A Chink in Ancestry.com's Armor

By Tom Gibbs - February 17, 2012 | Tickers: ACOM, CMCSA, GOOG, NFLX | 0 Comments

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Ancestry.com (NASDAQ: ACOM) is the world’s largest online family history resource, with nearly 1.7 million paying subscribers reported at the date of its most recent filing.  A project nearly 30 years in the making, Ancestry.com has compiled nearly six billion historical records that have been digitized, indexed, and put online for subscriber review and study.  Using the website’s proprietary platform and extensive historical record collection, users can subscribe for monthly or yearly access periods to research family histories, build family trees, upload their own records, and communicate with family members. 

The website actually provides a very unique service, and has become increasingly popular with the general public by compiling all of the necessary research into one space.  This has revolutionized the ease of the traditionally tedious genealogy process, even more so than the deep Google (NASDAQ: GOOG) based search. 

As one would expect, there exist huge barriers to entry in the way of the countless man hours that are put into the research, collection, digitization, and presentation of the billions of genealogical records the website provides.  Ancestry.com is by far the most recognized brand name in the space, and has enjoyed swift growth from its first mover advantage after essentially investing the service. 

As a result of the popularity, sales have been increasing at an increasing rate since the corporation’s 2009 filing – 13.8% between 2008 and 2009, 33.8% between 2009 and 2010, and 35.9% between four quarters ending September 2010 and the four quarters ending September 2011.  Likewise, 22.4% operating margins (ttm average) have led to very impressive returns on invested capital, which totaled 20.3% over the past twelve months. 

However, despite all of the positives associated with the company’s performance thus far, there appear to be several potentially hazardous chinks in Ancestry.com’s armor. 

In reading the Risk Factors discussion in the firm’s most recent annual filing, two key vulnerabilities stand out:

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1. “As we implement new marketing and advertising strategies, we have expanded into television advertising, which may have significantly higher costs than other channels and which could adversely affect our profitability.  Further, we have over time become disproportionately reliant on one channel or partner, such as NBC in future seasons of 'Who Do You Think You Are?' which could increase our operating expenses."

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Aired on Comcast’s (NASDAQ: CMCSA) NBC, “Who Do You Think You Are?” is a remake of a popular British television program of the same name.  The show is produced as a partnership between NBC and Ancestry.com, and each episode follows a celebrity as they go on a journey to trace his or her family tree. 

The corporation mentions the show’s title no less than fifteen times in its filing, yet barely touches on the other forms of advertising in which it engages – basic online mediums such as paid search, SEO, and display advertising.  This definitely raises the question of how reliant the corporation is on the television show’s success, and how much the show’s viewership has contributed to Ancestry.com’s rapid growth in sales over the past several years.

“Who Do You Think You Are?” premiered in March 2010 and the second season debuted the following February, which corresponds nicely with the large jumps in subscriber counts and revenues the corporation generated in these respective quarters.  (Revenues tend to lag subscription gains by a quarter, on average). 

Having such a strong correlation with the show’s success is a worrisome fact.  For the major networks, only one show out of every three new series end up seeing a second season, and even fewer last beyond the sophomore slump to a season three (Channel Guide Magazine).  Shows end up losing the punch they present on their debut, new shows come along to capture viewer attention, and viewers’ tastes simply change.  Ancestry.com CEO Tim Sullivan recently announced that the first two episodes of the third season drew around 17% fewer viewers than the program did last year. 

If the show fails, what are the chances that another producer will pick up the rights to the Ancestry.com brand name for a second try?  If a second series is even run, what are the chances that it will be successful?  If the show does not succeed, and no other producer picks up the rights for a new series, will the corporation rely on generic 30 second TV ad spots to supplement its basic Internet-based ad campaign?  Will this type of advertising be as effective and engaging to the consumer as a full 60 minute show highlighting the brand? 

Of course there are other routes to advertising the product, but with the heavy reliance on the show’s broad consumer reach, all of these questions are serious topics to consider.  A simple increase in revenues over a two year period, after all, hardly proves the solidification as an entity with long term viability and consistent profitability.   

Likewise, the advertising on this type of show raises a question as to what type of consumer the corporation is attempting to target.  A large majority of the viewers are likely of the “star-struck” type – the same viewers of shows like “Celebrity Apprentice,” “Dancing With the Stars,” “Celebrity Wife Swap,” etc.).  This does not go to say that these are unsophisticated people who have no interest in genealogy, but it is not a focused type of advertising that is going to attract the high-willingness-to-pay subscriber who is intensely interested in the subject and is willing to subscribe with the most expensive access package.

Instead, this shotgun approach to new subscriber targeting is likely to reach a large group of people who are willing to pay for base-level subscription packages, if any package at all.  There is no incentive for signing up for a full year of service when less costly (and therefore, less risky) pricing options are offered. 

This brings us to the next point. 

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2. “A majority of our subscribers has annual descriptions.  At any point in time, however, the majority of new subscribers generally signs up for monthly subscriptions and may not choose to renew.  We generally experience higher rates of churn for monthly subscribers than for annual subscribers.  We continually evaluate the types of subscriptions that are most appropriate for us and our subscribers.  As we make these evaluations, we may more aggressively market subscriptions that are shorter than our annual subscriptions.”

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The heavy focus (both in business practice and in discussion in its annual reports) on the “Who Do You Think You Are?” television show raises further questions about this particular risk factor.  As previously mentioned, the corporation does appear to be actively seeking a wider consumer base, which is a natural business decision – what company isn’t in business to increase revenues and expand operations?  However, there are several warning signs that this tactic may prevent future growth from having the same level of profitability as it has over the past several years. 

Acquisition cost rates decreased for the two periods during which the television show was aired (March 2010 and March 2011 quarters) – in essence, the disproportionate amount of new subscribers drove down the per subscriber costs to run the business.  Despite these two occurrences, which are solely based on the effectiveness of the television show advertising strategy, overall subscriber costs have been increasing. 

Even with factoring in the favorable decrease the corporation enjoyed due to higher subscription rates in March 2011, for example, average subscriber acquisition costs were 18% higher when comparing the first four and last four quarter periods presented (i.e. March 2008 – December 2008 vs. December 2008 vs. September 2011).  Likewise, churn rates, when comparing the same two time periods, are 12.5 basis points higher.  This may not be much, but churn rates are definitely not decreasing.  Managing churn rates has been very difficult for many newly introduced niche-focused Internet service providers.  It would not be very surprising if Ancestry.com soon followed the Netflix (NASDAQ: NFLX) route and refrained from reporting churn rates in its public filings.

This may imply that the highly demanded customer – the one who has a passion for genealogy and who will use and pay for additional services – is not very prevalent.  If this is the case, then investors can project with some certainty that revenue growth will slow, and the cost of attracting new customers will increase.  It costs Ancestry.com much more to advertise to the mass consumer base to pick up additional monthly subscriptions than it does to capture (one time) and retain (or a year, two years, etc.) one high-willingness-to-pay customer.

What does Ancestry.com’s consumer profile look like, and how has it been changing?  The corporation’s quarterly filings show that new subscriptions are more heavily favoring lower priced, shorter-term alternatives. 

Percentage of subscribers that are on monthly packages

• September 2011: 32%
• June 2011: 33%
• March 2011: 33%
• December 2010: 29%
• September 2010: 30%
• June 2010: 30%
• March 2010: 29$
• December 2009: 25%
• September 2009: Less than September 2010*
• June 2009: Less than June 2010*
• March 2009: Less than March 2010*

*The company does not release actual data for these quarters, but it does report that these quarters have a higher proportion of yearly subscribers than their corresponding quarters in 2010.

These customers are not only less loyal than the core consumers the corporation should (and would like to) attract, so they naturally come with higher average churn rates and are less likely to spend a significant amount of time/money on the site.  Likewise, as mentioned, they are more expensive to target, which is illustrated in the relationship between rising monthly subscribers and rising average subscriber acquisition cost.

Ancestry.com still provides a very unique service and has a large following, but investors should consider whether or not the stock is a bargain at current valuations.  If anything, 20x last year’s earnings and 10x enterprise value is close to fair value, and buying assets at fair value will not, on average and over the long run, generate disproportionately large returns. 

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