Personal finance site NerdWallet has filed a prospectus to go public, with reports indicating it could seek up to a $5 billion valuation. What should investors think about this business model? Join senior analyst Asit Sharma and host/contributor Emily Flippen as they discuss another upcoming IPO.

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This video was recorded on Oct. 19, 2021.

Emily Flippen: Welcome to Industry Focus. Today is Tuesday, October 19th, and I'm your Consumer Goods host Emily Flippen. Today, I am joined by Motley Fool Senior Analyst Asit Sharma. We're going to be talking about another business that's headed to public markets. Yes, we've been doing a lot of S-1 shows. But this company is really interesting and I think a lot of consumers may have heard about it before. It's NerdWallet.

Asit Sharma: Yeah. Emily, I'm so excited to be nerding out with you today for a few minutes on this one.

Emily Flippen: Yeah. I was really excited when I saw that this company filed to go public because I'm familiar with it. As a consumer myself, I will imagine that a lot of our listeners, if you engage with Motley Fool's content like listening to our podcast, subscribing to our services, I'm willing to take a bet that you've probably also engaged a little bit with NerdWallet. They are in the personal finance space, their website really aimed at providing financial education. But really, on all actually, trying to get you sound FERC credit card, maybe takeout alone if you need it. But they are really about empowering consumers. I was excited to see this business go public. But as we were preparing our notes for today's show, I noticed that we got different reads, I think, from this business. That's great because we don't often disagree, Asit.

Asit Sharma: It's a wonderful, Emily, to able to think, "I disagree with Emily on this one." [laughs] If you are too sympatico, it leads to not optimal investment results. I think this is positive and actually, I like this business. I mean, circling around to the business as a whole. Just a short cut where I'm going to land by the end of this half-hour, yeah, think it's investable. But there are few things did turn me off. Let's start with the things that you like. I think where we interpreted a bit differently around that the introduction of this company to the public markets. Yeah, I too have popped on their site a few times in the past few years. Haven't signed up for a product through NerdWallet, but it's certainly in searching for other things happened upon it and senior content. It's great story, well organized, etc. But tell us about the founding of the company and what you like when you were first going through that prospectus. [laughs]

Emily Flippen: I actually liked the CEO/founder. His name is Tim Chen. He founded the company back in 2009. Really, to start as a spreadsheet. I think he was working for his sister who is interested in getting a credit card, but was really confused about all the different options out there. He set up the spreadsheet essentially to kind of track and understand the benefits of different cards to help them power her to make the decision that was best for her finances. I enjoyed not only that back story, but actually reading through the shareholder letter. There's a big letter at the beginning of the prospectus written by Chen. The focus is really on providing, I won't say investors, I guess, consumers with simplicity and clarity. My personal Motley value here at the Fool is transparency. I think that so much of the financial services industry is committed to just convincing the average person that stuff is too hard or too complicated to do themselves. When reality, people should feel empowered to be able to make those choices. A little bit of an education goes along way. I felt some of those tones coming out in the shareholder letter, which maybe kind of happy to read through it. I think Chen probably agrees with that same level of mentality.

Asit Sharma: Yeah, I think you're right, Emily. Overall, this is a site that's doing a lot of good out in the world because there is so much to look at. You don't know who has just extremely vested interest in what they're selling you. I can totally see that, but I don't know about this. His letter really rub me the wrong way. I got Steve Ells vibes reading through it. [laughs] For those of you who don't know who's Steve Ells, he's the founder of Chipotle. Of course, he is no longer running the company, but he had a theme he would return to so much during the earlier years of Chipotle. Which is our focus on sustainability, doing good in the world makes us the good guys. These other guys, like McDonald's and quick-service operators, they're the bad guys. They are not trying to be sustainable. They are bad for the environment. He had just a derogatory attitude toward those. Now, Chen doesn't come across this way. Let me get that clear. But he did say something that rankled me in that same letter. He says, sales commissions effect trustworthiness and complexity makes it time-consuming for anyone to become knowledgeable across all areas of personal finance. Especially with the explosion of choice we are witnessing in financial services. As you point out, Emily, he encompasses this statements on either side with stories about his family and friends and how he constantly helped everyone cut through the weeds of personal finance and options and helped steer them away from vested interest in the investment world. But the company generates referral fees from the manner in which it reduces complexity. I'm going to read to you from the top of their homepage. "Many or all of the products featured here are from our partners who compensate us. 

This may influence which products we write about and where and how the product appears on the page. However, this does not influence our evaluations. Our opinions are our own." I totally don't have an issue with the way the company makes money. We've got a similar business here at The Motley Fool called The Ascent. But at the end of the day, let's not pretend that the advice is totally disinterested. If one of umpteen credit card providers you've ranked objectively pays you for prime space on your review page, that can affect that users decisions. Ultimately, to me, it's only slightly removed from a sales commission. The recommender has a financial incentive to push one product more pointedly than another. Anybody the advertising business has been around can tell you how important product placement is; placement on a webpage. If Chen hadn't tried to stake out this whole year since how ground versus commission products? I would have answered your problem with the statements. It affected my ability to trust management because it came across disingenuous to me.

Emily Flippen: I get that. There is a little bit of a holier than thou attitude by essentially coming in saying, we're not commission-based when the service is somewhat commission-based. You can think about it that way. To your point, advertisers pay to be on their platform and while they don't edit or adjust the review. Someone thinks of product is poor, but it's paid to be at the top. I mean, opinion expressed will be poor. But it does impact what US consumer sees. I will say it's an interesting business model. They are paid though, as a portion of this clicks that go through that ultimately generate revenue for that advertiser. If it's a credit card, it's getting someone to apply for that credit card. If it's a loan, it's getting someone to apply for that loan. Same thing's true for, say, insurance products. I think the one thing I will add is that there is some value and actually presenting useful information to the purse than he was reading the site. Because they need them to go through and actually make that application, make that loan application if that comes to push, and that's how they get paid. They want to present the best products in front of people there, which is out of maybe slightly better than our peer commission-based structure.

Asit Sharma: I will agree with that. I mean, simply presenting a consumer with options as a way of educating a consumer on what he or she can ultimately run with. I do think, overall, the business model, as I said, that's good in the world. But I got just a different vibe. [laughs] But let's move on, shall we? Emily, Chen is only 39 years old, he's been leading the company since she was 27. I mean, that's so impressive. He retains voting control, but he doesn't own any common shares or won't after the IPO. You know a founder who is still very vested and has control over decision-making, but might not have that financial stake in the ground. Let's talk about the mission. You and I both like this so we started to agree very quickly after a rare disagreement. We both like this mission. What is the mission here?

Emily Flippen: Their mission is to provide clarity for all of life's financial decisions. I like that because I think it's specific enough to what the business does, you get a good idea about what the future holds for them, while it's still broad enough to apply to a lot of different opportunities. It's not to best match consumers with their best credit card, that's a very limiting mission statement. But it's also not to make the world better, because that's really challenging, it apply it to anything. So very clear, provide clarity for financial positions. I like that A to B, I feel like it's sums up the business well.

Asit Sharma: I think financial life decisions or life's financial decisions are something that brings up emotion and uncertainty for so many of us when you're thinking about big picture decisions. Even getting a new credit card for many of us. You're getting your credit card with a certain limit, you're going to use it for x, but that's going to impact your personal finance on into mortgages and bigger decisions, products tied to that. I like the sense of relief that where a friend pointing in the right direction. I thought it was very strong. This business, we already mentioned that they're basically a financial services publication. They make money by charging advertising referral fees. Users like their sites, because as you wrote in our note, Emily, they can access unbiased, simple, and trusted information on finance questions like, which credit card should I get? Can you tell us about the partners on their site, how they benefit from the way this funnel is structured?

Emily Flippen: Yes, so NerdWallet, as many investors who are familiar with the business may already be aware, have a really strong top of funnel approach. They had in the most recent six months, over 21 unique users access their content every month. Lots of people coming in at the top of funnel, and even though only a handful or a select number this people will ultimately end up making a purchasing decisions based off their site, the people that are coming to NerdWallet are ready to make those decisions. You don't go to NerdWallet, you just casually read through what loans are available to you unless you were actively looking for a loan. The type of people coming through this really wide top funnel are ready to start making these purchases which means that it's a really valuable real estate for their advertisers or their partners to get out in front of those consumers' faces. Because it has such a strong brand reputation, they have really a lot of unpaid search where 70 percent of their traffic comes from unpaid organic searches. People say making a Google search and then clicking on NerdWallet article. Some really impressive SEO here that really makes it valuable to partners. I'd argue also consumers although the unbiased nature of it is obviously up for debate. [laughs]

Asit Sharma: So that's great organic search traffic, over 70 percent, 21 million unique users, but they also have an option to sign up and register with the site, and that helps them actually get a better beat on you. You're a more, I think, driven potential customer and you'll have a higher lifetime value. They say that those who register with the site they're more easily monetized because they are more engaged and the lifetime value of these registered users is five times greater than non-registered users. They also have more than twice the number of transactions and sessions as well. If you think about those unique users who are not registered versus the ones who are registered, there's a big Delta between the usage when someone goes ahead and submits their information, and I think that's also impressive.

Emily Flippen: It was this registered user approach that I thought was interesting about NerdWallet. When I think about the fact that they're reaching for what would be a five billion dollar valuation, we'll talk about their finances, but that's a big company. It's a big mission, bigger than just here are some referral fees and I like the fact that they have this offering for registered users, which provides personal finance, management in a sense. If you're familiar with Intuit's Mint, similar aspect there. They have credit tracking, net worth tracking, budgeting software. You come in, maybe get pulled in through a free article to NerdWallet. You like what you see, maybe you apply for something like a credit card or a loan, but then you also register for their site, and as part of registering that, you get all these tools to help you better manage your finances. They're not monetizing that. I don't really quite know how they would monetize that, but maybe that's good for at least base levels of engagement, around 43 percent of their total unique users are registered users, so about nine million of the 21 million users.

Asit Sharma: In this day and age, coming to market, you almost need to show some statistics that point to future recurring revenue. Something that looks like a software as a service model, even if it's not. So that's important for them. But it also points to how different this is from so many business models that we look at. The revenue from year-to-year is unpredictable. They've recently acquired a company called Fundera, which provide similar offerings. It's like a smaller site, small business loan information is what they specialize in, and they provide that to small and medium sized businesses. But Emily, this is a company that very much ebbs and flows with economic cycles. You had pointed out to me that you see this as similar to or driven by underlying demand in the banking industry. Could you explain to us a little bit of what you saw in reading through this S-1, how that's so similar?

Emily Flippen: Yeah, I would say that similar economic events that impact demand for banking are probably likely to impact NerdWallet. If you look over the course of 2020, their credit card revenue actually declined 30 percent because there were lower approval rates due to just general economic uncertainty. Their advertisers were less willing to give people loans because they were uncertain about the economic future. Meanwhile, over the same time period, loan revenue increased 48 percent because interest rates have been so low and there's really high demand for things like home refinancing. When you think about the type of economic structures that will impact the bank, you can think about it impacting NerdWallet. As we thought about risks for this business, I have to say, I had a hard time pulling out just classic red flags here. I think the biggest risk for me is the fact that so much of what they wrote about in their S-1 was aspects that drive their business that are completely out of their control. Virtually, all of the demand for their revenue, they can't do much to stimulate. The best they can do is still be the premium site with a best top of funnel. But when tides move against them, which they will, as the economy ebbs and flows, there's very little they could do to change that reality.

Asit Sharma: True. If you are the type of investor who really scrutinizes every quarter and gets emotional over one quarter relative to others this might not be the company for you. I was surprised at how lumpy the business is, but it makes sense if this is the type of company where, let's say you could employ a 10-year holding period, because any economic cycle is going to have one or two big exogenous shocks in a given 10-year time period. We know that. There was a great recession, then we had COVID-19 with increasing frequency. I think also because of climate change, we'll see this. Overall, NerdWallet can prosper, it's just not going to be this linear, smooth path to revenue and stock price appreciation. I think that this is a bet on the focus on consumption in the US economy because the business model is concentrated in the US. I see that growing at a pretty steady clip over the next several years, and there's no reason that they can't continue to grow in this lumpy variable fashion if they don't get disrupted themselves by newer challengers, it's not a high barrier of business.

Emily Flippen: That's certainly true. Let's think about their finances here. I mentioned earlier that they're seeking a five billion dollar valuation. They have 2020 revenue of just under $250 million. They're on a run rate right now for 2021 of around 360 million, so we're talking about a forward just price to sales of somewhere around 13-15 times, which is pretty lofty for this business. It becomes even a little bit more lofty when you look at their bottom line. While they were profitable in the past, 2019 and 2020, saw around a 10 percent and a two percent net profit margin, they were actually unprofitable for the first six months of 2021, largely because they've been ramping up their marketing expenses so aggressively. It's something to keep your eye on. I don't know if they're trying to fund growth here, they're reaching out trying get that top line to grow faster. To be honest, I'm not quite sure where they'd spend that money to make that a reality.

Asit Sharma: This is a business that needs that marketing as a lever. They had a very interesting turn toward the negative in operating cash flow that turned negative to the tune of 18 million bucks and tied to that, Emily, you pointed out they've got a very substantial receivable backlog. Receivables are up. Part of that is having an effect on the cash flow. They have a 25 percent concentration. Their end-of-period receivables for this S-1 to unnamed customers, and historically, they've been concentrated 20-30 percent among two or three names at each period end. I think what's important here for us to realize, again, for those of us who've been trained on software-as-a-service models, this is not a company that has your or me as the end customer, its customers are its referral partners. 

What this means is they really step into the world of procurement with these big companies just as a manufacturing company would, which means that you're waiting 60 days to get paid. You're dealing with the partners procurement system and you're going to be financing your business on those receivables. It's not that you're getting paid upfront like in a software-as-a-service model and then that money is in the bank, you just realize the revenue over the next 12 months, it's a slow cash moving model. We noted, looking at this company, that they have an asset baseline. Basically they're using their receivables as a working capital loan lending base. Just to keep in mind again, we talk about variability. It's not just in the sales, it's also in their ability to use cash flow. It makes even funding self-growth a bit harder. The way they compensate from that is what you mentioned, they turn up that marketing leverage that in any given period, there's going to be a huge expense in the income statement.

Emily Flippen: The good news there is that because their gross margins have been so impressive and steady at around 92 percent over the past few years, that if and when stuff shifts, whether it be a macro sense, whether it'd be just less sticky with their advertisers, they can scale back that marketing spend and pretty easily return to some level of profitability. Even considering those receivables, even considering the huge marketing spend that they've built up during 2021, if they see opportunity, they want to pull those people in, and when opportunities ceases to exit, they can probably cut that spend. The one thing I was really missing here and I didn't see it, it's possible that I missed it, although I did do my best to read through as much of this as possible, I didn't see any breakdown for things like lifetime value or acquisition costs for the actual people visiting their site. I had very little visibility into what the actual economics for their core customers were. I was hoping to get that, even if it was just for, say, registered users. I was really hoping to try to get some insight into the value of that customer they're bringing in because it does help classify that marketing expense. You can see it more clearly in your head.

Asit Sharma: True, and I have a guess that customers come to the site, they go away. If we were to look at the classic concept like churn, we'd see a lot of churn there. As we've been talking about it, as the economy starts to surge and people have more to spend, that's when they tend to make those life decision. It's cyclical business in some ways. But when the going is good, it's good. Just the last thing on the financials, Emily, that you liked, I like this very much. They've got a very nice topline in terms of the breakdown of revenue. It's evenly split between three big buckets. Could you walk us through those?

Emily Flippen: Yes. I like this too, pretty well diversified. The first big bucket is credit cards. It makes up around 30 percent of their revenue. That's a slow, steady grower for them, up 10 percent this year, thanks to the pandemic recovery largely. Then you have loans, around 36 percent of revenue as we mentioned earlier, and then what they call others, that's the remaining 35 percent of revenue and that includes things like their insurance business, but also that small to medium business revenue from Fundera, as well as things like investing or banking.

Asit Sharma: We've got just a few minutes left. Let's move on to risks. You've mentioned one already, Emily, tell me another big-picture risks and I'll throw in one as well.

Emily Flippen: We mentioned this earlier, but virtually all of their revenue comes from the US. They made one acquisition in the UK, currently, what they called NerdWallet UK, but it doesn't contribute materially to their earnings. But the biggest risk, as I mentioned earlier, I really do think is just how, I guess, out-of-control they feel about their financial performance, even looking at their credit card, the loans in the other segments, when management called out the performance of those year-over-year, it was all outside factors. Credit cards did better because of the pandemic recovery. There is a huge increase in mortgage loans up 94 percent, again, because of low interest rates. There's a decrease in investing revenue because lower consumer demand, lower excitement in 2021 for investing. It was all just like, well, you're telling me stuff that has happened to you that results in financial performance, but what are you doing to make financial performance a reality? I guess the business felt more reactive than proactive to me. That just stands out to me as probably the biggest risk.

Asit Sharma: To me, I think that there's a long-term risk in how its financial partners will be studying the return on their investment. I mentioned this actually a few weeks ago in terms of another industry, which was the travel industry. In that Marriott, huge hotel hospitality name gradually started marketing to its customers itself. It acquired the Starwood group with that end in mind because the Starwood group had such an amazing loyalty program. They turned that program into the Marriott Bonvoy program to bypass their partners, which were these online travel agencies which take a commission. They're slowly shifting more business to a direct model. I'm wondering if in the future and over time, big financial partners might become more savvy with the types of digital content marketing that sites like NerdWallet and our own, The Ascent are so good at and decide, look, it's a lot of investment upfront, we have to invest in new people and systems. But that lifetime value is worth it to us to have our customer come directly to us and stay with us because once we've got them, we can market directly to them. I see that as a secondary risk. But overall, I did like the brand power that NerdWallet has. I think it can at least alleviate most of the risks we've talked about today by capitalizing on that and then I wonder if geographic expansion at some point wouldn't be in the offing for this company. I didn't see a lot of discussion on that in the S-1.

Emily Flippen: I'd be really interested in particular to see what type of valuation this company goes public at. Like we mentioned a couple of times before, they're looking for five billion dollars. As much as I want to say I think that's ridiculous, especially because the market ties have turned a little bit over the past few months; maybe a little bit less forgiving to unprofitable growth companies that are depending on things like advertising revenue. However, I will say it's not unheard of, I don't think it's a completely ridiculous evaluation in comparison to some of the numbers that we've seen. So I'm just so interested to see how the market reacts to this. Personally, I am sitting on the sidelines for this business for at least a very long time into the future. I will probably continue to use their products as a consumer among a host of others, but do I have interest in investing? Probably not.

Asit Sharma: Yeah, same here. I'm going to make a prediction. I think on predictions, one out of 10 this year, I'm so bad at predicting the future, but I'm going to say, look 3-4 billion. The reason is we've seen so many companies get what they wanted from the markets. This is a company that doesn't have some strong annualized recurring revenue to point to, so investors can say, "I don't care, pay another few percentage points of multiple," because look at this locked in business, it's so great. We've seen that time and time again. This is a bit different. This model is different and investors should be a little more wary and not confuse it. It looks like a SaaS model, but it really isn't. It's got a few customers that it works with and neither sides knows exactly how many ultimate consumers will come into the funnel in any given quarter. For that reason, I'm interested as a long, long term hold, a 10-year hold, a 15-year hold. But I'm not jumping to buy shares just yet.

Emily Flippen: Asit, thank you so much as always for joining and talking about NerdWallet here. It's fun nerding out.

Asit Sharma: That was fun nerding out with you as well, Emily.

Emily Flippen: Listeners, that does it for this episode of Industry Focus. If you have any questions or just want to reach out and say hey, shoot us an email at [email protected]. As always, people on the program may own companies discussed on the show and The Motley Fool may have formal recommendations for or against any stocks mentioned, so don't buy or sell anything based solely on what you hear. Thanks, Tim Sparks for working behind the screen today. For Asit Sharma, I'm Emily Flippen. Thanks for listening and Fool on!