Most people manage personal finances with at least some borrowing. Consider the home mortgage, which represents the largest financial burden that the majority of people ever undertake. What a time- and paper-intensive hassle! Borrowers work with one lender at a time, exhuming papers from home files and sneaking mortgage-related calls and faxes discreetly into a workday. It makes taking out the garbage look good.

Management vision
That's why many of us have felt like Doug Lebda, a young PricewaterhouseCoopers consultant who in 1996 found his experience trying to obtain a loan for a $60,000 Pittsburgh condo so "confusing and disempowering" that he didn't know whether he got the best deal or had been taken.

With a story sporting all the trademarks of an Internet pioneer, Lebda turned his nasty experience into a business plan for a lending exchange. And when his University of Virginia business school classmates nixed it in a competition, he dropped out for a year to build the company and prove them wrong. Lebda raised $69 million in venture capital and over the next two-and-one-half years converted 163 lenders from competitors to partners. Along the way, he's also attracted some savvy, seasoned execs to help him take LendingTree (Nasdaq: TREE) to the top. And he's just 32.

That the company was LendingTree is no surprise to our Motley Fool Select subscribers and those who enjoy the conversation on our LendingTree discussion board. LendingTree makes revolutionary use of the Internet to make life easier for borrowers and lenders by bringing them together in a way not previously possible. It works like this: Lender partners supply underwriting criteria to the company's real-time, password-protected system. Potential borrowers fill out a simple online credit request (qualification form, or QF), at no cost or obligation. LendingTree retrieves the borrower's credit score, compares it and the QF information to the lenders' criteria, and forwards the QFs to appropriate lenders. LendingTree receives $9 for each referral.

Borrowers receive up to four offers from lenders within one day and can compare and review offers and accept online. The company's goal is to generate four offers for every borrower request regardless of geographic location or loan type. LendingTree earns additional fees (around $300 or so) when loans are closed and, in the case of its Realty Service Network real estate agent referral business, when homes are purchased or sold.

Management's vision is not just to be the number one online real estate mortgage lending exchange, but to have a lifetime relationship with borrowers for all their credit needs, including auto and personal loans and real estate referral services.

It's on its way. In two-and-a-half years, this company has gone from no revenue to originating 1%, or $20 billion, of the $2 trillion in U.S. home mortgage loans last year. LendingTree is clearly the top dog with gusto in an important, emerging industry. In fact, it's the only company that's a lending exchange and not a lender or solely a referral service.

The moat
That's right. LendingTree has no publicly traded, direct online exchange competitors today -- though there are a slew of traditional lenders with their own websites, online-only single lenders, online mortgage brokers, and referral-only sites. But LendingTree's success will almost certainly draw bees to the online lending exchange honey, whether independent companies or a group of mortgage banks or lenders similar to the five top national airlines that joined to form Orbitz to compete with Expedia (Nasdaq: EXPE),, and others. When that happens, there is at least a good chance that LendingTree's branches -- growing faster, farther, and healthier -- will fend off competition. Its business momentum and consumer brand offer a sustainable competitive advantage.

Business momentum
Because LendingTree promises the same as any good, scalable online business: revenues that grow faster than expenses. For example, LendingTree's Q1 revenues climbed year-over-year to 73%, but its operating expenses (product development; marketing and advertising; and sales, general, and administrative expenses) dropped 1.5%. And look at the previous five quarters' trend:

              2002          2001
               Q1    Q4    Q3    Q2     Q1
Sales vs.
  prior year  +73%  +96%   +91% +105% +173%
Oper. exp. vs.
  prior year �1.5% �0.9% �18.9% �2.2%  0.9%

This trend should continue, because management reported on the Q1 conference call that it expected no employee growth and no significant increase in capital expenditures this year. With this trend, it's easy to see why management projects Q4 profitability.

Consumer brand and network effects
Boosted by the company's very effective and humorous TV ads, the company claims 59% brand recognition, and its brand and business momentum feed on each other in a classic example of a network effect. Lenders go where the most borrowers are, and borrowers go where they receive the most choices, leading to more lenders -- you get the idea. Brand and network effects are what helped eBay (Nasdaq: EBAY) beat back Yahoo! (Nasdaq: YHOO) and Amazon (Nasdaq: AMZN) when both moved into the online auction business.

So far, this is happening. Instead of coming and going as business conditions change, lenders adjust their online filters ("dial up" or "dial down") on LendingTree to secure the desired mix of products and borrowers (what Lebda calls the "the bingo card"), assisted by LendingTree's up-to-the-minute best practices and pricing data. When times are good and lenders are having trouble meeting demand, they can dial down their filters to restrict capacity.

When times turn bad, lenders have more capacity and "dial up" the filters to increase its QFs. Lebda says that consumers find "more choice, lower prices, and better coverage" in bad times than during boom times, and he's been right so far. Look at online travel businesses in Q4 2001 and Q1 2002.

By the way, borrowers stick around, too, with 16% of completed forms now hailing from repeat users, against only 5% a year ago. Repeat business? It's not Starbucks (Nasdaq: SBUX), but we like it!

While business momentum and consumer brand will be the real alligators in LendingTree's moat, there is also one new baby piranha: On May 22, the U.S. Patent and Trademark Office issued a patent to the company for its online lending process that enables consumers to receive competing offers from multiple lenders. The company also generates 10% of its income through licensing, customizing, and servicing its Lend-X exchange software. The patent strengthens LendingTree's power. By choosing whether or not to license its patented software and for how much, it can further defend its business and make partners out of competitors.

Relative strength of 90 or more, 10x/5y, and "Overvalued!"
Once we believe our potential Rule Breaker buy has what it takes as a business, we put its stock to a few tests.

LendingTree shares hit bottom at the end of September and early October -- as did most stocks outside of defense, security, or Web conferencing -- but rebounded 294% from their October 16th $3.05 close to May 24th's $12.02 finish. The shares trounced the Nasdaq, S&P 500, and 97% of stocks, giving it by definition a top-drawer relative strength of 97.

We like that stock price momentum. But it does make us ask why the stock was so low back then and, now that it's already recovered smartly, whether it can return 10 times our investment in the next 5 years.

No more falling leaves
Sure it can. First, let's remember what the world looked like last fall when the stock hit a closing low of $3.05 on Oct. 16, 2001. The economy was, uh, uncertain, and this company was teetering on the brink, with only $2.4 million in cash and short-term investments to feed a $17.2 million annual cash burn rate. Things were so tight that the company was paying its convertible preferred stock shareholders in stock instead of cash, bringing more dilution.

But business grew during Q4 and Q1 2002, traditionally the low seasons for real estate mortgage loan closings. After borrowing $4.7 million and securing $5.9 million through private financing, the company says it will pay convertible preferred dividends in cash in the future and has enough cash to meet its needs for the "foreseeable future." With litigations of lawyers inspecting every word of each 10-Q and 10-K all over the place, "foreseeable future" is quite a statement of confidence.

Blowing through 10x/5y
Let's run some numbers, assuming that company's revenues increase and costs continue to decline. Interest rates at some point will increase again and reduce discretionary real estate mortgage refinancing, but increasing lender capacity will lead to more QFs transmitted to lenders and more income to LendingTree. Lebda also reports that the company's home equity loan business increased during the falloff in interest-rate sensitive refinancing from Q4 2001 to Q1 2002. Because home-equity loans have the highest closing rates, this boosted revenues. Let's also assume that increasing Internet penetration and comfort levels means steady growth in borrowers going online for credit.

We'll also adjust revenue growth annually for stock dilution, a possible 36% from stock options and convertible preferred shares over the next 10 years. With GAAP profitability projected beginning in Q4 this year, let's grant the company free cash flow beginning in 2003 with a Cash King Margin of 2.5%, increasing over six years to a terrific (but not unreasonable for the scalable, light business model) 25%. The market will bid the stock price up when it sees the rising free cash flow, leading to Rule Breaker 10x/5y returns somewhere in early 2006 and rising to over 14x about 6 years out.

Here's how it looks:

           Actual ('99-'01) Est. ('02-'05)
'99 '00 '01 '02 '03 '04 '05

Revs. (mil.) $7 $ 31 $ 64 $95 $133 $171 $211 Rev.Growth -- 340% 108% 49% 40% 35% 30% Revs. adjusted for dilution (mil.)-- -- -- -- $163 $201 Free cash flow (mil.)-- -- -- $ 3 $ 9 $ 21 Mkt cap*/FCF -- -- -- -- -- 40 50 Mkt cap (bil.) -- -- -- -- --$0.36 $1.05 % Return from 5/24/02- -- -- -- 45% 322% Return in x -- -- -- -- -- 0.6x 4.2x Years*** -- -- -- -- -- 2.6y 3.6y CAGR** 5/24/02 to year-end-- -- -- 15% 48% Estimated '06 '07 '08 '09 '10 '11 '12 Revs. (mil.)$256 $304 $358 $412 $474 $529 $590 Rev.Growth 27.5% 25% 22.5% 20% 20% 15% 15% Revs. adj. for dil'n.(mil.)$243 $292 $343 $395 $460 $513 $573 FCF (mil.) $ 38 $ 61 $ 89 $103 $119 $132 $148 Mkt cap*/FCF 60 50 40 35 30 25 25 Mkt cap(bil.)$2.3 $3.1 $3.6 $3.6 $3.6 $3.3 $3.7 % Return from 5/24/02 816% 1125 1330 1348 1334 1225 1386 Return in x 9.2x 12.2 14.3 14.5 14.3 13.3 14.9 Years*** 4.6y 5.6 6.6 7.6 8.6 9.6 10.6 CAGR** 5/24/02 to year-end 60% 55% 49% 41% 36% 31% 29%

Share price=$12.02 on May 24, 2002
Market cap=$249 million
*Market capitalization used instead of enterprise value because would vary by at most 5%.
**Compound annual growth rate.
***The years have a 0.6 added because they end on Dec. 31, about 60% of a year beyond the benchmark May 24.

Yet despite this possible future, the financial media cry "Overvalued!" as recounted in a February Business Week column. When the stock was only $8 a share, it drew criticism and a downgrade from Merrill Lynch analyst Michael R. Hughes, from buy to neutral. Imagine what he thinks today, at a recent price of $13-$14. My, my.

A classic Rule Breaker? Oh baby!

Regulatory risks
Congress has so far resisted pressure to tax or develop any overall regulatory scheme for Internet commerce. That can be good ("Keep your hands and taxes off my Internet!") or bad (confusion over whether old laws apply to the Internet). LendingTree must obtain state lender and real estate licenses to operate in a state, and there's no guarantee it can obtain permissions in all states. And while it believes it's complying with federal law prohibiting payment or receipt of referral fees for residential mortgage loan transactions, except for services actually performed or that bear a reasonable relationship to the value of those services, that's a risk, too.

So any investor must accept the possibility that federal or state action could harm LendingTree, as well as its current or potential competitors.

We're buying -- and we did say "risky"
LendingTree stands out as a survivor in Internet e-commerce. It presents an opportunity for explosive gains in four to six years, against the downside risk of a blowup due to regulation or a slow decline if online lending growth turns out to be anemic or competition more effective. That's why no investor should consider Rule Breakers for more than a small part of their portfolio.

We're going to start by investing $12,500 in LendingTree, roughly 4% of the Rule Breaker Port's value. We want to keep some cash available for future buys and to add to existing positions when opportune. We may invest more in LendingTree, too. In the near term, we're watching whether any shift in interest rate-sensitive lending affects the company's thin cash cushion.

Following The Motley Fool's Portfolio Trading Policy, we will sell $12,500 worth of S&P Depositary Receipts (AMEX: SPY) and snap up the same amount of LendingTree stock in the next five business days.

Please share your take on the company on our LendingTree discussion board, where the chairs are comfy and the friends inviting. For a more detailed analysis of LendingTree, please see this month's issue of The Motley Fool Select.   

And now, I'll make like a Tree and -- leave. Have a Foolish week! Updated Port returns are below.

Tom Jacobs (TMF Tom9) wishes to inform friends and family that he is not a lending exchange. At press time, he owned no shares in companies mentioned in this story. To see his stock holdings, view his profile, and check out The Motley Fool's disclosure policy. Tom reserves the right to be wrong, stupid, or foolish (small "f").

Rule Breaker Portfolio Returns as of 5/24/02 Market Close:

            RB        S&P     S&P 500
            Port      500      DA*    Nasdaq
Week      -0.50%**   -0.74%   --      -2.36%
Month      1.98%**    0.64%   --      -1.58%
Year     -14.92%**   -5.60%   --     -14.81%
 8/4/94   24.76%     11.65%  13.58%   11.30%

*Dividends added.

**Please keep in mind that these figures will be distorted for the RB Port once a quarter when we deposit $12,500 in new cash. See next note! 

***Compound Annual Growth Rate using Internal Rate of Return. This performance measure accounts for the periodic deposits. Total return wouldn't be meaningful, because we started adding cash to the portfolio in July 2001. In a total return calculation, or (Current Value - All Cash Deposited)/All Cash Deposited, cash added shows up as returns.