The Rude Awakening
Laguna Beach, California
Thursday, May 3, 2007 ------------------------- - Banking on Bankrate…or not,
- Competition hots up in this cooling market,
- A few dirty lies, some clean truths and nothing else…
------------------------- Eric Fry, reporting from Laguna Beach, California… Despite regular assurances from Wall Street's finest minds that the U.S. housing market is bottoming, it stubbornly refuses to do so. Just yesterday, the National Association of Realtors disclosed that its index of pending home sales slumped 4.9% in March - to the lowest level in four years. But Wall Street cannot be bothered with the facts, when fiction is so much more profitable. Thanks to happy fictions, investors will persuade themselves to buy all kinds of things that no reasoned analysis would allow. But if you listen to a happy fiction long enough, you just might find yourself buying a homebuilding stock in the middle of a homebuilding bust. Or you might even find yourself buying a mortgage lending stock in the middle of a mortgage lending bust. Heck, you might even find yourself buying shares of Bankrate Inc. (Nasdaq: RATE), a company that would seem quite vulnerable to a mortgage-lending bust. Even so, RATE has defied the skeptics for a very long time. It has been a great stock to own, plain and simple. But will it continue to be a great stock to own? Will RATE continue to befuddle the skeptics, or will it finally succumb to the slings and arrows of the mortgage market meltdown? 
As the nearby chart clearly illustrates, Bankrate's share price has continued to soar, despite the fact that home sales have not. Indeed, nearly every gauge of housing market health is flashing red, a phenomenon that has caused the lending market to lurch to a halt. "The home-buying public is wondering what the heck is going on in the housing finance system," David Seiders, chief economist at the National Association of Homebuilders recently griped. "This tightening of lending standards and all of this publicity of what's been going on in the mortgage sector may have frozen up the mortgage market." Maybe the ice-cold mortgage market is not fatal to Bankrate's growth prospects, but neither is it very helpful. In the column below, Dan Amoss, our resident skeptic and editor of Strategic Investment, explains why he finds little to like about the richly valued shares of Bankrate Inc. --- Last Two Weeks ---
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By Dan Amoss Bankrate's business model is easy to understand, but it's richly valued share price is not. The company operates a Web site that publishes mortgage interest rates. (Here, see for yourself: www.bankrate.com.) By so doing, it directs prospective borrowers toward prospective lenders…for a fee. Business was good during the housing market's boom years. But the housing boom has busted, and yet, Bankrate's high-flying stock (Nasdaq: RATE) seems not to have heard the news. Since Bankrate does little more than publish interest rate data, why should its stock sell for 50 times earnings? Could such a website have a lasting competitive advantage? Why couldn't sites with far larger audiences -- like MSN Money, Yahoo Finance, or Google Finance -- eat Bankrate's lunch in the Internet advertising game? Perhaps more importantly, since Bankrate's core customer base is in the midst of a nasty downturn, why should Wall Street expect 118% earnings growth in 2007? These are the questions that spring to mind when I think about Bankrate's business…and its lofty share price. Simply stated, I think RATE is a stock to sell. One caveat: 5.4 million shares, or 42% of RATE's public float is already sold short, so the potential for a further "short squeeze" is high. At the same time, many of these shares have been sold short by very accomplished, patient institutional short sellers that are usually proven right over the long run. Since many brokers have restricted short sales of RATE, I recommend put options as a more attractive way to play the downside in Bankrate. Bankrate describes itself as an owner and operator of "an Internet-based consumer banking marketplace. Our flagship web site, Bankrate.com, is one of the web's leading aggregators of information on more than 300 financial products and fees, including mortgages, credit cards, automobile loans, money market accounts, certificates of deposit, checking and ATM fees, home equity loans and online banking fees. We also own and operate Interest.com, a smaller, yet similar site, FastFind.com, an Internet-based lead aggregation firm, and Bankrate Print, which produces newspaper-based advertising and editorial products." (source: 2006 10-K) At 50 times trailing earnings, however, investors would seem to be paying way too much for this business, given the numerous threats to Bankrate's rapid growth story. Googling the word "mortgage" turns up a very long list of websites offering quotes, with Bankrate in the middle. Lending Tree, E-Loan, Quicken Loans, and even ABN Amro and Wells Fargo are listed above Bankrate's site. As Internet users grow more sophisticated over time, it's reasonable to expect that loan shoppers will search more and more websites for quotes. And it is also reasonable to assume that Bankrate will lose market share and pricing power over time. These competitive threats are formidable, but they are also long-term. In 2007, however, Bankrate faces an environment where housing sales will remain weak. Despite this grim reality, Bankrate has managed to tread water, revenue-wise, by making acquisitions and by paying other Web sites for leads. Either strategy could work in theory, but neither strategy has worked very well in practice. Bankrate has started paying "per click" fees to search engines like Google. This may boost growth for a little while, but it's a far more costly way of doing business and still doesn't solve the core problem of an intensely competitive online mortgage shopping environment. Meanwhile, the company has also tried to integrate a couple of recent acquisitions. In the fourth quarter of 2005, Bankrate paid $10 million in cash to acquire "FastFind" and $30 million in cash to acquire Mortgage Market Information Services and Interest.com. Despite having high hopes for FastFind, management is struggling to integrate it, discovering just how tough it is to compete it the "qualified leads" business. After several quarters of disappointing results, Bankrate is re-launching its FastFind business in 2007 under the name Bankrate Select. Management claims that FastFind was unable to generate sufficient interest among its key advertising customers. But they believe they've solved the problem by partnering with Lending Tree and gaining access to their lending network. Bankrate now has $120 million in cash on its balance sheet, and management clearly intends to use it to fund future acquisitions. Given their track record of spending cash on value-destroying acquisitions like FastFind, this should not be viewed as a positive. It's important to note that the Bankrate did not generate this cash from its business operations; rather, a $90 million chunk has been sitting on Bankrate's balance sheet earning interest since the company raised it in a May 2006 secondary stock offering -- an offering in which insiders took the opportunity to sell $16 million worth of stock. This is hardly a vote of confidence in the strategy of raising cash to fund acquisitions. Why did insiders sell $16 million worth of stock if they really expected this pile of cash to be put to work in a value-creating manner? Shouldn't they have held on to these shares if the opportunities they talk about are so wonderful? Clearly, Bankrate is being confronted with big challenges on both ends of its business. Borrowers are not lining up to buy D.R. Horton homes (or existing homes for that matter) and lenders will not be in the mood to aggressively advertise on Bankrate.com. Therefore, if the housing and lending markets are slowing down rapidly, is Bankrate's business really going to grow? Just wondering. Joel's Note: You'll notice we've been bringing you a few of Mr. Amoss' columns of late. Dan's propensity to "just wonder" always seems to lead to an intriguing, not to mention bankable, outcome. Here's a couple of his recent Rude musings and a link for his newsletter, Strategic Investment, just in case you are interested in wondering a little more. Mind Over Matter…and Money
Drilling Down
Strategic Investment
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