It's been almost a decade since advertisers recognized the internet as an effective advertising medium. In that time we've witnessed the dramatic growth of popular web portals like Google Inc. (Nasdaq: GOOG) and Yahoo! Inc. (Nasdaq: YHOO) that have proved the viability of the advertiser revenue business model on which much of their success has been based.
The Online Ad World
While the internet share of total U.S. advertising dollars spent is expected to rise from 6.2% in 2006 to 7.7% in 2007 and to 9% in 2008, the rate of growth is starting to decelerate. This is nothing to be worried about, but just a natural development for a business entering early stage maturity. This year total U.S. internet advertising is expected to hit $21.9 billion, compared to $16.8 billion the previous year. While that's a healthy 28% increase, it's less than the 34% increase posted in 2006. For 2008, analysts are projecting a further growth deceleration, calling for only a 21% year-over-year gain.
Given this slowing revenue growth for the overall industry, now might be a good time to start exercising a great deal more selectivity with your stock picking in the internet group. Finding those players with a compelling enough offering to attract and keep advertiser dollars will be a key to investment success. One key criteria for success seems to be dominance in one's space. To a large degree, Google's strong relative performance to rival Yahoo is a function of the overwhelming popularity of its basic search functionality. Depending on which industry stats you look at, Google's advantage is roughly 3:1 to 4:1.
Finding A Niche
In a industry structure with one big overall dominant player, the only effective strategy for the other industry players is to find a niche and quickly build up enough barriers to entry so that bigger operators will have limited interest in challenging your position. One such niche player in the internet group is wedding portal operator The Knot, Inc. (Nasdaq:KNOT).
The company was smart enough to quickly stake out one of the more attractive spaces to advertisers on the internet and now holds a dominant position. Despite the somewhat discouraging divorce statistics, getting married, and doing it in style, is still as popular as ever. Over 2.2 million couples get married every year in the United States, generating approximately $72 billion in retail sales including gifts purchased from couples' registries. The average U.S. couple spends about $14,000 on their wedding and makes more buying decisions during the year before and the year after they get married than at any other time in their lives. All this makes this group extremely attractive to advertisers as they are much more likely to be receptive to ads, and follow-up with a purchase decision.
Right now, just over half of The Knot's revenue comes from advertiser revenues, with another one-quarter coming from traditional print media sales of its own wedding magazines and lifestyle guides, and the balance from sales of its own merchandise and on-line wedding registry services. The current advertiser line-up seems pretty solid with big retail names like Target Corporation (NYSE:TGT), Federated Department Stores (NYSE:FD), Crate & Barrel, Tiffany & Co. (NYSE:TIF) and Macy's all on board.
Recently, the company expanded its footprint in the wedding space when it bought out competitor WeddingChannel.com last September. As a result, The Knot now gets a combined tally of 1.6 million unique web visitors per month; almost four times the number of next largest competitor Brides.com, which is simply the on-line compliment to the glossy wedding magazines that form part of the Condé Nast publishing empire.
A Drop In Share Price
While the acquisition may have clinched them top spot in the wedding space, short run integration issues have reportedly delayed the sign-on by some key new national advertisers. These concerns prompted a number of downward earnings revisions by analysts during last month, knocking 13% off the share price.
Based on the new downward revised consensus EPS estimate for this year of $0.50, the shares still command a fairly hefty 43x forward price earnings multiple. That's well over the 33x forward multiple that Google currently trades at, but I would have to say that the premium is justified.
While the bigger on-liner players like Yahoo and Google are likely to see their growth rates recede in line with the overall industry-wide slowdown in advertiser spending growth, The Knot, with its unique niche offering and smaller base should be able buck the general trend to post higher earnings growth than its larger peers. Given this likelihood, the recent share pull-back could be a buying opportunity.
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