MKTW - Unbelievable Business At An Unbelievable Price
Each Wednesday, we publish an idea about an interesting, under-the-radar stock that we think has long term potential and deserves a little attention. This week, we are looking at MKTW.
This may seem like a tangent, but stick with me here.
For those who aren't aware, Discordia Research LLC (which operates this account) is an options and investment research company. We publish research on low volatility, high yield options trades, and charge $129 per month. For well capitalized individuals and some smaller funds, it's a no brainer, as our price is, for clients, dwarfed by the premium they are able to bring in as a result of our research. As a business expense, we become indispensable in our client's investment process, and can build long term trust with those we serve.
Not only that, but our business model is highly attractive.
We have a small team that conducts research and analysis, and we are able to reach a huge audience with extremely low fixed costs and basically zero variable costs. Our total monthly infrastructure costs breakeven at *two* subscribers, and given that we haven't advertised yet, almost all of the revenue drops straight to our bottom line. Our LTV/CAC is infinity.
How is this relevant?
Recently, the biggest business in our space went public via reverse merger. The company is called "MarketWise", and is a huge publisher of financial media and newsletters. While they publish research that is, for the most part, more banal than ours - Recommendations like 'Buy Microsoft', etc - their economics are nothing to scoff at. The only reason we know & recognize the value in this business is because we have extremely similar, attractive metrics.
Recently, in his Greenhaven Road Capital Q2 letter, Scott Miller (an excellent investor who we align with on a lot of ideas), had the following to say about MKTW. We agree, and think this company could be a giant winner in the future with it's compounding potential.
This is an excerpt from the letter. Here's the full read: static.seekingalpha.com/uploads/sa_presentations/990/71990/original.pdf
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MarketWise’s 110% net revenue retention in 2020 would indicate that actual paying customers see value in their products. The actual paying subscribers subscribe to an average of four products, another indication that they see value. If subscribers were simply being tricked by advertising, would they not only keep a single subscription but also subscribe to three additional products? Would customers spend more in 2020 than in 2019? Customer retention is above 90%.
86% gross margins (this is better than most software companies).
Doubled Rule of 40 – software companies are considered healthy if they meet the Rule of 40 (growth rate + profit margin > 40%). MarketWise’s metric is currently > 80.
Capital light – a $50,000 investment 20 years ago was the only capital put into a business that will generate over 550M in revenue this year.
20 straight years of profitability.
Mid-20s historical revenue growth (accelerated recently) while remaining profitable.
LTV/CAC > 5 (customer lifetime values are more than 5X what they cost to acquire them), with breakeven point at 7-9 months and cash recovered in 3 months.
Quantitatively, the business is attractive: it is asset-light and cash flow generative with the ability to invest the cash at very high rates of return – a trifecta. Now, we are in a market where unicorns are priced like unicorns, and 30x revenue does not garner the guffaws that it used to. For MarketWise, we can actually look at cash flow. The company has guided to adjusted cash flow of 211M (I think the adjustments are reasonable) on an enterprise value of approximately 3B.
The stock trades for approximately 15X cash flow, a fair price for an attractive business. However, I believe that the true cash-generating power of the business is understated in the valuation above. Sales and marketing (acquiring new customers) is the largest expense, equaling 59% of revenue in 2020 (219M, 11M of which was stock-based compensation). There has been no updated guidance on this expense for 2021, but it is safe to say that sales and marketing will be materially higher as revenues are projected to grow from 364M to 561M and bookings from 548M to 751M.
The vast majority of the sales and marketing spend is really growth capex. I estimate that for 2021, the portion of sales and marketing that is growth capex will be in excess of 200M. If this capital were not spent on marketing, it would be taxed, so approximately 160M of extra cash that would be generated if they were not pursuing growth. Ultimately, steady state, MarketWise would generate in excess of 380M or a 12% free cash flow yield. If you look out a year or two, the numbers get even more compelling given the persistent high growth rates.
If MarketWise were a SaaS (software as a service) company, it would be valued on a multiple of sales. Given the high gross margins (86%), high growth rate (56% in last quarter), the attractive LTV/CAC, and profitability (will generate 200M+ this year), it would almost undoubtedly trade north of 15X forward sales. MKTW currently trades for less than 6X current year sales and just over four times forward revenues.
While I don’t expect Beacon Street/MarketWise to be valued like a software company, my point is that our entry valuation is not demanding, particularly if the growth is sustainable and the projections are reasonable. We should not have significant multiple compression and should have a chance to appreciate roughly in line with revenue/earnings growth, which is likely to be 25%+.
Are the projections for this year reasonable? The main revenue drivers for MarketWise are the number of subscribers and the revenue per subscriber. The company ended 2020 with 857K subscribers. During their analyst day this past April, they disclosed that 144K subscribers were added in the first quarter, so to meet their full-year guidance of 1.084M subscribers will require them to add just 83K subscribers for the remainder of the year. The subscriber number is important because it drives the revenue number, which was revised upwards in March to 561M for 2021.
When asked by an analyst if the guidance given in March was conservative, the CFO said that “March was another strong month for subscriber growth… So almost instantly our increased projection still looks pretty conservative relative to the – to our actual performance. You know, we did that (raised guidance) prior to us knowing what March numbers were. So the short answer is, it is conservative.”
While the 2021 numbers may be conservative, what does the future hold? With 20 straight years of profitability and revenue growth in 18 of the past 20 years, there is some historical precedent to suggest that the business will not fall apart. Historical growth rates were in the mid-20s and the growth over the next two years is projected at 41% per year. In the first quarter of 2021, revenue grew 56%. Are they just pulling demand forward and growth will collapse?
It is possible, as one-quarter of the Q1 revenue increase was driven by lifetime subscriptions, but lifetime subscriptions are not a new offering – they typically have small annual membership dues associated that are recognized over five years. The company has added employees and products, and, perhaps most importantly, they have significantly invested in their free-to-paid channel. As the CEO said,
"We’ve got a massive new distribution channel (free to paid) that we are only beginning to harvest. We have 10 million people in this community, and we should be able to convert a lot more than 200,000 of those a year to pay. Our early returns are 200,000 a year coming from that channel. So we’re kind of getting from the standpoint that we started to harvest these returns, it is a dramatically different company today than it was even 24 to 36 months ago."
Conversations with management provided more context on the growth of the free-to-paid channel. The company did not promote their free products historically due to the resulting delays in receiving cash/new paying subscribers. In 2018, they began to ramp up the efforts and grew the free product recipients from approximately 1M to 2.7M by year-end. Through testing and experimentation, they have found that focusing on converting free customers to paying customers can make economic sense for MarketWise, leading management to make a significant investment in growing this audience segment.
As indicated in the Q1 press release, “Our Free Subscriber pool is now responsible for roughly 40% of our new Paid Subscribers, so the continued momentum in this area is fueling additional future growth in Paid Subscribers.” As of the end of Q1, free product subscribers had grown to a total of 10.9M relationships, an asset that does not appear on the balance sheet but clearly has monetization potential and increases the likelihood that growth persists.
Will MarketWise continue to grow at such high rates? I don’t know, but it is clear they have invested in infrastructure, added new products that enable cross-selling, and have the capital and cash flow to make additional growth investments such that the possibility of future growth is not fanciful. I realize that this is a SPAC and that all projections are to be viewed with skepticism, but I don’t think we are paying for growth at a 12% normalized free cash flow yield, and I think, on a risk-adjusted basis, it is highly likely that we will see continued growth with no additional capital required.
This may seem like a tangent, but stick with me here.
For those who aren't aware, Discordia Research LLC (which operates this account) is an options and investment research company. We publish research on low volatility, high yield options trades, and charge $129 per month. For well capitalized individuals and some smaller funds, it's a no brainer, as our price is, for clients, dwarfed by the premium they are able to bring in as a result of our research. As a business expense, we become indispensable in our client's investment process, and can build long term trust with those we serve.
Not only that, but our business model is highly attractive.
We have a small team that conducts research and analysis, and we are able to reach a huge audience with extremely low fixed costs and basically zero variable costs. Our total monthly infrastructure costs breakeven at *two* subscribers, and given that we haven't advertised yet, almost all of the revenue drops straight to our bottom line. Our LTV/CAC is infinity.
How is this relevant?
Recently, the biggest business in our space went public via reverse merger. The company is called "MarketWise", and is a huge publisher of financial media and newsletters. While they publish research that is, for the most part, more banal than ours - Recommendations like 'Buy Microsoft', etc - their economics are nothing to scoff at. The only reason we know & recognize the value in this business is because we have extremely similar, attractive metrics.
Recently, in his Greenhaven Road Capital Q2 letter, Scott Miller (an excellent investor who we align with on a lot of ideas), had the following to say about MKTW. We agree, and think this company could be a giant winner in the future with it's compounding potential.
This is an excerpt from the letter. Here's the full read: static.seekingalpha.com/uploads/sa_presentations/990/71990/original.pdf
----------
MarketWise’s 110% net revenue retention in 2020 would indicate that actual paying customers see value in their products. The actual paying subscribers subscribe to an average of four products, another indication that they see value. If subscribers were simply being tricked by advertising, would they not only keep a single subscription but also subscribe to three additional products? Would customers spend more in 2020 than in 2019? Customer retention is above 90%.
86% gross margins (this is better than most software companies).
Doubled Rule of 40 – software companies are considered healthy if they meet the Rule of 40 (growth rate + profit margin > 40%). MarketWise’s metric is currently > 80.
Capital light – a $50,000 investment 20 years ago was the only capital put into a business that will generate over 550M in revenue this year.
20 straight years of profitability.
Mid-20s historical revenue growth (accelerated recently) while remaining profitable.
LTV/CAC > 5 (customer lifetime values are more than 5X what they cost to acquire them), with breakeven point at 7-9 months and cash recovered in 3 months.
Quantitatively, the business is attractive: it is asset-light and cash flow generative with the ability to invest the cash at very high rates of return – a trifecta. Now, we are in a market where unicorns are priced like unicorns, and 30x revenue does not garner the guffaws that it used to. For MarketWise, we can actually look at cash flow. The company has guided to adjusted cash flow of 211M (I think the adjustments are reasonable) on an enterprise value of approximately 3B.
The stock trades for approximately 15X cash flow, a fair price for an attractive business. However, I believe that the true cash-generating power of the business is understated in the valuation above. Sales and marketing (acquiring new customers) is the largest expense, equaling 59% of revenue in 2020 (219M, 11M of which was stock-based compensation). There has been no updated guidance on this expense for 2021, but it is safe to say that sales and marketing will be materially higher as revenues are projected to grow from 364M to 561M and bookings from 548M to 751M.
The vast majority of the sales and marketing spend is really growth capex. I estimate that for 2021, the portion of sales and marketing that is growth capex will be in excess of 200M. If this capital were not spent on marketing, it would be taxed, so approximately 160M of extra cash that would be generated if they were not pursuing growth. Ultimately, steady state, MarketWise would generate in excess of 380M or a 12% free cash flow yield. If you look out a year or two, the numbers get even more compelling given the persistent high growth rates.
If MarketWise were a SaaS (software as a service) company, it would be valued on a multiple of sales. Given the high gross margins (86%), high growth rate (56% in last quarter), the attractive LTV/CAC, and profitability (will generate 200M+ this year), it would almost undoubtedly trade north of 15X forward sales. MKTW currently trades for less than 6X current year sales and just over four times forward revenues.
While I don’t expect Beacon Street/MarketWise to be valued like a software company, my point is that our entry valuation is not demanding, particularly if the growth is sustainable and the projections are reasonable. We should not have significant multiple compression and should have a chance to appreciate roughly in line with revenue/earnings growth, which is likely to be 25%+.
Are the projections for this year reasonable? The main revenue drivers for MarketWise are the number of subscribers and the revenue per subscriber. The company ended 2020 with 857K subscribers. During their analyst day this past April, they disclosed that 144K subscribers were added in the first quarter, so to meet their full-year guidance of 1.084M subscribers will require them to add just 83K subscribers for the remainder of the year. The subscriber number is important because it drives the revenue number, which was revised upwards in March to 561M for 2021.
When asked by an analyst if the guidance given in March was conservative, the CFO said that “March was another strong month for subscriber growth… So almost instantly our increased projection still looks pretty conservative relative to the – to our actual performance. You know, we did that (raised guidance) prior to us knowing what March numbers were. So the short answer is, it is conservative.”
While the 2021 numbers may be conservative, what does the future hold? With 20 straight years of profitability and revenue growth in 18 of the past 20 years, there is some historical precedent to suggest that the business will not fall apart. Historical growth rates were in the mid-20s and the growth over the next two years is projected at 41% per year. In the first quarter of 2021, revenue grew 56%. Are they just pulling demand forward and growth will collapse?
It is possible, as one-quarter of the Q1 revenue increase was driven by lifetime subscriptions, but lifetime subscriptions are not a new offering – they typically have small annual membership dues associated that are recognized over five years. The company has added employees and products, and, perhaps most importantly, they have significantly invested in their free-to-paid channel. As the CEO said,
"We’ve got a massive new distribution channel (free to paid) that we are only beginning to harvest. We have 10 million people in this community, and we should be able to convert a lot more than 200,000 of those a year to pay. Our early returns are 200,000 a year coming from that channel. So we’re kind of getting from the standpoint that we started to harvest these returns, it is a dramatically different company today than it was even 24 to 36 months ago."
Conversations with management provided more context on the growth of the free-to-paid channel. The company did not promote their free products historically due to the resulting delays in receiving cash/new paying subscribers. In 2018, they began to ramp up the efforts and grew the free product recipients from approximately 1M to 2.7M by year-end. Through testing and experimentation, they have found that focusing on converting free customers to paying customers can make economic sense for MarketWise, leading management to make a significant investment in growing this audience segment.
As indicated in the Q1 press release, “Our Free Subscriber pool is now responsible for roughly 40% of our new Paid Subscribers, so the continued momentum in this area is fueling additional future growth in Paid Subscribers.” As of the end of Q1, free product subscribers had grown to a total of 10.9M relationships, an asset that does not appear on the balance sheet but clearly has monetization potential and increases the likelihood that growth persists.
Will MarketWise continue to grow at such high rates? I don’t know, but it is clear they have invested in infrastructure, added new products that enable cross-selling, and have the capital and cash flow to make additional growth investments such that the possibility of future growth is not fanciful. I realize that this is a SPAC and that all projections are to be viewed with skepticism, but I don’t think we are paying for growth at a 12% normalized free cash flow yield, and I think, on a risk-adjusted basis, it is highly likely that we will see continued growth with no additional capital required.
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