When I first wrote about Match Group (NASDAQ:MTCH) back in October 2017, I recommended holding off on buying shares due to the company’s high valuation. Although I stand behind that analysis based on the information that I had at the time, clearly there were elements that I missed.
Since then the stock is up 60 percent, yet the growth story remains fundamentally intact. Investors have by no means “missed the boat” on this company. Here I review Match’s attractive economics, and I also explain why my thinking has changed on the company.
Societal Tailwinds
I must confess that part of my about-face stems from personal experience with Match Group’s products over the last three months. As a young professional, I have found these online platforms to be a fruitful way of attracting dates. Within my own immediate and extended social circle, adoption of online dating has progressed rapidly over the last few years with a large measure of success.
This anecdotal evidence is backed by survey data. As I wrote in my previous piece, societal attitudes toward online dating have shifted massively since the advent of the internet. According to Pew Research, just 44 percent of Americans agreed that online dating is a “good way to meet people” in 2005. By 2015, 59 percent of responders agreed with that statement. In 2013, a mere 10 percent of people aged 18-24 had used online dating. That number has more than tripled over the last few years.
The Business Model
The first major tailwind is the company’s highly profitable and sticky business model. Like other social media platforms, Match’s various dating sites and apps benefit from network effects. With network effects, a product becomes increasingly valuable to users as more people sign on to the product. Any new entrant would have to build up a critical mass of consistent users before it could become a viable competitor. This is the reason why upstarts have found it difficult to dethrone 1990s stalwarts such as Craigslist, despite the latter’s severely outdated user interface. Match.com itself has survived for a remarkable 25 years as an online business.
Although online dating remains a fragmented market, Match Group controls the largest share of the pie through its portfolio of companies, which includes OkCupid, Tinder, Meetic, PlentyofFish, as well as namesake Match. These firms all cater to distinct demographics and possess unique brand identities.
One risk to the business articulated in the annual report is low switching costs. Most dating platforms make a free version of the service available to all users, and Match Group says that people have demonstrated a propensity for trying out several sites.
On the other hand, it seems self-evident that paying users would be more inclined to stay with their chosen platforms. Approximately 3 million of Tinder’s 50 million active users, or 6 percent of the total, have purchased a subscription that gives them access to more features. Throughout business history, the subscription model has proven particularly sticky. From newspapers to Netflix (NFLX), consumers generally keep paying for a long time.
The subscription model also makes for a more stable business overall, reducing the lumpiness of earnings and eliminating the need to ramp up and down in concert with business cycles. The best subscription businesses have also demonstrated remarkable pricing power. Since 2011, Netflix has raised the U.S. price of its unlimited streaming service from $7.99 a month to $11.99, a compound annual increase 5.5 percent. Meanwhile, inflation averaged 1.5 percent over the same time period.
A company that can raise the price of its product just a little bit above inflation every year is a compounding machine in the long run. Due to the increasing popularity and acceptance of online dating, as well as the enduring strength of Match Group’s brands, the company certainly possesses the ability to generate more revenue without lifting a finger.
The successful rollout of Tinder Gold is the earliest sign that, like Netflix, Match will be able to generate more sales by making its service more valuable to users. The marketing of Tinder Gold was nothing short of a masterstroke, playing on the need for instant gratification by tantalizing users with knowledge of people who had already “swiped right” on their profiles.
Financial Results
In the case of Match, 96 percent of the company’s revenue stems from its 7 million subscriptions and a la carte purchases. This “direct revenue” is split between North America (56 percent of total sales) and the international market (40 percent of total sales). The remaining 4 percent of overall revenue comes from advertisements, which are displayed to non-paying users.
The Tinder app, which mainly caters to the Millennial demographic, accounts for 30 percent of the company’s revenue. In 2017, Tinder was the second-highest grossing non-gaming app in the world, coming in second only to Netflix.
Over the last few years, average revenue per paying user (ARPPU) has trended down from $0.67 in 2012 to $0.54 in 2017. This is because fast-growing, youth-oriented services such as Tinder are offered at much lower price points than traditional sites aimed at an older audience (as little as $7.00 a month for Tinder versus a minimum $14.99 at Match.com). Monthly fees at Match Group’s sites vary by subscription type and length, as well as user location and age.
Owing largely to the Tinder phenomenon, Match Group’s earnings soared from $86 million at year-end 2012 to $350 million over the last twelve months, a compound annual growth rate of 32 percent. Unlike other online ventures trying to scale up quickly, this was accomplished without significantly increasing marketing expenditure. Between 2016 and 2018, SG&A expense only went up by 4 percent.
Why the low marketing overhead? As Match Group claims in its report, awareness of its products is spread primarily through simple word of mouth. No advertising campaign is as powerful as actually seeing one’s friends and acquaintances find relationships on a dating site.
Management
Over the last few months, Match Group has also installed new executives to replace the previous management regime, which was plagued by infighting, immaturity, and erratic behavior. New Match Group CEO Mandy Ginsberg has worked in various management roles at the company for twelve years, most recently as the head of Match North America. Elie Seidman, the recently appointed CEO of Tinder, previously earned his stripes by turning around the struggling OkCupid brand. In an interview that Seidman gave to The Wall Street Journal last summer, the executive provides a number of valuable insights that will likely prove prescient in the coming years.
Now the question isn’t how you make a dating app, what features you have, but its values—who goes there and what do you stand for? That’s the next frontier in the industry: Why would I use one instead of the other?
Downside Risk
As I noted in my previous article, Match Group is controlled by IAC (IAC), the media conglomerate run by billionaire mogul Barry Diller. Since going public, the company has showered its employees with largesse in the form of equity awards. In 2017 alone, the company incurred nearly $70 million of stock-based compensation expense.
Rival app Bumble, founded by former Tinder executive Whitney Wolfe, has also grown into a formidable Tinder competitor. Bumble differs from Tinder in that men cannot message women first, but otherwise largely mirrors the latter’s user interface. Last year, it was reported that Bumble rebuffed a $450-million takeover offer from Match Group. According to CNBC, sources now say that Bumble parent Badoo intends to put itself up for sale at a valuation of $1.5 billion.
Neither of these facts should enthuse investors, but in this case there are some mitigating factors. Match Group’s managers are compensated handsomely, to be sure, but they have also created enormous value. As to competition, online dating clearly will not be a winner-take-all market. And since failing to acquire Bumble, Tinder recently announced that a new option for women to message first will soon be incorporated into the app.
Potential Returns – What Changed?
When I first thought about Match Group’s valuation last year, I asked myself two questions: what is a satisfactory rate of return, and how long am I comfortable waiting?
At the time, I calculated that in order to produce an earnings yield of 7 percent, the company would have to eventually generate earnings of $470 million.
0.07 * $6.6 billion market cap = $470 million
Based on profit at the time of $200 million and a 15 percent growth rate, it would have taken six years to reach that target. I was not comfortable waiting that long in an industry where technical breakthroughs count a great deal.
However, the analysis should change when the facts change, and the success of Tinder Gold and users’ willingness to pay changes the equation. In order to produce an earnings yield of 7 percent today, Match would have to earn $770 million. Using $360 million in operating income as the new baseline, it would now take slightly more than five years to achieve that number. However, given greater willingness to pay as well as decreased marginal costs, a 20 percent annual growth rate for earnings seems more plausible. In that case, it would take just over four years to reach the required $770 million in earnings.
($360 million * (1.20)^4.2) = $774 million
Conclusion
The buy case for Match largely hinges on the company’s future earnings growth, which is by no means a cinch. There seems to be broad agreement that the company will be big, but no one knows just how big. As of 2016, approximately 15 percent of American adults, or 35 million people, report that they have used some form of online dating. About one-third of 18- to 24-year olds have used a mobile dating app. Clearly, the potential for greater user volume exists. Looking into the far future, the proportion of the population that uses online dating platforms will surely increase now that people are embracing it at an early age.
In order to justify the current valuation, some assumptions have to be made, but it is not far-fetched to say that 20 percent growth could be achieved over the next few years through a combination of upselling, price increases, and volume growth.
Owing to the rapid appreciation in Match’s share price, it is psychologically difficult to simply cover the last few years of the stock chart and judge the business from the present, but that is how investors should think. I remain wary of the tech sector’s valuation, but Match Group’s stock price is not in fantasyland. This is an actual business that rakes in a lot of money, and it ought to be treated as such. With a sticky business model, long runway for growth, and high return on investment, this is not a company to be dismissed lightly.
