Description

This is a short idea. I think Constant Contact has benefited from a relatively well known consumer brand in the internet space and has rocketed since November lows to sport a 600mm + market cap and 500mm EV which seems ridiculous- especially in the current market. I believe the business while growing very rapidly is extremely vulnerable to very very low barriers to entry and fierce price competition by competitors that will likely offer this product as  a valued add service for free. Many folks offer services in their portfolio for free right now (surveys by Survey Monkey).

What is the business?

The heart of what constant Contact does is offer individuals and small business a platform to run e-mail marketing campaigns and manage e-mail distribution lists. They let you create an e-mail that is rich in formatting and then launch it out to your list. There are dozens of these services. They manage the subscription process, various compliance issues and most importantly try to make sure that the e-mails don’t get caught in SPAM filters. They offer the service over the web through a tiered subscription model. But there is no sustainable advantage to their model, except being an early mover. The model has been replicated, with even better execution by others. Obama used a competitor’s service to execute his rapid fire e-mail campaign.

With relatively low costs, and a scalable platform it’s a good business that enjoys healthy gross margins.

    2008         2007            2006          2005         2004                                        

Revenue   $ 87,268     $ 50,495     $ 27,552     $ 14,658     $ 8,071  

COGS         24,251       13,031           7,801          3,747        2,211 

GM             63,017       37,464         19,751         10,911        5,860  

GM %              73%        74%                71%           74%          72%

They have an associated product that helps customers run and track surveys over the web. This follows a similar model and the product is very similar to survey monkey, but can be integrated tightly with e-mail campaigns.

Albeit a rocket of a growth on the topline they have achieved this by plowing almost all their surplus cash in into marketing. I think once they turn the marketing engine off their revenues will flat line or decrease. While the business seems scalable we certainly haven’t seen too much of that on the gross margin line with margins starting high and staying fairly constant. You would think headcount and SGA would scale but they have needed to plow tons into marketing to get the topline growth and the type of operational leverage we would hoped for hasn’t been exactly demonstrated yet.

They peg their customer acquisition cost at about $300 and get that back in revenue in about one year. Fully loaded I assume that on a net normalized EBITDA basis their ROIC is roughly 4 years on a customer. A good business but not worth anywhere near the current valuation.

Weak Moat:

This is about the simplest web business out there and if the market and growth are as big and easy to achieve as CTCT claims then it is a matter of web-time before many other start to chip away. I would say that this is even simpler than running an ISP, or e-mail hosting provider. If those two industries provide any indication this business will start to be stricken by price competition as folks just look to get incremental revenue on a fixed cost platform. The google factor is also around the corner. I have talked with various folks at Google Labs and  this is a real idea they have been bouncing around and working on.

Google has been slowly courting the small business customer with its Google Apps platform where a small (or big) organization can host e-mail, archiving and compliance solutions amongst other things. In fact we run our whole operation on Google and don’t even use Microsoft anymore. We went from paying $500 a month for e-mail archiving to $500 a year (through Google Postini). An offering like Constant Contact is a natural fit for Google or Microsoft and it’s too easy a business to create so I don’t think they would buy into it. Plus by building it from the ground up they can tightly integrate it into the existing Google infrastructure. As fast as the growth comes it can leave as well when folks like Google come on the scene.

Valuation:

Market Cap =   $668 mm (31 mm fully diluted shares * 21.57)

Net Cash 136 mm (3/31) (includes Option Proceeds)

Enterprise Value =  $ 532 mm  

EV/LTM Revenue = $532mm / 97mm  =  5.5 X

EV/EBITDA =  50 X (2009 estimates)

I think that while the underlying business seems very healthy and growing very fast I think the valuation is just crazy even if they ran the thing for cash flow and stopped the growth.

Risks:

• Cash rich, high growth
• Valuation could persist for a while.

Catalyst

Catalyst:

• Constant Contact is a relatively recent IPO (Jan 08) and roughly 35-40% of the shares seem to be in the hands of VC firms. With the pain in the VC world we think that their will be heavy selling of the shares as the firms try to gain liquidity from one of their star performers.
• Competition from Free Services
• Announcement from Google that it is experimenting in the space.