IPO stocks are down 8.4% as a group year to date. And that's despite an average 12% first-day pop. FriendFinder Networks, off more than 80% from its offering price, and Demand Media (NYSE: DMD ) , down 59%, are notable losers.
The last time it was this bad? 2008, when IPO shares fell 27% amid a broad market decline. HomeAway (Nasdaq: AWAY ) , down 11% since reporting third-quarter results late last month, is becoming part of the problem. I'm not so sure that's fair.
Revenue grew 36.9% year over year, resulting in a $0.05 per share net loss. HomeAway lost $0.11 a share in last year's third quarter. Gross margins remained steady, but margins based on profits from continuing operations fell by more than 50% as product development and marketing costs soared.
Still, there are three positives from the report that I believe deserve investors' attention:
- Cash is flowing. According to Capital IQ, HomeAway has generated positive free cash flow in each of the last three quarters -- more than $30 million after factoring in working capital, currency fluctuations, and the like. Capital expenditures rose steadily during this time. Heightened investment could continue, but HomeAway also retired preferred stock obligations that hurt profitability in Q3 and cost more than $54 million in dividend payments over the last nine months. The improving balance sheet should aid future cash flows.
- Listing revenue is expanding geometrically. Paid listings rose 22% to 626,528. Some of that must be due to the April acquisitions of realholidays.com.au in Australia and Second Porch in the U.S. Yet in the 10-Q, HomeAway also says these deals "did not significantly contribute" to revenue growth in Q3. Organic sales increased 28.7% in the third quarter, largely on the strength of higher listing fees. Average revenue per listing grew 6.7% to $335 in Q3.
- New tools are emerging. Finally, HomeAway's Reservation Manager software for helping property owners complete bookings and accept payments directly from the HomeAway.com and VRBO.com portals is now live. Owners were clamoring for it earlier this year, and while online community posts show that bugs remain, there appears to be broad enthusiasm for this differentiating service.
Why HomeAway is cheaper than you think
There are still many that believe HomeAway is too expensive to ever produce meaningful returns for shareholders. I can understand why. No stock trading for 500 times earnings is ever going to be deemed cheap. Fortunately, a triple-digit P/E ratio is only part of the valuation story.
Consider the dynamics of the timeshare industry. Marriott's $1.5 billion in 2010 timeshare sales amounted to roughly 13% of its overall revenue and 25% of all timeshare industry revenue. What's that worth? Investors value the whole company at $10.6 billion in market cap. Take 13% and you've got a $1.4 billion implied market value for Marriott's soon-to-be-spun-free timeshare business.
We'll get a better view for how investors value Marriott Vacations when the spinoff is completed later this month. But if my math is even within spitting distance of correct, the entire industry is priced at about $5.6 billion -- or more than double HomeAway's current market cap.
Big markets getting bigger
Importantly, timesharing is just part of the disruptive opportunity emerging here. In building marketplaces that resemble priceline.com (Nasdaq: PCLN ) and Orbitz Worldwide (NYSE: OWW ) , HomeAway, Expedia's (Nasdaq: EXPE ) FlipKey, and privately held AirBnB are creating more than a timeshare alternative. They're positioning vacation rentals as hotel alternatives, and in the process increasing the addressable market for property managers used to fighting for the attention of the timeshare-weary.
Let me repeat that, because it's incredibly important. HomeAway and its peers are increasing the addressable market for property managers. Rule Breaking happens when a new model creates attractive economics for a large class of customers. HomeAway benefits most, I believe, because it has the best-known brand, the largest listing catalog, and distinct tools to help managers reap profits.
Foolish final thoughts
Say what you will about HomeAway's lack of profitability and triple-digit P/E ratio. I've heard it all before, and history calls these concerns overblown. So does the performance of our Motley Fool Rule Breakers scorecard.
True, a substantial numerical valuation could hold the stock back for several quarters or even years. I'm willing to wait. Authentic Rule Breakers -- and I believe HomeAway is one -- are always worth it. Do you agree? Disagree? Please weigh in using the comments box below.
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