Description

LoopNet (LOOP) operates an online marketplace for commercial real eastate in the United States.  The company enables commercial real estate agents to list properties for sale.  LOOP currently trades at 25x ’08 earnings which we believe are at least 15% too high.  The industry’s primary data source, CoStar Group (CSGP), is launching a competing product during Q1 2008 at prices 80 – 90% below what LoopNet currently charges.  Sell side analysts are uniformly bullish on pricing trends for LOOP and earnings growth for the company hinges on their ability to increase prices going forward.   We believe that CSGP’s new product will result in the unraveling of LOOP as a sustainable business over time by 1) taking away market share and 2) creating severe pricing pressure in the industry and thus on LOOP’s margins.  Furthermore there is evidence that the company’s paid subscriber growth is decelerating in the face of LOOP’s recent price increases.  For a stock that currently trades at 25x consensus ’08 estimates, is 100% levered to a weakening commercial real estate market and experiencing higher churn rates every time they raise prices we believe LOOP is at best worth half of the current stock price. 

 

Company Description:

LoopNet is an online marketplace that allows commercial real estate agents to list properties for sale or lease in order to find a buyer or tenant.   The company has two types of membership – basic and premium.  Basic membership is free and premium members pay a monthly subscription fee described in more detail below.  The primary differences between basic and premium membership are as follows:

• Basic members are allowed to view some, but not all of the content on the site. 
• Basic member listings can only be viewed by premium members, not by other basic members.
• Basic members can post properties but with only a limited amount of information.
• Premium members can post and view all listings, get premium placement and access to a variety of content.

 

Pricing:

Pricing for premium membership is offered on a tiered basis for property listers and property searchers.  Listers are charged a monthly subscription rate of $89.95 for four or fewer listings and approximately $110 per month for 5 – 9 listings.  This is up from $69.95 per month a few months ago.  Searchers are charged a monthly subscription rate of $49.95 a month for full searching functionality.  The company offers 10 – 20% discounts for premium members that are willing to pay upfront (quarterly or yearly).   

 

Revenue Model:

The company generates revenues from four different products.  The premium membership subscriptions generate 80% of LOOP’s revenues and the other three products generate 20% of revenues (the company has not broken out the other three products by percentage of revenue).  The products are as follows:

1)      Premium membership subscriptions (discussed above)

2)      BizBuySell –  BizBuySell is an online marketplace for the sale of small businesses.  Most of these businesses are for sale for less than $1M.  The company charges between $59.95 and $99.95 per month per listing.  To list an unlimited number of businesses LOOP charges a $24.95 set up fee and a monthly subscription of $39.95.  Searchers can search for free.

3)      LoopLink – LoopLink is a private label solution for commercial real estate firms.  It enables them to show properties on their own website.

4)      RecentSales – RecentSales is a database of recent comparable transactions.

 

Sell Side Bull Case:

The bull case for LOOP revolves around a few themes:

• Online marketplaces take time to build.  LOOP has been aggregating members for several years and has become the leader in the space.
• Pricing trends have been positive.  Average pricing was $43.35 in 2005, $45.74 in 2006, estimated to be slightly above $50 in 2007 and estimated to grow by another 7 – 20% in 2008 according to street esimates. 
• There is an opportunity to grow its ancillary products and add advertising as another revenue stream.
• Operating margins have been running at >40% and the business is very scaleable - other than bandwidth there is no meaningful expense the company incurs for brokers posting additional listings. 

 

 

CoStar Group (CSGP) Description:

There is a fair amount of sell side research written on CSGP so I won’t go into too much detail.  Essentially, CSGP can best be described as the “Bloomberg of the commercial real estate market.”  If you are a buyer, seller, banker, leesor or leesee or anyone else who does business in the space you subscribe to CSGP’s database.  It has a research  team of over 1,000 people that gather data on commercial real estate including tenant history, price history, demographics, tax history, ownership history, building photographs, maps, floor plans and every other piece of data needed to make a transaction.  It is the gold standard in the industry and EVERYONE uses it.  They have gathered data on 150-180 different markets, either buying their competitors or putting them out of business along the way.  CSGP is now 20x bigger than anyone else in the space.  The moat they have built is impressive (NOTE: We are NOT recommending CSGP as the stock trades at a ridiculous multiple and is also levered to a slowing real estate market).   To understand our thesis, it is important to understand how imperative CSGP is to the industry.  CSGP is to the industry as Bloomberg is to an bank’s fixed income trading desk.   

 

Pricing for CSGP’s products range from $30 per month to $1600 per month. 

 

Difference between CSGP and LOOP:

There are two primary differences between LOOP and CSGP that one needs to understand to appreciate our thesis:

1)      CSGP is used primarily as a research tool by industry professionals and LOOP is an online marketplace used by the lower end of the market (small commercial brokerage firms, mom and pops looking to buy a multi-family house etc).  In general, 90% of the top 500 brokerage houses, investment banks etc use CSGP but only 10% of the two person firms use CSGP – these are the types of firms that use LOOP. 

2)      CSGP is a closed community (i.e. you must subscribe to CSGP to see any data) and LOOP is an open network where anyone with an internet connection can view properties.  

 

Short Thesis:

I have rarely seen a company that is facing so many obvious headwinds – competitive and pricing pressures will begin to hit them like a ton of bricks in Q1 / Q2 while their end markets have begun a cyclical slowdown.   Additionally, recent price increases have been met with higher churn rates and a disturbing slowdown in premium (paid) membership growth.

 

Launch of a competing product by CSGP:

In Q1 of 2008 CSGP will launch a product called Showcase that is an online marketplace for commercial real estate – the exact product that LOOP currently offers.  More importantly, we believe that CSGP will price their product at somewhere between $10 and $15 per month, or 80 – 90% cheaper than LOOP’s product (assuming the CEO of CSGP is telling us the truth).  This new product will be available to anyone with an internet connection – ie. there will be absolutely no difference between Showcase and LoopNet.  We believe that this is a disaster waiting to happen for LOOP.  Every single sell side model has a) LOOP prices increasing in 2008 and b) positive subscriber growth in 2008.  How can LOOP possibly increase prices when their biggest competitor is charging a fraction of what LOOP charges?  Furthermore, we believe that Showcase will become the go to marketplace over time because it already has 90% of the professional marketplace as subscribers.  Another $10 or $20 per month on a $600 per month bill is peanuts.   It is not a question of if Showcase will cannibalize LOOP, it is a question of how fast.   

 

 

Growing membership but SLOWING premium (paid) membership:

For the past several years  the company has shown positive membership growth.  The key here is that the growth has largely been driven by basic members (i.e. those who don’t pay).  When we peel back the onion we see a disturbing trend – premium (paid) memberships growth is decelerating, and decelerating at a faster rate every time the company tries to raise prices.  This has become particularly obvious over the past several quarters.

 

            Membership Growth      Premium Memb Growth            Avg Pricing

Q1        58%                             30.4%                                       $49.75 (up from $45.02 YoY)

Q2        57                                 24.4                                          $51.33 ($45.30 YoY)

Q3        50.5                              18.5                                          $53.07 ($45.40 YoY)

Q4*                                          decline from Q3                        $55 (estimate)

 

* Management has guided Q4 for a decline in the absolute number of premium registered members for the first time in the company’s history which will obviously result in a continued slowing of the premium membership growth. 

 

As growth in the free membership continues to accelerate while premium membership growth slows, the company has been spending more on marketing – the result is rising customer acquisition costs and eventual associated margin pressure. 

 

We believe these issues surrounding premium membership growth, pricing and margin deterioration will become exacerbated when CSGP launches its Showcase product early next year. 

 

Slowing commercial real estate market:

We follow the commercial real estate market closely and it will come to noone’s surprise that the market has likely peaked and is experiencing a deceleration due to everything from the credit turmoil to a slowing economy.  Every company up and down the supply chain including manufacturers, suppliers, service oriented companies, builders etc have begun seeing these trends and slowing order books and backlogs lend credence to our belief.    The fact that the company is facing competitive threats, pricing pressures, slowing paid sub growth and higher churn when also beginning to be faced with a cyclical slowdown in its end markets adds an even more convincing layer to our short thesis.   

 

Estimates / Valuation / Price Target:

We have developed a model and run sensitivity analysis based on what we believe to be the impact of the headwinds discussed above.   Current 2008 consensus = $0.62.  Models are driven primarily off of pricing, premium subscription growth and churn (which has recently been at the high end of managements guidance).   Assuming a continued slowdown in the premium subscription growth rates, churn rates equivalent to the most recent quarter and flat pricing from 2007 gets us to a number closer to $0.52, or 16% below what the street is forecasting – and we believe that this is being generous.  In reality, pricing should be down, sub growth should be down more than we have estimated and churn should be up.  This sensitivity results in a number closer to $0.45, or 27% below what the street is forecasting.  Although we could be wrong in timing (perhaps it takes and extra quarter or two for Showcase to begin making an impact), we firmly believe that directionally we are right. 

 

What should an investor pay for a business where your biggest competitor is launching a competing product at a fraction of the price, churn is increasing, premium membership is slowing, street expectations are too high AND there is evidence of a cyclical slowdown?  I’ll be generous and say 15x our $0.45 to $0.52 number to get a stock price in the $6.75 to $8 range, or less than half of where the stock is currently trading.   Even if you put a 20x multiple on these numbers you get a stock price in the $9 - $10.40 range, or 40% below where the stock is currently trading.

 

NOTE: This is not a call that the company will issue below consensus guidance, or miss its next quarter’s earnings.  It is a call that street numbers are significantly too high when we start looking out the next four to six quarters.  We believe the impact will begin to be felt in the June quarter (assuming a Q1 launch of Showcase) and will grow worse over time.   This is the type of name you can stay short for a few years and just watch the business deteriorate.

 

 

 

Risks:

1)      CSGP delays the launch of Showcase – we have had detailed discussions with the CEO and CFO of CSGP who have told us that the product will definitively be launched in Q1 2008 but stranger things have happened.

2)      CSGP launches Showcase at higher price points than we discussed – again, conversations with the CEO and CFO of CSGP lead us to believe that pricing will be $10 - $15 per month.

3)      Amount of time it takes Showcase to cannibalize LOOP might be longer than we have estimated.  We are extremely comfortable with our thesis here and believe that it is only a matter of when, not if.

Catalyst

• Launch of a competing product in Q1 2008 by CoStar Group, the industry’s primary data provider
• Launch of CSGP’s product at prices 80 - 90% below what LoopNet charges
• Softening commercial real estate market
• Continued deceleration in premium (paid) membership growth
• Analyst estimates that are too aggressive