Description

Insweb in our opinion is remarkably undervalued and we think the company is trading at about 20-50% of what believe and have seen strategic buyers pay for the #1 and #3 competitors in the industry. We think Insweb is worth at least $12 from here with minimal downside. Insweb is a highly scalable Internet auto lead generation business with a highly attractive industry structure where three competitors control 85-90% of the market: #1 Netquote (private as we mentioned a year ago strictly rumored sold for 3x sales to Spectrum/Stripes PE in 2005), #2 Insweb 0.45x ev/sls, and  #3 Insureme.com (was acquired by BankRate for 2.66x ev/sls paid in cash (midpoint of earnout) in Feb '08 and on this weeks call Bankrate said Insureme on pace to hit earnout that would drive the sale price to 3.1x ev/sls).  

Whats different since our last write-up, September 2007

INSW by share price is 15% lower, and on EV/sls basis 40% cheaper, while revenue is up +25% LTM and FY’08 guidance is for $42mn (up from $33mm last year)

See last sentenace of the first paragraph

Feb '08 Insureme.com was bought by BankRate.com for 2.66x sls (mid point of earnout) paid in cash and said on track to hit earnout which would be 3.1x sls last year insureme reached profitability (paid 28.5x Taxed Net income on mid point of cash paid and earnout potential)

INSW just signed State Farm as new Partner: http://www.agentinsider.com/about/partners.html  (which allows their 17,000 agents to buy AgentInsider leads with partial StateFarm reimbursement)

Company hired top notch talent from MapQuest/Vivendi, State Farm, and Progressive.com

INSW sees significant market opportunity and has added 35% to head count year to date (team now fully built out)

INSW is trading for less than 1 times its annual customer acquisiton budget on an EV basis! (in 1Q08 they generated CFO/Direct Marketing = +12.5%)

Why is it cheap?

What appears to be an ugly second quarter is not as bad as it looks in our opinion. Insweb held its guidance of 25% revenue growth for 2008. But several one time hits derailed the bottom line: $400K severance to President, a week later INSW hired Mike Crosson the Former Head of Advertising from MapQuest (who was on board when it sold for $1.1 bn to AOL), $100K for accounting analysis of NOL (it is good for $190mn or 6x the market cap), and $150K in recruiting costs. We view these as one time in nature which is $650K of the $977K loss. The rest came from what we think was the perfect storm in terms of one carrier negotiating rate hikes in 7 states pulling back their lead buying. Finally INSW head count is up 35% year to date as they build out a number of new platforms, with minimal capex, $60K+/- a quarter.  Insweb has been loading up on talent and has a very strong team: including a lady that ran Progressive.com in the mid/late 1990's, Head of Advertising from MapQuest, recent hire from State Farm, and the CEO who sold the largest reinsurance brokerage on the west coast (early 90's) who pays himself $1 a month salary. 

Why should this change?

Our industry contact at a major portal recently said remnant ad space is readily availiable (summer and economic slowness) which is great for INSW, in contrast to Q2 where ad space was tighter. There business is comparison shopping for auto insurance, with high gas prices and the ability to save the average customer $600 a year this is an attractive business. If you track www.alexa.com and put in insweb.com you can see a huge spike in traffic to the site in July and early August. Last time a similar spike hit in Feb the first week of March the company preannounced record revenue growth (apples to apples +90%). Not sure if this will correlate again, but we think it will (it did for 2Q08).  Also, INSW is creating and syndicating its own content to attract naturally traffic to its site.  They hired 3 FT writers and are in the process of signing some syndication deals.

At the risk of over-using the term we believe INSW has significant optionality:

Share Price: $6.00

Sales per share: $8.00 (guidance $42mn in 2008, TTM $38mn)

Cash Value $2

Per share in annual customer acquistion budget $4.50 (this is 100% of the current EV)

NOL $2-3 this is the value to an acquirer per section 352 (valued at $35 per share good through 2022)

Cash Flow from Operations +$705K YTD vs. +$490K year ago.

Lead growth 124% 1H08 yr/yr

Revenue growth 31% yr/yr

AgentInsider agent growth 35% and 11% qtr/qtr

12 of 13 largest auto insurance carriers are using INSW platform (State Farm, GEICO, AIG, Farmers, Progressive, Travelers, Allstate, Nationwide, Met Life, Liberty Mutual, American Family, Cotton States, Country, esurance, etc)

New business launch: www.insurancerates.com and content syndication should lower costs to acquire customers

3 million opt in monthly email subscribers from their newsletter (embedded with links)

Insweb's Agentdirectory (essentially an online yellow pages for up to 8 local agents per zip code) reached profitability second quarter in existence

Largest competitor in the industry buys some of their leads from INSW (agreement through Oct 09)

We see this business eventually potentially running at OM in the 20%+ range (Bankrate is running 35% OM), If this happens we think the stock is worth $30 (or $150mn market cap with only 5mn shares outstanding) or 15x EBIT which should approximate Net Income.

So what is this option worth:

INSW 2008 revenue $42mn

Using an EV/sls

1x = $10

1.5x= $14

2x = $18

2.5x= $22

3x = $26

It will depend on revenue growth and ability to monetize leads.  

However, INSW 2009 revenue should range $50-55mn

1x= $12

1.5x $17

2x= $22

2.5x= $27

3x = $32

Factors:

For every $1 increase in avg lead sold revenue goes up $13 million per year (with significant profitability) INSW is selling average lead $3.57 Netquote and Insureme sell leads for $6-8 per lead. In fact, Netquote buys leads from INSW in both Auto and now Home Owners. INSW gets $6-8 per lead for a small but growing percentage of leads sold on their AgentInsider platform.  

Given a mix of quantitative and qualitative factors we think a realistic valuation on INSW is $12-14 today with potential significant upside over the next year or two.

We think the upside is with so few shares outstanding we could see INSW getting to $4 per share in EBIT ($20mn+/-) which would approximate NET at $100mn over the next 3-4 years. If this happens we think the stock could be $50-60 or a $200-300mn market cap (EV would probably be $170-$270).

If you are patient investor we think INSW offers significant upside and limited downside given the market structure and industry trends.

Moat: there are really no scale players in this industry outside the big three, there are a lot of little sites but they do not generate much traffic. Netquote's site claims they generated 25mn in leads in 2007. Netquote in terms of revenue we would guess is a heck of a lot bigger hard to say but they cover a wide range of insurance verticals and they get $6-8 per lead sold. While Netquote spends $50mn a year acquiring leads (not sure if this is double counted from what they buy from INSW) vs. INSW $20mn+ (souce: Netquote.com). INSW is for the first time is hiring field salesman to sell to agents build out their network in various geographies. Insweb is serves 1 billion ads a month. Only 6% of the traffic today originates at Insweb.com. That is about to change with www.insurancerates.com which will be a consumer advocate portal relating similar to Thestreet.com, Bankrate.com, Creditcards.com. Go to  www.insweb.com go to bottom left corner add 91101 in zip code (directories are beginning to fill up) this product was launched in mid January 2008.

We are not fans of all lead generation businesses: they usually lack spreads wide enough to make the business interesting due to highly competitive market structures, or sell leads that have low ROI or into industries where the end buyer is cyclical and or distressed (Mortgage, Home Loans, Car buying leads, etc).  Where we believe the auto insurance lead generation market is different: it is a consistent business and essential service (what percent of the population drives without insurance?), and the ROI is very attractive from the carrier and agent perspective (which is why the Internet Distribution channel is taking share from other pieces of the pie). If you go to www.highpayinggooglekeywords.com and search insurance you can see that carriers are paying on a cost per click basis between $15-22 per key word (some of the highest CPC key words on Google). INSW CPC for carriers is $6.26! There is a significant opportunity to increase pricing.

Company should do well in a recession:

a) High gas prices, consumers stretched, Insurance companies raising rates (first time in four years) this is causing consumers to more aggressively comparison shop all type of insurance.

b) Ad pricing will come down and this will free up ad space for INSW that serves 1 billion ad impressions a month

c) Carrier, Consumer, and Agent adoption as one of the most efficient lead channels (tracking costs and gaining real time purchases) (State Farm the only big company INSW was missing joined the platform very recently State Farm has 17,000 agents (no idea how many will use INSW: http://www.agentinsider.com/about/partners.html 

d) Carriers are now subsidizing the cost to buy leads from INSW: Specifically Allstate, Farmers, and Nationwide (see above link)

 Since eHealth was written up on VIC. We will briefly contrast. eHealth is an agency and not in the lead gen business. They buy leads from other web sites and do their own marketing. You can see Insure.com has a partnership on the lead gen front with eHealth/GEICO. Health and Life are less scalable models as most customers need to spend time on the phone with an agent. Not saying either model is better or worse just different. Auto is a relatively very easy transaction well suited for the Internet. Life Insurance is getting more interesting as Carriers are offering no physical exam buy on the spot life insurance and have upped from $250K to $500K. This is significant because most husbands get urged to buy life insurance to cover home mortgage in case of death. So a policy you can complete in 10 minutes online and $500K is attractive and additional scalable area for INSW.

Catalyst