A value investor does not make investment decisions based on markets as a whole. Although, when markets are low, it is much easier to find value to buy. When markets move higher, it is easier to find "value" on the short side of the market. The present conditions seem to reflect the latter scenario.
One can see from my past columns, I have been exclusively long for the past year. However, when I find a company that in my opinion is trading at an expensive valuation by any rational thought process, I do not hesitate to go short. There are a few companies out there today that have had tremendous runs and trade at rich evaluations such as Tesla Motors (TSLA) or in the "hot" 3-D printing sector like 3D Systems Corp (DDD); however, experience tells me that these companies have legitimate prospects that can propel them to much higher valuations well beyond the current levels.
Sure, these companies have arguably gotten ahead of themselves - but at least it is fathomable that they can -grow- into (and at some point beyond) their current valuations. That's because they have legitimate long-term growth prospects. With 3-D printing, basic sense tells us that at some point that technology is going to become mainstream. It is the next best thing to teleporting. When the technology is further developed and the price of such technology becomes less expensive, 3-D printing is sure to become an enormous market. It is merely a question of when that will happen.
Shorting a company like Tesla Motors might be tempting because we know how difficult it has historically been to compete against the majors. Short sellers can hearken back to examples of failed companies like DeLorean for encouragement. But after seeing some success, despite the almost $10 billion market cap, longs can see a possible payoff at the very least in a future acquisition by one of the majors.
Angie's List (ANGI) on the other hand has almost tripled in value within the past 52 weeks, has revenue of just over $150 million in 2012 yet is now trading at a market cap of almost 10 times that revenue at approximately $1.45 billion.
At 10 times sales, I believe an investor has every right to expect such a company to dominate its industry and more importantly for its industry to be one with extraordinary demand. This company founded in 1995 doesn't seem to have any major catalyst to rationally propel it to the market value it commands.
Angie's List is often lumped in with the technology sector but that is a stretch reminiscent of 1996, a time when any company that sold something on the Internet was linked to the tech genre. In reality Angie's List is more of a glorified consumer report.
Despite not turning a profit since inception in 1995, it does have at least one bright spot. It is currently growing subscribers at a respectable rate. It took Angie's List 16 years to reach the 1 million subscriber mark; however, it reached 2 million subscribers just 18 months after reaching 1 million. It is difficult to for me to believe that growth rate in subscribers will be long sustainable when considering the competition and the size of the market. Even if it keeps growing subscribers, it spends a substantial amount of money to do so.
Angie's List went public in November of 2011. Much of its revenue is derived from call centers selling leads to contractors (as a recent SeekingAlpha blog elucidates). Its current assets are barely more than current liabilities and it is carrying $14.87 million in debt. I like to see current assets of at least twice the current liabilities and prefer no debt with small caps in low margin industries (that just recently raised money in a public offering).
On page 4 of the S-1 there are several Risk Factors enumerated. One risk factor worth considering is the competition.
A quick web search will put the proliferation of available consumer ratings services into context. Some of the competitors are for-profit and some are non-profit. Consumer Reports is a large competitor from the non-profit side. CR publishes reviews and comparisons of consumer products and services based on reporting and results from its in-house testing laboratory and survey research center. It also publishes cleaning and general buying guides. CR has approximately 7.3 million subscribers (compared with Angie's 2 million) and an annual testing budget of approximately U.S. $21 million. It also has user reviews in addition to its own testing. Consumer Reports does not allow outside advertising in the magazine. There are some ads on the website.
On the for-profit side, Yelp Inc. (YELP) may be Angie's most formidable competitor. As its website proclaims on the home page, "People use Yelp to search for everything from the city's tastiest burger to the most renowned cardiologist." I conducted some sample searches on Yelp including one for "plumbers" in my area. My search returned many credible reviews featuring members who wrote about their experiences with various local businesses in great detail.
I'm familiar with the pro-ANGI argument about people potentially writing faux reviews at Yelp because they are not paid subscribers and can be somewhat anonymous. That may be true, however, the available quantity of reviews seems to make up for that fact. Many can discern between a "hit piece" and an earnest review when considering the totality of reviews on a specific company. When you have a dozen to peruse, the quantity puts it in perspective. Any company that has been around long enough can have a few dissatisfied customers. It is entirely possible that a disgruntled customer is the problem in a given scenario. In my due diligence process as a consumer, I prefer to look at a larger sample of reviews. If a company is suspect, one can reasonably expect to observe patterns in the reviews. From that standpoint I prefer a free service that offers a larger sample of reviews as opposed to a paid subscription service with a more limited quantity. A more limited quantity of reviews, good or bad, can be less conclusive and more vulnerable to anomalies.
A Potential "Dark Horse candidate"
Anyone can ask their friends and family for referrals. Facebook makes it easier to do this. I have seen friends post on their Facebook (FB) wall asking for referrals of good service providers and what is fascinating is to see how many people pounce on the opportunity to refer their mechanic or their plumber. What can be more powerful than referrals from people you actually know who will write about their experiences?
From that standpoint, I'm not one who believes Facebook can be all things to all people but this industry really does play into Facebook's greatest strength - relationships. Recommendations of services can carry much more perceived credibility when the "rec" is by someone you know, or perhaps even when the reader can see that the recommendation is written by a family member or friend of one of their friends. If Facebook were to further develop an application to integrate with its platform, it could harness the power of its social dominance and potentially become the leader in this industry.
Does Angie's List have a future and why did it go public?
I'm not saying Angie's List is the next WebVan or HomeGrocer, but what I am saying is that if Angie's turned profitable and its margins were 100%, Angie's List would still be over-valued at $1.45 billion. Using the most sanguine projections, considering the business model, the low potential profit margins and with competitors like Yelp Inc. on the rise, I see the legitimate value of ANGI at 1-2 times current revenue at best. The median long-term price-to-sales ratio for the S&P 500 is approximately 1.42 and a little higher for the NASDAQ 100. Most of those companies have made profits.
Considering the service it actually provides, I cannot see how Angie's warrants much more than an average price-to-sales ratio. I understand that Angie plans to continue losing money for quite some time in order "to further penetrate the market" but to what end? Call me cynical but coming public so late in the game, this IPO looks to me like little more than an exit strategy for the founders and perhaps some VC firms.
It is difficult to see Angie greatly surpassing (if at all) the 7 million paid subscribers of Consumer Reports, which has been around since 1936. There are no published statistics quantifying the total number of consumers who pay for such reports nationwide. We can look at the leaders and develop a rough estimate but it is conjecture as to what that number might be. Here's my best attempt: There are approximately 313 million people in the U.S. and 24% of them are under the age of 18 according to U.S. census data. If one out of 10 of the remaining Americans pay to subscribe to such a service, that makes a total pie of around 24 million potential - paying - subscribers. Think my one out of 10 assumption is too low? Perhaps it is but whatever the pinnacle of total paying subscribers turns out to be, we would probably be quibbling over trifles as I doubt the variance would be enough to render my conclusion too far askew.
Ask any group of 10 people you encounter how many of them actually pay for a consumer report service of any kind. THEN, ask yourself how many of those people joined due to a temporary large purchase they were contemplating? Ask yourself how many of these subscribers will just keep paying the fees indefinitely? Then draw your own conclusions because at some point Angie will plateau as it runs out of people willing to pay for such a service.
Yelp looks to be more of a threat to Angie than Angie will ever be to Yelp.
I believe free services like Yelp and possibly Facebook present more opportunity for growth as they cover more industries and have more diversified revenue sources. Yelp seems to be gaining the critical mass and the mobile application may keep it on a growth trajectory for years. I believe the restaurants and entertainment segment will draw in substantial users as these enormous markets are daily relevant to this entertainment-consumed culture. I more often find myself on Yelp through my Android while already "out on the town" and I suspect I'm not unique in that regard. For me it is less difficult to envision consumers going to Yelp for prospective roofers or dentists than it is to envision them going to Angie's List for restaurants.
Unlike with a Tesla Motors, 3D Systems or a Netflix (NFLX) that is at the forefront of major changes in how consumers watch programming in a multi-billion dollar industry, with Angie, there is no future catalyst to fear as a short. The "greater fool theory" could potentially drive it higher but there are more esoteric and exciting industries with which to play the greater fool.
That is why I recommend that short sellers avoid shorting Tesla, 3D Systems and Netflix and see the potential in ANGI (if they must short something). I see the value in Yelp or Facebook as alternative long positions for those who want to invest in that sector. Based upon a realistic assumption of the number of people who would realistically continue to pay for such a service, Angie's List looks to me like a viable business, the valuation of which seems to exceed any resemblance to its legitimate growth prospects (in my opinion). It is difficult to see Angie's List growing into the price - even if profits finally come to fruition.
In conclusion I believe that Angie's biggest future competitor may very well be Facebook, which has not yet even entered the business.
Additional disclosure: I am short ANGI