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Ancestry.com (ACOM) is the world's largest online family history resource, with just over 1.7 million paying subscribers around the world as of December 2011. The company has experienced significant growth in recent years and has enjoyed tremendous operating leverage. However, the market has been brutal to the stock over the last six months, sending it down by 40% to the current $27.50. As a result, ACOM trades for just over 10X 2012 FCF on a one-year forward basis, which we think is way too cheap given what we consider to be very strong growth opportunities. We expect the company's wide moat will allow it to remain the industry leader for years to come, while its inherent leverage will allow the company to grow profitability much faster than revenue.
While the company has only been public since 2010, ACOM has been a leader in the family history market for over 20 years and has helped pioneer the market for online family history research. While genealogical research is not new, Ancestry.com has revolutionized how this research is performed: what use to be a very slow and laborious process involving a lot of travel and snail-mail has now been replaced with a very user-friendly website that can be accessed from the comfort of home.
The foundation of Ancestry.com's service is an extensive collection of billions of historical records that it has acquired, digitized, indexed and put online over the past 14 years. The company has developed and acquired efficient and proprietary systems for digitizing handwritten historical documents, and has established relationships with national, state and local government archives, historical societies, religious institutions and private collectors of historical content around the world. Ancestry.com has invested nearly $100 million over the years acquiring, digitizing, and indexing over 6 billion records such that the company now boasts a document collection that spans US, UK and Canadian censuses, Immigration records, WWI and WWII draft records, casualty reports, family and local histories, slave narratives, newspapers, maps, city directories, state birth/marriage/death records, country, church/court/land/probate records, obituaries, and yearbooks. Further, there is a substantial amount of internal user-generated content (e.g., family trees database) on the Ancestry platform that is not easily replicable. Additionally, the company has invested heavily in its technology platform, developing a proprietary vertical search engine for historical content as well as a record-hinting technology that helps accelerate research.
Ancestry.com is primarily a subscription-based business. ACOM offers two packages on its website, U.S. Deluxe and World Deluxe, and subscribers can choose among various subscription periods such as monthly or semi-annually to each. Subscribers to the U.S. Deluxe package gain unlimited access to the complete United States collection of records, including the ability to view images of original records. They also can communicate and collaborate with other members of the subscriber network. The World Deluxe plan includes unlimited access to all of the content on Ancestry.com Web sites, including the content from the U.S. Deluxe plan plus the global collection of records.
The company also offers a number of ancillary products and services, although the overall sales mix from these ancillary segments has declined from 10.1% in '05 to 7.6% in '09 as Ancestry.com has taken off. Some of these are quite interesting but because the core subscription service is the key value driver, we will not delve into them in further detail here.
We have come to the conclusion that ACOM’s genealogical subscription service is a natural network-effect business similar to search, whereby the owner of the most sophisticated technology with access to the majority of content is able to provide the most effective solutions to its end-users. This generally creates significant competitive hurdles and tends to result in dominant market share.
Specifically, as of December 31, 2010, Ancestry.com registered users have created over 20 million family trees containing over two billion profiles. Members have uploaded and attached to their trees a combination of more than 50 million photographs, scanned documents and written stories. ACOM’s registered users also have attached to their trees more than 800 million records, a process that is helping further organize this collection by associating specific records with people in family trees. This growing pool of user-generated content adds color and context to the family histories assembled from the digitized historical documents found on Ancestry.com Web sites. It also would seem to cement Ancestry.com as the destination of choice for anyone with serious interest in their genealogical history. Because of this, Ancestry.com benefits from the network effect: Ancestry.com has the most unique content, which drives users to the website, and these new users create more unique content, which then drives even more users to the website, and so on.
In short, Ancestry.com has established significant competitive advantages that will not be easily eroded, though there are of course competitors. ACOM competes with a variety of online and offline genealogy services providers around the world, spanning non-profit and commercial entities, with free, ad-supported, fee- or subscription-based offerings. In the US market, Ancestry.com is the dominant player in online genealogy. The closest domestic competitor is FamilySearch.org, owned by The Church of Jesus Christ of Latter-day Saints. Although FamilySearch has a large collection of data (over 2.3M rolls of microfilm and 180K sets of microfiche), a large quantity of it is still not digitized and essentially offline, with the online data made available online and across its 4,500 family history centers in 70 countries free of charge. As mentioned before, Ancestry.com has developed a proprietary vertical search engine for historical content as well as a record-hinting technology that helps accelerate research. This search engine is presented in an extremely user-friendly and attractive format that provides a vastly superior experience versus FamilySearch.org, in my opinion. Additionally, a variety of sites offer family tree building services free of charge such as MyHeritage.com, but without a foundation of underlying institutional content; as a result other services have five to seven people connected to a family tree on average, versus 100 people on Ancestry.com properties. In short, ACOM doesn’t face an aggressive, well-capitalized competitor in the U.S. market currently that we can find. Of course, there are potential competitors. One could see Google or Facebook making an effort to compete in this business. On that front, Ancestry.com recently named a Facebook executive to its Board of Directors and we expect that there will be many opportunities for the two companies to collaborate over time given the highly social nature of ACOM’s services. As far as Google, it would seem to us that given ACOM’s very modest valuation, it would be easier to buy ACOM than start from scratch.
One of the more interesting marketing angles ACOM has utilized has been the TV show "Who Do You Think You Are?” on NBC which is sponsored by ACOM and which analyzes the family history of celebrities. After two successful seasons, the show has been renewed for a third season and will run 11 episodes, versus the 8 which were run in the second season and the 7 which were run in the first season. An additional catalyst that should drive interest to Ancestry.com is the release of the 1940 US Census data, which is expected to occur on April 2, 2012. This is big news in the genealogy world because the last such release was a decade ago with the 1930 US Census data. We believe this release may lead to a surge of activity for Ancestry.com in early 2012 and we wouldn't be surprised to see analysts upgrading the stock in anticipation of this potential catalyst in early 2012.
In looking at the stock, the company has only been public for less than two years. Spectrum Equity Investors, a private equity firm, purchased majority ownership in the company for $300 million back in 2007. Spectrum took Ancestry.com public in 2010, and sold a significant amount of its shares in a secondary offering in May 2011 at a price of $42.
In looking at the financials of the business, ACOM is an asset-light, cash flow heavy business with very high and growing margins. In 2010, ACOM produced $300 million in revenue, but produced $62 million in operating income and $79 million in FCF, though reported GAAP profits were only $36.8 million, or $0.76 per share. ACOM generates considerably higher cash flow than its reports in GAAP earnings due to the depreciation and amortization of historical acquisitions as well as previously capitalized content and software costs, though the company expenses much of its R&D. The company has been spending $15-20 million per year of cap-ex (which includes content acquisitions) such that FCF is just about 25% of revenue. As the business has grown, Ancestry.com has experienced tremendous operating leverage such that the company's OCF margin has nearly doubled over the past five years. We expect that ACOM produced something close to $145 million in EBITDA in 2011, with $100 million in FCF on about $400 million in revenue. As far as the balance sheet goes, the company had no debt and $46 million in cash as of September 30, 2011. We expect the company to use its excess cash to repurchase shares, and the company began buying back stock in earnest in the second half of 2011. In early January ACOM reported that it ended 2011 with 1.7 million subscribers, and guided for 15-18% revenue growth in 2012 along with EBITDA margin expansion. Given this guidance, we think that Ancestry.com should produce $160-170 million in 2012 EBITDA, and are looking for a 10-15% jump in FCF as well to roughly $115 million.
At the current $27.50, ACOM has a market cap of $1.2 billion and an EV of about $1.15 billion. Assuming our EBITDA and FCF estimates above are close, the stock is valued at a forward EV/EBITDA multiple of about 7 times, and an EV/FCF multiple of about 10X. This seems pretty attractive for a company that appears to have a very strong competitive advantage in its niche, is growing sales at a double-digit rate and has tremendous operating leverage in the business model. Using pretty conservative assumptions, we come up with a range of values starting at $35 and going to nearly $50 depending on how long one believes double-digit FCF growth is possible. We therefore think there is a good chance the stock will see $35 or better in 2012.
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