An In-Depth Look at LoopNet's IPO (LOOP)

On June 1st, Bill Simpson wrote an analysis of LoopNet (LOOP). LOOP shares priced at $12 a share on June 7th. The text of Mr. Simpson's original writeup follows:

LOOP- LoopNet (around as currently structured since 2001) plans on offering 6 million shares (2 million from insiders) at a range of $11- $13. Credit Suisse is lead managing the offering, Thomas Weisel and Pacific Crest co-managing. Post-offering LOOP will have 37.5 shares outstanding for a market cap at $12 of $450 million. IPO proceeds will be used for general corporate purposes.

From the prospectus:

We are a leading online marketplace for commercial real estate in the United States, based on the number of monthly unique visitors to our marketplace....Our online marketplace, available at www.LoopNet.com, enables commercial real estate agents, working on behalf of property owners and landlords, to list properties for sale or for lease by submitting detailed property listing information in order to find a buyer or tenant. Commercial real estate brokers, agents, buyers and tenants use the LoopNet online marketplace to search for available property listings that meet their commercial real estate criteria.

LOOP through www.LoopNet.com allows the sources of commercial real estate supply and demand to meet on one online destination. Essentially LOOP, through the website, is an online commercial real estate marketplace. As of 3/31/06, LOOP had approximately 360,000 listings for more than $296 billion of property available for sale and more than 2.8 billion square feet of property available for lease. Listing a site is free of charge as is searching for listings.

The commercial real estate market is comprised of office, industrial, retail, multi-family (apartment complexes), and land for development. This market is loosely valued at over $5 trillion in the United States and primarily relies on brokers and agents to facilitate sales/ leases of property. Historically much of commercial advertising has been placed locally through newspaper, on-site ads, mailers etc... Historically there has not been a central database for listings as exists with residential real estate. LOOP since inception has attempted to fill this need by creating one central source for all commercial real estate listings. Ambitious.

LOOP averaged 500,000 unique monthly visitors in 2005 and 590,000 unique visitors per month first quarter of 2006. Content is user generated as listings are placed by those visiting the site.

Okay, how does LOOP make money off of these 360,000 online commercial real estate listings? All users of the site must register, providing the basic e-mail address, name etc. Registration is free, however basic registration has limited access to the site and listings. For complete access LOOP offers Premium Memberships for $49.95 monthly, $44.95 monthly if paid quarterly, and $39.95 monthly if paid annually.

Listings are placed free, searching is free; LOOP makes money from Premium Memberships pretty much exclusively. LOOP derives 80% of their annual revenues from Premium memberships to their site. As of 3/31/06 LOOP had 1.2 million Basic members and 65,000 Premium members. Those 65,000 then are LOOP's revenue base.

Why would someone choose to pay for LOOP's service when listing and search are free? Good question, here is the answer. While a basic member can list and search properties, those listings will only be seen by Premium members and the only listing that basic members will be able to see are those listed by Premium members. In other words a Basic member to the site cannot view listings by other Basic members and any listings they may place cannot be seen by other Basic members. Premium members can view all listings and any listings placed by Premium members can be viewed by the entire 1.2 million subscriber base.

It would seem to me that the Basic membership would work for an entity with one to a few listings or needs while high volume commercial real estate participants would need the Premium if interested in utilizing the LOOP online marketplace. There are also a few other perks for Premium membership, including automatic prospect lists for and daily e-mail alerts for specific search criteria. The driver to shift Basic members to Premium member status (and thus revenue generators) is the complete access to listings that Premium membership provides.

So how is LOOP doing shifting Basic members to paying members? Since inception, the average monthly rate of conversion of basic members to premium members has been approximately five percent, the average monthly cancellation rate for premium members has ranged between three and five percent. LOOP is churning roughly 50% of their premium membership base annually, although they are converting Basic members at a greater number. Result is Premium memberships have been steadily growing annually the past 3 years.

The growth strategy is fairly obvious-- LOOP wants to expand their membership base and convert more Basic members to revenue generating Premium Members.

In addition to LoopNet.com LOOP also operates BizBuySell, an online marketplace for businesses for sale. Business sellers pay a fee to list their operating businesses, and interested buyers can search listings for free. As of March 31, 2006, BizBuySell contained approximately 38,000 listings of operating businesses for sale. BizBuySell runs on a slightly different business model than LoopNet.com as those listing pay a fee while searches are free. There are also membership levels.

Note that there is advertising on both sites, however it is not a major source of revenues for either currently.

A fairly straightforward business model. LOOP stands to benefit from a strong commercial real estate market and in turn, it would stand to reason from a soft United States commercial real estate market. While all this sounds fine and good, the truth always comes out in the financials. Whether LOOP's business plan is working will be shown in quarterly revenue growth trends, margins, margin expansion and bottom line growth.

Financials

Approximately $2 a share in cash post-offering no debt.

The financials look quite strong here. LOOP has booked a quarterly profit each quarter the past 3 years. In this time they've generated strong positive cash flows at a pace often not seen in such a young company. This business model is clearly working and working well. Thus far LOOP's trends are everything you want to see in a company coming public:

1) 9+ straight quarters of sequential revenue growth;

2) gross margins are getting stronger annually;

3) operating expenses as a percentage of revenues are decreasing annually;

The combination of the three trends above allow small growing companies to swiftly grow the bottom line and often gives them powerful future earnings growth. A few IPOs of the recent past exhibiting similar trends include CTRN/ HITT/ VLCM.

Revenues increased 75% in 2005 to $31 million. Gross margins were 88%, the third annual gross margin increase in a row. Operating margins topped 36%, again the third annual increase. Net margins (assuming full taxes) were a strong 24%. LOOP earned 20 cents a share in 2005, fully taxed. At a $12 pricing, LOOP will be coming public 50 X's trailing earnings.

LOOP's trends have continued into the first quarter of 2006. Revenues were up 11% sequentially from the 12/05 quarter making this at least the 9th such sequential quarterly revenue increase for LOOP. Gross margin expanded by 1/2%, operating margins grew 9%. This last number is the key here. LOOP gross margins at 88% have most likely plateaued. However for such a young growing company LOOP is doing a very nice job managing expenses, allowing more of that gross margin to flow down to operating earnings. LOOP, with much of their operating expenses as fixed website costs, has controlled sales/ marketing expenses very nicely. They've grown the business every quarter for three years, but have done so without gutting revenues with massive sales/ marketing expenses. Simply put, LOOP is flowing their revenue growth to the bottom line quite nicely at higher and higher %'s.

Net margins for the first quarter '06 were 30%, up from 2005's full year 24%.

What will LOOP earn in 2006? I think LOOP can grow revenues in the 60% ballpark to $50 million. I also think net margins for the year will approach 33%. That is 33% net after tax margins.

At those run rates LOOP would earn 40- 45 cents a share in 2006. At a pricing of $12, LOOP would be trading 27 X's current year earnings. Note that cash flows here are even stronger. LOOP could easily do 80 cents a share in positive operating cash flow in 2006. LOOP is currently a money making machine.

27 X's current year earnings for a company growing revenues and net margins this strongly is too cheap. The trends here are very strong and if they continue as they have the past 3 years, LOOP could easily be a $20+ stock.

There are risks, aren't there always:

Economic weakness tends to slow commercial real estate activity. In the '01/ '02 recession commercial real estate slumped badly in some parts of the US. It stands to reason similar in future would stall LOOP's growth.

Barriers to entry here are not prohibitive. LOOP will continue to need their commercial listing base to grow, meaning they need commercial agents/ brokers to continue to list with them. LOOP faces competition from traditional listings such as newspapers and business weeklies. Also LOOP is not the only online source for commercial listings by any means. Yahoo (YHOO) for example offers commercial real estate listings from cityfeet.com. Should be noted that a recent search of yahoo/ cityfeet for commercial retail space for lease in the greater Los Angeles area resulted in only 9 listings. That doesn't seem like a comprehensive listing by any means. Craigslist.org is another potential competitor, a free competitor at that. Currently neither cityfeet/ yahoo nor craigslist come close to LOOP's comprehensive listings though, however the internet is known for innovation and competition and that must be kept in mind. I would not be at all surprised to see Google enter this space in some fashion down the line.

LOOP's principal competitor currently is CoStar (CSGP), although online commercial listings are only a part of CSGP, not the entire business model. From what I've read it appears most high volume commercial agents/brokers/investors that would be interested in such services tend to subscribe to both CSGP/LOOP.

Also 2 sort of similar recent IPOs in the residential listings space have bombed, ZIPR/ SOLD. Note that the residential housing market has slowed while commercial real estate still appears in recovery mode. Also neither ZIPR nor SOLD had remotely as strong trends pre- IPO as LOOP. ZIPR, with high overhead was struggling to reach annual profitability when it IPO'd, SOLD's net margin on IPO were 1/2 of LOOP's.

So yes, there are risks here. I feel though that the extremely strong trends and margins LOOP has been able to display outweigh these risks. The trends/ margins are screaming, 'this model works', regardless of the potential pitfalls or skepticism. I always fall back on the numbers and the trends….and the numbers/ trends here are very similar to the best performing IPOs of the past few years. Sequential quarterly revenue growth over a period of years coupled with margin expansion excite me, regardless of the sector or niche. LOOP has shown an ability to steadily grow their paying subscriber base each quarter, and in turn filter that revenue growth in stronger measure straight through the bottom line. I like this deal, I think it will work very well.

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