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Why growth is fundamental for ANGI

Angie's List (NASDAQ:ANGI) is a web-based company that, according to its website, aims to provide reviews to its clients/members "to find the best local service providers, like roofers, plumbers, handymen, mechanics, doctors and dentists."

ANGI is one of the most representative "new-new-economy" stories that (very much like the "new-economy" companies of the late nineties tech bubble) is betting on growth instead of bottom line results (others include Workday (WDAY), Salesforce (NYSE:CRM), etc.).

ANGI is at present valued by the market at close to $1.4 billion for sales of $177 million in the last 12 months. This means a very high market cap vs sales relation, of about 8. ANGI's bottom line presented losses every year up until now, and the management guidance does not anticipate a change of this pattern for the foreseeable future.

After a very significant infusion of capital due to the IPO in the end of 2011, stockholder equity has been dropping with each quarterly loss, and has just gone to negative with the last quarterly report.

So, even for the most ardent of Angie´s List supporters, it must be indisputable that a strong future revenue growth is the only thing that can justify the present valuation of its stock. (Additionally, of course, one also needs to believe that the revenue growth can eventually - preferably soon - be translated into positive net income, and that afterwards the growth goes on, to enable the net income to reach a high enough level to justify the present high stock valuation.)

A difficult business model

Basically ANGI's business model is not friendly or tempting for the final service customers that constitute the stated objective of the company. In the first place, it has well-known, free alternatives with much larger numbers of reviews (a recent discussion of this can be found here). In the second place, there are important drawbacks from the non-anonymous review procedure that is used by ANGI. Citron's very good report illustrates quite well the problems that this review model can produce for Angie's (paying) members.

The result of this limited attractiveness of Angie's model for final service customers is that, at present, ANGI makes most of its money from service providers' advertising, not from its paying "members" (according to its last quarterly report, its "members" are contributing less than 1/3 of its revenues, and service providers are contributing more than 2/3).

However, paradoxically, this "inverse" revenue model can only succeed if ANGI keeps the declared/official model centered on the final clients, and if its numbers grow (and so, through its increased numbers, its value for the service providers also grows). Obviously, nothing would justify large publicity investments from the service providers if ANGI assumed to be just an expensive publicity-based "web-magazine", instead of advertising its presently stated consumer-centered model.

Knowing this, ANGI still claims in its website that "Companies can't pay to get on Angie's List" (at the very least an extremely misleading statement, given the actual source of its business revenues), and all the website is built with the aim of convincing the final clients of service providers that ANGI is focused on them, instead of caring for the service providers side.

In short, it seems clear and indisputable that ANGI's future depends on strong growth of its paying, service customers / reviewers.

The hard facts - ANGI's growth is already stalling

So, how is ANGI's client base growth evolving? Not well…

The following table, based on the data provided in ANGI's quarterly reports, shows the evolution of its paying clients/members. These data can be found in the SEC reports filled after the IPO's date - but since those reports include year-on-year information, they include data back to the beginning of 2011, before Angie's IPO. Older data is not as easy to find, but I would argue that it is also not very relevant, since it would be related to a different Angie's List - before the increased structural size and the much greater capitalization that resulted from the IPO. Anyway, these data seem representative of the recent evolution of the clients/members growth. In the table, the second column shows the number (in thousands) of members at the end of each quarter. The third column shows the percentage evolution in the end of each quarter, in relation to the end of the previous quarter.

This table illustrates the strong seasonality of client growth. Usually, Angie's client base grows more in the second quarter, closely followed by the third quarter, then by the first quarter, and at last (with greater difference to the other quarters) by the fourth quarter. This is seasonal behavior that ANGI's management recognizes. This strong seasonality means that the evolution in each quarter needs to be compared with the evolution in the same quarter of previous years.

The table also shows a strong and very consistent reduction in growth rates:

  • Second quarter growth was reduced from 22% in 2011 to 17% in 2012.
  • Third quarter growth was reduced from 20% in 2011 to 16% in 2012.
  • Fourth quarter growth was reduced from 9% in 2011 to 8% in 2012.
  • First quarter growth was reduced from 14% in 2012 to 9% in 2013.

The future

Predictions are a risky business, especially when they deal with the future. Yet, investing involves making educated predictions and they are the only way to separate potentially good from potentially bad investments.

So, here it goes: If things evolve as can be expected, my prediction for the future of Angie's List member growth is that it will continue to drop at rates similar to those exhibited in the table above.

Let's risk some specific predictions for member growth in the next quarters:

  • End of Jun. 2013 vs end Mar. 2013: Close to 13 or to 14%. (Was 22% in 2011 and 17% in 2012.)
  • End of Sep. 2013 vs end Jun. 2013: Close to 12 or to 13%. (Was 20% in 2011 and 16% in 2012.)
  • End of Dec. 2013 vs end Sep. 2013: Close to 7%. (Was 9% in 2011 and 8% in 2012.)

Naturally, actual growth rates significantly above my predictions will constitute a bullish surprise for me, while growth rates significantly below will constitute a bearish surprise.

Conclusion

Member growth is the most important point to watch in the next quarterly results, and the fast reduction of that growth is the biggest problem for Angie's List.

It seems unquestionable that if it can't find a way to reignite the members' growth rate, ANGI will never be able to justify the present valuation, even if the management achieves greater operational efficiency - and through that reaches small positive bottom line results.

Only a strong forward growth can keep the present investors in the stock, and maintain the present lofty valuation.

Disclosure: I am short ANGI. I have a small short position in ANGI, and expect to keep it for a very long time (or until the stock drops to a very limited fraction of the present values). I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

Source: Angie's List's Big Problem