A Look Into The Quinstreet IPO Filing

As most followers of performance marketing space know, one of, if not the largest, pure plays, certainly within the online lead generation segment, filed to go public last month. It is a company that has for many years had its eyes on a public offering, and their determination to do so reminds me of Advertising.com, who in 2000 probably felt close to an exit of their own before the market correction. Both showed the difference between a company aiming for an exit and one whose only chance for success was through an exit. Both companies persevered, stayed focused on growing a profitable business, knowing it might be years before the payoff. For Adverising.com, that payoff took place shortly after filing their S-1. For Quinstreet, referenced above, we will see whether they get snapped up or go public. Regardless, the S-1 presents followers of the online customer acquisition space a rare glimpse into a company who has to date ranked among the most tight lipped. Despite their reticent nature, theirs is a fascinating story, one that could fill an entire book let alone a handful of posts.

Having smart friends with greater patience and ability to interpret the S-1 than I, below consists of a collection of their thoughts along with some of my thoughts on the business - its successes, opportunities, and challenges going forward.

In General

There are very few public comparables to Quinstreet, so I would say that many who aren't normally fans of the company are in some ways rooting for them. A successful exit would pave the way for others of near size or great growth stories. I'm relatively optimistic, as theirs is a digestible story. And, perhaps in an ode to differentiate themselves from Valueclick (VCLK), Quinstreet refers to themselves as a leader in "vertical media and marketing online." You will find "lead generation" on the homepage but not as a descriptor of the company itself. I have mixed feelings about this, but from a positioning standpoint I understand.

By The Numbers

Quinstreet notes having 477 Employees at the time of filing.

152 Product/Engineers
62 in Sales
52 in G&A and
211 in Ops
They have raised a significant amount of venture capital; they own ~40% pre-IPO

For their fiscal year ending June 30, 2009, Quinstreet put up revenues of $260 million, and for the three months ending September 30, 2009, they have shown growth of 23.4% compared with the same three months last year - $78.6mm vs. $63.7mm. EBITDA is also strong, $56.9mm for the year ending June 30, 2009. Revenue comes from three verticals, Education, Financial Services, and Other (presumably encompassing home services, B2B, and elder care.)

Education is Quinstreet's largest contributor to revenue representing 58.1% of revenue FYE June 30, 2009. In a sign of solid diversification, this percentage is down significantly from two years ago, when education represented almost 80% of their revenue. And, while Education has seen mid-single digit growth year over year, they start with a large base. Customer concentration catches most people's eye when looking through the S-1 and as summarized below. Their largest client, DeVry University, who FYE June 30, 2009 was 19% of their revenue, is one with whom they have an almost agency of record relationship. It is a relationship similar to that between Apollo Group's University of Phoenix and Advertising.com from 2004 - 2006. The DeVry relationship is being handed over to an ad agency, so it will decrease in terms of its contribution.

The Top 20 clients made up 68% of revenue for this same period. It's higher than many, but declining as they aggressively diversify. Their clients, too, are relatively stable, and in my opinion there is some elasticity. If they lost a top client, they could compensate with others.

Phil Fresen, a partner of Garros Group, shared with me the following spreadsheet that I used for the information above; it is presented here:

Quinstreet Revenue Analysis

Organic Growth vs. Acquisition Growth

In addition to client concentration, the topic raised by everyone with whom I've spoken involves Quinstreet's organic growth compared to their growth due to acquisitions. And acquisitive, hardly begins to describe Quinstreet. As mentioned in the S-1, Quinstreet says, "“Our growth over the past several years is in significant part due to the large number of acquisitions we have completed. Since the beginning of fiscal year 2007, we have completed over 100 acquisitions of third-party website publishing businesses and other businesses that are complementary to our own for an aggregate purchase price of approximately $189.5 million." An investment banker I know chimes, "In my experience, they have been financially disciplined around price, structure and terms." But even he was surprised by the aggregate purchase price.

The acquisitions are predominantly, smaller ones, at least in quantity - a large number of six and seven figure transactions with several, rarely publicized eight figure ones. The larger ones all focus on diversification and establishing a foot hold in those markets. They then roll-up smaller properties to increase the number of leads generated by properties they own and operate. Large and notable acquisitions include (in no particular order):

SureHits - Insurance lead generation, counts under Financial Services
Reliable Remodeler - Home services lead generation, e.g., kitchens, baths, etc.
Internet.com - The most recent purchase, presumably to beef up their B2B traffic
ElderCareLink - Senior care, a starter before getting into senior housing
VendorSeek.com - Their initial foray into B2B
WorldWideLearn - One of the oldest acquisitions I can recall, cementing their SEO foothold

Of the above, SureHits ($27.5 million in cash and $18.0 million in potential earn-out payments), a primarily auto insurance marketplace where clients pay on clicks not leads, has been an absolutely winner for Quinstreet. Here is what they say in the S-1, "Financial services net revenue increased from $15.2 million in the three months ended September 30, 2008 to $31.0 million in the corresponding 2009 period, an increase of $15.8 million, or 104%. The increase in financial services revenue was driven primarily by lead and click volume increases at relatively steady prices." Much like Google whose AdWords became AdSense, Quinstreet, post acquisition has scaled distribution of Sure Hits pay per click ads.

Another friends comments, "How much is Surehits? In fiscal 2007 (pre-SureHits), financial was 7% of 167m, or 12m. Surehits came on about ½ through fiscal 2008. So that’s about 100m in incremental revenue (annualized). I think between mortgage and debt they are probably doing about 10m annualized. They are probably doing some straight insurance lead gen. Hard to say how much. Doubtful it’s more than 20m. So that leads me to think SureHits is in the 70-80m annualized rev range."

As Phil Fresen says, "I’m certain that the question of acquisition vs organic growth will be a threshold issue to investors and come out in the roadshow. There will be a nuanced answer to the organic growth because they will want to get credit (as they should) for the post-acquisition 'synergies.' I would expect that they will give examples of large and small success stories. I would also expect that they will build an acquisition growth story around the ample opportunity to continue to pick up subscale web properties and convert them into high quality lead flow for major companies."

The bearish version on the organic growth vs. acquisition can be summarized with, "The one thing they don’t tell you is how much growth is from acquisition. I think the answer is 'all.' This is a company without organic growth. And ALL of their partner-driven business is vulnerable (they give low payouts and lock up them up, meaning they run when they get a chance). On the other hand, their CEO was a former nuclear sub commander and Bill Bradley is on the board."

Bottom line: The company is well diversified in its traffic and verticals. Some weaknesses exist to grow education through internal media buying versus buying smaller sites with traffic.

Additional Thoughts

I'd thought I'd share a collection of feedback from others after they read the S-1. Comments include:

Gross margins are 30% and Operating margins are 15% - NOTE: these numbers are depressed since there is rather significant (6-8%) of D&A in these numbers
It's a roll-up play now
They note SEASONALITY in their business (not substantial but not neglible)... essentially 4Q is weak and 1Q is strong(er)
They have CONTINUED to see solid revenue growth in their EDU lead business (6-10%) due to volume increases and recently, PRICE INCREASES!
Page 59 reports on some of their interesting technology platforms (high-level is helpful)... 1/3 of their 500 employees are Engineers!!
Also, they note that they have VERY LOW ATTRITION - no $100k or more rev client (per month) has left in the last year.
Goodwill on the balance sheet is SUBSTANTIAL (120m as of 9/30/2009)... Amortization of this is a non-cash expense and is upwards of 10-15m per year so take it out of our analysis of the margins... AKA this is still a great biz!
More than one person in the space has quit their job, built a small business and then sold it Quinstreet as their exit

What Happens Next

According to my banking friends, Quinstreet is "in quiet period until the SEC approves their registration statement. Once that happens, they can start the roadshow and promote the IPO." "There is typically some iteration that goes on between the SEC and the bankers/company to make sure they’ve covered all the risks, properly laid out financials, etc."

Continuing, he adds, "The bankers will mail out the prospectus to all the institutional investors. They will tear through the document and then there will be a roadshow where investors get access to management team and bankers (no one really cares to talk to them) to do further diligence. Then there is a ‘book building’ phase, where the equity capital markets team at the bank reaches out to all the institutional investors (some portion is allocated to retail as well) to get a bid with price and volume."

On pricing of the offer, he shares, "There is a history of ‘under-pricing’ IPOs to make sure there is plenty of demand (and a nice stock pop once the thing starts trading). So generally, if a bank is doing a good job, the IPO will be oversubscribed by some multiple 1x – 4x (so there may be $1Bn of demand for QuinStreets $250MM offering). The bankers can then move the IPO price up and still meet the company’s funding requirement with less dilution. Once the book is filled and the price is set, the money comes in to the company and the shares begin to trade. I assume they are aiming to start the roadshow after the holiday season and start trading in late Jan/early Feb (assuming markets hold firm)."

As for price, "Last week they valued shares at $19. There are 34.6m shares, so they value themselves at about 660m or 9x their annualized EBITDA of (4 * 18.15m). I think Ancestry.com is the purest comp, and they are valued at 9.3x TTM EBITDA." Quinstreet's growth story looks better, so it should go out higher.

If I had to guess, Qunstreet will easily see a $900 million valuation by the end of the first week trading. Any friends and family shares left guys?

Comments

Makes sense. I work with an ex-QS guy and he's the best I've ever seen at M&A.

Posted by: Brandon | December 10, 2009 at 11:49 PM

What is even more interesting are some of the stories that you can find through a quick Google search about QS's business practices with the sites they have revshare deals with (that is, those they have not consumed already). Apparently they are harsh mistresses and do some heavy scrubbing.

Posted by: Michael Shostack | December 21, 2009 at 12:34 AM