Match: Increased Confidence In The Moat

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About: Match Group, Inc. (MTCH)
by: Detroit Bear
Summary

Match posted fantastic Q4 results after sandbagging Tinder subscriber growth during its Q3 '18 earnings call.

Revenue growth and runway remain robust, as does free cash flow generation.

I am increasing my fair value range to $50-60.

Shares of Match (MTCH) have come surging back to within spitting distance of all-time highs after the company posted robust subscriber growth at Tinder that revealed its Q3 guidance to be a sandbag. Given the strength of the core Tinder product augmented by durable performance from its legacy brand portfolio, I am increasing my fair value range to $50-60, though shares look about fairly priced. Let’s take a look at Q4 results, as well as recent business updates that have driven an increase in my estimate of intrinsic value.

Q4 Revenue Growth: Tinder Subscriber Growth Crushes

In my view, there were two primary drivers for the decline of Match’s share price following Q3 results: 1.) The $2 per share special dividend; and 2.) Vague, bearish commentary on Q4 subscriber growth at Tinder. Several investors assumed the $2 special dividend was a baffling move considering majority shareholder IAC/InterActiveCorp’s (IAC) large cash position, potentially signaling a slowdown in M&A and repurchases. However, I believe it was simply a large scale way of returning cash to shareholders that, while lacking the tax efficiency of a buyback, was accomplished with much more rapid velocity.

On Tinder subscriber growth, management warned that Q4 growth could be soft against the anniversary of the Tinder Gold introduction in Q4 '17 with lower levels of net additions against the backdrop of higher churn. Tinder has typically generated subscriber growth in the 200-250 thousand range, and the market priced in a drop below these levels. Whether management simply forecasted wrong or was being ultra conservative, Tinder subscriber growth in Q4 totaled net-adds of 233,000 sequentially, up 1.2 million y/y. This helped drive revenue growth up 21% y/y to $457 million.

One of the more interesting insights on the call was the penetration rate of online dating in the US. Pre-Tinder, 29% of all singles in the US used online dating apps, which has now grown to 39%. Even more telling, the penetration rate amongst 18-24 year olds has grown from 16% to 47% over the same time period, with the number of apps used basically doubling from 2 to 4. In a short period of time, online dating has become a staple of the US. However, categories like retail and travel have over 90% penetration in the US, and CEO Mandy Ginsberg noted that she does not see why online dating wouldn’t reach the same penetration rate.

Even more telling, included in the graphic below, is the penetration rate in other countries. Match has several markets where online dating can be developed significantly, demonstrating the long runway the business maintains for organic and inorganic growth and capital deployment.

Source: MTCH Q4 '18 Investor Deck

With a long growth runway ahead, I actually expect to see elevated sales and marketing spend to accelerate adoption of Tinder and other products internationally. Management mentioned brand awareness and TV ad spend in South Korea and India, and is why sales & marketing spend grew 20% y/y in Q4, though revenue growth was able to offset the increase, generating 10 basis points of P&L leverage in this category.

In fact, from a cost perspective, other than a 160 basis point increase in cost of revenue, Match was able to squeeze at least moderate cost leveraging out of every major category in Q4 in spite of high teens growth in product development costs and G&A.

For the full year, Match was able to drive revenue growth of 30% to $1.7 billion, which drove a whopping 39% increase in EBITDA to $654 million. With strong subscriber growth across the core Tinder platform, EBITDA margin grew by about 250 basis points y/y to 37.8%, and management continues to see runway to 40%+ EBITDA margins as penetration increases. Although competition from the likes of Bumble and other apps may surface, I like the odds at Match achieving EBITDA over 40%+. Given that most consumers use multiple apps, I believe growth in one app can help develop the whole market, reducing the long-term need for marketing spending. Likewise, much like Visa (V), Facebook (FB), or Google (GOOG) (NASDAQ:GOOGL), the network effect becomes increasingly powerful after these apps expand, and I believe Match won’t need to add significant marginal costs to continue growth.

This powerful network effect, combined with low capital requirements and strong revenue growth, is why I am increasing my fair value.

FY19 – Another Strong Year that Will Fully Include Hinge

Based on guidance for FY19, I believe Match's shareholders are in for yet another strong year. Management is expecting a mid-teens revenue growth rate driven largely by strength in Tinder and stability in other platforms. I believe there is some upside here, as Match fully acquired the rest of Hinge, which is taking significant share in the serious dating market, especially in cities like New York and London. In addition, management guided to adjusted EBITDA of $740-790 million, with a conversation rate to free cash flow in excess of 70%.

At a 70-80% conversion rate, this implies free cash flow of $520 million to $632 million, which implies a current valuation in the 24-26x range – not unreasonable for a company with a growing moat, solid earnings growth prospects, low capital intensity, and clear secular headwinds. I am increasing my near-term outlook for Tinder’s prospects, as well as my belief in the durability of Match’s competitive advantage, and therefore, I am increasing my fair value range to $50-60. Although I personally redeployed my position into a situation with asymmetrical upside, this was simply a function of limited capital. Otherwise, I would still confidently hold shares.

Disclosure: I am/we are long V, FB, GOOG, GOOGL. 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.