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Morningstar | IAC 3Q Numbers Beat All Expectations, but Shares Remain Fairly Valued; Maintaining $195 FVE

IAC reported third-quarter results ahead of our expectations and consensus as revenue growth in Match and ANGI Homeservices remained strong while further operating leverage from the two plus the Applications and Publishing segments widened operating margin. In our view, continuing growth in ANGI Homeservices’ users and professional service providers, and improvement in monetization of the users indicate that possibly a network effect moat source is developing. IAC’s fourth-quarter and full-year guidance was in line with our projections and consensus. After adjusting our model based on IAC’s third-quarter numbers, we are maintaining our $195 per share fair value estimate on the firm. While trading at a discount to our fair value estimate, it remains a 3-star stock, and we recommend waiting for a more attractive entry point before investing in this no-moat and high uncertainty name.

IAC’s Match reported total revenue of $444 million, up 29% year over year as the firm’s paying subscribers (or paid member count, PMC) increased 24% from last year. Such PMC growth was accommodated by 4% year-over-year growth in average revenue generated per user (ARPU), which we view is indicative of the firm’s success in rolling out new premium features, mainly on the Tinder app such as Tinder Feed, TinderU, and Picks, which was rolled out in late third quarter.

We must note that the firm continues to invest heavily in R&D and marketing of its other apps, including Match.com as the look and feel of those apps require some changes in order to attract more users. Continuing improvement and growth in the monetization of Tinder was partially offset by lack of subscriber and revenue growth in most of the non-Tinder apps. However, the popularity of Hinge, an app for the millennials seeking long-term or serious relationships, may indicate that Match’s dependency on Tinder could decline a bit in the future, which we view as positive.

Indirect revenue, which is mainly advertising revenue, declined 14% year over year as the implementation of GDPR is impacting Match’s ad inventory sales. Plus, on the Match.com app, the company is making some changes to its user interface including showing less ads in order to keep users on the app longer. Adjustments such as this are also lowering ad revenue. Over time, we expect the impact of lower ad inventory sold to be partially offset by higher prices as growth in Match’s non-Tinder apps subscribers and user engagement will again attract the ad dollars.

Match generated $140 million in operating profits during the third quarter, representing a 31.5% margin, up 5 percentage points from last year but down 420 basis points sequentially as the firm is incurring some additional litigation costs related to the case involving Bumble. In addition, Match’s more aggressive marketing efforts for not only Tinder but also Hinge will limit operating margin expansion. We expect this to continue throughout the fourth quarter and most of 2019. However, we look for some operating leverage and margin expansion in late 2019 as growth in revenue, mainly driven by Tinder and the further rollout of Hinge, and some stabilization in Match.com, is likely to outpace operating expense growth.

Total revenue generated by ANGI Homeservices increased 21% from last year to $303 million driven by growths in service professionals (SPs) and service requests. To us, growth in supply (SPs) and demand (service requests) could be a sign of a network effect moat source possibly developing. In addition, this moat source could become an economic one as ANGI Homeservices is continuing to monetize the increasing service requests more effectively--third-quarter average revenue per service request was up 36% from last year.

The segment’s operating margin of around 11% was a significant improvement from an operating loss in 2017. Plus, the margin widened by more than three percentage points sequentially. While we expect ANGI Homeservices’ operating margin to widen further next year, the firm’s acquisition of Handy, may limit that to a certain extent. While Handy, which matches service providers with requests for smaller tasks, will likely drive further growth in ANGI Homeservices’ revenue, it will be accommodated by additional platform integration and marketing expenses in 2019. However, if executed successfully, we do think that the addition of Handy could spur continuing strong top-line growth beyond 2019 and help the segment progress further toward creating the network effect economic moat source. We are assuming 11% operating margin for ANGI Homeservices next year after which we think it can hit 22% by 2022. Such expansion is expected to be driven mainly by revenue growth outpacing growth in marketing expenses.

Within the video segment, IAC sold Electus (which was another technology driven platform for content creators) in October. That segment generated around $64 million in revenue, up over 20% year over year, mainly from Vimeo. The subscriber count for Vimeo increased 10% from last year to 932,000. Plus, according to management, monetization of the newer subscribers exceeds that of the older ones, while retention remains high. On average, Vimeo subscribers or content creators remain on that platform for at least five years. As nearly none of Vimeo users need assistance in how to use its various content creation, editing, and publishing tools, the potential operating leverage to be created possibly by continuing top-line growth in the business is appealing. Although, for the time being strong revenue growth will come on the back of higher spending on sales and marketing. We remain confident that IAC’s video segment can break even by 2022. We must note that IAC management is planning to make Vimeo a separate business segment in fourth quarter.

Revenue from publishing came in at $139 million, up around 57% from last year, driven mainly by growth in Dotdash, which helps manage and further monetize various publishing brands online. We expect strong growth in this segment in fourth quarter and beyond as in addition to some organic growth, the segment will include what is today the video segment excluding Vimeo. Regarding IAC’s applications business, as users continue to spend more time on mobile devices rather than desktops, usage of IAC’s applications is also transitioning toward mobile devices, which we think bodes well for the firm. This represents opportunities such as sales of more native apps ad inventories, which we think was already the main driver behind the segment’s 13% year-over-year and 8% sequential growths during the quarter. Applications’ revenue came in at $154 million during the quarter.