|Shares Out. (in M):||83||P/E||0||24|
|Market Cap (in $M):||8,809||P/FCF||0||17.8|
|Net Debt (in $M):||76||EBIT||0||585|
|TEV (in $M):||11,323||TEV/EBIT||0||19.4|
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The market has left a $20 bill with IAC’s logo on the ground. IAC today consists of three groups of assets: its stakes in publicly traded MTCH and ANGI and a collection of other assets I term the Stub (or “StubCo”). The current price of IAC less the value of its stakes in MTCH and ANGI ascribe a negative value to StubCo which is worth nearly $20 per share. The StubCo can be bought for -$1.60 today, for total return potential of $21+ per IAC share (+20%, with low market risk). Before delving in, the basic investment structure consists of:
Long 1x share of IAC
Short MTCH (2.5559x shares per IAC share)
Short ANGI (4.958x shares per IAC share)
The negative Stub value might make sense if IAC were a cash burning HoldCo with no other assets, but that’s not the case. The StubCo actually owns $10+ of non-operating assets as well as businesses generating nearly $60m of EBITDA and positive free cash flow. The table below outlines the implied StubCo price and valuation.
Together, the StubCo has $7.80 cash, $3.08 in real estate and VC investments (collectively $10.88 of non-operating assets) and operations worth close to $9 per share. Yet, market prices suggest the StubCo is worse than worthless: it is destroying value at IAC.
This situation has existed since the announcement of the ANGI Homeservices deal in May, but last week management validated the opportunity by calling it out in IAC's shareholder letter (link: http://bit.ly/2vtm79g). The company describes the situation well (for more color on IAC’s segments read the current and past IAC letters; Joey Levin and the team do a great job outlining the strategy for each segment):
“…if a bandit walked into our offices and said, “Give me $300 million dollars and every business in IAC besides your stake in MTCH and ANGI Homeservices, or I’ll shoot,” we’d actually be wise to accept his proposal, and not just to save our lives. Why? Because if you believe the market’s view that these assets are not just worthless, but are actually depressing the overall value of IAC, by giving them away for nothing we’d unlock in excess of half a billion dollars in value even if we didn’t receive so much as a nickel for the assets themselves. And yet, the bandit would walk away with Vimeo (with 828,000 paying subscribers and revenue accelerating), our Publishing business (which cumulatively ranks as a top ten publisher on the web – profitable and growing), our Applications business (which will generate in excess of $100 million in operating cash flow this year), and everything else, plus $300 million in cash to fund corporate overhead for years. It’s an absurd outcome given that these businesses are clearly neither worthless nor even a cash drain – they are in aggregate profitable and growing, but such is the message from the market right now.”
While investors can debate the values of MTCH and ANGI, this hedged position is economically indifferent to their respective valuations. If both MTCH and ANGI dropped to zero, the loss in the IAC long leg would be offset by gains in the MTCH/ANGI shorts. Another way to conceptualize an investment in StubCo is to view it as buying IAC after the complete spin-offs of MTCH/ANGI which we expect to happen over the medium term. When that happens, investors will be left with a collection of cash and cash flow generating assets. Unless one believes these would trade at a negative value, an arbitrage exists.
Two upcoming catalysts will drive the spread closed and force the revaluation of StubCo: (1) closing the ANGI Homeservices deal in October and (2) announcing plans for the tax-efficient monetization of MTCH by year-end (likely a spin-off). The StubCo value should turn meaningfully positive as the operating assets continue to outperform.
StubCo’s Non-Operating Assets
Calculating the implied StubCo price and capitalization requires backing out the consolidated debt and cash at MTCH as well as the value of the ANGI and MTCH shares. The table below illustrates the StubCo price and net cash calculations:
IAC consolidated debt above includes $40m of pro-forma debt at ANGI Homeservices. IAC’s actual debt is $1.573 Bn.
As of 08/03/17, IAC owns 213.9m shares of MTCH (latest 13D/A: http://bit.ly/2fnL93J).
To create a custom index for the Stub price use: IAC price (-) MTCH price x 2.5679 (-) ANGI price x 4.958.
IAC doesn’t explicitly breakout the value of its building at 527 West 18th Street in Manhattan, but we estimate book value is near $135m. The Frank Gehry-designed building was completed in 2007 before Google acquired its New York headquarters a few blocks away and the neighborhood became the epicenter of New York’s tech industry. I have heard from other investors that the building has been appraised for over $300m.
IAC’s VC investment portfolio is held on the balance sheet for $122m. The details of the portfolio are not publically available, but the company has confirmed it has a small early-stage investment in Pinterest that may be undervalued.
StubCo’s Operating Assets
StubCo’s operating businesses are varied and appreciating in value. The segments outperformed expectations in the most recent quarter and IAC’s latest FY guidance increased projected StubCo EBITDA to $33m-$58m, from prior guidance of $14m-$45m. Vimeo shows the most promise and has the potential to be IAC's next billion dollar business over the next 3-5 years.
StubCo Summary Historical Revenue and EBITDA
Video consists of Vimeo, a subscription-based online video management platform (the growth driver), DailyBurn, CollegeHumor and Electus, IAC’s production studio.
Vimeo: Vimeo’s 828,000 subscriber base is growing 20%+ y/y with average subscriber payments of ~$100 annually. The business should generate $105m of revenue this year and is on a path to grow to $130m+ revenue next year. Churn figures haven’t been explicitly provided, but management has said retention rates are high and continue improving. Consumer and corporate customers use Vimeo to create paywalls around content, monitor detailed viewer statistics, control viewer access, collaborate, and customize the presentation of content.
Vimeo generates nearly 60% gross margins and, while operating margins will remain depressed through 2018 as IAC invests in feature development (live video), it is easy to see a path to profitability as average annual subs exceed 1m exiting 2018.
The rest of the Video segment includes a profitable, but lumpy video production studio called Electus which has produced a few notable shows including Flaked, Jane the Virgin and Marco Polo. DailyBurn and CollegeHumor are relatively small pieces of the Video segment.
Valuation: SaaS platforms like Vimeo are typically valued at high multiples of revenue (5x-10x). I have used a 1.5x-2.0x multiple on the segment implying $4-$7 p.s. of value ($385m-$550m). To point out the potential, Vimeo could become a $50m-$90m EBITDA business over the next five years as it reaches 2m subs. A business of that scale would warrant a $1 Bn+ valuation ($12 p.s.). I use $7 in my base case.
The applications segment is a collection of software, browser extensions, and apps. The majority of revenue is generated by browser add-on search referrals to Google. Under a new agreement with Google that became effective in April 2016 (expires March 2020), Google’s share of revenue increased which caused a material drop in Applications revenue and profitability in 2016. The business has lapped the negative impact and is now growing modestly and generating 21%-23% EBITDA margins.
There are bright spots within Applications, namely a collection of for-purchase and subscription apps developed by IAC’s app development company, Apalon. The majority of Apalon apps offer popular functionality for $0.99 (emoji keyboards, alarm clocks, calculators), but with the recent launch of “Coloring Book for Me”, Apalon has expanded into higher margin, higher recurring revenue subscription apps. Mobile apps and Slimware (a desktop cleaning utility) now account for 15% of revenue (~$85m annually) which is all generated outside the Google agreement (growing 40% y/y, up from 5% non-Google revenue—$40m—in 2015).
Valuation: At 4x EBITDA, Applications is worth $6.50 per share ($545m). I use a low multiple given the uncertainties around the Google relationship after 2020 (although the business won’t go away under subsequent agreements and management has a track record of successfully right-sizing the business to generate cash flow).
IAC’s Publishing business operates the legacy About.com website (now dotdash.com), Investopedia, Dictionary.com and The Daily Beast. IAC’s Publishing segment is also dependent on revenue sharing with Google which significantly impaired performance in 2016 (revenue was down 41% y/y). IAC is beginning to lap the negative impact and the business is EBITDA positive.
The company recently turned About.com into a portfolio of six websites focused on different content verticals: health & wellness, home improvement, gadget news, personal finance, trip planning and general daily news. The recent change has not had a meaningful impact on revenue or EBITDA yet, but management is optimistic in the early traffic trends. Publishing is seeing encouraging green shoots that could driver future growth and decrease the dependence on Google.
Valuation: I value Publishing at 4x EBITDA ($0.70 p.s., $50m) given the segment’s similar reliance on Google. The segment should generate ~3% margins this year with potential to expand to ~5% margins next year as Dotdash monetization improves.
IAC pays ~$60m of annual cash corporate expenses (and ~$60m of corporate stock comp). The IAC team has a long track-record of value creation and the corporate expense has, historically, been money well spent. Also, the dilution from stock comp at the corporate level has been muted in the past as IAC has bought back shares at very attractive valuations. As the Q2 Shareholder Letter points out, the $365m of shares IAC has repurchased since the MTCH IPO over a year ago, have more than doubled in value. The company still has 8.6m shares remaining in its share repurchase authorization.
Valuation: I use a 7.0x multiple on annual cash corporate expense for a value reduction of -$5.00 p.s.
Putting this all together, the StubCo operating businesses are worth about $8.80 p.s. ($735m). The table below outlines the StubCo sum-of-the-parts valuation*:
*Note: to calculate the implied equity value for all of IAC, add the value of 213.9m MTCH shares ($4.02 Bn, $48.25 p.s.) and 413m ANGI shares ($4.92 Bn, $59.10 p.s.) to $19.71 (= $127.06 p.s.).
Quick Background on IAC’s MTCH and ANGI Stakes
A number of VIC write-ups do a good job describing IAC as Barry Diller’s internet conglomerate with an impressive 14% annualized return since inception in 1995. The company has a great track record of growing and spinning-off assets including EXPE, TRIP, TKTM, TREE, ILG, HSN, MTCH and ANGI later this year.
Today, IAC’s two most valuable assets are its stakes in Match Group and ANGI Homeservices. IAC’s 213.9m MTCH shares were retained after a partial IPO of Match Group in November 2015 and IAC’s ~413m ANGI shares are a pro-forma holding that IAC will own following the merger of HomeAdvisor with Angie’s List (announced in May, expected close in October, investor presentation here: http://bit.ly/2eLp0vU)*. The StubCo’s other assets are addressed in detail above.
*See the ANGI Homeservices investor presentation and management comments for more details on the deal. IAC guided to owning ~413m ANGI shares in the latest investor letter.
Isolating the StubCo requires going long IAC and shorting out the proportion of IAC’s value derived from its MTCH/ANGI stakes. The table below illustrates a hypothetical position with $1m long IAC and the returns under various scenarios.
How the Spread Closes: The Stub should be insulated from price changes in MTCH and ANGI. Intraday the Stub can swing +/- a few dollars, but the spread has started to narrow since the beginning of July and I expect it to close completely before the ANGI Homeservices deal closes in October and/or when IAC announces the spin-off of MTCH. ANGI’s valuation is arguably expensive at 24x 2018 EBITDA and, with large insider selling last week, it is likely the spread closes through a combination of a decline in ANGI and a rise in IAC’s price. IAC should benefit as the StubCo assets continue outperforming expectations.
Tax Drag: IAC prides itself on tax efficient deal structuring; it has been a pillar of the IAC playbook and a key contributor to the company’s strong annualized returns. Management has indicated it intends to pursue tax efficient methods of realizing the value of its MTCH and ANGI stakes (i.e., through spin-offs).
Cost of Borrow: The annualized borrow cost is ~2.7% on MTCH and ~2.9% on ANGI for a fully hedged cost of ~2.8% on IAC. On an annual basis, that is a drag on returns, but with a couple of near-term catalysts it is likely StubCo will revalue significantly by year-end so the realized borrow cost will be much lower.
True arbitrages rarely exist. When they do they tend to involve crummy assets that are losing money and require investors to estimate how much cash burn is tolerable for the investment to be interesting. In this case, you not only get a sizeable amount of cash and cash flow positive operating assets, but also the investment vehicle of Barry Diller, one of the greatest value creators in corporate America. There are also clear catalysts for realizing the compelling 20%+ return over the next six months as IAC completes the ANGI merger and announces monetization plans for MTCH.
Dilution from IAC stock comp: IAC’s annual $120m stock comp expense is considerable. Taken at immediately, fully dilutive value that equates to ~1%-1.5% annual dilution. In reality, comp is deferred over multi-year periods and is less dilutive under the treasury stock method. IAC has an active buyback that has mitigated share dilution over time.
M&A: IAC has signaled its intent to pursue M&A opportunities, most likely in the Vimeo business. Management is considering smaller add-on acquisitions that expand Vimeo’s feature-set to improve sub adds and upselling. An acquisition may be dilutive to earnings in the near-term, but will enhance Vimeo’s long-term competitive position. The company is unlikely to pursue a large transaction or add-ons for the Publishing and Applications segments.
Spread widens: It is possible the Stub spread could widen and result in losses in both the IAC long and ANGI/MTCH short legs. I expect large gaps in the spread will close over a relatively short period as event funds try to capture the higher return potential.
ANGI Homeservices deal doesn’t close: I consider this a very low risk. ANGI shareholders are sitting on a 100% gain from the pre-announcement price of $5.89. If the deal were to break, ANGI’s stock would plummet. HomeAdvisor has stolen significant share from ANGI since the original merger was proposed in November 2015 so ANGI would be in an even worse position. The two companies have substantial synergy opportunities that would not be available to other potential buyers.
Limited borrow availability: only ~13% of the ANGI Homeservices pro-forma shares trade so it takes time to accumulate shares to borrow for a sizeable Stub position. The same dynamic exists for MTCH.
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