Checking The Knot on Analyst Day

| About: XO Group (XOXO)

By Kris Tuttle

The Knot (NASDAQ: KNOT) has their analyst day in NYC today. (For some reason the event is not being webcast.) It’s a name that I only recently started looking at but in the last year we’ve been very attracted to Internet-based businesses that focus on meaningful niche markets like or streamline traditional processes – OpenTable (NASDAQ:OPEN), SPS Commerce (NASDAQ:SPSC), Higher One Holdings (NYSE:ONE) are examples.

The Knot is a destination site for weddings. It’s deeply established in its niche and has built many relationships around things like bridal registry that are meaningful advantages. In addition the company has taken some steps to broaden its market into adjacent spaces like homemaking (The Nest) and starting a family (The Bump.) I’m really not sure about these names but I’ll let it slide for now.

Some basic stats: Revenues $111M, Gross Margins 77%, EBITDA Margin 11%, Growth ~6%, Balance Sheet $124M cash, no debt, Market Cap $298M, TEV/Revenue 1.6x.

The stock had a great run from 2005 to early 2007 and moved from $5 to $30. Since 2007 the performance has been a mirror image but the stock has started to perform well in the last few months. The company has gone through a period of restructuring and rebuilding the business. Most brokers seem to have price targets in the $9 to $10 range but as we know these targets are only lines in the sand.

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There’s lots of opportunity for The Knot but the company has been behind the curve and somewhat uninformed regarding the Web. The company launched vendor reviews and rankings in May of this year. The good news is that they launched something like this, although it comes some years after these techniques have been mainstream for online companies. They note that they have spent a lot of time to rebuild their back end systems and are now prepared to drive innovation.

The relationship with Macy’s (NYSE:M) is changing in early 2011 to a more standard arrangement. This has resulted in a big drop in registry commissions from Macy’s which was a major driver for the company. New partners are expanding rapidly, though, and within a year this will cease to be a drag on YoY compares. The potential for online purchases from bridal registries is over $1B today and is a market that The Knot should own. The Knot is in the perfect position to re-engineer the registry process so that brides and guests can see an entire registry and sync guest purchases with the master so that everyone knows what gifts have yet to be purchased for the bride. This is a pretty mundane commerce application but one that certainly has value and can help lock in customers.

There is some bad history with The Knot, alienating people who sign up for the service because they distribute the contact information broadly and with little restriction. Some reviews of the site tell brides “use the information there but don’t sign up!” We have not had the ability to address this with the company and are not sure if analysts will bring this up today at the meeting. It’s possible that this issue is solved but we still see online comments that suggest people are still leery of the site.

Management and culture at the company may need something to be desired based on comments from recent employees. This is no Zappos! Communication is very lacking between management and employees at all levels and the company promotes a “sink or swim” style of employee development. It also sounds like the “right sort” of people tend to do better than most. In this case white, preppy females fit well, others like men or minorities are not likely to find the environment there as welcoming.

The Knot is trying to build a bigger profile in China which could certainly be a big opportunity. It’s early days however and there’s no way to know how material this will be for the company at this point. The company is spending about $2M/year to try and build a business there.

Advertising appears to be growing again and represents the biggest slice of revenue for The Knot. The company has restructured and added staff in direct sales and support to grow this business faster while reducing churn and average customer spend.

Strangely the company has not purchased any stock despite having an approved stock repurchase agreement in place for several months. They had plenty of opportunity to buy back shares between $7 and $8 for most of the summer.

The shares have an Intrinsic Value of $12 if we assume fairly limited growth but disciplined expansion in margins back to 16% of the next few years. If the company can execute better and drive higher growth rates post 2011, the shares could have more room to appreciate.

Our overall conclusion is that this is a valuable asset and the current share price represents some value. We prefer names like as a business but The Knot has lots of room to improve their execution and capitalize on the opportunity in this market. The reason for not falling in love with The Knot is a combination of their so-so execution and a management style and corporate identity we find a bit off-putting.

Disclosure: The R2 Model Portfolio has a small long position in The Knot.