#onlinedating | Spark Networks: LOVe The Acquisition (NYSEMKT:LOV) | #bumble | #tinder | #pof

Spark Networks (LOV) has recently filed its 1H20 financial statements and the results are generally positive. The acquisition of Zoosk coupled with increased marketing efficiencies has greatly improved contribution margins. At its current price, LOV may well be at a significant discount to its fair value.

Background

Spark Networks is a global operator of premium online dating sites, boasting a collection of brands catering to the niche market such as the Jewish community (JDate, JSwipe), Christian community (Christian Mingle), the senior community (SilverSingles) and mature/educated community (EliteSingles), which brings both competitive advantages and disadvantages to its competition. More on this below. With its most recent acquisition of Zoosk, a younger-demographic focused dating site, LOV is arguably the fourth largest in its industry, after Match Group Inc (MTCH), Meet Group Inc (MEET) and Bumble/Badoo. Estimated industry size worldwide is $6.69B in 2018 and is expected to grow to $9.20B by 2025. Another report estimates the industry size to be $8.4B by 2024.

LOV operates in an industry with a declining business model, akin to pharmaceutical drugs. The successes of the users in using the product/service, translate to less usage of said product/service. For example: when someone falls sick, they take medicine to get better. Thus, pharmaceutical company selling the drug gains a customer. When the patient gets better, they no longer take the medicine, and the pharmaceutical company loses a customer. In the online dating business, strangers turn into couples, and thus the business loses customers. Fortunately for these businesses, their respective markets are “cyclical” – people still get sick, and relationships end.

The stock has experienced a tremendous fall from its 3/27/19 high of $16.94 and from its acquisition closing price, 6/28/19, of $11.78. However, recent developments provide hope that better days are ahead.

Niche vs Mass Market

Spark Network’s sites are operated on a freemium basis, with a very limited free access to get users to subscribe to premium. A positive note about its niche market: users have greater willingness and ability to pay as opposed to its mass-market competitors, measured by average revenue per user (ARPU). While not an apples to apples comparison, the table below provides a general sense of ARPU differences.

ARPU

Spark Networks

Match Group

Meet Group

As of 2Q20

$14.61 – $21.07

$0.53 – $0.65

$1.59 – $4.78

Range

(From – To)

(Int’l – N. America)

(Int’l – N. America)

(Web – Mobile App)

Source: SEC Filing; LOV, MTCH, MEET

The current pandemic seems to provide tailwinds to the industry. CEO Eric Eichmann mentioned during the 1H20 earnings call Q&A that “in general, Silver and Elites have higher ARPU than Christian and they’re growing a bit faster”. It seems that Covid, a health threat to all but especially the elderly, and an economic threat to ((generally)) lower income earners, may be a tailwind to LOV due to its niche market. However, looking at daily average subscriber count, the trade-off is clear:

Subscriber Count

As of 2Q20

Spark Networks

Match Group

Meet Group

North America

600,126

4,703,000

N/A

International

314,672

5,360,000

N/A

Total

914,798

10,063,000

4,596,000

Source: SEC Filing; LOV, MTCH, MEET

The acquisition of Zoosk provides the company an avenue to pursue the mass-market through targeting the younger demographic as opposed to non-Zoosk platforms. The key to unlocking value is in combining the best of two types of platforms (niche and mass-market): price and subscription volume, while driving costs down through synergies.

Revenue

A top-line view of the company’s revenues reveal that non-Zoosk revenues have been on a decline. Looking a little closer, the decline is in the international market. As the company moves away from the international markets and towards North America, international revenues have decreased substantially, while revenues in North America are slowly increasing alongside an impressive increase in contribution rates. However, one concern is the decreasing rate of revenue growth in the North America market.

Ever since the company acquired Zoosk in July 2019, the company has been transparent on their performance. They have also been generous enough to split Zoosk and non-Zoosk performance for a better view of the organic changes within their original portfolio prior to the merger. The company started mentioning contribution rates for each of North America/International Zoosk/non-Zoosk in 1H 2020. As such, contribution margins for 2H19 are simply an estimate using Excel’s data analysis, with these constraints:

  1. International margins are higher than North America margins
  2. Contribution from non-Zoosk in 2H19 is higher than 1H19
  3. Non-Zoosk 2H19 contribution total = 24,414k

As shown below, non-Zoosk revenues in North America is increasing at a much slower rate, while the impressive contribution rates are a result of spending cuts than revenue increases. This suggests that the increase in contribution rates may not be sustainable as it relies on decreased spending rather than larger earnings. This is especially in LOV’s case where scale plays a significant role in cost savings.

Source: Author generated through SEC filings and Excel data analysis

A bright spot is the substantial increase in Zoosk contributions as a result of an increase in revenues coupled by the decrease in direct marketing expenses. Investors should also be encouraged as this increase is occurring on the first half of the year, which is generally the lower-contribution half of the year. In general, revenues are trending favorably and so is contribution. The only possible source of concern is the slowing of non-Zoosk revenue increases which may create a false sense of sustainability in raising contribution.

Zoosk
North America Revenue DM Cont
2H19 42.741 29.893* 12.848
1H20 48.359 25.415 22.944
HoH Change % 13.1% -15.0% 78,5%
International Revenue DM Cont
2H19 9.186 3.249* 5.937
1H20 9.080 3.308 5.772
HoH Change % -1.2% 1.8% -2.8%
Total Revenue DM Cont
2H19 51.927 33.142* 18.785
1H20 57.439 28.723 28.716
HoH Change % 10.6% -13.3% 52.8%

Source: SEC Filings; (*) data analysis estimation based on given constraints above.

Costs

In past earnings call, CEO Eric Eichmann has noted repeatedly that scale plays a big part in the success of the business.

“Significant size…a critical success factor in our industry” – 1H20 earnings call

“Spark has been focusing on acquisitions that gain size and scale, which was — because I think that’s kind of key elements of success in the industry” – 2H19 earnings call

“(Match Group) has been performing extremely well, and there you can really see the benefit of scale. So when you have scale on the dating side, you can generate really high profitability and also really high cash generation.

When you look at our business as well, what you can see is with the increase in scale, we have been able to increase our EBITDA margins year after year.” – 1H19 earnings call

Scale plays a big factor in two parts: more subscribers allow more interaction between users, which results in greater spending, and decreasing marginal cost per new subscriber. We can see this is generally true by comparing contribution margins and average subscriber count. To be noted that 2H19 contribution margins do not fully reflect the positive impact of higher subscriber count to margins because the combined entity had yet to realize synergies. The trend points to scale being a large factor, and thus being larger certainly helps. The question is, how much is scale worth?

Source: Company SEC filings.

M&A Activities, Debt and Valuation

Not only is the company a serial M&A participant, it has a habit of combining with a larger firm. As shown below, the company is a serial M&A participant:

Target

Closing Date

Total considerations

Smooch Labs;

JSwipe

Oct 14, 2015

N/A

Samadhi

((Attractive World platform))

Sept 30, 2016

N/A

Affinitas

EliteSingles, eDarling

Nov 2, 2017

Merger;

Affinitas owns 75% of combined entity

Zoosk

Jul 1, 2019

$258M in cash and stock;

Zoosk owners own 49.9% of combined entity

Source: Author generated based on SEC filings.

Its most recent acquisition essentially increased share count by 100% and placed a $125MM debt on the balance sheet due June 2023. As of 1H20, the debt is at €88.84MM (~$104.83MM), with a $3MM (~€2.54MM) quarterly principal payment and interest at LIBOR + 8%. At the current LIBOR rate, the interest rate is about 8.25%. With a guidance of $34MM to $36MM EBITDA and a historical $4MM capex brings us about $30MM to $32MM for debt reductions or expansion. The company is looking to improve their debt position as per the 1H20 call. A reduction in interest rate would greatly benefit the company, but we’ll have to wait until next year to find out its progress due to the company’s foreign filer status.

Zoosk has contributed about €109MM of revenue in one year. LOV currently has an EBITDA margin of 16.5% and looks to stabilize margins at 20-30%. Applying a conservative 15% EBITDA rate brings us €16.35MM. At an exchange rate of 1.18, this values the Zoosk acquisition at 13.33x EV/EBITDA. However, currently, LOV trades at a meaningful discount to its peers. As comparison:

As of 2H20 MEET MTCH LOV Zoosk Acq
LT Debt 28,672 459,042 92,189*
ST Debt 3,500 12,646*
Cash 47,644 129,294 11,959
Net debt -15,472 329,748 92,876
Shares out 72,793 260,020 26,057
Share price 6.29 117.49 4.74
EV 442,393 30,879,498 216,385 258,000
EBITDA 28,661 402,144 34,000** 19,358
EV/EBITDA ((Ann.)) 7.72 38.39 6.36 13.33

Source: Yahoo! Finance

All in (‘000) except share price

Share price based on 02/09/2020

* Assuming EUR/USD of 1.18

** Low estimate of management guidance

Valuation

LOV trades at a discount to its peers’ EV/EBITDA multiple. Granted, the subscriber count of both MEET and MTCH are much larger than LOV, as shown before. However, should LOV trade at a similar multiple to MEET as of 1H20, this represents a share price of $6.51, a 37.3% appreciation from current levels.

In valuing LOV, we assume that no debt repayments are made in 2020 other than the $3MM required principal payment per quarter, and for conservatism’s sake, no increase in cash position. The base revenue growth of 6% represents the industry growth rate, and the 15% EBITDA margin is obtained from the minimum implied EBITDA margin based on management’s earnings call (EBITDA of $34MM on $228MM of revenue).

(in USD, ‘000 except PPS) Bull Base Bear
Revenue, 2020, guidance 224,000 224,000 224,000
Revenue growth (2020-21) 9% 6% 3%
EBITDA margin 18% 15% 12%
Implied EBITDA 43,949 35,616 27,686
EV/EBITDA multiple 7.5 7 6.5
EV 329,616 249,312 179,962
Less: net debt 80,876 80,876 80,876
Equity value 249,740 168,436 99,086
Shares outstanding 26,057 26,057 26,057
PPS 9.55 6.46 3.80
Upside (Downside) 101.4% 36.4% (-19.8%)

On a base rate, LOV has a 36.4% upside. This assumes that the company fails in all value-creation and merely sustains its current trajectory as compared to the industry. This conservative base rate means no interest rate reduction, no more cost synergies, no marketing efficiency improvements. The only non-conservative action is the EV/EBITDA multiple of 7, which when compared to peer EV/EBITDA, is still conservative. If this happens, the company’s value still has a 36.4% upside.

Risks

Several risks should be noted in investing in this company.

1. Competitive risks: LOV is a small company in a large online-dating industry, dominated by Match Group, and albeit slightly distant, social network powerhouse Facebook. It is easy for LOV to be driven out of the market if their competitors decide to create niche online dating platforms, especially with their financial muscle.

2. Acquisitions: As previously mentioned, LOV is a serial M&A participant. In the first earnings call held by the latest CEO, acquisitions were again mentioned. It seems that there’s almost always M&A activity, and as shown above, the M&A transactions are getting a whole lot more expensive. If the synergies are not as well as expected, or the company overpays, M&A activities may lead to value-destruction instead.

3. Headwinds: While the pandemic and stay-home orders suggest that online dating is increasing, the economic implications may well cause a shift in users from the more expensive LOV-based sites and apps to say, Tinder, which offers more freebies.

Conclusion

At the current price, LOV trades at a significant discount to its peers. The North America market continues to be the main driver of growth and the niche market combined with the pandemic has enabled increases in ARPU. With a growing subscription base and improving cost margins, LOV should be able to trade at much higher prices than today.

Disclosure: I am/we are long LOV. 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.

Additional disclosure: The article above mentions a micro-cap stock. Please be aware of the relevant risks.

Editor’s Note: This article covers one or more microcap stocks. Please be aware of the risks associated with these stocks.




Source link

————————————————————–
Source link

.  .  .  .  .  .  . .  .  .  .  .  .  .  .  .  .   .   .   .    .    .   .   .   .   .   .  .   .   .   .  .  .   .  .