It’s not every day that investors come across a firm with a cash-rich, subscription-based business model with substantial revenue growth prospects and operating-leverage tailwinds. And certainly one wouldn’t expect to find it with a name such as Ancestry.com (ACOM). But whether you’re a family history buff or not, this name may be a perfect fit for the aggressive growth portion of your equity portfolio.
Here are five reasons to buy this name at these levels:
1) Ancestry.com’s long-term market opportunity is phenomenal.
2) The firm’s incremental margins on new subscribers are more than triple that of current reported results, offering a long runway for earnings leverage.
3) Ancestry.com’s cash-rich, subscription-based business model benefits from one of the strongest competitive advantages out there -- the network effect.
4) The firm’s social-networking endeavors and international efforts are only in the early innings.
5) The firm’s valuation presents significant upside potential and little downside risk.
Ancestry.com’s long-term market opportunity is phenomenal.
Ancestry.com provides a complete experience for users interested in building out their family trees, learning about their family histories, and uncovering pictures and stories about their family’s past. Genealogical research is not new. What is new, however, is how users are performing genealogical research. Many now flock to the convenience of using searchable, digitized databases on the internet to accomplish what was once a snail-mail and painstaking research effort. Perhaps the greatest evidence of the emergence of this structural shift is the growth rates of gross subscriber additions at Ancestry.com during the past few years. Thanks in part to a successful television show, “Who Do You Think You Are?” (WDYTYA), gross subscriber additions have more than doubled to 1.02 million in 2010 from 480k in 2007.
Ancestry.com’s subscribers now total 1.6 million at the end of the first quarter of 2011, roughly doubling levels from the end of 2007. Despite this impressive growth during the past few years, the firm’s market opportunity remains robust. As Ancestry.com continues to invest in new content on its website, previous users that opted to cancel have started to come back. In fact, according to management on their first-quarter earnings call, about 20% of gross subscriber additions per period are returning customers. As such, the aggregate 2.7 million gross subscriber additions during the past four years is probably the best gauge to use as the current penetration rate of Ancestry.com’s addressable market. In other words, it’s fair to assume that users that may have stumbled upon the website a number of years ago may now again be interested in the firm’s upgraded services.
There are a few ways of sizing up Ancestry.com’s potential market opportunity. Management is targeting roughly 16 million subscribers across an estimate of roughly 163 million households. This may be a touch optimistic. According to the US Census Bureau, there are roughly (.pdf) 39.6 million people in the US that are above the 65+ age category, a demographic well-known for pursuing genealogical research. If we restrict Ancestry.com’s market opportunity to just the 65+ age bracket, based on the 2.7 million gross subscriber additions during the past 4 years, only 6.8% of this market has recently used Ancestry.com’s product offering. Based on Ancestry.com existing subscriber base of 1.6 million, just 4% of this market currently uses its services.
Admittedly, it’s unfair to restrict Ancestry.com’s market opportunity to just the 65+ age group. The firm’s customer base spans all age groups, as we doubt that the 65+ age group is completely responsible for the 1 million downloads (.pdf) of Ancestry.com’s mobile app for the iPhone, iPad, and iPod. Nonetheless, such an exercise reveals the firm’s vast subscriber growth potential ahead of the company. And with viewership of its television show WDYTYA at many, many times its current subscriber base, a doubling or tripling of subscribers over time should be viewed as a conservative base-case forecast.
The firm’s incremental margins on new subscribers are more than triple that of current reported results, offering a long runway for earnings leverage.
Ancestry.com generates over $200 in annual revenue per subscriber on customer acquisition costs of about $80 (these metrics were better in the firm's first-quarter results (.pdf)). Incremental margins on each new subscriber are north of 60% and dwarf the firm’s reported operating margins of 20% in 2010 and 15.6% in the first quarter of 2011. With subscriber growth thus far, operating margins have already advanced 12 percentage points from the 8% mark in 2008. With such a vast market opportunity in front of it, operating leverage will be substantial, and long-term operating margins are likely to hit over 50% within the next 5 to 7 years.
Presented in the table below are relatively bullish, yet achievable forecasts that put to numbers the firm’s substantial growth potential and significant operating leverage. At the high end of its guidance range for 2011, management is targeting revenue and total subscribers of $400 million and 1.73 million, respectively. Consensus estimates for 2011 and 2012 appear extremely conservative relative to the expectations below:
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Ancestry.com’s cash-rich, subscription-based business model benefits from one of the strongest competitive advantages out there -- the network effect.
Ancestry.com’s business model is a veritable cash cow, as the firm reaps subscription revenue across a plan duration mix of monthly, quarterly, 6-month, and annual subscriptions. The firm also benefits from product sales at about 7% of revenue, but subscription growth should dwarf its contribution over time. At the end of the first quarter of 2011, about 60% of the firm’s subscribers (.pdf) are on an annual plan and 33% are on a monthly plan, with the balance choosing quarterly or a half-year service. Although churn rates are much higher for monthly subscribers, which represent about 60% of gross subscriber additions, Ancestry.com charges a higher fee for providing the convenience of allowing monthly subscribers to move in and out of the service over time.
This customer convenience often results in high reported cancellation rates per quarter, but it’s important to note that a meaningful portion of the churn represents satisfied subscribers that expect to return at a later date, pending additional content upgrades. Ancestry.com has invested between 14%-17% of revenue per year in technology and development to keep subscribers coming back for more. For users relatively new to genealogical research, a subscription to Ancestry.com could last years, as discovering 128 great-great-great-great-great grandparents, for example, could take some time.
It’s difficult not to be fond of Ancestry.com’s competitive position. After all, encountering another subscriber on the firm’s website with a common ancestor could save years of time and lots of money, a feature that goes unmatched by competitors. And as more subscribers input their family histories and trees on its website, the more valuable Ancestry.com’s product offering becomes to the incremental subscriber – a true network effect. Many subscribers also add stories and pictures to their trees as well, offering new users the rare chance to learn more about their family’s past and even view the face of a long-lost ancestor.
The firm’s social-networking endeavors and international efforts are only in the early innings.
Though a transaction is not to be expected, Ancestry.com’s product offering can be viewed as a natural extension or ancillary service to the social-networking behemoth Facebook. Management expects to launch a substantial improvement to its social-networking capabilities within the next quarter or two, and it would not be surprising if Facebook is a large partner in this effort. This is a key positive catalyst for further subscriber acceleration, especially within the younger age demographics.
International growth presents another opportunity for Ancestry.com. Non-US subscription revenue represented roughly 25% of last year’s total subscription revenue, with the UK and ‘all other countries’ expanding nearly 70% during the period. As Ancestry.com acquires additional foreign content during the next few years, non-US growth should be expected to accelerate further.
Ancestry.com also has the opportunity to ramp up sales of advertising on its website, a revenue stream that appears to be minimal at this time. With a subscriber base of 1.6 million that likely invests hours of time on its website, it’d be valuable for Ancestry.com to further develop this profitable revenue stream. Other subscription-based business models with similar customer demographics have been successful, and there doesn’t appear to be any reason why Ancestry.com couldn’t do the same.
The firm’s valuation presents significant upside potential and little downside risk.
Though investors may shy away given the firm’s lofty earnings multiple, it’s probably best to look at this high-growth firm through a discounted cash-flow model. Below are relatively bullish, yet achievable forecasts for the firm’s adjusted EBITDA and enterprise free cash flow. At the high end of its range, management is targeting $140 million in adjusted EBITDA for 2011.
Under the scenario presented in the tables found in this article and employing a 10% discount rate, Ancestry.com is worth roughly $70 per share on a discounted cash-flow basis. This represents over 60% upside from today’s price levels.
If we were to perp 2012 enterprise free cash flow at a growing perpetuity of just 3% and add the $100 million in net cash sitting on Ancestry.com’s balance sheet at the end of the first quarter, we’d arrive at an equity value of about $40 per share. It seems very likely that Ancestry.com will achieve free cash flow growth well north of a mere 3% for many years to come, revealing little downside risk at today’s prices.