Description

We’re recommending shorting Angie’s List (“ANGI”) as we believe a major dislocation is taking place these days. At $11.46, ANGI is currently trading 35% above IAC’s proposed acquisition price of $8.5 per share. We think the recent run-up in the stock since the deal was announced was driven by: (i) deferred demand from investors looking to own a direct stake at HomeAdvisor, without the complexity of IAC’s holding structure and its ownership of other assets; (ii) low float of ANGI shares relative to the pro-forma market capitalization post-transaction; (iii) large short interest in legacy ANGI prior to deal announcement, and (iv) to a lesser extent - lack of understanding of the deal mechanism by some market participants.

Before we continue, we should note that we own IAC shares, so our trade here is somewhat hedged. We significantly decreased our IAC stake in recent weeks, but we still think the shares are undervalued, even after assuming ANGI shares will revert back to around or below the announced deal value, as we expect. We also think highly of IAC’s management, even if we are about to sound a bit critical on some issues.

We’re recommending the short position regardless of our position at IAC. However, if one views the situation differently than our perspective, then long IAC is probably a good way to play it. As of today, the fair value of IAC’s stake in publicly traded MTCH and ANGI plus its net cash is worth $118 per share, 16% higher than its closing price today. This valuation is before taking into account the rest of IAC’s assets - namely Vimeo, and the Applications & Publishing segments (it’s also admittedly before applying any discount for holding structure / SoTP valuation).

Background

On May 1st, after markets closed, IAC announced the acquisition of Angie’s list (“ANGI”) by its HomeAdvisor unit. The deal will take place by merging HomeAdvisor with ANGI’s publicly traded entity, basically reverse IPO’ing HomeAdvisor. ANGI shareholders will be able to choose between either one share of the merged unit - now called ANGI Homeservices Inc - or $8.5 in cash. The deal values ANGI at $510m but the cash part will be capped at $130m (IAC will be issued shares representing 87%-90% of the new entity, dependent on the eventual size of cash payment).

This looks like a smart move by IAC’s management as they were able to determine the pricing of their HomeAdvisor unit without going through a traditional IPO process. Their implied valuation for HomeAdvisor of $3.6b represents 42x the mid-point of HomeAdvisor adj. EBITDA guidance for 2017, or 21x 2018 expected EBITDA assuming operating leverage kicks in and EBITDA margins for the stand-alone business go up to 15% next year. In other words their valuation, even if not unusual in the current market, does not appear overly conservative.

In most cases, a similarly structured deal, where most of the value comes in the form of a recently illiquid/privately held stock, will trade below the announced deal price. Reason for this is pretty straight forward - the mechanism that determines the fair value of the currency used seems very subjective and most likely to be skewed upwards by the buyer - in that case IAC’s management. However this hasn’t happened in this case. IAC’s management was able to assign its dream valuation for HomeAdvisor shares at at least 2x what the market was ascribing it as reflected from IAC’s SoTP analysis, but investors saw IAC’s numbers and decided to raise.

On May 1st, only a few hours before the deal announcement, ANGI shares closed at $5.89, giving the company market capitalization of $354m. IAC’s valuation before the announcement was $6.6b, but only $1.9b once we back out its share in Match Group and its net cash position. Hence, the market was ascribing $1.9b for IAC’s four divisions excluding Match - HomeAdvisor, Video, Publishing and Applications, net of any discount for corporate expenses and holdings company structure. Diving into the valuation of each of the different assets isn’t within the scope of this writeup, but it’s obvious that HomeAdvisor was the leader within that group. So for the matter of this extremely cumbersome argument, let’s assume the entire $1.9b value was attributed to HomeAdvisor, while the rest of the assets simply mitigate the negatives of IAC’s holding structure and corporate expenses.

Cutting this long story short, the point is as follows - investors were giving HomeAdvisor a maximal value of $1.9b as of two weeks ago. IAC’s management (and so did we) thought HomeAdvisor deserves a higher valuation, and found a clever way to determine what this valuation is ($3.6b as a stand-alone and $4.1b for the merged entity). Investors then immediately changed their mind on HomeAdvisor and decided it was actually worth a lot more then what IAC’s management figured (pro-forma market cap is $5.6b as of today).

Trying to put a logical explanation to this situation, we see three possible explanations:

1. IAC’s management was being conservative in their own valuation and investors recognized that.

2. Investors understand the potential of the new ANGI Homeservices better than IAC’s management.

3. Synergies between the merged companies make this combined entity worth much more than it seems.

Now let’s tackle these different explanations.

IAC’s valuation of HomeAdvisor was conservative. We think this is unlikely as IAC had every possible reason to price HomeAdvisor as high as possible since it’s basically paying for 75%-100% of the deal in HomeAdvisor shares. Moreover, the low cap for the cash portion (at ~25% of deal value) clearly demonstrates that IAC’s management prefer paying with shares rather than cash, although IAC has a large net cash position and CEO Levin even somewhat complained in his last quarterly letter about lack of opportunities to put this cash to work.

IAC’s management is missing something. This is also very unlikely given how little information on HomeAdvisor’s operations and financials were disclosed to date. The information gap in this case is much larger than in any other public company. HomeAdvisor is operating as a reporting segment within IAC, but the information that is publicly disclosed has been very limited and basically include only (i) revenues; (ii) EBITDA (iii) Number of service requests, and (iv) Number of domestic paying service providers.

The combined entity is worth much more than reflected in the pricing of the deal. This may have been a (partially) valid argument if IAC was actually buying a decent performing business. Lasrikas wrote up ANGI as a short in 2013, laying the case of how flawed its business model and value proposition really is. Angie’s membership revenues are now down 6 quarters in a row and probably going to be completely eliminated in the next few months as the company recently introduced a free membership model and HomeAdvisor doesn’t charge for membership either. Revenue from service providers is also drifting downwards since mid-2015, and it’s very likely that there’s a significant overlap between HomeAdvisor and ANGI’s service providers so they won’t be able to charge listing fees from both - leading to some negative revenue synergies.

So what was it exactly that IAC actually acquired here? This is what IAC’s CEO Joey Levin had to say in his quarterly letter to IAC’s shareholders:

“To give you a sense of the impending ANGI Homeservices, on a pro forma basis the entity generated an estimated $17 billion worth of home improvement jobs over the last 12 months for more than 190,000 different U.S.-based paying service professionals (SP’s). We served over 15 million consumers in the US, facilitating home improvement jobs in over 700 different categories. Combined revenue would have exceeded $850 million in the last twelve months, driven by growth in HomeAdvisor’s domestic business, which just clocked its 8th straight quarter of growth in excess of 35% year-over-year, all while improving margins. And Angie’s List has done a wonderful job building a brand, with 46% unaided brand awareness – a rare achievement for any brand in any category. They’ve done so well that the most frequent response I get at cocktail parties when explaining the HomeAdvisor business is, “Oh, you mean like Angie’s List!

The strategic rationale for the transaction is simple: combine Angie’s brand-conscious and qualified traffic with the largest paying SP network and most advanced product from HomeAdvisor. Adding Angie’s traffic, brand, and SP network quickly catapults HomeAdvisor several years into the future. The increased liquidity in the marketplace enables new product innovation, increased customer satisfaction, faster category penetration and accelerated expansion.“

Levin’s letter as well as the merger presentation highlight ANGI’s brand and traffic monetization.

What this brand is worth exactly is hard to say, but we believe IAC’s assumptions regarding monetization of ANGI’s qualified traffic are aggressive. Specifically, we think that the synergies slide from the merger presentation is very misleading. The bottom line says $100m-$250m of potential synergies, but only $50m-$75m are actual cost synergies while the rest of the “upside” is from using the combined network for driving more revenues. Putting aside the question on whether these numbers are achievable, these are definitely not “net” synergies as there are costs associated with these revenues. Even when taking IAC’s announced long-term adjusted EBITDA margin of 35% - the actual range is $67.5m-$136.25m.

The merger presentation also guides for Adjusted EBITDA of $270m in 2018, excluding up to $100m of one-time acquisition related cost. This number may be achievable but looks very aggressive for us, especially given Angi’s current revenue trends. Even if achieved, this puts current pro-forma valuation at 21x 2018 EBITDA and excludes stock-based compensation that tend to be a material number in all of IAC’s businesses.

To conclude, we’re not the biggest advocates of efficient markets, but in some cases too much of inefficiency is worth digging in. We’re aware that this thesis lacks a proper near-term catalyst (other than maybe deal closing), which is often a problem with short positions. However, we think it’s likely that common sense will prevail as we get closer to closing, and that the current situation is attractive in terms of risk/reward.

Additionally, if we’re wrong and the price stays where it is or goes higher in the next few months, we think it’s likely IAC will take advantage of this situation and either pull a full spin-off or sell at least part of their 90% stake. After all they’ve proved to be astute capital allocators and it seems like the market is valuing their asset at least 35% higher than they do.

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Catalyst

• Getting closer to closing
• Common sense prevails 
• Full spin-off