|Would like to pick this up sub $20.|
You may get your wish. If you do, I will be joining you.
The Knot Marries Fast Growth, Obscene Margins
By Jack Hough
March 21, 2007
KEEP A HANKY handy. This love-against-all-adds story has the makings of a miniseries on Oxygen, the women's channel. (Only it comes with a stock pick.) It starts in December 1999 with the marriage of Wall Street and The Knot (KNOT1). The company owns a wedding information web site, Knot.com, and makes most of its money by selling ads for honeymoon resorts and such. It wasn't profitable at the time. Its losses were mounting, in fact. But they were mounting less quickly than sales.
In its first year of operation in 1996 (via America Online; TheKnot.com didn't launch until 1997) The Knot generated $71,000 in sales, but it spent more than 10 times that amount in operating expenses. Two years later sales topped $1 million. Operating expenses ballooned, too, but were now less than three times sales. On Wall Street in 1999 that was enough good news for an Internet company to raise $35 million by issuing shares of itself to investors, as The Knot did, at $15 apiece on Dec. 2.
Things were stormy from the start. Shares gained 69 cents the following day. They lost $1.63 the next day and $1.18 the day after that. Investors gradually decided that profits were fashionable again and clever business plans without profits were not. Within two years of their debut, The Knot shares fetched 25 cents apiece, for a loss of more than 98%.
Today the stock goes for $24 and change. If you've held it since the initial offering you're up 60% over a time when the Nasdaq stock market through which The Knot trades has lost 28%. The company turned its first profit in 2003, and gradually improved over the next couple of years, but last year it produced a stunning increase. Sales jumped 41% to more than $71 million, while operating expenses rose only 27% to $47 million. Add some investment interest and take out for taxes and you're left with a $23 million profit — vs. just $4 million in 2005. Wall Street analysts were caught by surprise. The Knot surpassed their quarterly targets all year by an average of more than 20%.
The fast growth caught the attention of one of our stock screens, appropriately named the Fast Growth screen. It looks for rapid increases in sales and earnings and projections for more of the same, along with a dose of share-price momentum. (Run it anytime you like using our stock screener2 and screen recipe3, and check out some other companies4 that recently survived the screen.) Of course, finding fast-growing companies isn't the same as finding ones whose shares are poised to head higher. But there's reason to believe The Knot shares remain under-priced. More on that in a moment.
Last year The Knot made only half of its money from advertising. It has three other sources of income. It brought in 21% of sales by selling wedding-themed merchandise through its web site, mostly personalized or hard-to-find items, like disposable cameras for reception tables, only in plain white. The company also publishes wedding magazines and books and dabbles in co-producing television programs with Oxygen, for a quarter of last year's sales. Finally, just 4% of sales came from the company's registry business, whereby couples solicit gifts on the site from a selection of retailers, and those retailers pay The Knot a commission for the right to be included.
The Knot currently enjoys more than 80% of wedding-themed web site traffic. It owes part of that dominance, and much of its profit growth last year, to its purchase last June of its largest competitor, Wedding Channel, for $58 million in cash and $1.1 million in stock. A planning specialist, Wedding Channel has an active registry program that enjoys gross margins of 99%, say analysts.
Current trends bode well for at least two of the company's four businesses. Customers are shifting en masse from print publications to online ones and advertisers are following. Still, The Knot currently collects just 3% of the more than $1.4 billion spending on wedding-targeted ads, according to CIBC, an investment bank. Local vendors spend less than half as much with The Knot as with the yellow pages. Both suggest the company has room to grow. It also has pricing power. In July it raised rates 20%. The registry business may hold the biggest promise. In 2005 web sites attracted about 20% of registry spending and Wedding Channel (now The Knot) captured just 2%. CIBC analyst Jason Helfstein sees web sites collecting 30% of registry sales by 2009 and The Knot, 15%.
To those promising signs add that the wedding business is nearly recession-proof, as families tend to save up for years or borrow to spend big whether they can afford to or not, and that the industry carries obscene margins, judging by how $800 worth of photography suddenly costs $3,000 when it's for a wedding. Profits for the company are now projected to increase by a whopping 40% a year over the next five years. The stock now trades at a seemingly pricey 52 times Wall Street's 2007 earnings forecast. But that might be too cheap; divide the price/earnings ratio by the growth forecast and you get a PEG ratio of 1.3, suggesting a discount of more than 15% to the broad market.
One cautionary note: Fast-growing companies with rising share prices sometimes get carried away in issuing new shares to raise money. That hurts existing shareholders. The Knot issued several million shares last year. The number doesn't seem excessive and the use of the proceeds (Wedding Channel) seems justified. But watch for a string of new stock offerings if you own shares. Of course, the antidote for liberal stock issuance is a management team that owns shares. The company's three top bosses together hold close to a million shares, but they've been sellers of late. All told, the stock looks promising, but only if the bosses can keep the share count from expanding like a wedding invite list.