This Stock Is on SALE Following its IPO

Brian is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.

It is often difficult to evaluate a company following its IPO. Share price volatility and hype bombard investors, while financial data and a detailed look into the company can be much more difficult to find. To get a better picture of whether a recently-public company is a buy or not, it is important to understand as much as you can about the company and the risks and opportunities that will drive the share price into the future.  With this context in mind, here is a look into RetailMeNot (NASDAQ: SALE), a company that has been public for less than two weeks.

Understanding the business

RetailMeNot has a very simple business model: the company operates the largest digital coupon marketplace, including the largest coupon website in the United States (www.retailmenot.com) and United Kingdom (www.vouchercodes.co.uk). The win-win of attracting 450 million visits to its websites during 2012 from consumers looking for savings and 60,000 retailers (10,000 paid retailers) looking for any opportunity to attract customers is a simple, yet powerful business model. Connections between consumers and businesses through RetailMeNot were responsible for 2% of the total e-commerce sales in the United States from Thanksgiving to Cyber Monday last year.

RetailMeNot's management team has an array of relevant experience and is led by CEO Cotter Cunningham. Cunningham worked for seven years as an executive at Bankrate, a personal finance website that connects a different set of consumers and businesses through a similar win-win model as RetailMeNot.

Understanding the growth thesis

Since entering the digital coupon market in 2009, RetailMeNot has grown at a staggering rate. On the top-line, RetailMeNot has enjoyed a compound annual growth rate (CAGR) of 193%. Thanks to the simplicity of its digital business, the company's net income grew by an even more impressive CAGR of 233%. This impressive growth has been the result of a ramp up in organic operations as well as a number of acquisitions.

Going forward, future growth is expected as a result of further improvements in the company's existing websites thanks to the network effect that comes from increasing consumer brand recognition and use leading to more retail partners, which then further increases consumer traffic. In addition to this virtuous circle, there is significant opportunity to continue to grow through acquisition domestically given that there are a tremendous number of smaller coupon sites out there. Approximately 80% of RetailMeNot's revenue comes from the United States, so there is significant opportunity to expand internationally as well.

Understanding the risks

The key to RetailMeNot's success is its ability to raise awareness of its web properties such that it is the first place consumers think to visit prior to making an online purchase. Achieving a scale that allows for this type of success is the only way to combat the thousands of competing coupon and cash back websites that are out there. Said differently, RetailMeNot's moat will be completely reliant on the ability to have the most appealing and recognizable portal for consumers looking to save money. Failure to achieve this will give competitors the opportunity to take market share and very quickly erode the value of RetailMeNot's competitive advantage.

Another key risk is the company's strategy for pursuing acquisitions going forward. To date, the company's acquisitions appear to make a lot of sense in terms of price, synergies, and reinforcing the company's existing strategic objectives. Overpaying or making acquisitions of failing web properties will quickly defeat the growth opportunity that comes from further consolidation of the digital coupon and cash back market.

Understanding the valuation

Unlike many high-growth companies, RetailMeNot has been solidly profitable for years. In fact, a number of traditional valuation metrics make RetailMeNot appear reasonably priced compared to other companies as noted below:

 SALEYELPAWAYOPENZ
CAPS rating (out of five stars) 3 stars 1 star 2 stars 1 star  2 stars 
Share price $27.58 $42.10 $31.72 $65.54 $74.61

Market capitalization (in billions)

$1.2 $2.7 $2.7  $1.5  $2.6 
           
TTM revenue (in millions) $156 $156  $310 $168  $133 
TTM price to sales ratio 9.6 17.1 9.1 8.7  19.9 
           
TTM net income (in millions) $27 N/A  $20 $26  $1 
TTM price to earnings ratio 51.1 N/A  132.2  58.5  138.2 
           
TTM free cash flow yield 3.0% N/A  1.7% 2.6%  0.6% 
Debt to equity ratio 0.1 0.0  0.0  0.0  0.0 
           
Source: Motley Fool CAPS - 7/28/13          

 
As noted in the chart below, each of the four companies used above for comparison purposes has outperformed the S&P 500 over the past year.

While operating a wide range of businesses, each of these companies operates a consumer-facing website that attracts consumer traffic thanks to a unique value proposition. Yelp (NYSE: YELP) operates a website with over 20 million reviews for everything from restaurants to doctors; the company has managed to capture a significant amount of web traffic despite competition from much larger companies, such as Google. This David versus Goliath battle is quite interesting given Google's inherent advantage of being able to control the order of search results on its dominant search engine. While popular with consumers, Yelp hasn't quite translated millions of visits into dollars of income thus far. In contrast, RetailMeNot has been solidly profitable and already occupies the "top dog" designation as the largest competitor in the digital coupon realm.

HomeAway (NASDAQ: AWAY) has successfully consolidated much of the for-rent-by-owner market, and appears to continue to seek international consolidation with moves like its recent acquisition of a majority stake in travelmob. While this track record of acquisitions is similar to what we have seen (and expect to see) from RetailMeNot, there is a key underlying risk to HomeAway's business that is not present in RetailMeNot: reliance on paid subscriptions by property owners. RetailMeNot's revenue is largely generated through pay-for-performance arrangements, making it less likely that retail partners would walk away from the company.

Similarly, Open Table (NASDAQ: OPEN) relies on restaurants' willingness to continue to pay the company for access to its platform and in-restaurant technology. While most restaurants continue the relationship once it is forged, there are some that question whether incremental traffic is generated or whether the restaurant is simply paying Open Table to seat diners that it would have seated through phone reservations or walk-ins. In many cities, Open Table hasn't quite reached the ubiquity that is required to form a wide moat and protect its popularity from competition. Yelp's recent acquisition of SeatMe is an example of just how vulnerable this position may be.

In a slightly different business model, Zillow (NASDAQ: Z) has created a new and user-friendly way for people to find homes for sale (or rent). The ongoing recovery in housing, the rapid shift to mobile computing, and unique features like its trademarked Zestimate have continued to drive traffic to Zillow's website and corresponding share price gains. Zillow's success in changing the way people look at real estate is quite parallel to RetailMeNot's re-invention of the way people seek to save money via coupons.

While all of these companies have performed well recently, RetailMeNot is trading at the lowest P/E ratio and free cash flow yield of the group. 

So is RetailMeNot a buy?

Shares of RetailMeNot may not be for everyone. Many investors have trouble getting comfortable with the valuation metrics of companies like those referenced in the table above. However, for those investors that believe in the growth potential of Internet companies like Yelp and Zillow should find RetailMeNot to be an interesting addition to a basket of Internet stocks. The potential for continued growth from geographic expansion, consolidation of a fragmented industry, investments in mobile, and continued increases in brand awareness thanks to recent marketing campaigns, is as solid for RetailMeNot as it is for any of the companies listed above. 

While there is always volatility following an IPO, RetailMeNot's business plan and track record of impressive results makes it worthy of consideration.  

The retail space is in the midst of the biggest paradigm shift since mail order took off at the turn of last century. Only those most forward-looking and capable companies will survive, and they'll handsomely reward those investors who understand the landscape. You can read about the 3 Companies Ready to Rule Retail in The Motley Fool's special report. Uncovering these top picks is free today; just click here to read more.


Brian Shaw owns shares of Google. The Motley Fool recommends Google, HomeAway, OpenTable, and Zillow. The Motley Fool owns shares of Google, HomeAway, and Zillow. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy. Is this post wrong? Click here. Think you can do better? Join us and write your own!

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