Over the past few weeks, Ancestry.com has continued to take some major hits as short sellers look for confirming evidence of their thesis. We noted the bias of the investment community against the online geneological research provider in one of our previous posts here. Frankly, short sellers often take at face value a small portion of the company's business metrics, in this case churn, and build up a case against the entire firm. We don't think this is justified and maintain the firm is worth north of $60 per share.
For starters, we outlined our discussion regarding the short thesis in a previous note here, and welcome interested readers to take a read and come back to this article after doing so. Simply put, there are three reasons why the stock has taken a pounding in recent weeks, and all of them combined are negligible to our intermediate-term thesis. Unfortunately, it's going to take some time to reverse the negative feedback loop among the investment community, but it starts with facts and fundamentals, which we seek to provide.
The first reason is a technical breakdown. The company has broken through key levels of support, and believe it or not, some institutional investors won't come near a stock if its "chart is broken" no matter how undervalued it is. We aren't big advocates of chart reading, and only view technical analysis as a way to best pinpoint entry and exit points on the most undervalued and overvalued stocks, respectively. Unfortunately, we can't go back in time to draw a pretty historical chart for the technicians, but it is what it is, and Ancestry.com remains one of the best values on the market, nonetheless.
The second reason: Wedge Partners allegedly put out a note stating that management is evaluating its subscription pricing plans: "raising short-term fees while offering long-term discounts." It was reported as such that the evaluation of its pricing plans "probably wasn't factored into guidance." We don't believe that this should be viewed as a negative. The trend among Ancestry.com's duration mix has been toward monthlies for some time (annuals still represent nearly 60% of subscribers though), and management likely saw that the third quarter was also showing a similiar strong trajectory of new subscriber growth and took the opportunity to test out the new pricing schema to lock in monthly subscribers longer, thereby helping to reduce churn (and the major fundamental short case against the company).
We don't view the third quarter numbers or full-year numbers in jeapordy at all -- in fact, we're looking for another beat and raise, as it did in its second quarter. If management needed to boost third-quarter results, it would have announced the new pricing scheme in August to book higher revenue from its monthlies in September (the last month in the third quarter) and wouldn't have offered a lower price for its annual plans at all. Management was simply responding to Wall Street's concerns regarding churn, and put together a plan to solve them, and the stock has been punished unjustifiably as a result. Our view is that churn is not a problem at this time -- the firm is growing like a weed, and the service will not be liked by everyone. Plus, we don't view this as anything like the subscription pricing move Netflix (NFLX) put into place: Ancestry.com is reducing prices on its annual plans -- not raising them -- and most existing subscribers probably won't even notice, unlike the upheaval among Netflix's subscriber base!
And the third reason we've heard during the past few weeks has been a refocus on potential concerns regarding UK-based competitor, FindMyPast. For starters, FindMyPast has been around since 1965 -- yes, even during the significant growth Ancestry.com has experienced during the past few years. We think the global market for geneological research is big enough for two or more competitors, and we think a merger agreement between the two entities down the road is more likely than any price war. From what we can tell, FindMyPast only has records in the UK, Australia, and New Zealand, and comes nowhere near what Ancestry.com has in the US, the major growth market backing our long-term thesis on the company. For almost all people in the US, searching for ancestors begins in the US, and Ancestry.com is the king of this online market. And when these US subscribers load all of their US records on the firm's website (the cloud), they are very unlikely to switch to a competitor, even if their past leads them outside the US (Ancestry.com's UK and ex-US product is not too shabby either). As we outlined in this note:
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 (just in. 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.
Granted, FindMyPast will continue to impact Ancestry.com's international growth (solely for people whose ancestors never came to America and live in the UK), but revenue from outside the US represents a fraction of the firm's total revenue (less than 25%), and this percentage has fallen since 2008 due solely to significant US expansion -- as seen below - (click chart to enlarge):
Source: Ancestry.com's 2010 10-K
All things considered, we took the opportunity to add to our position in Ancestry.com in our portfolio in our Best Ideas Newsletter on the company's stock-price slide. We underestimated the strength and selling power of the shorts in the past few weeks, but we continue to believe the firm has substantial upside to over $60 per share with identifiable catalysts ahead of it (the release of the 1940 US Federal Census in April 2012). Ancestry.com is trading at 7 times EV/EBITDA (this year) on growth of 40%! We're not alone in defending the stock either. Morgan Keegan, Bank of America and Piper Jaffray have all stepped in to defend the stock. We think the market is wrong on Ancestry.com.