LoopNet: 5 Reasons to Stay Away

Shares of LoopNet, Inc. (LOOP) have traded higher in recent weeks after hitting a low in early March. The company reported first-quarter results yesterday after the close, and reinforced several reasons why we believe a lower valuation is appropriate for the shares at this time.

First, key operating metrics have now steadily weakened for four consecutive quarters. Most important among these, in our opinion, is the fact that the number of paying members has declined at an increasing year-over-year rate in each of these periods. During the first quarter, the number of paying members was down 15.8% versus the year-ago period.

Second, we expect that transaction volume in the commercial real estate industry will remain constricted in the near-term. We anticipate that weak operating fundamentals and tight credit availability will create a wide bid-ask spread, as owners are reluctant to sell at what they consider to be a low-point of the real estate cycle, and buyers are limited in their ability to pay up for properties due to a higher cost of capital.

Third, we note that the company’s primary competitor, CoStar Group (CSGP), recently launched an online marketplace that competes directly with LoopNet. While we still consider LoopNet to be the dominant player, customers now have another viable option.

Fourth, beginning with its Q2-08 release, the company began issuing non-GAAP earnings guidance, excluding ongoing litigation costs and share-based compensation expenses from its EPS guidance. We believe that this shift away from the company’s traditional GAAP earnings guidance may cause some confusion among investors. We do not consider the litigation expenses to be one-time in nature, and our forward earnings estimates include both litigation and share-based compensation expenses, as is standard.

Fifth, in March the company sold $50 million in convertible preferred stock to private equity investors, while giving no clear use for the proceeds of this capital raise. Management stated only that the “financing will provide LoopNet with additional resources to pursue and accelerate our growth strategy.”

The convertible shares, which do not pay or accrue dividends, are convertible into 7.4 million shares of common stock at a price of $6.72 per share.

During 2008, the company repurchased 4.9 million shares of common stock for an aggregate purchase price of $54.6 million, or approximately $11.08 per share.

We find it somewhat confusing that only a few months later management would then issue stock at a price nearly 40% below that at which it repurchased its shares. In our view, this move not only resulted in the dilution of existing shareholders, but the destruction of capital, as the company essentially bought high and sold low, and without a clear use of proceeds.

Given these issues, we recommend avoiding shares of LOOP at current levels.