Although the economic recovery in the US is slow, in the tech world people are partying like its 1999—witness Facebook’s billion dollar acquisition yesterday of a 12-person photo-sharing startup with no revenues. We all know how that story of ‘irrational exuberance’ ended in 2000…
Which brings me to Angie’s List (ANGI), one of the crop of recent tech IPOs. The company has never been profitable and in fact the losses are mounting each year—from $15 million net loss in 2007 to $49 million net loss in 2011—as the company spends more and more each year to acquire users. What does the market think about this? Well, the market seems to be paying attention to user growth and not profits (sounds familiar?). Paid memberships grew from 602,882 in 2010 to 1.07 million in 2011 and so the stock has managed to appreciate slightly from the $13 IPO price: at a current price of $14.52 with 57m shares outstanding, the market cap is $827 million and the company trades at 9x revenues!
Given such a high valuation, you’d expect to see at least some kinds of barriers to entry or unique assets; however, the company has no patents and invests only 10% of revenue in technology. Big competitors offer the same service as Angie’s List, but for free. ANGI offers online reviews of service providers, like plumbers or doctors, and users need to subscribe to the service both to access those reviews and to write reviews! Yelp, which went public last month, offers the same service, but for free, and attracts 66 million monthly unique visitors. Big tech companies like Google are also investing heavily in local service reviews: last September Google bought Zagat for the purpose of growing their offering in this area. There are also traditional competitors, like Yellow Pages providers (see the deal announced yesterday by Cerberus to buy a majority stake in the Yellow Pages directory division of AT&T for 1.8x 2011 EBITDA), small niche competitors in vertical sectors like RateMDs for doctor’s reviews, and divisions of web companies like IAC’s Insider Pages. All those competitors offer a similar service to ANGI, but for free. Probably the biggest competitor is some small group of developers in a garage that want to create an app or web site for user-generated reviews and figure out a better way to leverage social networks to make the experience more compelling. In fact, having the basic address and location data on businesses is not a barrier to entry because there are 3rd party providers who will sell that data to startups.
With so many free options out there, why is Angie’s list still growing? The answer is simple: they are spending heavily. Last year, a total of $89.9 million was spent on sales and marketing, compared to 90 million in revenue! The marketing expense, a total of $56 million, relates directly to user acquisition at a cost of $78 per user. This seems like a huge amount when a 1-year membership costs between $28 and $46: http://my.angieslist.com/angieslist/visitor/price.aspx Renewal rates are high at 75%, but my experience with the service is that this is mostly because the company automatically renews with your credit card, and then makes it very difficult to cancel the subscription (similar to what America Online was famous for in the last tech boom). My suspicion is that most people ‘renew’ largely because they don’t notice the recurring charge on their credit card statement.
In addition to the subscription fees, ANGI sells advertising services to companies that want to reach ANGI’s subscribers. This generated $56m in revenues last year, but at a cost of $33m in sales, for a net revenue generated of only around $23/subscriber. Paying $78 to acquire a user that generates roughly $37/year in average subscription fees and $23/year in advertising revenues seems like a dangerous business when most of your competition offers the same service to consumers without any subscription fee.
Even though the company has $88 million in cash, given that Angie’s List lost $49 million on $90 million in revenues last year, it seems to me that the cycle of paying high marketing fees to acquire users can’t continue forever. At a valuation of 9x revenues, it doesn’t take much for the stock to fall significantly: when user growth slows the valuation should deteriorate rapidly. Furthermore, if user growth slows and churn rates increase, then the advertising revenues will also become threatened. The end of the lock up on shares could be a catalyst that starts the decline: 46.7m shares (of the 57m shares outstanding) are subject to lock-up agreements which expire in 2012—so I expect we will see heavy selling by insiders as the lock-ups expire.