Hidden Gems Recommendation: Loopnet (LOOP)
Company Type: Fast Grower
August 23, 2007 Recent Price: $20.28
By Chandler Lutz
The Short Story:
LoopNet is an online marketplace for commercial real estate engines that is priced high compared to earnings but supports strong growth rates and a clean balance sheet. Even though LoopNet is a great business, at current valuations it does not make for a great investment.
In Depth Analysis:
The Business:
LoopNet provides a subscription service and serves as an online marketplace for commercial real estate market. Most of LoopNet’s subscribers are commercial real estate agents. Also, LoopNet runs another site called BizBuySell that serves as an online marketplace for operating businesses are for sale. The third part of the business is their Looplink database that allows the commercial real estate firms to display their properties on both their own website as well on LoopNet. Loopnet has an advantage over traditional real estate outlets since it allows (paid) subscribers to search and list properties and gain exposure to more potential buyers and sellers than other advertising means. Many people in the real estate market find this service very helpful, but others find the service expensive and not helpful. You can check out some product details and a few user reviews from Amazon here.
The Fundamentals:
LoopNet’s balance sheet is clean with absolutely zero debt. Also, the level of cash and equivalents has increased from 18.8 million in 2005 to over 72 million in Q2 2007. The only blemish on LoopNet’s balance sheet deals with the number of shares outstanding. In 2004 there were 34.752 million shares outstanding and this level has risen to 38.787 million shares in Q2 2007. The increase in the number of shares outstanding is mostly due employees and executives exercising their stock options. If LoopNet continues to grow and increase in value, employee stock options will further add to the total number of shares and adversely affect shareholder value. In the last year, there have been no insider buying and a significant amount of insider selling.
The income statement is a real star in LoopNet’s fundamentals. Revenue has increased 66 percent a year between 2003 and 2006 while profits have increased a staggering 256 percent a year over the same period from 1.6 million dollars in 2003 to 24 million. G&A expenses have been increasing substantially at LoopNet, but these increases are in line with top-line growth.
Turning to the cash flow statement I notice that owner’s earnings/structural free cash flow increased from 4.27 million in Q1 2007 to 4.79 million in Q2 2007; a 12 percent increase. The only downside of LoopNet from the cash flow statement’s prospective is the decrease in Structural Free Cash Flow from 2005 to 2006. In 2005 Structural Free Cash Flow was 18.722 million compared to 15.444 million in 2006. The culprit of this decrease was a drop in net income between 2005 and 2006. However, I do not think this drop is something investors need to worry about due to LoopNet’s prospects going forward.
LoopNet margins are all quite impressive and besting the industry averages. In order for LoopNet to keep these high margins it will have to fend off competitors and maintain its moat. (see industry analysis and Competition for more on this point)
Analysts:
There are currently seven analysts covering LoopNet. Four analysts with buy or strong buy recommendations and three with hold recommendations. Analysts are also expecting earnings growth to be 30% a year for the next five years
Valuation:
Sporting a p/e ratio north of 40 and an expected growth rate of 30 percent a year, LoopNet seems expensive compared to growth with a PEG of 1.4. Also, LoopNet’s price to sales is 13.31 which is twice that of the industry average.
Industry Analysis and Competition:
The industry is very competive as LoopNet competes against traditional real estate brokerage outlets and its main rival Costar Group (CSGP). Also, there is no telling when another major player will enter this field such as Ebay (eyeing LoopNet’s high margins). LoopNet’s moat is derived from the fact that many real estate agents use LoopNet’s service. This fact may drive away smaller competitors but may attract larger competitors that already have brand name recognition. Another thing to consider is the status of the credit markets. If the illiquidity of the credit markets extends to commercial real estate, LoopNets business may decrease sharply as their will be fewer buyers looking purchase real estate. Just recently, LoopNet announced the acquisition of their second largest competitor, CityFeet.com (a private, profitable stand alone company). This acquisition will solidify LoopNet’s position as a market leader.
Buying Point:
Right now I don’t see LoopNet at an attractive buying point. With much of the expected growth priced into the stock (in the form of high earnings multiples), LoopNet share price will not increase as substantially as earnings (assuming that earnings grow as predicted). The best time to buy will when bad news comes out of the industry or from the company in an event such as an earnings miss. Once this happens, and the stock drop to more reasonable levels, LoopNet may be a quality investment.
Conclusion:
LoopNet is a great company with great potential, but in order to become a quality investment, there needs to be a reduction in the share so that investors can reap the rewards of LoopNet’s high growth potential.
Chandler Lutz does not own shares in LoopNet or any other company mentioned