QuinStreet (QNST) January 2, 2019

Cash Flow Can Grow 55% Year Over Year in 2019

All of us have watched multi-billion dollar market cap companies be created such as Amazon and Netflix as consumers spend more time and money on-line.  One of the enablers of this success are companies that identify and sell qualified leads which are then converted into purchase transactions. The most successful public example of a company selling qualified leads is Lendingtree (TREE). The stock has appreciated fifty-fold since 2011,  primarily by helping consumers apply for home mortgages on-line versus offline. Quinstreet is helping consumers to shop on-line for auto-insurance versus the most common method of visiting an insurance agent at their retail office.

Secular Growth Opportunity:

The auto insurance industry is in the early stages of shifting marketing dollars on-line. As of 2017 under 10% of the annual $6 Billion dollars in marketing spent by the auto insurance has migrated to the internet. Quinstreet has one auto insurance customer that is now spending 15% of its marketing budget on-line.  If all of Quinstreet’s auto insurance customers spent money the same way, Quinstreet’s sales from this one industry would rise from $200 million to $1 Billion per year.

Which Companies Will Be Winners versus Losers?

Even in a rapidly growing industry not all companies thrive. Quinstreet during 2011-2017 was one of those losers.  During the time that Lendingtree’s stock was a fifty bagger, Quinstreet’s stock price plummeted by over 50%. Sales fell (25%), and EBITDA plunged by (86%) over the six year period.

Quinstreet’s  troubles were caused by their  overdependence on the for profit education industry. The company generated over 60% of sales in 2010 from generating on-line leads for the education industry. Unfortunately this was the wrong industry to depend on as  President Obama via the Department of Education declared war on the for profit industry and their recruiting and enrollment practices. Over six years Quinstreet’s sales to the education industry fell by 60% which explains why sales,  profits and the stock price suffered.

In 2015 the company introduced a new product named the Quinstreet Media Platform (QMP) that is responsible for driving the turnaround at the company. The QMP allows clients to access high intent digital traffic seeking to purchase auto insurance. The platform can segment, qualify and match the on-line traffic that is researching and comparing auto insurance products with the right insurance carrier. The QMP product is a combination of software, a database, artificial intelligence and machine learning. It is helping insurance carriers to reduce their customer acquisition costs, identify the right customers and grow more rapidly.  Progressive is the most sophisticated auto insurance company with its on-line marketing activities. In a mature industry Progressive is adding two million new customers in 2018 with the help of Quinstreet. Progressive openly states that Quinstreet is their lowest cost customer acquisition channel on the internet. Progressive has grown their marketing spend with QMP from zero in 2015 to $93 million in sales in 2018. In the March 2018 quarter Progressive’s sales at Quinstreet rose +83% year over year. The rest of the auto insurance industry has noticed Progressive’s on-line marketing success and have also begun to spend more money with Quinstreet. The table below shows quarterly sales for the financial services segment at Quinstreet.  You can see that quarterly sales were stable in 2016. In 2017 sales growth accelerated and in the September 2018 quarter sales rose +32% year over year.

The good news is Quinstreet is now bringing the QMP capabilities to the on-line application process for home mortgages, personal loans, bank deposits and credit cards. Thus QNST is entering  several on-line markets that are spending billions of marketing dollars per year. We are in the very early stage of adoption, but sales are doubling year over year in these new industry verticals.

Dozens of blue chip customers believe that the QMP product provides a higher return on marketing dollars than other media options.  Now the primary goal for Quinstreet is to persuade customers to allocate more of their marketing budgets to Quinstreet.

Rapid Sales Growth Expected, But Wall Street Is Only Forecasting +19% Sales Growth In 2019

Clearly Quinstreet has a best of breed product and rapid sales growth should continue for multiple years. Nevertheless, Wall Street analysts are being conservative.  They are forecasting that Quinstreet will grow sales +19% in FY2019 and then sales growth will slow to +14% year over year in the Fiscal year ended June 2020.

Significant Positive Operating Leverage Expected, But Not By Wall Street

Quinstreet reported 10% EBITDA margins in the September 2018 quarter, and Wall Street analysts are forecasting that EBITDA margins will stay at 10% even as sales grow.  The reality is that Quinstreet generates a 30% variable marketing margin on higher sales. Even with additional investments in fixed overhead, incremental EBITDA margins will be far above 10%.

Future Quarterly Profits Should Exceed Wall Street Estimates

Quinstreet has a June fiscal year end, but I am presenting EBITDA profit forecasts below on a December year end basis.

Readers are welcome to generate their own forecasts, but it should be clear that the Wall Street estimates are too low.

Numerous Quinstreet customers have been testing the QMP product the past few years.  Customers have been convinced through real world results that QMP can help their business. State Farm the largest auto insurance company in the United States became a new customer in October 2017,  and six months later was the #2 customer at Quinstreet that may spend $35-$40 million in 2018. Wow! Meanwhile Quinstreet is rapidly diversifying its sales base into 4-5 additional very large financial services verticals.

Quinstreet has the opportunity to generate $113 million EBITDA for calendar year 2020, or 55% above Wall Street consensus estimates of $73 million. To be more conservative I have assumed $103 million EBITDA forecast for 2020.  Two discrete factors can lead to this upside scenario.

We discuss them below.

AmOne Can Provide $10 million EBITDA in Synergies Within One Year.

In October 2018 Quinstreet acquired AmOne, a firm that generates leads for personal loan originators that lend to consumers with a bad credit history. The industry calls these non-prime loans.  Quinstreet believes that AmOne will be one of their most accretive acquisitions and that the benefits will be seen within one year. Management has identified $50 million in revenue synergies from improved pricing, better matching leads with lenders and selling to  new customers. At a 20% EBITDA margin AmOne synergies can add $10 million in EBITDA.

The Independent Insurance Agent Portal Can Add $30 Million EBITDA Within Two Years.

Anyone who has purchased auto insurance from an independent agency recently knows that the process is archaic and time consuming.  There is no on-line single access point for an agent to obtain insurance quotes for a consumer that is shopping for a new auto policy from several insurance companies in a few minutes. Today the agent will need to contact each insurance company separately by phone or email and often wait several hours for the answers.  Quinstreet saw the opportunity to automate and speed up the entire process by creating a unified platform that would access insurance quotes from several auto insurance carriers at once. The new platform is in beta and will be rolled out nation-side in 2019. Progressive has signed up as the lead customer and several more carriers are likely to join in 2019. Adoption by independent agents will be rapid as the insurance companies will require that future auto insurance policies be originated through this platform.  Quinstreet will earn a small fee every time the platform is used by the agents. Agents won’t be resistant as today they are already paying a fee to 3rd parties that have archaic systems. In the future the transaction fees will just be redirected to Quinstreet.   At full adoption this insurance quote platform can generate $30 million EBITDA/year.

Lowest Valuation Within The Industry Peer Group:

Above is a list of three companies that derived the majority of sales from generating qualified leads on-line.  Ironically Quinstreet is growing sales the most rapidly with 29% sales growth year over year in the September 2018 quarter.  At the same time Quinstreet has the lowest valuation. Its 2018 enterprise value to sales ratio is 1.4x which is 50% below its peers.  Its 2019 EV/EBITDA valuation based on First Call numbers is the lowest. In fact valuation is even lower as I expect future sales and EBITDA to exceed the First Call estimates.

RISKS:

Quinstreet has no control over its customers spending.

In 2016 the auto insurance industry lost billions of dollars due to natural disasters such as hurricanes. With 85% of the top 20 insurance carriers losing money in 2016, money spent on marketing in 2017 was curtailed.  Quinstreet still gained market share, but financial services sales growth decelerated sharply from 50% growth in 2016 to +7% growth in early 2017.

Quinstreet’s QMP product technology could fall behind the competition

Quinstreet’s success or failure is a function of its product technology helping its customer base.  Competitors are always trying to catch up and there is no guarantee that Quinstreet can continue to innovate and retain a best of breed product line.

The current CEO Doug Valenti was also the CEO during the tough times of 2010-2017

Mr. Valenti was a founder at  Quinstreet and owns shares worth over $70 million.  Nevertheless, he still made the mistake of allowing Quinstreet to become  too dependent on the for profit education industry as a customer. It has taken Quinstreet years to recover from the spending decline among its education customers.

Education Segment represents 17% of sales

Sales to the for profit education industry have consistently declined since 2010. The March 2018 was the first quarter in years that sales grew +2% year over year. This slow growth rate reduces the overall sales growth at Quinstreet, but the impact is manageable. Meanwhile the for profit education industry has entered a more supportive regulatory environment with the Trump administration.

Potential Stock Appreciation:

Lendingtree currently trades at 14x First Call EBITDA estimates for 2019.

As a result I am applying the same multiple to Quinstreet for its stock price target.

Lendingtree did reach a 25x EBITDA multiple recently, but the stock price has declined as investors are concerned that rising rates on home mortgages will reduce the number of residential mortgage applications and negatively impact Lendingtree’s proifits.  The key point is that Quinstreet could be valued at an EBITDA multiple above 14x, but even at a 14x multiple the stock provides attractive potential appreciation.