As regular readers know, I’ve been a strong a proponent of owning Match Group (MTCH) since 2018. It’s a rare business that possesses strong network effects, generates enormous return on capital, and remains solid even during a recession (or pandemic). With a portfolio of dozens of leading brands, the $28 billion Match Group dominates the online dating industry. The stock surged from $15.20 a share in November 2015 to $105 today.
The small-cap Spark Networks (LOV) frequently touts itself as the second-largest online dating company in North America. Perhaps hoping that lightning will strike twice, many bulls point to Match’s valuation metrics as reasons why Spark should be worth several times its present value.
But upon closer inspection, such comparisons seem inappropriate. Spark’s struggles over the last five years have been well-documented. The company has churned through chief executives. Core brands haven’t kept pace with newer entrants. Spark has engaged in a flurry of M&A activity over the last few years, but it isn’t clear that this has produced shareholder value. Meanwhile, subscriber count and revenue at core legacy brands is in decline, and the company is losing money as it tries to shift focus toward uncertain growth initiatives.
In 2016, Spark Networks was, by all accounts, a total disaster of a company. The owner of JDate and Christian Mingle, which boasted some 270,000 paying subscribers in 2012, had declined to 178,000 by 2017. Between 2011 and 2016, the company went through four CEOs. Spark’s legacy brands, designed for an online desktop, never adapted fast enough for the mobile age. That Spark had to sue (and eventually acquire) a Jewish-focused swipe app attests to the company’s astonishing lack of innovation in the age of Tinder.
In 2017, Affinitas, the German owner of the Elite Singles brand, completed a reverse merger with Spark. Affinitas’ CEO Jeronimo Folgueira took over as chief executive of the combined company. Affinitas had a track record of success going into the deal. In 2016, its three biggest brands increased revenue by 20 percent. The combined company topped €118 million in sales in 2018.
An Expensive Acquisition
Perhaps Affinitas hoped to turn around Spark’s business at a bargain price; management has consistently spoken of “stabilizing” sales at legacy Spark brands. But the company didn’t stop there, instead going on to acquire U.S. dating app Zoosk for $258 million in cash and stock. Spark financed the cash consideration by taking on substantial debt.
The Zoosk purchase was yet another fixer-upper. Zoosk was initially founded as a service that built dating extensions for social media platforms like Facebook. The company raised over $60 million and once planned an IPO; those plans were scuttled in 2016, as Zoosk’s business was decimated by Tinder. The founders resigned, and the company laid off a third of its staff. Shortly before it was acquired, Zoosk reported flat revenue for Q1 2019. Tinder, on the other hand, grew sales 43 percent during the same period.
Throwing Good Money After Bad
To sum up the situation thus far, Affinitas diluted its solid brands by pursuing mediocre opportunities in Spark and Zoosk, at best. Management has maintained that reducing overhead and building scale is necessary to compete against giants like Match Group, but increased size hasn’t produced much value for Spark. In fact, revenue from the company’s non-Zoosk brands declined 6 percent to €97 million last year, and average paying subscribers fell 11 percent.
Management attributed the decline to reduced marketing spend on the international segment; the expenditures were instead shifted toward North America. Simply to maintain market share with Zoosk and legacy Spark brands, the company spent €86 million on direct marketing efforts in 2019. This figure represents nearly 60 percent of Spark’s €149 million in sales. By comparison, Match Group’s marketing and advertising expenses comprise some 20 percent of total sales.
Last year Spark’s board fired Folgueira as CEO. New chief executive Eric Eichmann admitted earlier this year that the Zoosk brand needs work.
Zoosk was a brand…that was in decline. It was very clear to us that when we acquired Zoosk, it was to reach a certain size. And we also believe it was a very strong brand that needed some revival, if you will. And we’re in the process of doing that.
Responding to questions about continued losses, Eichmann added on the Q2 call that the company hopes to “stabilize [Zoosk] and start growing again in 2021 and beyond” using the company’s solid businesses as the piggy bank.
And so we have a number of cash cows in international. We have a brand name in Hungary. And we have a number of brands that contribute EBITDA and we like that. But obviously, we’re not sort of looking to grow those numbers. And so that’s another factor that comes into it. As we ramp up marketing, as we continue to improve our products, our expectation again in 2020, we’re stabilizing and then we’re preparing ourselves for future growth.
In essence, management plans to reallocate capital from legacy businesses toward uncertain prospects with Zoosk and other new initiatives. But in doing so, it risks damaging the cash cows that fund these growth prospects in the first place – as noted previously, international subscribers at non-Zoosk brands declined last year.
A Tough Hand
After several years of management turnover and M&A activity, it doesn’t appear that Spark is in much of a better position than when it started. Spark hasn’t turned a GAAP profit in the last three years, and now its debt load stands at €88 million after the Zoosk acquisition with just €12 million in cash.
Perhaps a new brand will come out of left field and become a hit for the company. Management spoke of a new app that it is developing in-house, which it simply calls “Spark.” The company hasn’t released many details on the Spark app, other than it is currently Beta testing the product in Canada.
But at the end of the day, the company finds itself in a difficult situation. Spark’s growth prospects remain dubious, but to have any chance of realizing new growth, the company must shift investment away from its smaller but more profitable cash cow businesses. Seeing as Zoosk now comprises half of the company’s revenue, it doesn’t have much of a choice.
Maybe management can pull off this transformation, but they’re playing with a tough hand. It isn’t a bet that I would take.
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.
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