At Ancestry.com, The Family Tree Takes Root

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Does looking into the past have a future?

Investors inAncestry.com ( ACOM ) seem to think so, as they've pushed shares of the online genealogy research firm up almost 50% since early June. A strong earnings report, along with rumors of a potential leveraged buyout, have fueled the online time-machine.

Published reports have claimed that Ancestry.com is a leveraged buyout target with several private equity firms looming as potential buyers. An Ancestry.com spokesman declined to confirm or deny the rumors, saying only that the company does not comment on speculation.

Clay Brethour is a portfolio co-manager of the Buffalo Growth and Buffalo Discovery mutual funds. He holds shares of Ancestry.com in both portfolios. Brethour was asked why Ancestry.com would be an appealing LBO target.

"It's a very profitable business model. They have very good operating margins and free cash flow. They have a tremendous runway for further growth," he said.

Revenue Growth

In the second quarter reported in late July, Ancestry.com's revenue of $119 million rose 18% from a year ago. At $42.9 million, adjusted EBITDA exceeded both analyst expectations and company guidance. The key to the strong performance was the continued growth in the subscriber base. During the quarter, Ancestry.com added 135,000 paying subscribers, representing a 20% year-over-year growth rate. Ancestry.com now has just over 2 million subscribers.

Revised pricing also helped the company reduce subscription "churn" to a nine-quarter low of 3.4%. Ancestry.com has been able to convert some of its one-month subscribers into more lucrative six-month deals.

Subscription growth is the key fundamental in evaluating Ancestry.com's prospects. It is important because nobody really knows how many people will pay to research their family trees.

"The addressable market has been an issue. It has been difficult to quantify," noted Anil Gupta, an analyst with Imperial Capital.

Gupta does expect some slowing in subscription growth. Despite the 20% expansion in the second quarter, Gupta sees just 18% subscriber growth for all of 2012. Next year, he expects growth to slow all the way down to 11%.

Still, Gupta thinks Ancestry.com shares, trading near 31, can go higher. "I certainly think the stock is worth more than what it's worth now," he said. He lends credence to the LBO rumors, saying some of the whispers "are consistent with what we're hearing."

Brethour is not just a portfolio manager who owns the stock. He is also an online user of the genealogy service. He believes that Ancestry.com will benefit from a "network effect." As more and more users join, the value of the user network grows exponentially.

One example is the company's recent offer to evaluate subscriber DNA samples. Customers pay $99 to have their saliva samples analyzed. Ancestry.com then looks for genetic links between that user and others in its database. "By comparing a customer's DNA with all the other samples in our database, we are able to identify distant cousins, most accurately fourth cousins or better, but also some cousin matches that are far more distant," CEO Tim Sullivan told analysts in July.

But right now, Ancestry.com's ability to match is limited. That's because it's restricting access to the DNA offer to its most active users. But as Ancestry's DNA database grows, its ability to locate all those unknown fourth cousins -- and hence its value to users -- will balloon.

At present, Sullivan said, "demand for this service is materially exceeding our current ability to fulfill supply."

One issue is cost. Ancestry.com is currently subsidizing some of the cost of the DNA test, explains Gupta. So for now, it's limiting access to the new service "to our best and most loyal subscribers." These would be the users who have built the most extensive family trees. Presumably, they would be the richest source for cousin matches.

An avid family-tree plotter, Brethour says he has researched his family back to the 1600s. He stands ready to send in his saliva for the DNA service. Interestingly, he has not yet qualified for the program, only making it to the waiting list.

Network Of Cousins

This suggests the network for tracking down cousins is still in its infancy and will hugely benefit once Ancestry.com extends its service to meet demand.

One major factor in Ancestry.com's success to date has been its sponsorship of the NBC TV show "Who Do you Think You Are?"

In tracking the family histories of celebrities, Ancestry.com has been able to broadcast the appeal of genealogy and build its subscriber base. But the show has been canceled by NBC. Ancestry.com executives have indicated they have other TV opportunities. Most likely, observers believe, is a cable deal. But that will attract a smaller audience than NBC.

So Ancestry.com will have to rely more on building its own archival offerings to enrich the family tree-building experience. One new feature allows users to look up personal records from the 1940 census. Google has begun indexing those personal records. So Google searches for 1940 census participants will help drive traffic to the Ancestry.com site.

Ancestry.com shares have pushed higher with the LBO rumors. Gupta allows that the shares have been "trading on headlines recently." But he thinks they still have some upside. "At this point, the risk-reward still makes sense," he said.



The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of The NASDAQ OMX Group, Inc.



This article appears in: Investing , Investing Ideas

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