Match Group Is Still Undervalued

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About: Match Group, Inc. (MTCH), Includes: IAC
by: Mike Berner

Summary

Even after a 17 percent rise following the most recent quarterly results, Match remains modestly valued.

The latest subscriber numbers show that Tinder is not slowing down as initially expected.

Here I discuss Wall Street's cluelessness and the factors that will continue driving Match Group's growth well into the future.

As I have stated repeatedly over the last few months, the plunge in Match Group's (MTCH) stock price triggered by the announcement of Facebook's (FB) new dating service presented a major buying opportunity. Following the social media giant's opening salvo, shares of Match closed as low as $34.58 per share back in May.

Those who saw the volatility as a passing phenomenon were richly rewarded today as Match Group's Q2 revenue and earnings blew past expectations. As of closing time, the stock was up 17 percent to $45.60 a share - just slightly below the high achieved prior to the Facebook announcement.

But this is only the beginning.

Wall Street Just Doesn't Get It

The latest beat was entirely predictable by those who understand Match Group and the dating industry, but the rest of Wall Street is only just getting clued in. The company reported subscription growth for the Tinder app rose by 299,000 sequentially, absolutely crushing management's prior guidance for 200,000 - 250,000 sequential additions.

The Street fared no better in its predictions. J.P. Morgan analyst Doug Anmuth forecast 350,000 sequential subscriber growth in Q1 and undershot by about 5 percent. However, Anmuth's prediction of 230,000 was clearly off the mark by a wide margin - as was his price target of $42 a share.

Whoops.

Furthermore, almost one-third of Match Group's float was sold short prior to today's earnings report. The very idea of shorting the company's stock seems downright insane; why would anyone bet against a company that generates enormous free cash flow (to the tune of $400 million over the last twelve months) and inspires such incredible user growth?

Well, maybe if you believe that Facebook could take away Match's business. Oppenheimer analysts opined that Facebook Dating would likely create lasting multiple pressure for Match in a May 2 note. But where is the baseline evidence that Facebook would "likely" have any discernible impact whatsoever - other than the fact that the company has a huge user base and a lot of resources?

If anything, past experience strongly suggests that Facebook Dating will not impact Match Group's business in a material way. As we all know, Facebook succeeded in killing Linkedin (MSFT) with Facebook for Work, Craigslist with Marketplace, and PayPal (PYPL) with payments in Messenger.

Oh wait.

As Match CEO Mandy Ginsburg points out, people compartmentalize when it comes to dating and social media. The company quickly discovered this when it started offering new users the option to sign-up via text message rather than through a Facebook profile:

Within two months of offering Tinder users an alternative to sign-up with Facebook, new users went from 100 percent Facebook sign-up, down to only 25 percent Facebook sign-up, even though Facebook sign-up with the first option on the screen and the most frictionless

Thus, the idea that Facebook will necessarily take away Match's business due to its size is simply a non-sequitur. At best, it is an improbable outcome.

Connecting the Dots

As I have written before, the Match growth story is driven by three key realities: societal changes, a strong, sticky brand, and fantastic business economics.

The first point is difficult for the older generation to grasp. Approximately one-third of relationships in the United States now begin online, and attitudes toward the practice have shifted massively. 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 second point is even more difficult to wrap one's mind around without having used the products, but network effects help explain it. Any new entrant to online dating must build up a critical mass of consistent users before it can become a viable competitor. 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.

With paid subscription numbers soaring, 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.

Combine societal changes with a strong brand and you get a company with a robust moat and mouthwatering economics. As I argue in "Match Group And Netflix Have A Lot In Common," Match's rise closely parallels the streaming giant's ascendancy. For both companies, technological advances made their services more appealing to consumers. Even though newer products like Tinder and streaming cannibalized the legacy businesses at lower price points - resulting in lower average revenue per user - total revenue shot through the roof.

Best of all, Match spends very little on advertising because people know of its products through word-of-mouth. Can anyone think of a more powerful incentive to purchase a product than watching friends and acquaintances find emotional and sexual fulfillment? No wonder marketing expenditure fell from 28 percent of sales in Q2 2017 to 21 percent as of the latest quarter.

Modest Valuation

Even with Match now guiding toward $1.72 billion in sales and $650 million in EBITDA for the full fiscal year, the valuation for the company remains modest. Management expects that EBITDA margins for the entire company will exceed 40 percent over the long-term, which means that after-tax earnings would come in somewhere around $450 million.

Here is some food for thought: assuming that earnings remain static forever at $450 million, the entire company would be worth $11.25 billion at a 4 percent discount rate:

$450 million/4 percent = $11.25 billion

With such a long growth runway, though, it would be silly to think that this is it for earnings. At a market capitalization of just $12.3 billion, Match is almost certainly undervalued.

Disclosure: I am/we are long MTCH.

I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.