Growth Investors Should Swipe Match Group Right

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About: Match Group, Inc. (MTCH)
by: Dilantha De Silva
Summary

Match Group shares have climbed significantly higher over the last few years, supported by the growing profitability of the company.

Competition might increase in the future, but the online dating industry is set to grow exponentially in the next decade.

International markets provide a robust growth opportunity for the online dating industry, and Match Group will pursue such growth opportunities aggressively.

Shares are trading at a discount to my fair value estimate.

Investment thesis

Match Group (NASDAQ:MTCH) has been a great growth story so far, and favorable industry dynamics have certainly helped the company become more profitable in the last few years. Along with these favorable industry conditions, Match Group has embarked on a strategy driven by building on its brand value, and acquiring more brands to penetrate into more regions. As company profitability increased, Match shares have returned more than 280% to investors since 2015.

(Source - Morningstar)

Despite the expected increase in competition, I believe Match is poised to grow exponentially over the next decade, and shares are trading at a discount of 21% to my fair value estimate.

Company overview & business strategy

Match Group is a provider of online dating products, and has over the years built meaningful competitive advantages, that are now helping the growth story of the company.

(Source - Match)

Match operates quite a few brands under its portfolio, and all of these brands have gained traction over the last several years.

(Source - Match)

Tinder is by far the most revolutionary service offered by Match, and the massive growth of Tinder has been the driver of company profits over the last many years. Tinder has certainly helped Match Group become the leader in the online dating space, and I expect Match to remain the leader of this industry for many years to come.

The primary business strategy of the company is to expand its horizons and acquire more users from all over the world. However, monetizing the existing customer base is also another key strategy of the company, and I view this as an important strategy to drive earnings growth for the company.

Another important business strategy of Match is to continue to acquire more brands for its brand portfolio. This becomes a very important strategy to expand internationally, as Match should address the needs and wants of people from different demographics.

Recent acquisitions

(Source - Crunchbase)

Match Group is focused on keeping its customers within the ecosystem of the company by providing products and services that meet the requirements of singles from varying age groups. For example, Tinder is widely famous among young users, as the focus of Tinder is to match singles with each others with a view of maintaining a short-term relationship. On the other hand, match.com addresses the needs of singles to find a long-term partner to live with. In this sense, the company is trying to ensure the young generation attracted by the popularity of Tinder remains within the products and services offered by Match Group even when they grow older. I believe this provides a massive competitive advantage to the Match Group, as the company has various types of products and services that could keep its acquired customers within the company ecosystem for an extensive period of time.

Building on the brand value of the company certainly remains a key focus area of the company management at this point in time, as the success of a social media platform, whether it be dating or not, depends entirely on the credibility of the platform and its popularity. I believe the company will continue to spend millions of dollars on marketing campaigns to build on the brand awareness, which should in return help secure the long-term sustainability of earnings.

Industry analysis

The online dating industry has continued to grow over the last several years, and with the increasing popularity of online dating services, the industry is set to grow for many more years to come.

Online dating industry revenue

(Source - Statista)

Even though revenue growth is expected to decelerate over the next 5 years, I believe industry-leading companies will not have a problem growing their revenues at double-digit rates, as international markets are providing a robust growth opportunity for these companies.

The number of people using online dating apps will continue to grow for many more years, and I believe the industry is nowhere near its maturity at present.

Number of online dating app users worldwide

(Source - Statista)

I believe there are a few tailwinds driving the online dating industry forward on a global basis. Even though the U.S. online dating industry might be maturing, I believe the addressable market opportunity on a global basis is worth billions of dollars. As emerging countries develop their technology related to infrastructure, I expect the internet penetration rates in developing countries to expand over the next decade. This will open many doors for online dating companies to bring their products and services in front of billions of new internet users.

Internet penetration worldwide

(Source - Statista)

At present, the U.S. and China are comfortably the largest contributors to the global online dating industry revenues, but soon, I expect many other countries to become meaningful contributors to industry growth.

(Source - Statista)

The competition in the industry is expected to increase in the future, as social media networks such as Facebook can become an alternative source for singles, and with deep pockets and billions of users, these gigantic social media networks can pose a meaningful threat to existing players in the industry. However, I believe it would take some time for users to shift from the platforms they already use, and this provides existing players with an opportunity to retain users by providing a higher level of customer support, innovative features, and price discounts for subscribers.

A particular risk of expanding in to developing markets is the cultural upheaval these online dating companies might face in such countries. Failure to strike a balance between these things might become an obstacle for online dating companies in their expansion plans.

Overall, I believe the the online dating industry is poised to grow exponentially over the next decade, and expanding into international regions will be the name of the game for industry players. Even though competition is set to increase, there are enough growth opportunities in the market for existing players as well. Despite the massive growth opportunities present in outside markets, I believe the U.S. and European countries still present many growth opportunities as well.

Evaluation of financial performance and valuation

Match Group has enjoyed the benefits of the growing popularity of online dating, and a shift to everything online has certainly helped the company gain traction over the last decade. Innovative solutions provided by Tinder has led the charge for Match, and revenue has grown more than two-fold over the last 6 years.

(Source - Author prepared based on data from company filings)

In line with this massive revenue growth, the company has been able to improve its operating and net profit margins in the same period, which has been a growth catalyst for the company. Margins, however, might come under pressure in the future if Match is forced to spend more than what they plan on marketing campaigns or if it is forced to provide price discounts other than what they have already planned for, due to increased competition. Even then, the nature of the industry the company operates in leaves room to maintain high profit margins.

Profit margins (%)

(Source - Author prepared based on data from company filings)

In any case, the addressable market for Match remains a significant number, as more than two thirds of users in the developing world are still to try their hands at online dating apps and services. Notably, less than 50% of U.S. singles aged between 18-24 use online dating services, which is expected to improve significantly over the next several years, and this will create many growth opportunities for Match, which has a leading position in the industry.

Online dating penetration in selected emerging countries

(Source - Company presentation)

Online dating product usage in the U.S.

(Source - Company presentation)

Tinder, the crown jewel of Match Group, continues to deliver strong results, and I expect Tinder to gain traction in all parts of the world for many more years. A higher subscriber base in Tinder allows the company to market their premium products to a higher user base, and on the other hand, incentivizes advertisers to use Tinder as a platform of choice to market their products and services.

Tinder average subscribers

(Source - Company presentation)

Tinder will certainly play a major role in the growth story of the company, as average revenue per user (ARPU) of Tinder has improved substantially in comparison to other brands over the last couple of years.

(Source - Company presentation)

Higher profitability levels seen in Tinder is something the company can build on certainly, and Match will probably try to replicate the results of Tinder in its other products and services as well.

Apart from investing in building the brand value and popularity of Tinder, the company is focused on improving the array of services and innovative features provided on its other platforms, which is a winning strategy in my opinion, since the company can develop certain brands for specific regions or countries.

One thing the company can focus on more is attracting more advertisers to the platform. However, Match has to be careful so as not to lower the user experience levels by trying to focus on higher revenues from the advertisement segment. Nonetheless, Match can slowly but surely focus on bringing more advertisers to the platform, which should add another meaningful revenue source for the company.

In line with this favorable industry outlook and the growth plans of Match, I expect company revenues to grow at a compounded rate of 16% over the next 5 years. I expect margins to shrink temporarily, driven by my belief that the company will not be able to improve its operating leverage meaningfully over the next 5 years.

Match Group has grown in profitability, but has assumed a higher level of debt to fund its growth plans.

(Source - Author prepared based on data from company filings)

However, its leverage ratio has fallen over the last 3 years, which is a promising sign for the company. On the other hand, it is normal to see a fast-growing company having a considerable amount of debt in its capital structure, as long as the company is generating sufficient cash flows to service debt payments.

(Source - Company presentation)

The cash flow-generating ability of Match has remained intact over the last few years, and this will be a catalyst for future growth of the company.

(Source - Author prepared based on data from company filings)

Throughout the last 5 years, Match Group has provided great returns to its shareholders, and the low capital requirements have helped the company achieve stellar Return on Equity for an extensive period of time.

(Source - Morningstar)

Despite trading at a price to earnings multiple of 34, which might put some investors off of Match immediately, I believes investors need to take a second look as the industry and the company is poised to grow exponentially over the next several years.

(Source - Morningstar)

In order to value Match, I have used a two-stage discounted cash flow model, and major assumptions used in this model are listed below.

  1. Revenue growth of 16% in the next 5 years, which is considered the high growth period, and 2% in perpetuity.
  2. Operating margins of 31% in the high growth period, and 34% in perpetuity.
  3. Cost of capital of 7.51%
  4. Tax rate of 23%

With these assumptions, I arrive at a fair value estimate of $66.67 for Match, which represents an upside of 21% from the current market price.

(Source - Author's calculations)

I believe this presents a great investment opportunity for growth investors, as the company is operating in a very lucrative industry which is set to expand.

Risks & challenges

As competition is expected to increase in the future, and possibly will come from social media giants, I expect Match to spend billions of dollars in acquiring new customers. The company will be forced to spend more on marketing campaigns for this matter, and operating costs will rise in line with this new development. However, higher competition might result in lower operating leverage for the company, as users might not subscribe to paid services of Tinder and other brands operated by the company. I see this as one of the biggest risks of investing in Match Group, as the bulk of company revenues are earned from subscription services offered by the many brands operating under Match.

Match Group certainly focuses on international markets to provide robust growth opportunities, but these plans might come into question if the company fails to acquire more brands with a local touch. On the other hand, the company might need to adapt a different strategy to acquire more users in international regions, and the strategies that worked well in the U.S. might fail to function meaningfully outside the U.S. Therefore, it is of high importance for the company to study international markets thoroughly before launching marketing campaigns in order to maximize the results of such campaigns.

Conclusion

Headwinds are expected in the future, but the future looks bright for Match, and growth investors should find Match shares undervalued at the current market price. Even if the competition in the industry heats up, I believe it will take many years for such competition to eat into profits of the company. I remain bullish on the Match Group, and rate Match a buy at the current market price.

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.