http://www.businessweek.com/stories/2005-08-02/the-good-news-about-iac

The Good News About IAC


By Timothy J. Mullaney F. Scott Fitzgerald notably wrote that the sign of a first-rate intelligence is the ability to hold two seemingly opposed ideas in one's mind at the same time. Well, Hollywood refugee Barry Diller is nothing if not of first-rate intelligence.

And it's possible to hold two opposed ideas about him: that he can be a little impetuous and run off executives at companies he acquires (see BW Online, 8/1/05, "IAC: The Unraveling of an Empire") and still build a business whose stock prudent speculators might want to own.

DIVERSE DOINGS. Indeed, this week's news about Diller's IAC/InterActiveCorp (IACI) is pretty good. On Aug. 2, the New York City-based e-commerce conglomerate disclosed that it had beaten Wall Street's second-quarter earnings forecasts by a cool nickel a share, putting up revenue of $2 billion and posting profits before taxes and amortization of $308 million.

That's up 34% for revenue and 24% for profits. As usual, parsing the numbers at IAC makes for a tough exercise: IAC consists of dozens of companies and, at any given time, some of them are doing well, some are struggling, and some are in investment mode in hopes of bigger scores down the road.

But as Diller prepares to split up the company -- its Expedia, Hotels.com, Hotwire, and TripAdvisor travel sites are spinning off as Expedia Inc., undoing a series of mergers that happened only in 2003 -- both sides of IAC will come to the spin-off in pretty good shape. (Trading in the new companies commences Aug. 9.) "The businesses of IAC are going to emerge from the fog and be seen for their true potential," Diller vowed in yesterday's conference call with analysts.

SOLID CORNERSTONE. Initially, it looks as though the "New IAC" -- which includes cable-shopping channel HSN, Ticketmaster, and online loan exchange LendingTree.com -- might have the cleaner break out of the gate. Its revenue of $1.4 billion had risen 44% from a year ago, helped by the acquisition of catalog retailer Cornerstone Brands earlier this year.

IAC's operating income, excluding Expedia, was $66.5 million, up 127%, and the closely watched operating profits before amortization -- a measure that factors out some of the noncash accounting complexity that clouds the picture of Diller's constant deal-making -- rose 39%, to $124.3 million. Excluding Cornerstone, revenue for the group rose 23%, and operating profits before amortization climbed 37%.

The winners: Ticketmaster had a big quarter, helped by an active, attractive summer concert schedule. Local entertainment and services portal CitySearch made its first profit ever, $1.8 million. And IAC Financial Services and Real Estate boosted revenue 192%, to $130 million, and upped profits 166%, to $15 million.

EXPEDIA OMENS IAC Financial Services got its boost from the acquisition of HomeLoanCenter.com, which helped LendingTree expand from simply referring borrowers to lenders (which brings a small commission) to funding some of the loans itself (which means much bigger fees).

"The LendingTree acquisition right now, well, you could say it's a double," Diller says of the company he bought in August, 2003, for about $730 million. "But it has the potential to be an enormous home run."

At Expedia, there were signs that the company is overcoming recent struggles. Hotels.com, where growth had been negative the last two quarters, saw sales rise 7%, with quarterly gross bookings topping $500 million for the first time. And CEO Dara Khosrowshahi stressed upcoming efforts to start a loyalty program for Expedia travelers this fall, dangling targeted discounts and benefits in a plan modeled on the successful Total Rewards program at casino operator Harrah's Entertainment (HET).

CHASING COMMISSIONS. But revenue was up just 14% overall, to $555 million, well below the blistering pace Expedia was on before Diller bought it in 2003, as both Hotels.com and Expedia.com's hotel business continued to see sales and margins compressed by hotel chains' efforts to keep IAC from discounting their rooms. Forrester Research analyst Henry Harteveldt cautions against thinking the loyalty program will get consumers to turn to Expedia, en masse, instead of booking at airlines' or hotels' own Web sites. "It's a little deal, not a big deal -- but it's a good deal," he says.

The big near-term boost to Expedia was being able to cut growth in marketing spending. Net income rose more than 50%, to $73.4 million, growing faster than sales, because marketing expenses ascended 10%, to $180 million. The slower ad growth added more than 3% to operating profit margins, Expedia says.

Both companies, however, have their reclamation projects. At "New IAC," HSN had a weak quarter, growing just 2% in its core U.S. business. Financial Services profits are held down by the fact that much of the division is in investment mode: In particular, Diller is pouring development and marketing money into building up RealEstate.com, his play to grab a share of the $60 billion market for residential real estate commissions by matching home buyers and sellers with Realtors in exchange for up to one-third of the commission.

JUICING JEEVES. IAC-referred brokers closed 4,000 transactions worth just under $1 billion in the quarter, with both numbers up about 50%. "RealEstate.com is still in its early stages but is making unambiguous progress," says IAC's CFO Thomas McInerney.

Most intriguing, IAC is sending its newly acquired Ask Jeeves search engine into the shop to overhaul its business model. Bought on July 19, Jeeves is cutting back on the number of ads that appear on each search page, beginning Aug. 3. The goal: Reduce clutter that includes up to 10 paid links per search that appear before the results produced by the site's algorithmic search.

Initially, the change will make profits fall -- margins at Jeeves will tumble to 20%, from the 24% IAC had projected before, and sales growth will be in the low single digits instead of 20%-plus -- before an anticipated recovery next year. The idea is that by reducing ad clutter on pages, Ask Jeeves will generate more search volume.

"EXTRAORDINARILY CHEAP." Despite the short-term issues at IAC, however, Diller is clearly building a large, profitable company. At Piper Jaffray, analyst Safa Rashtchy wrote yesterday that the spin-off will help the stock by increasing the multiple that investors pay for the Expedia part of the business, once it's set loose from slower growers like HSN and Ticketmaster.

Legg Mason Value Trust analyst Randy Befumo, whose fund owns about 14.4% of IAC, says the business is throwing off enough cash to pay for all of Diller's acquisitions in as little as 10 years. "It's extraordinarily cheap," says Befumo, who puts IAC's presplit value per share in the low 40s.

When IAC formally breaks up next week, the market's debate over what Diller is worth won't end. The shares are down more than 30% since the Expedia and LendingTree mergers closed two years ago. "We can make all the claims we want, but it is in the performance that our strategy will out," Diller told analysts on the call. True enough. But even if IAC and Expedia don't quite relive their shares' salad days of 2003 after the spin-off, there's a lot of meat there.

Mullaney is BusinessWeek's E-Business editor, based in New York


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