Investing for Global Love: IAC/Match 3Q19 Results [IAC]

IAC owns an 80%+ stake in Match Group (the dating company), which fell sharply after coming up short in its outlook. Is the reaction justified?

Refresher on IAC
Match Group (MTCH), the online dating giant whose portfolio includes brands such as Tinder, Hinge, OKCupid, plentyoffish, and Match.com, fell sharply on Wednesday after coming up short in its outlook.
IAC is a leading media and internet holding company that owns a portfolio of more than 150 brands and products. Its largest revenue contributor is its 80%+ stake in Match Group, so naturally IAC's stock tends to follow MTCH's.
Let's break down what happened in Q3, why the stock fell after hours, and what we think is the path forward.
What Happened in Q3
Match added 437,000 paying Tinder subscribers in Q3, setting the company up for its best year yet of Tinder subscriber growth. It now projects an annual increase of about 1.6 million paying users once 2019 is complete, compared with 917,000, 1.5 million, and 1.2 million in 2016, 2017, and 2018, respectively.
Those strong subscriber results flowed through to sales and earnings, too. Match reported revenue of $541.5M (vs. analyst estimates of $540.7M) and adjusted earnings before interest, taxes, depreciation and amortization (EBITDA) of $206.1M (vs. estimates of $204.4M). Earnings per share of $0.51 were 16% higher than analysts' $0.44 estimate.
Match's special committee also continues to evaluate IAC's proposal to spin off Match Group from IAC (see our other research update on the IAC/Match spinoff for details).
But alas, the market doesn't care about what happened in the past. All eyes are on guidance these days. What will next quarter look like, and more importantly, 2020?
That's where Match Group (and therefore IAC) came up short.
Why the Stock Fell After Hours
Match stock fell more than 15% in after-hours trading Tuesday, after the company's outlook came up short. IAC traded down more than 10% initially, but recovered to down roughly 5%.
For Q4, Match expects $545-555M in revenue and $205-210 in adjusted EBITDA. Analysts were calling for $559M revenue and $228M in adjusted EBITDA, so Match came up ~2%/~9% short, respectively.
At first glance, earnings are down vs. expectations. It makes sense why the stock is down after-hours. Earnings are what drive long-term stock prices, and some investors are worried that elevated investments could weigh on Match's earnings for the foreseeable future.
Additionally, for a stock trading at 33x 2020 P/E and 21x EV/EBITDA, there didn't seem to be much "valuation support" for many hedge funds who own this name and are playing for a near-term catalyst (e.g., upcoming IAC spinoff). In other words, even 15% lower, the stock doesn't "screen cheaply" on the surface. It's easy to rationalize why the stock is down so much.
But rather than reactively look at the stock price and try to come up with explanations, we prefer to listen to the company's management team and understand the data. Is the Q4 / 2020 guidance a one-off issue, or something more worrisome?
Q3 Trends In Dating
Match disclosed that Tinder subscribers are becoming more engaged with the service. The number of users who visit the service seven days a week is up 30% YTD, and the average user comes to Tinder more than five days a week. About 85% of Tinder users come back to the app the following month.
That sort of engagement is extremely rare, and advertisers love it. That's why Match has been growing average revenue per user (ARPU) by ~4% annually. Strong and growing engagement gives the company pricing power.
And the momentum also extended for some of its other brands beyond Tinder. Hinge has seen 2.2M global downloads so far this year, compared with 1.2M in the comparable period a year ago. The app has been gaining traction in part due to ads that portray the product as being focused on driving actual relationships. Match plans to focus on monetizing the product even more next year.
When it comes to the fundamental business health, we didn't see anything in the Match Q3 trends that makes us worried about the company's momentum, market opportunity, or business model.
The Path Forward
Now that we discussed Q3, it's important you understand why Match is guiding to lower earnings in Q4. Below is a slide from management's earnings presentation. In their words:
"[It is due to] discretionary product investment and marketing spend to expand globally…[plus] legal, regulatory and other non-discretionary items, such as French digital services tax."
When asked why they've investing so heavily (which hits Q4 and 2020 earnings), Match's management said:
"[We're] continuing to invest in several of our new bets that are showing strong momentum."
Based on the high margin nature of mature dating platforms (Match is generating nearly 40% EBITDA margins, higher than Google (!)), it makes sense to invest heavily in expanding subscriber base globally. It should be extremely profitable at maturity, and so maximizing subscriber growth today is the best use of capital. Short-term shareholders be darned.
Side note: why is online dating so profitable? Because dating platforms have virtually no marginal costs to stay in business - just marketing spend to acquire and retain customers. And their strong network effects generally make for sticky subscribers even when you pull back marketing spend.
Back to Match Group. Once it's saturated the international markets (a long ways away -- only 5M int'l subscribers today vs. 10Ms potentially), we think Match can pull back its discretionary marketing and product investments.
We'd rather have Match take the near-term earnings hit to grow to 20M+ global subscribers generating 40% profit margins in 5 years than, say, pull back on investment and tap out at 10M subscribers earning 40% profit margins today. It's a time horizon gap that not everyone is willing to wait for, however. Which is why the stock is lower after hours today.
We'll be watching for whether the Q4 and early 2020 investments in marketing and product actually do pay off. International subscriber growth needs to trend nicely for us to believe they're worthwhile investments. We're cautiously optimistic.
Nov. 5th, 2019
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