Here's our bull case on Ancestry.com.
Potential: 14 million subscribers x $220 annual revenue per subscriber = $3 billion-plus revenue on the top line. The firm has 1.6 million subscribers currently and a top line expected to be about $400 million in 2011. Viewership for their sponsored television program 'Who do You Think You Are" is currently around 13-14 million viewers. There are 163 million households in all of their addressable markets. Therefore, 13-14 million subscribers and the resulting $3 billion revenue stream represents only 9% total penetration of their addressable markets. Reasonable.
Subscriber acquisition costs = ~$70 per subscriber (last quarter). Incremental margins are therefore 70% on each new subscriber: [(220-70)/220]. As mentioned before, the company receives about $220 per subscriber annually. Operating margins in the first quarter were only 15%, leaving a long runway for operating leverage.
What happens when growth and leverage occur over the long-term on this name: $3b top line at about 30% operating margins (conservative, as incremental subcriber could drive even better performance/margins) -- let's also assume a 35% tax rate as well. It results in roughly $600m annual long-term earnings potential [(3b*0.3)*(1-.35)].
By extension, current $1.8 billion market cap divided by $600 million earnings represents a peak/long-term P/E ratio of just 3 times. Assume market multiple is 15, we will wait patiently for this 5-bagger from current levels. Or if we're being too optimistic with our subscriber forecasts, a double or triple. Total subscribers grew 33% in the last quarter.
Let's look at this another way. Equity free cash flow was $18 million in the first quarter -- let's assume $80 million for the year on expectations of $135m-$140m in adjusted EBITDA per management's guidance. A simple growing perpertuity at 5%, assuming a discount rate of 10% gets you to about $1.6 billion in equity value or about $35 per share. That's if free cash flow only grows 5%!!! Last quarter, free cash flow was up over 60%; revenue is expected to grow over 30% this year.
What's more, the company's business model is solid. The firm benefits from a network effect -- the more subsribers that build out their trees on Ancestry.com, the higher barriers to entry for a competitor. Family history is never finished, and as subscribers invest a significant amount of time exploring their family's ancestry, continuing their subscription and retaining their trees and information becomes a no-brainer. Churn rates for users longer than 2 years is less than 2%! Plus, these users aren't only interested in building out their trees, but they are interested in learning about the where/when of their family's past. And when they find out an ancestor may have served in the Civil War, WWI, or the Revolutionary War via pension records or draft registration cards, they really becomed hooked (for life). Try it out for yourself -- you'll really be surprised what you're able to find. I know I was.
And one can't argue with the merits of a cash-rich, subscription-based business model. It's the best type out there, in our opinion.
Worse-case scenario, we're looking at a stock that's worth $35 per share -- best case well over $100 per share. Base case: $55. The skeptics are continuing to rule the day in setting the market price on this firm, which is why we like it so much. I hope it doesn't go back down to $35.
No one can time the market, but we'll take the opportunity to invest in a potential five-bagger over the long-term, with little downside risk.
Thanks for all your work! I first got interested in ACOM when a friend mentioned that he'd been a subscriber for many many years and had traced his roots back to France in the middle ages. At that time ACOM looked inexpensive (as it still does), so I invested. As is typical, I took a 1/3 position and then added over time.
You get the US only databases for I think $130 per yr, I would suggest most subscribers go for that, not the world sub at $220.
I think it's a buy about at this level, and if it ever got back up into the 30's, a sell.
I do think there are varying opinions on how much growth Ancestry.com can achieve during the next several years.
However, let's look at Ancestry.com this way. What's the company worth if what the bears say is true (no growth after year 2, flawed business model, etc). This is where things get really interesting -- there's significant upside with little downside risk at these price levels. In order to achieve little to no growth, the firm would likely turn off marketing and ad spend, resulting in earnings explosion.
Specifically, in a no-growth scenario, we're looking at over $3.50 in earnings power NEXT YEAR (2012), ex marketing and advertising. Please see the P&L below. The takeaway here is not that the company is going to reduce marketing and advertising expense to 0 in 2012, but instead the tremendous opportunity it presents in terms of earnings and cash flow generation when the firm turns it down after the high-growth period -- whether it be 5, 10, 15 years from now (or after year 2 if you're a bear).
Here's an example P&L with no marketing and advertising spend - the bottom line is very impressive. Please do not assume that this is my base case. I'm simply illustrating a point revealing the tremendous earnings potential in this cash-rich business model. Please forgive me for the presentation of the data, as my model would not paste easily into the entry box.
Ending Subs 1,813,383 2,176,060
YoY % Growth 30.0% 20.0%
Sub Rev 375,325 459,398
YoY % Growth 33.3% 22.4%
Prd Rev 24,021 27,794
YoY % Growth 24.7% 15.7%
Tot Rev 399,346 487,192
Tot Rev YoY% 32.7% 22.0%
Sub COGS 56,711 66,379
SubCOGS%SubRev 15.1% 14.4%
Prd COGS 7,470 8,726
PrdCOGS%PrdRev 31.1% 31.4%
Total COGS 64,181 75,106
TotCOGS%TotRev 16.1% 15.4%
Gross Prof 335,165 412,086
Gross Margin 83.9% 84.6%
Tech and Dev 56,707 68,207
Tech/Dev%TotRev 14.2% 14.0%
GrossSub Adds 1,494,546 1,450,706
Net Sub Adds 418,473 362,677
Sub Acq Costs 84.00 85.00
Total Cancel 1,076,073 1,088,030
Mark Ad Spend 140,029 0
Gen & Admin 42,291 49,903
YoY % Growth 19.5% 18.0%
Tot SG&A 182,320 49,903
Tot SG&A%ofrev 45.7% 10.2%
Amort of intang 17,080 17,080
Tot op expense 256,108 135,190
Income from op 79,058 276,896
Op Margin 19.8% 56.8%
Int expense -428 -428
Other income 0 0
Income bef tax 78,630 276,468
Tax expense -27,717 -96,764
Eff tax rate 35.3% 35.0%
Net Income 50,913 179,704
Dil Shares Out 50250 50250
Diluted EPS $1.01 $3.58
Again, this P&L is for 2011 and 2012; 2011 includes marketing and advertising expense and 2012 does not. The firm's current $42 price per share divided by ~$3.58 earnings per share in 2012 (ex mark & ad) = under 11 times earnings. Translation: the company is fairly valued right now only if it fails to attract any new subscribers (assuming a market multiple meaningfuly below 15 is justifiable for no/low growth company). That said, an argument can be made that given its cash-rich biz model, it could still warrant a 15 times multiple even with no/little growth. 15 x 3.58 = ~$55. We've run the valuation across a number of different scenarios now -- PEG below 1; bear-case P/E below 15 times next year; DCF basis over $55 per share, etc.
The shorts are betting on a thesis that has already been proven wrong via valuation. Having a conversation about growth is just icing-on-the-cake for the longs. When we're talking about growth, we're talking about whether this is a double, triple, or more in stock price from these levels.
Fair disclosure: Including marketing and advertising expense of $138 million in 2012, we expect the firm to earn over $1.75 per share.
Ancestry.com's has minimal downside risk with significant upside potential.