Description

Q&A sites are getting high valuations due to enormous scalability and profitability driven by low no cost user generated content. In early 2010, Quora in start up mode got a valuation of $90 million (pre site launch), and at the end of January, Demand Media (owners of eHow and other businesses) will have a $1.2 billion market cap post-IPO.  However, Answers.com (ANSW), the industry leader (in terms of Q&A database size) and only pure play public company, has been totally ignored for a couple of understandable but we think temporary reasons. In fact, ANSW stock price is up a mere 10% since 12/31/08, while the company remains one of the 20 most visited sites in the US with 13 million daily unique visitors and has seen its traffic nearly double over the last two years. A number of key changes should be imminent which we believe should lead to a far higher valuation.

Answers.com is the 138th most visited site on the web worldwide, and it scored inside the Top 20 in the US in October 2010. Answers.com gets more monthly traffic than ESPN, Linkedin, Disney and Best Buy. This popularity was achieved through the creation of a question and answer database that has just under 6 million registered users with 11 million answers. Despite its size, the company is still growing key metrics at a reasonably good pace, as the number of questions at Wikianswers grew to 11 million in January 2011 from 2 million in September 2008.  Wikianswers makes up 77% of revenue and MRQ grew 31% yr/yr.  The company has made good progress growing their database in the more lucrative segments, such as financial services and automotive.  Every 1.5 seconds a question is asked in the automotive vertical, a highly monetizeable market. This is a very good recent article I suggest interested investors read:

(http://www.mediapost.com/publications/?fa=Articles.showArticle&art_aid=142605).  

The key to realizing significant shareholder value comes down to the monetization of their traffic, as measured through RPMs (revenue per thousand impressions).  Operating margins have fallen from 28% to 9% over the last three quarters, so the trends suggest a potentially ugly scenario.  However, we believe the company has hit a significant inflection point, given the recent changes to their business model that should improve results this quarter and going forward. Over the last 11 quarters ANSW has averaged $6.10 in RPM, however traffic has increased significantly.  Below is a sensitivity of ANSW's revenue in their WikiAnswers segment (about 80% of revenue) to changes in RPM's and average daily page views.

We believe it is likely that ANSW will begin to generate much better RPM's than where the company is at as of 9/30/10 for the following reasons.

A)      Answers.com will tie into the Facebook platform and Twitter, and members will have an option to follow contributors, and make it easier to make recommendations to friends and ask friends.  

B)      Working with Vibrant Media on rich media hyperlinks that are running on 25% of pages and rising  (www.vibrant.com).  These hyperlinks are much more eye-catching and have higher click through rates.

C)      Active discussions with a company that offers interactive monetization toolbars, which will began  testing during Q4

D)      New Ad banner placement strategy coming in 1Q11 with relaunch of the site

E)      Targeted vertical category inventory "... business, shopping, automotive, legal...perform 2 to 5 times greater than general overall RPM's" "We are also reaching audience scale in a number of the most desirable and highest monetizing advertising verticals, and our plan is to exploit this potential in 2011." Nov 10 CC

F)      Direct Sales force to sell advertising: Previously tried this two years ago and stopped. "Over the last two years, from 3Q08 to 3Q10, our traffic has jumped 86%, and this volume changes everything." Nov 10 CC

G)     Relaunch of site with reputation ranking system (higher quality content, better user experience, higher ad click through rates)

Regarding these changes the CEO commented, "We are confident that Q4 2010 revenue will be materially better than Q3 2010 revenue, and we expect that our 2011 revenue will also exhibit healthy growth over 2010. In the beginning of 2011, we plan on adding two new direct ad salespeople to help exploit the potential of our large and growing audience and deliver significant new revenues and profits. Furthermore, in the first quarter of 2011, we plan to release a redesigned, streamlined Answers.com site that we believe will enhance both traffic and RPM."  This likely significant short term revenue improvement combined with ANSW's operating leverage should provide a reasonable catalyst.

We believe the market is looking backwards and is not appreciating what will continue to be positive catalysts for the company.  We believe few to none of the initiatives have been taken into account from the one analyst that covers the stock.  Currently the analyst is predicting slight improvement (management stated "material improvement") not only for 4Q, but also forecasts that revenue should be down 1% in 2011 over 2010. That would be difficult to believe given growth in key metrics and significant changes to the business model.

Simply put, we think Answers.com has a great business model whereby a universe of 6 million people answer questions to common issues which the company can sell advertising around forever without having to pay the writer to create the content, and avoiding distribution/material costs.

Below we show a sensitivity of ANSW's 2011 revenue and earnings to the variables of average daily pageviews and revenue per thousand pageviews.   

Venture Capital firm Redpoint Ventures http://www.redpoint.com/ owns approximately 25% of ANSW with a cost basis of just over $5 and has two board seats (previous investments include Netflix, Myspace, Tivo).

Demand Media's S1 provides some useful metrics for comparison purposes, since their eHow business operates in a similar manor to answers.com (albeit with one key difference).  eHow.com is an online community dedicated to providing visitors the ability to research, share, and discuss solutions and tips for completing day-to-day tasks and projects.  The site generates RPMs of $12 vs. $4.50 for ANSW.   Given that eHow pays for their content (which results in higher quality than on answers.com), we do not think that ANSW will get to $12.   However, we do believe that they should be able to do significantly better than $4.50 given that each of their new initiatives is designed to do exactly that.  Currently 26% of revenue comes from display ads and 74% comes from Google Adsense.  RPM's on display ads are up 50% while Google Adsense revenue has fallen by 33% on yr/yr basis.  Google Adsense is based on Cost Per Click and ad Click Through Rates (CTR's are big driver in revenue).  ANSW is working with Google to analyze data to better address their click-through performance by taking Google's advice on ad placements. The younger demographic at Answers 15-30 years old is tech saavy with lower click through rates, and it is much more effective to sell display ads (on a RPM model than depend on ANSW's current model that works on revenue per click). We think advertisers would love to reach this demographic and makes a lot of sense to hire a direct sales force to sell this inventory.

Demand Media IPO is scheduled for January 25 led by Goldman and Morgan Stanley.  Below is the implied valuation based on the announced range of $14 - $16.

What is the business worth?

We think the business could significantly grow the top and bottom line in 2011. It is difficult to predict how much, but at current prices if ANSW hits our base case it is trading at about 6x EV/EBITDA for what we think is a unique asset with what should be 30%+ margins.  We think the upside could be $18-20 and downside $5-6, based on the value of their huge traffic alone.

Catalyst