Even With A Change In Business Model, Angie's List Is Overvalued

Oct.30.13 | About: Angie's List, (ANGI)

With Angie's List (NASDAQ:ANGI) down some 30% from where I shorted it, I decided to take a look at the valuation to see if it is time to cover. I initially shorted the shares because:

1) I viewed the company as having a confused business model charging consumers and service providers while telling consumers it is impartial.

2) I saw increasing competition from Homeadvisor.com and Thumbtack.com among others.

(3) ANGI offered an inflated valuation, as the stock was selling at 5.5x 2013 estimated revenue.

Two things have changed since I initiated the short position. First, the share price has come down: ANGI now sells at 3x 2013 estimated revenue. Secondly there is the prospect of Angie's List changing its business model. The purpose of this article is to estimate what Angie shares are worth if the business decides to give free access to consumers.

Speculation about moving to a free model began in early October when the Wall Street Journal reported Angie was significantly discounting its membership plans in several markets. While paid membership has long been a key differentiator for ANGI, as it portrays itself as having an engaged customer base providing reviews under real names, the company has had difficulty managing the inherent conflict of interest (of telling consumers it is a consumer advocate while deriving the bulk of its revenue from service provider advertising). Additionally there has been a significant increase in competition from free to the consumer models. There has been speculation amongst some on both the buy and sell side that the company may eliminate its subscription fees altogether.

If Angie's List were to drop its subscription fees, here is what we could expect:

  1. Instant loss of ~27% of revenue.
  2. A payout of $42 million in deferred revenue to members - a change in policy to a free model would likely require Angie's List to refund membership money collected upfront (so that everyone is receiving a free membership in 2014). Otherwise it would risk alienating customers, receiving bad press, and facing lawsuits.
  3. A temporary increase in marketing expenses - Angie's List would have to do more television advertising to announce to the world that it is now a free service. I imagine advertising would come back down in 2015 (unless competition continues to increase).
  4. A rise in service provider revenues as the audience broadens. We will explore this in greater detail below. The magnitude of this increase will be a big factor in determining whether or not Angie's List is a viable business and what the stock is worth.
  5. A rise in selling costs as Angie's List spends more to attract additional service providers.

Here's a model which explores what Angie's List might look like if it followed such a model:

2012a

2013e

2014e

2015e

2016e

Revenue - membership

47.7

65.8

0.0

0.0

0.0

YoY Growth

38.0%

-100%

0.0%

0.0%

Revenue-service provider

108.0

183.2

256.4

333.4

416.7

YoY Growth

69.6%

40.0%

30.0%

25.0%

Revenue - total

155.7

249.0

256.4

333.4

416.7

Expenses

Operations

27.1

40.7

48.8

53.7

56.3

% of revenue

17.4%

16.3%

19.0%

16.1%

13.5%

Selling

58.6

93.8

102.6

130.0

158.4

% of revenue

37.6%

37.7%

40.0%

39.0%

38.0%

Marketing

80.2

85.8

97.4

90.0

91.7

% of revenue

51.5%

34.5%

38.0%

27.0%

22.0%

Technology

16.9

26.9

30.8

36.7

41.7

% of revenue

10.9%

10.8%

12.0%

11.0%

10.0%

G&A

24.1

29.1

33.4

36.1

37.9

% of revenue

15.5%

11.7%

13.0%

10.8%

9.1%

Total Expenses

206.9

276.2

313.0

346.5

386.0

Operating Profit (Loss)

-51.2

-27.2

-56.6

-13.1

30.7

% of Revenue

-32.9%

-10.9%

-22.1%

-3.9%

7.4%

Click to enlarge

Let's take a closer look at a) service provider revenue and b) selling costs. I've reduced the growth rate in service provider revenue to 40% YoY (vs. nearly 70% expected for 2013) and to a 31.5% CAGR over the next three years. I used a lower growth rate because service providers are likely going to have a lower willingness to pay for what may be perceived as a less engaged audience (they didn't pay to use the service, maybe they aren't as serious) even though that audience is likely to be significantly larger (since it is free). This makes ANGI's advertising rates more susceptible to competitors' pricing as the services are now virtually identical. Secondly, and more importantly, is that I don't even know that there is capacity to sell more advertising to service providers. Service providers pay a premium to show up at the top of a search in a given area. There is a finite amount of space at the top of the page (who would pay to show up 13th on the list?). I simply don't know where the additional ads would go. In the past, Angie has expanded into new markets (both new geographies and new areas like offering reviews of doctors) to prevent running out of capacity. Perhaps there is some untapped ground which will allow the company to continue to grow service provider revenue at a high rate (though entering new markets has proven to be very expensive historically). While this is my best estimate at this time, there is a risk that my top line assumption is too high. If service provider revenues are capped (due to a lack of capacity), this could mean that Angie's List will remain a subscription service (though in my opinion that model is doomed as free competition continues to encroach).

As for selling costs, the above model assumes that these grow at just 19% per annum over the three year forecast period. Essentially, I am giving the company the benefit of the doubt that it is able to more efficiently sell advertising to service providers. Perhaps it can reduce some of the commission it pays to sales people or get rid of its less productive workers to gain efficiencies.

The above assumptions project that ANGI can eventually earn $30.7 million in operating profit by 2016. However, since the company will likely incur further large losses on the way and it will have to pay back deferred membership revenue, I'm assuming that it will raise an additional $120 million by selling new shares (10 million shares at $12, a -10.5% discount to Friday's close). This should provide the company with enough cash to make it to profitability. Given its large losses to date (and expected for the next couple of years), I don't expect Angie to pay taxes for at least a decade. So I'm going to consider operating profit to be net income. With $30.7 million in operating income, no taxes, 68.5 million shares outstanding (taking into account the 10 million share issuance), I get to 2016 EPS of $0.45/share. I'd give this a market multiple of 15x which gets a fair value of $6.70. However, we need to discount this back two years since this is a 2016 value. This brings me to a fair value (as of today) of $5.60.

I have concluded that I will maintain my short position in Angie (I may add to it) and re-evaluate covering around $5-6/share.

Disclosure: I am short ANGI. 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.

Disclosure: I am short ANGI. 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.