To the untrained eye, IAC/InterActiveCorp (NASDAQ:IACI) probably looks like a haphazard conglomerate of hastily thrown-together businesses. But I believe that deeper digging reveals aspects that value and growth investors alike can appreciate.
Although IAC doesn't look as cheap at $31 per share as it did at $24 earlier in the year, I'm hanging on to my shares, which account for 15% of my portfolio. IAC has outperformed Internet peers Amazon.com (NASDAQ:AMZN), eBay (NASDAQ:EBAY), and Yahoo! (NASDAQ:YHOO) over the past year, and ran neck and neck with standout Google (NASDAQ:GOOG). Despite the stock's run, I'm still bullish on IAC's distribution business model, its widening economic moat, and its reasonable valuation.
Business model
Many words describe IAC's business model: distributor, matchmaker, broker, middleman. IAC introduces buyers to sellers, has them shake hands, and takes a cut of the ensuing transaction. IAC's many businesses include the Home Shopping Network (HSN), Ticketmaster, LendingTree, Ask.com, RealEstate.com, Citysearch, Evite, Match.com, Service Magic, and Interval International. These businesses serve as gateways between providers and consumers of tickets, loans, information, entertainment, love, home services, and timeshares. I believe IAC's distributor business model is attractive for the following reasons.
No inventory risk
As a distributor, IAC generally doesn't have inventory risk, because it doesn't have inventory. If a concert doesn't sell enough tickets and takes a loss, Ticketmaster still gets paid a processing and convenience charge for every ticket sold. Interestingly, the inventory at Match.com is the subscribers themselves -- it's a pretty good deal when your customers pay you to make money.
Low capital intensity
Not only does IAC carry low levels of inventory, but it also doesn't have to build out capital-intensive manufacturing plants or branches. Many of IAC's services are distributed via the Internet, where marginal costs are miniscule. This allows IAC to throw off serious free cash flow and undertake shareholder-friendly share buybacks. In 2006, IAC has bought 34 million shares for $909 million (in contrast to IAC's current $9.4 billion market cap) and additionally authorized a whopping buyback of 60 million shares.
Recurring revenue and organic growth
Most of IAC's services are recurring in nature, ensuring a steady flow of sales. IAC's customers have a continuing need to buy tickets, query its Ask.com search engine, look for online dates, buy items from HSN, exchange time-shares, and apply for mortgage loans. Furthermore, most of these businesses should grow organically over time. For example, many of Ticketmaster's contracts incorporate regular pricing increases. Also, many of IAC's online services still have decades of growth in front of them, as customers become more comfortable using the Internet for dating, loan applications, and advertising.
Economic moat
The pitfall of being a distributor is that you're vulnerable to being cut out of the transaction. If A can go directly to C, then why pay B a commission? The fortitude of a distributor's business model depends on its bargaining power. Wal-Mart (NYSE:WMT), at its core, is basically a distributor. It provides a setting in which customers can buy from manufacturers such as Procter & Gamble (NYSE:PG) at a low cost. Customers can't bypass Wal-Mart and buy directly from suppliers such as Procter & Gamble because it would be extremely impractical to go to different sources to buy goods such as toilet paper, laundry detergent, and dog food.
Like Wal-Mart, IAC serves as a middleman between two fragmented parties. The more widely separated buyers and sellers are, the less bargaining power they have, and the more they need a middleman to introduce them to one another. Because most of IAC's end-customers are individual consumers, its buyer base is extremely fragmented. Most of IAC's providers are similarly scattered -- think of the thousands of venues and advertisers that sell through Ticketmaster and Ask.com, and the hundreds of mortgage lenders who rely on LendingTree.
Network effect
Metcalfe's Law states that the value of a telecommunications network is proportional to the square of the number of users. Many of IAC's businesses exhibit this network effect, where the value of the business increases exponentially with the number of users. Match.com's appeal increases with its number of subscribers. After all, would you want to subscribe to an online dating website with only 100 users? Service Magic, which gives pre-screened recommendations for plumbers and other services, unites 40,000 service providers with 200,000 consumer service requests per month. Obviously, this only works if Service Magic has a big enough network to encompass enough local providers, and the ability to offer those providers enough sales leads to make it worth their while.
Incumbent infrastructure
Businesses benefiting from network effects are notoriously difficult to displace, because of their incumbency. Not only do they have the most users, making them the most valuable networks, but they also have incumbent distribution infrastructure and mind share. Ticketmaster has already placed its ticketing infrastructure with venues; a competitor would have to convince the venue to switch from a distribution system it's been using for years to a new and unproven system. Furthermore, Ticketmaster and Service Magic generally sign multiyear exclusive contracts, making it nearly impossible for competitors to build a comparable network.
Information cascade is a term that describes how observers make decisions based on the choices of others. For example, a couple might walk by two empty restaurants and randomly choose one of them. The next couple to walk by might choose that same restaurant, based on their perception that the first couple had information about which restaurant was better. This cycle would repeat itself, resulting in one restaurant being packed and other empty, based on the belief that the crowd knows better. Entrepreneurs trying to sell their product actively seek out distributors such as the Home Shopping Network because of its well-known brand and popularity with other entrepreneurs.
Value investors rarely find great businesses trading at reasonable valuations. IAC's market cap is roughly $9.5 billion, and it has $1 billion in net cash, giving it an $8.5 billion enterprise value. In the last 12 months, IAC produced roughly $1 billion in operating cash flow and spent $250 million on capital expenditures, giving it $750 million in free cash flow, which equals almost a 9% free cash flow yield. I believe this is far too cheap for a company with IAC's strong organic growth prospects and pristine balance sheet, and I'm hanging on to my shares.
For related Foolishness:
Amazon, eBay, and Yahoo! are all Motley Fool Stock Advisor recommendations. Wal-Mart is a Motley Fool Inside Value pick.
Fool contributor Emil Lee is an analyst and a disciple of value investing. He has a long position in InterActiveCorp, and appreciates your comments, concerns, and complaints. The Motley Fool has a disclosure policy.
