Description

Spark Networks owns and operates dating websites. Its main asset (80%+ of profits) is Jdate.com, the leading Jewish dating website. Since this stock was written up a little more than a year ago by skimmer610, I will do my best to try not be too repetitive. Nevertheless, I believe the stock offers the ability to buy a strong asset with no capital requirements and strong barriers to entry at less than 6x my conservative estimate of pre-tax earnings. In addition, I believe management is strong and shareholder oriented (more than 20% of stock repurchased last year), and the company has the potential to improve earnings significantly. In a sale to a strategic buyer (IAC, which owns match.com, Yahoo, or eHarmony), I think the company could fetch double the current price.

Background: Spark Networks owns and operates Jdate.com (Jewish Networks), a number of dating websites aimed at other ethnic and religious groups (Other Affinity Networks), a general interest website that is being wound down (General Market Networks), and a small offline business. I will ignore the last two pieces, as the former is being wound down, and the latter is too small to matter.

The market for dating websites tends to skew toward those with the largest market shares. This is the whole "network effects" thing in action - no one wants to pay for membership to a site that has fewer members. Spark has seen proof of this in its General Market business - there's no competing with match.com and eHarmony, and Spark's AmericanSingles.com website has suffered as a result.

Here are Spark's numbers:

 Average Subscribers
2008 2007 2006
Jewish Networks 90,806 94,246 95,168
General Market Networks 30,486 56,071 92,041
Other Affinity Networks 63,859 61,398 49,438
Offline and Other 1,806 1,783 0

Revenue (000s)
Jewish Networks 33,740 33,624 32,213
General Market Networks 7,762 15,707 25,446
Other Affinity Networks 13,749 13,314 9,724
Offline and Other 2,015 2,573 1,470

Contribution (Revenue Less Direct Marketing Expenses)
Jewish Networks 31,221 30,343 27,669
General Market Networks 4,274 7,245 11,735
Other Affinity Networks 5,874 5,486 4,772
Offline and Other 887 1,049 103

The main cause for concern that jumps out is the decline in subscribers at Jewish Networks; some of it is probably the result of price hikes taken over the last two years, as well as a decline in direct marketing spend. Profits (contribution) have increased each of the last two years despite the decline, but it is an issue management indicated they would concentrate on next year. Overall, I see the core business (Jewish Networks and Other Affinity Networks) as a business that should be able to keep its subscriber base steady and increase prices with inflation for years to come.

Q4 08 Adjusted EBITDA 3,666
Stock Comp 757
General Market Contribution 771
Depreciation 229
Pro Forma EBIT 1,909
Annualized EBIT 7,636

2008 Adjusted EBITDA 16,200
Stock Comp 3,868
General Market Contribution 4,274
Depreciation 867
Pro Forma EBIT 7,191

Price 2.21
Shares Outstanding 20,551
Market Cap 45,418
Net Debt 333
Enterprise Value 45,751
Runoff Value of General Market 2,000

Adj. Enterprise Value 43,751

Multiple
EBIT 7,500 5.8x
After-tax Income 4,500 9.7x

 Based on last year's results and backing out the contribution from the General Market division, I believe this is a company that can easily make $7.5 million per year pre-tax. This works out to a 10% after-tax FCF yield based on the current market price. In addition, I identify two areas of significant upside:

Advertising. They have not really tapped the advertising potential of the site yet, and they have stated they intend to do so in the future (though this is not the best market to be trying to sell advertising). Any incremental revenue would drop to the bottom line, so if they could sell even a million dollars a year, it would be a material boost.

Overhead Expenses. This would mostly come into play in the event of a sale. It's not unreasonable to assume they could shave off $1 million in public company expenses alone, not to mention what could be saved in duplicate overhead. I would not be surprised if a buyer would view the company as having $10 million in pretax earnings power. At a reasonable 8x multiple, that would be a purchase price of $4 per share.

Other Considerations:

Taxes. They have a net asset of $4 million on the books, mostly related to comp accruals. They also have some NOLs related to stock option exercises, but those may never materialize given where the stock is. On the other hand, they almost certainly have a significant amount of cash trapped overseas, given that they have about $7 million in both cash and debt.

Great Hill Partners. They own over 9 million shares, or about 45% of the company, so they have all of the motivation in the world to get this thing sold at a reasonable price. I think their interests are generally aligned with those of outside shareholders, so I view their involvement as a plus.

Catalyst

sale of company

return of cash flow to shareholders