Description

Spark Networks (LOV) has been written up numerous times on VIC before, but the write-ups only cover what has now become the legacy asset of LOV and not its future. There is a fundamental transformation occurring at Spark Networks that I will attempt to demonstrate has the potential to create 4-6x multiples on money in 2-3 years with limited risk of capital loss.

LOV is 44% owned by Great Hill Partners, a well-regarded private equity firm that has nearly 6 years now into its investment in the company. This means there is a strong catalyst for LOV to be sold in the next several years to provide an exit for Great Hill, and it also means that capital allocation will likely be strong. 

LOV is a $105M market cap company with $13M of cash and no debt. For your ~ $100M, you get essentially two assets: J-Date and Christian Mingle. J-Date, the dominant online dating site for Jewish Americans with prodigious free cash flow characteristics, has been written at length on VIC with extensive message boards on each write-up. Various VIC analysts have valued J-Date in the few hundred million dollar range. The site generates $23M+ of contribution profit dollars (revenue less direct marketing expenditures) which to an acquirer can flow substantially to EBIT as larger dating sites (Match.com, eHarmony, etc.) have fully built out overhead and IT structures. For example, LOV estimates that 85% of incremental contribution profit dollars flows to EBIT.

However, for my purposes, even value J-Date at 0 and view it as I do – as a funding mechanism for the asset that really matters, Christian Mingle. J-Date’s $23M+ contribution profit dollars essentially offsets LOV’s overhead and tech infrastructure of ~ $25M per year.  This allows LOV to plow 100% of Christian Mingle revenues back into marketing expenditure to grow this asset without requiring a dilutive equity raise.

Christian Mingle is a dating site for Christians looking to date other Christians – it is the future of LOV because the addressable market for Christian Mingle is much larger than J-Date, the company estimates it is 30x larger. 

In 1Q12, Christian Mingle generated $7M of revs or ~ $30M run-rate and is growing at ridiculous rates. The number of subscribers in 1Q12 were up nearly 3x vs. 1Q11 and grew over 30% from 4Q11 in just one quarter. There is a meaningful lag with revenues during high growth mode as new subs first join dating sites for free and then upgrade to paying customers after a few months (as they see people they are interested in) so that they can contact them.  There is also a virtuous cycle in play, as the more revenue scales, the more LOV can spend on marketing given J-Date’s ability to cover all company expenses.

As such, given a $30M run-rate in 1Q12, I don't think $50M in annual Christian Mingle revenues is a stretch. We will use this as case one, and for case two we will assume more of a home run and Christian Mingle gets to $100M in revs. For perspective, eHarmony is heavily associated with Christian dating and while private, press articles suggest it is doing ~ $300M in revenue. 

Mgmt has said on conference calls that once the high growth phase is over and Christian Mingle gets to a mature state, the site should have 45-50% contribution margins (revenue less direct marketing expenses, J-Date has close to 90% but it is a near monopoly franchise). The company thinks there is upside from 50% but let’s use that. They expect over 85% of those contribution profit dollars to flow though to EBIT given that J-Date already covers the full corporate and technical infrastructure they are leveraging. So in case one the company would generate $21M in EBITDA and in case two $42M.  

Using case one first, what should a company producing $21M in EBITDA in this space sell for? IAC analysts doing sum of the parts analyses for Match.com have used a 10x EBITDA multiple, which is not crazy given low cap x requirements and a recurring revenue business model. For case one though let's use a 7x or nearly $150M of value vs. current EV of $90M. But LOV won’t be a stand-alone company forever, Great Hill will be seeking an exit. As a strategic can lever overhead and technical infrastructures, there is $25M of LOV overhead that could theoretically be added to EBITDA. Not 100% can be levered, and the strategic will not want to give all of the benefit of synergies to LOV in the form of purchase price, so let’s say a strategic bumps up the $21M in stand-alone EBITDA to $30M they are willing to pay for. That gets us to $210M vs. $90M.

Case two is the home run case, so let's use 10x EBITDA. Stand alone EBITDA is $42M and $52M upon sale to a strategic using the same logic as above. This gets to ~$500M type of value or close to 5x off the current market cap.

I think $100M of Christian Mingle revenues at the end of the high growth phrase is not unreasonable given the trajectory the site is on, the natural lag between growth and revenues, the virtuous cycle of higher revenues meaning greater and greater marketing budgets given the crucial role J-Date plays in funding all other op ex, and finally the amount of revenues eHarmony. 

Key Risk: partially because J-Date is being used a funding tool and little is being spent to market it, subscribers and revenue are declining for this business and there is risk that the dominant position the site has had in its market for so many years is being eroded. If Christian Mingle does not grow and/or fails to achieve normal profitability, J-Date will have lower revenues and EBITDA than it has in the past. Without overhead cuts, the company could be EBITDA break-even or even have negative EBITDA.

I still think J-Date would have considerable strategic value and acquirers would see substantial incremental EBITDA $ when the site is layered onto their platform, so I think the downside is still well protected in this case. However, it's a guess whether J-Date would be sold for $50M, $100M, or $150M+. What we do know is that Great Hill will seek to maximize value even in this downside case and will likely move to sell the company vs. letting it bleed EBITDA as a stand-alone busines with a fully burdened and duplicative overhead structure. 

Catalyst