Description

IACI is a collection of Internet consumer businesses.  Last summer, IACI broke itself up into five different publicly traded companies, separating the three major mature businesses (HSN, Interval and TicketMaster), as well as the most challenged one (Lending Tree).  The remaining IACI is a pure-play Internet company that is increasingly focused on search and local applications.  The company's primary segments are Match.com, Media and Advertising (principally Ask.com and CitySearch), and ServiceMagic. 

The investment is interesting because the company has so much cash that investors can create the operating businesses "for free".  The company ended 2008 with $1.8 billion of net cash after closing the sale of its minority interest in a Japanese home shopping network for almost $500 million.  Over the course of 2009, cash from a tax rebate, warrant transaction, and the sale of a few other non-core businesses will yield another several hundred million, getting to ~$2.2 billion of net cash.  This is a little over the current market capitalization of the company.  While it is unusual for businesses to trade with no enterprise value, it is not unheard of.  However, typically these situations occur when the underlying operating businesses are extremely weak or capital intensive; this is not the case with IACI.

The operating businesses of IACI are attractive, with low capital requirements, reasonable margins, and good growth prospects.  Match.com is by far the largest online dating service, with over 1.3 million paid subscribers and 10x as many total users.  Match's large size provides a significant competitive advantage since its business benefits from both marketing scale and "network effects" (e.g. if you want to find your soul mate, you have a better chance looking where there are more souls).  Match had EBITDA of $100MM in 2008, up from $86MM in 2007.  This business should be fairly stable in 2009, as it is a subscriber-driven business with limited economic sensitivity.

In Media and Advertising, Ask is one of the principal search engines on the web, albeit a small player vs. Google.  It is unclear what the long-term economics will be for the non-Google players in this industry, and we view Ask's prospects as having a wide distribution of potential outcomes.  CitySearch is a leading "local" search service, and is a growing contributor to earnings.  Media & Advertising had EBITDA of $178MM in 2008, up from $119MM in 2007.  The economy in 2009 will put a lot of pressure on this segment, but over the cycle it is likely to have good growth and profitability.

ServiceMagic is an online marketplace that connects consumers with pre-screened, customer-rated home service professionals.  ServiceMagic is paid based on "lead generation", and is well positioned to take substantial share from the Yellow Pages for applications as simple as fixing a sink to as complex as remodeling a house.  The company is the leading player, and the business offers the potential of strong network effects similar to Match.  Despite negative headwinds in the housing market, this business has been growing rapidly and is highly profitable.  ServiceMagic had EBITDA of $29MM in 2008, up from $23MM in 2007.  This business should be relatively flat in 2009, as secular tailwinds are offset by cyclical headwinds.

IACI also has many "Emerging Businesses", from brands like Evite and Gifts.com, to shopping comparison sites like Pronto.com.  The company is in the process of shutting down or selling the less promising ones, and focusing its efforts on its core "search and local" activities.  Emerging Businesses had EBITDA losses of $28MM in 2008, up from $6MM in 2007.  In 2009, the company expects losses to be reduced by approximately $18MM.

Reported EBITDA in 2008 was $171MM, and included significant "over-spend" in corporate expense and Emerging Businesses.  Management has guided to reducing corporate expense by almost $55MM and cutting Emerging Business losses by $18MM.  The combination of these two effects would be a $72MM tailwind, and bring EBITDA to $243MM.  However, the weak economy and "self-inflicted" decisions at Ask will be an offsetting headwind.  We think EBITDA in 2009 should range between $150-$200 million; in a better economy it could be $300 million.  In a better market, these earnings could make the stock fairly valued if it had no excess cash.

We believe this situation exists for several reasons.  First, investors are concerned about how CEO Barry Diller will allocate the company's excess capital.  At various times in his career, Diller has been perceived by Wall Street as a visionary or a dog.  Right now, he's firmly in the dog house - and investors are fearful he will squander the company's cash by overpaying for assets.  We think a fair treatment of his track record is more mixed.  Importantly, he has been clear recently that the company a) is going to be very patient with M&A because the economy is only getting worse and b) is unlikely to spend more than half its cash on M&A, and therefore expects to have substantial excess capital to return to shareholders through share buybacks or other methods. 

The second issue is that Liberty Media ("LINTA"), which owns approximately 30% of IACI but has given its voting proxy to Diller, is under liquidity pressure and has recently been selling some of its IACI shares in the open market.  We believe this is creating technical pressure on the stock, but is a transitory event.  Finally, we simply believe the degree of undervaluation is not yet fully visible.  The company is a recent spin-off, and the cash adjustments to the balance sheet are only recently becoming transparent.

Our view is that investors are either getting the businesses for free or the cash for free.  We believe that some of the excess capital will be spent on M&A, and that there should be a significant amount left for buybacks or other distributions to shareholders.  If the economy gets better, we could see a double in the stock without heroic things happening.  Importantly, in a continued difficult economy there should be limited downside and good upside just from getting a "better than dead" valuation.

Catalyst

• Cash balance grows from ~$12/shr to ~$14/shr
• Company begins to use excess capital for shareholder friendly purposes in 2H09
• Earnings should be reasonably achievable vs. current low expectations