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Friday, May 8, 2009

People Are Still Getting Married

Two wedding related companies reported results yesterday: Blue Nile (NILE, $44.58) and The Knot (KNOT, $8.91). Both companies are what we call niche franchise Internet companies and, in our view, have strong competitive positions with asset light business models (that is, they typically require limited capital expenditures to maintain/grow the business). Considering the economic environment, March quarter results weren't bad:
  • Blue Nile reported revenue of $62.4 million, a Y/Y decline of only 11%, while operating income totaled $2.9 million compared to $3.0 million in the prior year quarter.
  • Management signaled that sales trends are improving: “Consistent with last quarter, we are not providing specific financial guidance due to the continued uncertainty surrounding the economic environment and consumer spending. However, on a directional basis, we want to provide some context for our view on the full year. Sales trends improved in the first quarter compared to the fourth quarter of 2008, and we anticipate further improvement as we progress through 2009 with an expectation that the fourth quarter will post a year-over-year sales increase."
  • Results for Blue Nile can be found here.
  • The Knot reported revenues of $23.7 million, only slightly lower than $23.8 million in the prior year period. The sales mix was as follows: "Revenue from online advertising was flat to the prior year’s first quarter as a 4% increase in local online advertising offset a 9% decline in national online advertising revenue. Merchandise revenue from the sale of wedding supplies grew 12%, while registry services revenue declined 3%. Publishing and other revenue declined 11% compared to the first quarter of 2008."
  • Reported operating loss was $2.3 million compared to nearly break-even in the prior year period. Operating expenses were higher Y/Y for a number of reasons. We note that realizing operating leverage is sometimes a challenge for online media companies even in normal economic times.
  • The company is cash rich with cash/investments representing approximately 40% of the company's market capitalization.
  • Results for The Knot can be found here.
So, revenue was down only 11% Y/Y for the leading online diamond retailer (perhaps benefiting from value shoppers) and flat Y/Y for the leading wedding Web portal. These results strike us as fairly good and we highlight as a sign that the sky is not entirely falling.

We don't own shares of either company and, while we see sustainable competitive advantages, valuation is not compelling at first blush: NILE trades at nearly 60 times 2008 earnings while The Knot trades at nearly 70 times 2008 earnings. Even looking at perhaps more normalized earnings from 2007 (when times were good), the companies trade at 43 times and 25 times, respectively. However, if we conclude with confidence that both companies will be (1) around in five years and (2) generating higher revenue, earnings, and excess cash flow because of durable advantages, then we can assign a required rate of return of 10% (discount rate) with perpetual cash flow growth of 3% (inflation, which will arrive at some point).

In this case, valuations are not as egregious: we arrive at a mid- to high $30s valuation for NILE (below current levels) and mid teens for KNOT (above current levels) using 2007 free cash flow figures (assuming the more generous FCF definition of cash flow from operations less capital expenditures as opposed to owner cash flow). However, this assessment can swing widely depending upon assumed cash flow and discount/perpetual growth rates. We plan to keep an eye on The Knot , but prefer to focus on companies trading at a low multiple of current free cash flow such as Youbet.com (UBET, $2.53).

Jeffrey Walkenhorst

Disclosure: long UBET.

© 2009 Jeffrey Walkenhorst
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