exempt, publicly traded stock. Because it pays greater than 90% of its income as dividends, those dividends are not double taxed. BDCs are usually financial companies, often in the business of loaning money for various purposes. They raise capital from public market investors via sales of stock and deploy that capital into funding loans—often in niche industries that are unserved or underserved by more traditional banks. That’s why the BDC is a perfect format for something like Medallion Finance: it allows investors to access this high-barrier market much more easily.
This is the path we take into the venture debt markets, which have been vastly underserved. When companies are pre-IPO and need capital to buy servers and expand operations but don’t want to further dilute shareholders, they turn to the venture debt markets. Specifically, they look to a handful of specialized lenders, companies like Hercules Technology Growth Capital (HTGC), which provide funding to companies that are otherwise ignored by the banks. All such publicly traded companies are BDCs too, managing their loan portfolios and distributing the earnings right back to shareholders without any corporate tax. Share prices are low and dividend yields quite high, as this largely undiscovered sector has chugged along nicely since inception a few years ago.
But unlike the medallion market, there are a number of choices in the technology growth capital markets for average investors, and even more for the accredited crowd. That’s because the loan portfolios of just the public BDCs total more than 10x that of Medallion. That market is still very small in the grand scheme of things, but it’s big enough to provide a lot of different opportunities for investors to choose from—not just one company.
So I have to give this category to our venture debt investments too, based on the sheer amount of choice available in easily traded BDC stocks.
- Taxi Medallion 0 = 1
- Venture Debt +1 = 3
Liquidity: As many a former Antiques Roadshow guest can probably attest, an investment whose value cannot be realized is not worth anything. No matter how much the market or some expert says your asset is worth, it doesn’t matter if you can’t actually sell it.
Taxi medallions, for a million-dollar-plus market, are actually surprisingly liquid. Looking at the NYC market again, approximately 300 medallions, or 2% of the float, are sold each year. And as the auction participation and high watermarks for price have shown, it’s not for lack of bidders that the number is low. It’s that most owners see the value and are holding, driving prices higher and higher.
As for TAXI’s stock in the BDC, it’s a relatively thinly traded equity for being a $13 stock. Only about 190,000 shares trade on average every day, which means there’s about $2.5 million in daily liquidity. If you’re looking at a relatively small investment, that’s sufficient to make it easy to buy and sell near the market. Even if you were planning to put a few million dollars into the category, over a few weeks you could easily do so without affecting the market price—something that cannot be said for the medallions themselves.
The public venture debt investments, however, are far more liquid, with Hercules alone trading 4x more shares and value per day than Medallion on average. Add in the volume of other players and you’ll find about 10x the market for venture debt as you will for TAXI.
So that’s one more for venture debt:
- Taxi Medallion 0 = 1
- Venture Debt +1 = 4
Stability, and Political and Economic Risk: Sure, that governmental effect on the price is one of the key factors of concern for the medallion investor. But there’s also a macroeconomic headwind to consider, created in part by politics: the NYC economy lives and dies by finance. Without all the investment banks, the city quickly deteriorates, as we saw in 2000 and in 2008. In spite of those temporary blips, the price of the taxi medallion has held up well because of the limited supply. In fact, the average price never really softened—liquidity just slowed for a bit.
A more protracted downturn would, of course, be a very different story. Any long-term decline in NY residents, tourists, per capita income, or similar measure would quickly decrease usage of one of the city’s more expensive transportation options. But the average annual political and economic change is unlikely to dent this stalwart industry. The TAXI BDC does diversify your risk across multiple cities… but only a little. Its portfolio includes Chicago, Newark, Boston/Cambridge, and only a handful of tokens elsewhere, so don’t think you’re exactly getting a slice of the global cabbie pie. If it would expand to include London, Paris, Taipei, and Hong Kong, then maybe it would help. Right now, though, if the big banks suffer, so will this business—albeit with some lag.
Still, I’d take that risk over a lot of other income portfolios I see nowadays, laced as they are with scary fixed-interest-rate bonds and little in the way of upside potential. I think there’s a good chance the NY taxi medallion will fail to perform as well over the next few years as it has over the last decade, but based on its historical stability, I have to give it credit. The medallion has held its value steady through every major recession this country has seen since it was introduced (thanks in part to that low liquidity reducing the volatility).
How does venture debt stack up on this one? To grasp that, you have to realize that it is to some degree a market created out of crisis. The reluctance of banks to get in the game is a side effect of both their own low appetite for risk and the regulations that seek to further curb their behavior. Banks have no interest these days in investing in anything difficult to understand. If it breaks the usual mold, forget it. And so, when it comes to specialized industries like social networking—which is just one small example of what you’ll find in these portfolios—the dedicated practitioner not only has a decided advantage in due diligence, he also has very little competition. That’s great on the upside, as you can demand much more of your customers.
But we’re talking stability… and here we’re dealing with plenty of risk, of course. These businesses could go under. On the other hand, we’re not talking about early-stage start-ups here. A company rarely qualifies for venture debt unless it’s already profitable or very close. Nor are we talking about some kind of “peanut butter” bond portfolio with an equal spread of everything out there, assembled by algorithm instead of a trained practitioner. No, in the venture debt world, managers get to be choosy and can select the best loans possible.
That’s why the default rates for these BDCs tend to be very low for debt that would otherwise be rated “junk” on the bond market—about 200-250 basis points lower in our experience, when looking at the best players out there.
During a severe economic recession, there will of course be struggles for the category, just as there will for the taxis. But altogether, the risk profiles of both are much lower than they might appear at first glance.
So I have to call this one a tie, and give them each a point. Neither is particularly vulnerable, except in a protracted downturn.
- Taxi Medallion +1 = 2
- Venture Debt +1 = 5
Portfolio Quality and Upside: Of course, the rate of return is what ultimately matters for an investment. No matter how stable, liquid, or accessible a market is, if you cannot turn a profit, it’s meaningless.
The NYC taxi-medallion market directly returned a very impressive compound annual growth rate (CAGR) of 19.5% over the past decade, plus a 3-4% income stream on top. However, after a hockey-stick-shaped bull run like that, I have to wonder if it can continue to post those kinds of numbers. Personally, I doubt it. And it’s all but off limits to the likes of you and me directly, so we have to use vehicles like Medallion Finance to access to the market instead.
TAXI stock has returned impressively as well in the last few years, with a current yield of about 6.9%. That’s down a bit from the average for the last few years, part of a steady decline since inception. So the payout isn’t spectacular on its own, but it comes alongside a 5.5% CAGR on the stock price over the last decade. Reinvested along the way, that’s led to a ballpark 22% CAGR over the last decade. So we can chalk this one up as a hit too, even though it’s deteriorating a bit right now with the expansion of the company beyond medallion financing.
So how do the growth capital companies stack up? Pretty darn good.
Let’s look specifically at Hercules. Now, I can’t go back a decade, as these companies are pretty new to the world. But we do have a few years of history to go on. And by that measure, we’ve done quite well. We originally recommended HTGC in the August 2011 edition of Casey Extraordinary Technology. At that time it was trading for $9.35 a share. Since then we’ve gotten $2.68 in dividends (the current yield is about 8.9%), and shares have climbed to $14.20 in recent trading, as the profits of the fund have steadily increased. That’s a 79% return in 3.5 years, or more than 25% CAGR. Not bad if I do say so myself.
Those are all hugely impressive growth rates. All three investments have far outpaced the decade average return for the DJIA or S&P 500. So once again, we’re looking at tie… for a grand total score on our simple comparison of:
- Taxi Medallion +1 = 3
- Venture Debt +1 = 6
Riding a Shooting Star
Sure, buying and holding a taxi medallion in NY would have been a darn good investment, had your grandfather had the foresight to grab one. Owning one was like hitching your wagon to the back of a shooting star, making a little cash while you let one of the most vibrant city economies in the world do the hard work. But today, if you want to get in that game, you need some serious capital to devote to a single asset class. You have to compete for a limited asset against dozens of other bidders at a time. And even then the long-term return is uncertain after such a historic run-up.
If, instead, you want to bet on the next set of rising stars, consider looking at venture debt. It offers the predictability of the bond market—where price discovery is better and values more stable than in any other market in the world—coupled with the upside potential of the high-tech start-up world, thanks to the senior secured status of the loan. It’s more liquid, more diversified, and offers strong market-beating returns just the same.
To me, while the taxi-medallion investment is much better than I think most would have considered, venture debt is still the clear winner.
So, which mezzanine lender is the right one to buy today? Grab a copy of our exclusive venture debt getting-started guide, Earn 10% Yield with Growth Capital, for a list of our top investment choices and why.