The Knot Wedding Portal -- All Story, No Facts? (KNOT)

| About: XO Group (XOXO)

We're not getting married anytime soon (last we checked, you're only allowed one at a time), but someone is. And if they are young and hip and spending lots of money, as these sorts of folks often are, there's a good chance they'll check out, a leading portal for wedding planning. The wedding business in general is a great place to be, since fantasy spending goes up during down times and stays up during good times. They are both a bait (and here) and an e-commerce company.

There are a couple of features that we are looking for these days in the e-commerce/advertising space, that we believe provide somewhat elevated competitive barriers, and are currently underserved:

* Local services - Providing good content online of a local nature is very difficult. Big players have failed miserably. Craigslist is the best so far, but leaves a lot to be desired (including the fact that it's private). The yellow pages still win. Why? We've outlined a lot of the reasons (precision and completeness) earlier, but in addition, it's just a lot harder, from a back-office standpoint, to serve local communities. It takes local infrastructure, local participants, local knowledge etc., in each locality. Once that is built up, it is hard to duplicate - a lot harder than just writing another search bot to scan and index websites. Last time you needed a plumber or heater repair, did you use the phone book, or go online? Yeah, there's a reason for that. The point - any online business that can profitably succeed in the local service search business will have a good competitive barrier.
* Local advertising - If you have a good local search service, you can sell accurately targeted local advertising. That's a holy grail. But it depends on the willingness of your participants to accept advertising (a problem for cell-phone companies trying to get into this market), and the accuracy of your service listings (a problem for major search engines trying to get into this business). The main competitors are newspapers, yellow pages, and local magazines - all old-line franchises. So the sector is great, but tough.
* Pay-for-performance - Hand-in-hand with the accuracy requirements listed above, what we would like to see is pay-for-performance advertising, rather than pay-for-click advertising. Long time readers know we view the latter as a useless fraud and the former as the desirable model. Why pay for advertising if you haven't made any money from it? Because that's all you can get. But if you could get the pay-for-performance model, and it drove business your way? Ahhhh, that would be sweet. A highly accurate and specialized local search service ought to be able to provide results good enough to support such a model, and once again, that would be a tremendous competitive barrier.

That was a long preamble to determining whether or not The Knot hits any of those criteria, as a patently local service search company.

Their sign-up numbers are phenomenal - either 4200 or 3600 new members each day, depending on where you read the number on their site. They claim to be #1 in the online wedding sector. Hopefully they don't get a lot of repeat business, so those numbers shouldn't be cumulative, but rather establish a certain baseline user level, with growth coming from market share. On the other hand, wedding party members and wedding guest shoppers also use their site, and those memberships could grow cumulatively.

Checking in my local community, some aspects were adequately served (e.g. wedding locations) but most were not (e.g. caterers, flowers). Further, their refinement guides did not allow adequate tools (e.g. I want a local florist, not one 100 miles away). Unfortunately, they may be the biggest, but their offerings seem far from adequate. So far I'm not impressed. How are their numbers?

Company: From their Q4 and FY 2005 report, they have had FY Y/Y revenue growth of $10M or 24% ($51.4M/$41.4M), and gross profit growth of $10M or 33% ($40.3M/$30.3M). That is, their costs of goods sold stayed fixed, showing that top-line revenue growth is the key for their business growth.

Operating expenses increased $7.8M or 27% ($36.9M/$29.1M), at about the same rate as revenue growth.

Operating income grew 147% ($4.7M/$1.9M), but that's only $2.8M Y/Y. Those give an OP margin (operating earnings/revenue) of 31% (1-$35.6M/$51.4M) for 2005 versus 32% (1-$28.3M/$41.4M) for 2004, essentially flat. But their OOP margins (operating earnings/gross revenue), which we consider more important, increased to 12% (1-$35.6M/$40.3M) from 7% (1-$28.3M/$30.3M) between 2005 and 2004. So, of the dollars they keep, more of them are dropping to the bottom line. That's good, even though these margins are not all that high. They're profitable, but they are a bit Blah.

Stock: For 2005, with operating earnings of $4.7M and 24.9M shares outstanding, KNOT has 2005 operating EPS of $0.19. At a current share price of ca. $15, they have a trailing operating P/E of 79. For a slow growth company, with only middling products, that's absurd. This stock is all story. The promise is there, but the facts are not.

KNOT 1-yr chart:

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