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Valuing Conglomerates, Online Companies and Social Media: A Modest Assessment of United Online - Part II

August 09, 2011 – Comments (0) | RELATED TICKERS: ELNK , UNTD , AOL

Part one is http://caps.fool.com/Blogs/valuing-conglomerates-online/620359

United Online – Beautiful Swan

On June 2, 2011, Barron’s featured United Online in its Weekday Trader column. After making a few of the headwind arguments I made above, it made an argument that United Online has more promise than the market is giving it credit.  After all, it has a dividend!

Then an analysts valuation of United Online was divulged – $8.50 a share, just about exactly 50% higher from what was then its current price of $5.65. Its current market capitalization is approximately $500 million [1].

Finally, how this valuation would be realized was laid out, which in a nutshell was the result of a transition from dial up to Classmates /Memory Lane revenues.

I am usually a fan of Barron’s, but the piece left me wanting.  Granted, it was meant to be a quick hit and not an in depth look, but I had been banging this company around in my head for a while beforehand and had much more expansive scenarios to share, a condition to which I am prone. My scenarios contained many more ideas, both short and long.

Three arguments have convinced me that United Online is a much better long bet than short bet:

-> The August 3, 2011 conference call (and quick reviews of previous conference calls)

-> Dividend safety

-> Potential for value realization of United Online’s place in the business ecosystem

August 3, 2011 Conference Call

A few important points, both direct and indirect.

What was abundantly clear in the call was that flower selling is the foundation of the future of United Online, and that is OK with the company and should be for investors.  Its revenue is five times the level of the next largest unit at the company, will be responsible for the bulk of the earnings and where most future dividend payments come from.

United Online clearly recognizes this.  Its recently obtained a credit facility, as was explained on the call, was clearly for the FTD unit, not wild goose chases.  Its business is both a U.K.business (Interflora) and a U.S.business (FTD), allowing them to weather single currency fluctuations. Flowers is a competitive but stable business.

I recently tried the service and the flowers were attractive, as advertised, and while competitively priced with other online flower sellers, still added $50 to my most recent credit card bill.  High purchase prices mean thicker revenue streams.  They have been discussing adding related gift offerings to its mix.

On Facebook, they made it clear on the call that it is a partner and United Online benefits immensely from being able to advertise and make connections on the Facebook platform.

MyPoints is holding its own and not declining as I had been worried about given the onslaught of potential competition.

The company did spend time discussing how it would continue improve integration of Memory Lane and Classmates, and spread the word about its offering through online and offline advertising.

On this call and previous ones (given a quick review), the calls are professional, down to business, and do not spend time waxing poetic about soaring ideas, exciting new business models, and the potential of this that and the other thing.  President Goldston and his crew discuss financials and how their little cash generating machine is being carefully tended.

What I didn’t hear, probably because it was tentative, was of a settlement of the class action suit related to how Classmates.com unfairly lulled people into signing up for Gold Classmates memberships. If this link is be believed, the settlement seems more amenable to the aggrieved than a previous settlement proposal, may result in lower total payouts, and ends a distracting chapter in United Online’s history.

Dividend Safety

United Online’s most recent financials release contained no red flags indicating there might be a problem with their dividend.  No cliff yet for the dial-up business and from the conference call, it sounded like churn might actually be down due to the aging of the dial-up customer population.

United Online’s Place in the Online Ecosystem

Ecosystems are complicated places, where relationships between organisms run the gamut from nonexistent, to indirect, to symbiotic, to parasitic, to predator and prey.  These interactions are further complicated by changing environments and resource levels.

United Online might have not been the winner in the Facebook challenge, but it is uniquely situated to take advantage of its position in the marketplace.

If United Online is examined properly, it can lay claim to a piece each of three currently richly valued business models, as well as that of an interesting kicker model:

-> Content Permissions, Aggregation and Delivery

-> Social Media Ecosystem

-> (Successful) Paid Subscription

-> Reunion Services

Content Permissions, Aggregation and Delivery

Perhaps you’ve heard of Netflix?  Worth $13 billion. The content aggregator and distributor has so far resisted significant competition, either from copycats like Hulu (widely accepted valuation estimate is still $2 billion as it was in 2010), cable providers such as Time Warner or content owners like Liberty Media with properties like Starz.  Even YouTube (Purchased for $1.65 billion in 2006) / Google TV, while running a successful advertising supported distribution model, is struggling to make successful a paid distribution model.

Similar to these other entities, United Online is becoming a content aggregator and distributor of content – nostalgic content, much of that content in areas NOT already spoken for on a broad basis.  This includes yearbooks, commercials, even magazines.  No other company offers this interesting, useful and value added body of content. With their head start, while their current offering is small, they have the potential to become the go-to non-traditional content offering.

Social Media Ecosystem

A moment in May 2012 or earlier will remind us once again the value and ruthlessness of the network effect.  Of course, that is the most recent widely accepted date for Facebook’s IPO. At an estimated $100 billion, this lofty valuation points to the spectacular power social networking has in drawing eyeballs.  It is expected that social search will change the way we search, and possibly the way we consume whatever we find when we search.  Myspace (purchased by News Corp. for $580 million in 2005, sold for $35 million in June of 2011), Friendster (sold December 2009 for $30 million) and United Online to a greater or lesser extent failed against the network effect juggernaut, and all suffered some consequences.  And the pain and suffering continues, as this techcrunch article suggests regarding MySpace’s accelerating decline in traffic.

But not everything gets eaten in ecosystems.  Ecosystems are dynamic, and for every expanding species, not only are there shrinking species but there are adapting species. Social media is so promising and Facebook SO huge and powerful that the there is plenty of money to be eaten in the growing ecosystem forming around just the leader in this new ecosystem.  Oodle, Zynga, Wildfire, Slide, and Rockmelt are some of the better known beneficiaries.  United Online could have an important place in this ecosystem as the repository, aggregator and distributor of our shared school and generational histories.  Over time I see many more companies integrating their offerings seamlessly into the Facebook interface (ed. – duh). In the bricks and mortar world, retailers lease space out to retailers within their stores such as Home Depot does with its garden centers.  Once integrated, we can all howl uproariously at our yearbook pictures easily accessible from our Facebook tablets with a seamlessly integrated Memory Lane by United Online.

And if United Online adds additional true social features e.g. chat, walls, email, etc., stickiness and value of the offering increases, sweetening the pot.

Paid Subscription

Sticky, successful paid subscriptions were hard to come by until recently.  Except for the Wall Street Journal Online (Part of Dow Jones, purchased for $5 billion in 2007) and later Ancestry.com (Current cap of $1.65 billion), there were almost no successful paywalls of any scale in spite of high profile efforts over the past decade.  Ubiquitous mobile hardware, social media and standardizing content licensing are allowing paywalls to succeed where they did not in the past.  The newest New York Times second effort seems to be working, and Dow Jones is walling off additional content as it builds on its existing model.  Memory Lane / Classmates is creating a repository of content, and is custom editing some of it to identify the most memorable parts of the content they license, adding value. Unless a company has the scale of Google, it cannot make desirable content available for free on advertising support.  So far, United Online seems to be making a successful transition from its old revenue streams to a hybrid advertising and paid model for its nostalgia business.

Reunion Business Services

United Online is not in this business, at least not officially.  And this isn’t a hot business model like social networking.  But let’s look at the reunion business for a moment.  It is highly fragmented.  Thousands of companies organizing tens of thousands of reunions. Every reunion startup has to learn the same lessons afresh, establish the same relationships with reunion spaces and caterers, buy paper in relatively small quantities, etc, etc.  Each organizer has to reinvent the wheel each time it sets up a reunion.  Why not offer online reunion management and registration software, while showing ads on the pages!  I believe I have seen some of the new medical electronic records management (ERM) systems with the same model.  A reunion supplier network organized by United Online can offer organizers bulk discounts on supplies.  United Online’s nostalgic content and yearbook catalog can be used to ease the creation of reunion invitations and materials, a reunion database, and enhance the reunion experience.  United Online has all the pieces in place to make this a reality.  What finally crystallized this was hearing about competing reunions being organized on three different online platforms. A business ripe for development.

After spending an excessive amount of time bashing conglomerates in section one of this piece, how can I now laud diversity in the next?!?!

After reexamining the evidence, I have rebutted the objections posed above as follows:

-> Real Synergies, not Fake Synergies: Synergy can be real, too.  Sellers of flowersshould naturally offer gifts as an extension of their business.  And before your reunion, you really might want to consider buying flowers for that crush from high school. There are real offenders of this in the market but United Online doesn’t seem to be one of them.

-> Related Business, not Fake Diversity: One company’s fake diversity if another company’s related business.  If a related business can use the same infrastructure e.g. social networking source code i.e. Trombi and StayFriends, then maybe it is the same business.

-> Cash Cow, Even if Late to Game: During the rise of cell phones, smart phones, laptops with broadband cards, I will never forget Whitney Tilson suggesting buying pager operators.  The craziness!  I don’t think I understood until now why that was a great idea.  Cash generating businesses continue to generate that cash for a very long time after their technology is “obsolete”.  United Online still earns plenty of free cash from its dial-up unit even though dial-up is on the decline.  Seeing the writing on the wall years ago, United Online wisely invested that cash wisely in new businesses e.g. it spent only $56 million dollars in 2006 on Classmates.  An excellent purchase, it turns out.

-> Goose Chases or Innovation: We have unrealistic expectations of our leaders sometimes.  Most acknowledge that Brian L. Roberts of Comcast has done an excellent job, even if he hasn’t yet come up with the solution to the competition offered by the speed and mobility offered by mobile phone operators.  We remember the successes of innovation leaps of faith, not the 100 times as many failures.  Companies are often terrible at allocating capital and United Online has done pretty well balancing investment with restraint.

-> Mini-Conglomerate, Not Lack of Focus: United Online has but a fraction of the businesses that Interactive Corp, and United Online’s diversity has served it well where its flower business has gracefully replaced the declining revenue of its dial-up business.

-> Management Self Control and Competence, Not Management Limits: Given my deeper assessment of United Online, it simply doesn’t appear that the company has management constraints.

Game of Valuations

Market capitalizations, and purchase and sale prices have been sprinkled throughout to prepare us to play a game; “How Much is United Online Worth”. Now, before you answer, consider carefully, are we in another tech bubble? And how much would this affect the value of these companies? Once you have those answers, let’s ask, and answer, questions such as “Which is more right, United Online at $500 million or Facebook at $100 billion, 200 times larger?” Or if you please, “Which is more wrong?” Granted, Facebook is growing very rapidly, already booking over $2 BILLION worth of revenue, the primary source of which is advertising.  This is eight times United Online’s $250 million or so of revenue.

But wait, there’s more. We should gather a few more breadcrumbs.  LinkedIn just IPO’ed, for a market cap of $6 billion dollars. Its revenue last year, however, was approximately $240 million, around the same as for United Online. Twitter is estimated at a $5 billion valuation, with $50 million in revenue last year (2010), possibly $150 million in revenue this year (2011) and $250 million in revenue next year (2012).

United Online’s move to Memory Lane is a wise lateral move that is the foundation of a solid offering that complements the future build out of social media. If the markets are valuing Linked in at $6 billion and Facebook at $100 billion, then United Online should certainly be receiving more reflected glory than it currently is. Obviously traditional valuations based on revenue, earnings, cash flow and returns aren’t working purely fundamentally here. Perhaps a valuation based on active members?  If Facebook has 600 million active members and Classmates has 10 million, then with 1.67% members, might it have half the value per user as that of Facebook? This calculation would value United Online at $835 million or approximately $9.40 a share.

So, whether it is $8.50 as Barrons suggests, $9.40 or a simple double ($10.00), I urge you to (re)consider this company is a new light.

[1] Unless otherwise noted, market capitalizations from recent media coverage January through July 2011 and are for broad comparisons only.  In this market, daily valuations are a crap shoot.

[2]  While I felt the need to mention MyLife (the old Reunion.com), I had no idea what to say about it.  How to value this strange beast with its massive marketing spending including hundreds of TV spots?  According to Wikipedia, 90% of revenue from subscriptions – people really pay just as they do for Classmates. Does MyLife really offer unique content or a unique service?  It is supposed to have $60-80 million revenue this year, with perhaps 50 or 60 million members, although how many actives is an open question. How much of that revenue is eaten by television advertising? According to some sources, it claims to be adding social interaction tools to its site.

Parts I & II together, with occasional updates, edits and corrections is here.