1/27/2010

Deep Value created by large buybacks supported by free cash flow

Spark Networks (LOV) continues to be ignored by the general market in terms of price appreciation and institutional ownership. LOV posted 19% increase over the past year and lost -20% over the prior 3 year period. Symbol LOV (Spark Networks) operates dating websites and has a vast portfolio of web sites that includes JDate.com, AmericanSingles.com, BlackSingles.com and about a total of 23 unique dating sites. The sites include multiple user functionality like real time chat, instant messaging services user profiles, onsite email centers, and offline single events. The company’s most valuable asset at this time and having a huge economic moat is Jdate.com. It’s the leading Jewish dating website and has been mentioned on popular TV shows such as House, South Park and the Daily Show. The word of mouth impact keeps promotion costs low for this business.
The LOV (Spark Networks) story is simple so I won’t bore you with a lengthy business description. Instead, I will try to focus on the main reasons why I think the stock is worth a closer look, management, capital allocation, sustained free cash flow, activist shareholders, high ROIC and clean capital structure.

Let’s start with the management team. Great Hills advisor took a 45% minority stake and was able to get a board seat and push to find an experienced and shareholder oriented management team incentivized with large amounts of stock options. The large amount of management options outstanding are far out of the money and should motivate management to drive the stock price higher along with the influence of a board seat from Great Hills advisors. I’ve never seen such a highly educated and experienced executive team and board members for such a small company.

Adam Berger is the CEO who led WeddingChannel.com, Inc. and grew the company for seven years through its sale toThe Knot, Inc. He received a Havard M.B.A. with distinction and a B.S. in Chemical Engineering from the University of California at Berkeley. Gregory R. Liberman was appointed President on June 2006 and Chief Operating Officer August 2005. Mr. Liberman earned a J.D. from the University of Chicago and an A.B. in Economics from Stanford University. Brett A. Zane was appointed the Chief Financial Officer December 2007. Mr. Zane holds an MBA from UCLA and a B.S. in Economics from The Wharton School, University of Pennsylvania. Gregory J. Franchina was appointed as the Chief Information Officer on June 2007. Mr. Franchina has over 22 years of technical and operational experience. Franchina holds a B.S. in Computer Science from The College of William and Mary.Joshua A. Kreinbeg has been the general counsel since April 2006 earned a J.D. with honors from Duke University’s School of Law as well as an M.B.A. from Duke University’s. Mr. Kreinberg also holds an A.B. in Quantitative Economics and Political Science from Stanford University. The board is just as strong with Great Hill Partners getting representation with Michael A. Kumin. Kumin is a partner of Great Hill Partners, LLC where he has served as an investment professional since June 2002. Previously, he served at separate times as an investment professional for Apollo Advisors, L.P. and Goldman Sachs. He holds a B.A. from Princeton University.

Valuation:

Management has bought back a stunning amount of shares over the past 2 years. In fact $47,354,000 was expended for share repurchases over the two year period from 12/06 to 12/08. The share count was reduced from 31,271,000 for the period ending 09/06 to 20,582,000 for the period ending 09/09. LOV may have paid a bit more than was necessary but when looking at the true intrinsic value I believe it was a smart use of excess capital. The buybacks were supported by their strong free cash flow. I calculated the average price paid was $4.20.

LOV generated $5,057,000 in FCF from 12/31/08 to 09/30/09 , $15,160,000 from 12/31/07 to 9/30/08 and $13,701,000 from 09/30/06 to 06/30/07. To put this into perspective using the current enterprise value of $69,792,000 this would provide a FCF yield of 7.25% ,21.72% , or 19.63% for the yearly period ending 09/09, 09/08,09/06 respectively. The drop from 21.72% (09/08) or 19.63% (09/06) to 7.25% (09/09) could indicate the stock is trading at a discount to normalized earnings.
Return on invested capital has also been stellar with pre tax ROIC at 39.93% (2008), 14.04% (2007) and 17.76% (2006). It’s important to note that the FCF would be much higher with a new or larger company as the SGA could reduced given the current large salaries that were required to recruit and retain the executive talent and turn the company around or simply dress up for a future sale.

There are several scenarios where LOV receives a higher market price . I would not be surprised if Jdate.com alone receives a price greater than the current market cap for the entire company. Match.com owned by IAC, Yahoo , MySpace or e-Harmony are all potential suitors. A dividend may be initiated given the consistent FCFand I’m sure the 45% active shareholder Great Hills advisors is seeking to monetize their work and risk.

Andrew Ross Sorkin wrote in the NY times on January 4, 2008. “The parent company of the popular Jewish online dating site JDate has put itself up for sale, people close to the auction said Thursday, and is already in talks with several prominent media companies. For rivals like the unit Match.com unit of IAC, analysts say Spark would bolster business, allowing it to offer more niche categories to its 20 million members. Spark could also provide a personal service for MySpace and a natural extension for eHarmony, which has focused strictly on its high-end subscription service and falls right behind Spark, with total traffic of 2.18 million.”
http://www.nytimes.com/2008/01/04/technology/04deal.html

At year end 2009 the successful micro cap value and sometimes activist institution Osmium Partners run by John Lewis filed a 13g reporting a 5% position.

So in conclusion there are many forces that make this 61 million market cap idea worth a closer look including proven management talent, strong capital allocation, activist shareholders, outstanding FCF, high ROIC, balance sheet strength, a clean capital structure with a dramatically reduced outstanding share count or simple mean reversion along with the economic moat provided by Jdate.com.

Disclosure:Long LOV

4 comments:

Anonymous said...

i thought your writeup here was excellent, so i went a little deeper and typed up a blog about it on my covestor, i'll just paste it here, what do you think? summary- it doesn't seem very cheap and i don't see any reason to bank on them increasing revenues:

Long story short I think this is a pretty easy company to pass on. Their subscriber base on all fronts has been in a constant decline since they went public in 2006, from 236,000 avg subscribers then to 165,000 now. i don't think this is a cyclical decline, especially after talking to some of my friends that engage in online dating... i think the nature of online dating has changed and the big companies have the momentum/subscriber base to keep expanding, OKCupid.com and plentyoffish are huge/free/quality sites (especially okcupid) so with time LOVs revenues decline and don't come back.

also i don't think management's done a great job, they've wasted money on a couple value-destroying acquisitions in the last few years ($2mm for hurrydate.com??? $2.3mm for LDSSingles.com? That's craziness.)

it's hard for me to say that this company will do any better in the future than they are today and even today they aren't that cheap, their FCF yield is mediocre. today's price implies at least some growth in the future and with the online dating market being what it is today and management that's highly compensated but have done poorly at creating value i don't see a reason to believe that there will be any growth.

there's no cheapness here, I pass.

ShadowStock said...

Thanks for taking time to comment.

Management has made some mistakes in the past but I believe the stock has some merits as an investment now or placed on a watch list.

These were my comments on seeking alpha and I hope they may provide answers on your comments if not let me know

http://seekingalpha.com/article/185106-many-potential-scenarios-can-spark-a-move-higher-in-lov?source=yahoo

I can’t argue with most of the data presented but this won’t prevent me from introducing the stock or believing it will outperform the market. It’s important to point out LOV has appreciated only 14% since January versus 27% for the NASDAQ or 21% since March versus 39% for the NASDAQ!

As you stated, management is aware of the sites that are not returning an acceptable ROIC and will focus on the higher ROIC sites. Management appears to be more concerned about shareholder value as opposed to empire building and I view this as a positive.
It’s not so outlandish to believe the stock goes up 66% to $5. I agree that the low turnover value micro cap specialist Osmium Partners’ buys at the end of the year pushed to stock higher.

This stock is down 20% over the past 3 years or only up 14% for 2009. But management is fully aware of what is needed to increase the stock price and that is one of the reasons I’ve added a small position to my highly diversified portfolio.

In my opinion your points are valid but this is what makes the stock attractive as a contrarian idea that is quietly building shareholder value without the appropriate price appreciation.

The market rarely gives credit for the following shareholder building activity for most micro cap stocks including LOV

- Total liabilities reduced from 21.8 million to 16.6 million

- Share count reduced from 31.271 million to 20.58 million

- Activist shareholders

- Deep competent management team

- Mean reversion, down 20% over 3 years only 14% for 2009

- High ROIC coupled with High earnings yield using FCF (good company at a cheap price / Joel Greenblatt magic formula)

- Out of the money options

- Mean reversion

- Huge economic moat with the highly profitable Jdate.com

It appear they are setting the ground work for a higher price based on a future sale, going private, dividend or simple market recognition of its deep value.The current closing price of $2.97 and the high free cash flow yield makes for a reasonable margins of safety in my opinion

Regards
John

Anonymous said...

Hi
Very nice and intrestingss story.

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