Big news came out in the consumer technology world last week when Alphabet (GOOG 0.16%) (GOOGL 0.07%) -- the parent company of Google -- announced that it was lowering the fees on its app store for mobile developers. This fee change was welcome news for investors in companies whose businesses flow through the app stores, like Duolingo and Bumble. Both stocks jumped more than 10% higher on the announcement.
One of the biggest companies this will affect is Match Group (MTCH 6.50%), the owner of popular dating apps like Tinder and Hinge. The stock popped 14% on Google's announcement, although most of those gains have faded away as the stock now is up only 6.5% in the past five days. Here's what the new rule means for Match Group and its stock going forward.
The rule change
Starting in 2022, the Google Play Store will have revised fees on the first year of recurring subscriptions. Previously, the Play Store took 30% of subscription fees in year one and 15% in year two and every year thereafter. Now, subscription fees will be 15% starting in year one. Since Match Group monetizes a lot of its apps through subscription services, this fee reduction should flow directly through to the company's bottom line. For example, Tinder did $399 million in direct revenue just in the second quarter of this year.
It should be noted that this specific change, which only affects the first year of the subscription, will likely be most beneficial to dating apps. Why? Given the inherent cyclicality of dating apps, Match Group probably has more users who turn on a subscription for a few months until they get a relationship, then turn it off again. Match Group probably has a higher percentage of one-year subscriptions than a subscription service that is more of a utility with long-term value, like a streaming service for music or videos. Therefore, this rule change should benefit it more than most other applications.
Lower fees = higher margins for Match Group
Again, investors should note that this lowering of fees will directly reduce Match Group's cost of revenue, which is why the stock jumped so much on this announcement.
In Q2, Match Group's operating margin was 30%, which was lower than usual because of its new acquisition of Hyperconnect (the segment is operating at break-even right now) and the fact that it is still reinvesting for growth. The company's single largest expense is fees paid to app stores like Google Play, which the company estimates is over $500 million a year right now, or in between 20% to 30% of revenue.
Once Google Play drops its subscription fees and if/when Apple follows suit due to the competitive pressure, Match Group should see a sizable boost in operating margin. Couple this with the fact that it is already masking its profit margins with its core apps because of Hyperconnect, and it is not hard to envision Match Group's operating margin going north of 40% two to three years from now.
Plus, with a huge amount of legislative pressure around the world against the app stores, it is possible these fees could be forced even lower by lawmakers in the coming years, which would benefit Match Group too.
The valuation just got more reasonable
One complaint any prospective Match Group investor might have is the stock's aggressive valuation. Based on its full-year 2021 guidance of $3 billion, Match Group trades at a price-to-sales ratio (P/S) of 15.8. However, if Match Group's operating margin can expand to 40%, then the stock's price-to-operating income (P/OI) would be around 40 based on $3 billion in sales.
To be clear, Match Group's operating margin is not going to be 40% in 2021, but this exercise is important to see what it might get closer to in 2022 and beyond. Plus, if Match Group can continue growing its revenue at around 20% a year, then its forward P/OI could be much lower than 40, making the stock's valuation a lot easier to stomach.
Overall, any decision that lowers app store fees -- either from the companies or lawmakers -- is a good thing for Match Group, and that is why the stock jumped so quickly after this announcement from Google.