IAC's Catch-22


By Scott Kessler IAC/InterActiveCorp (IACI

; recent price $22.27) owns some of the best-known brands and businesses on the Internet. It generates lots of cash and has what we at Standard & Poor's Equity Research Services see as a strong balance sheet. Also, the shares trade at notable discounts to their peers based on a variety of metrics.

So, what's S&P's recommendation on the stock? Hold.

It may sound unexciting, but we think the stock is reasonably valued. It's worth noting that a slew of sell-side analysts -- more than two-thirds of those that cover IAC, based on our estimate -- are recommending purchase of the shares, with price targets suggesting appreciation into the $30s.

ALPHABET OF BRANDS. But one factor about IAC really concerns S&P. It isn't the uncertainty related to the pending spin-off of the travel businesses, the proposed acquisition of Ask Jeeves (ASKJ

; S&P investment rank 3 STARS, hold; $28.08), or what we consider IAC's somewhat weak corporate-governance practices (see BW Online, 3/22/05, "Diller's Search Finds Ask Jeeves"). Our biggest concern about IAC is its growth strategy.

IAC's brands span the alphabet, from America's Store and Anyway.com to WWTE and ZeroDegrees. Online travel, electronic retailing, ticketing, Internet personals, online local guides, Internet invitations, and online financial services -- these are growth businesses, right?

Actually, IAC's normalized revenues rose only 9% in the fourth quarter. In fact, only one of IAC's seven primary operating segments -- financial services and real estate, which is also one of its smallest business units -- posted growth of more than 11% in the last reported quarter. Margins improved, albeit only slightly using IAC's suggested operating income before amortization measure.

INTENSE COMPETITION. We see competition as intense and mounting in many of IAC's areas of focus. For example, IAC Travel competes with online travel agencies, suppliers such as airlines and hotel companies that are bolstering their online capabilities, Internet travel-search companies, and indirectly with so-called GNEs -- a term for new entrants to the global distribution system (GDS) business such as G2 SwitchWorks and ITA Software. Home Shopping Network has but 3% of the Internet and TV-retailing market, and it faces competition from the larger QVC, Amazon (AMZN

; 3 STARS; $34.27), and eBay (EBAY

; 3 STARS; $37.26), niche online players, and a multitude of traditional retailers large and small.

Ticketmaster is trying to enhance growth and profitability through ticket auctions, in our opinion, but IAC completed only 374 such sales in all of 2004, while eBay had over 51,000 live listings on the morning of Mar. 31. The Web has hundreds of online dating sites, including Yahoo Personals (YHOO

; 4 STARS, buy; $33.90). AOL CityGuide (TWX

; 4 STARS; $17.55) is a solid second to Citysearch in the local guide category, and Google (GOOG

; 4 STARS; $181.51) and Yahoo are increasingly investing in, and deploying, local search offerings. Evite faces competition from startups to Microsoft's Outlook (MSFT

; 5 STARS, strong buy; $24.17). And, it seems like every major financial-services company is pursuing online opportunities. Talk about engaging in a multifront battle.

A bevy of brands and businesses hardly guarantees lasting success, in our view, but we think those units do contribute to vast corporate and financial complexities. Spinning off IAC Travel under the Expedia moniker makes sense to us, especially because the results of this large segment essentially drive perceptions related to IAC and the stock.

MORE DEALS? Nonetheless, our sense is both IAC and Expedia will continue to be notable consolidators. IAC was built through acquisitions -- this is what the company does. In March, 2005, alone, IAC announced the proposed acquisitions of Cornerstone Brands, a family of multichannel retailers, and Ask Jeeves, in transactions valued at more than $2.5 billion in cash and stock. Given this recent activity, what we see as a strong -- some would argue, overcapitalized -- balance sheet, and a clear history of growth through acquisition, isn't it reasonable to expect more deals?

As a result, it seems to us that the planned spin-off of Expedia will lead to perhaps less simplicity than some might expect. At S&P, we think even apart the companies will probably still be more complicated than the other Internet names we follow. However, we believe the key question for IAC going forward doesn't involve structure, but, rather, strategy. Will IAC, and Expedia, choose clarity or growth? We think it's a choice of one or the other.

The pending spin-off of Expedia and comments from management suggest to us that clarity is now of primary importance to IAC. Additionally, the company was relatively quiet on the acquisition front in 2004. The multiples at which IAC's large-cap Internet peers trade suggest that greater simplicity could lead to a more favorable valuation. Perhaps clarity really is, and should be, IAC's priority.

NOTABLE CHALLENGES. However, choosing simplicity may likely mean not pursuing acquisitions and resulting growth. Without much dealmaking in the fourth quarter, IAC's revenues rose just 9%. Google's fourth-quarter revenues more than doubled, Yahoo's surged 62%, eBay's were up 44%, and Amazon's rose 31%. Why the discrepancy? Sluggish organic growth and a lack of deals, in our view.

We think IAC is trying, perhaps unrealistically, to have the best of both worlds. It's pursuing clarity through the planned spin-off and growth through recently announced acquisitions. The March, 2005, launch of Gifts.com, a free Web site that offers users suggestions on gift ideas, indicates to us that management is also starting to think more about internal development as a source of growth.

A relaunch of RealEstate.com is planned. In January, 2005, IAC announced that it's going to rework Hotels.com to become more focused on content than on pricing. In addition, even though IAC seems to be poised to purchase Ask Jeeves, it has some significant plans for revenue synergies.

But in our view, achieving revenue synergies from acquisitions hasn't historically been IAC's focus or strong suit. And unlike its large-cap Internet peers, IAC doesn't have a delineated income statement item for research and development or technology content. This doesn't mean IAC will be unsuccessful with such internal investment initiatives. In our view, it just signals that notable challenges are related to such endeavors.

CAUTIOUS ABOUT STANCE. Perhaps IAC will make more small acquisitions of companies whose assets (e.g., offerings, technology, and/or customers) are particularly complementary to IAC's. However, we think IAC's track record with these types of transactions has been mixed. For example, we believe the company is considering the sale of ZeroDegrees, a social-networking startup acquired a little over a year ago, in part because it hasn't met IAC's prior expectations.

Ultimately, at S&P we believe IAC faces a Catch-22: Clarity or growth? Interestingly, we think it has decided on the former, which is completely counter to IAC's corporate history and culture. We're cautious about IAC's apparent new emphasis on synergies and innovation. Such investments, in our opinion, could reduce what we view as the overcapitalization of its balance sheet, and eventually its market capitalization as well.

Note: Scott Kessler has no stock ownership or financial interest in any of the companies in his coverage area. All of the views expressed accurately reflect the research analyst's personal views regarding any and all of the subject securities or issuers. No part of analyst compensation was, is, or will be, directly or indirectly, related to the specific recommendations or views expressed. Price charts and required disclosures for all STARS-ranked companies can be found at www.spsecurities.com

Required Disclosures

As of December 31, 2004, SPIAS and their U.S. research analysts have recommended 26.5% of issuers with buy recommendations, 61.3% with hold recommendations and 12.2% with sell recommendations.

5-STARS (Strong Buy): Total return is expected to outperform the total return of the S&P 500 Index by a wide margin over the next 12 months, with shares rising in price on an absolute basis.

4-STARS (Buy): Total return is expected to outperform the total return of the S&P 500 Index over the next 12 months, with shares rising in price on an absolute basis.

3-STARS (Hold): Total return is expected to closely approximate the total return of the S&P 500 Index over the next 12 months, with shares generally rising in price on an absolute basis.

2-STARS (Sell): Total return is expected to underperform the total return of the S&P 500 Index over the next 12 months and share price is not anticipated to show a gain.

1-STARS (Strong Sell): Total return is expected to underperform the total return of the S&P 500 Index by a wide margin over the next 12 months, with shares falling in price on an absolute basis.

All of the views expressed in this research report accurately reflect the research analyst's personal views regarding any and all of the subject securities or issuers. No part of analyst compensation was, is, or will be, directly or indirectly, related to the specific recommendations or views expressed in this research report.

Additional information is available upon request to Standard & Poor's, 55 Water Street, New York, NY 10041.

Other Disclosures

This research report has been prepared by Standard & Poor's Investment Advisory Services LLC ("SPIAS"), and may have been provided to you either by: (i) Standard & Poor's under a license agreement with The McGraw-Hill Companies, Inc., which holds the copyright to this report; or (ii) a Standard & Poor's client who is granted a sub-license by Standard & Poor's. SPIAS is affiliated with various entities which may perform services for companies covered by the recommendations in this report. Each such affiliate is operationally independent from SPIAS. The equity research report and recommendations are performed separately from any other analytic activity of Standard & Poor's. Standard & Poor's equity research analysts have no access to non-public information received by other units of Standard & Poor's. Standard & Poor's does not trade in its own account.

Past performance is not necessarily a guide to future results.

Disclaimers

This material is based upon information that we consider to be reliable, but neither SPIAS nor its affiliates warrant its completeness or accuracy, and it should not be relied upon as such. Assumptions, opinions and estimates constitute our judgment as of the date of this material and are subject to change without notice.

This material is not intended as an offer or solicitation for the purchase or sale so any security or other financial instrument. Securities, financial instruments or strategies mentioned herein may not be suitable for all investors. This material does not take into account your particular investment objectives, financial situations or needs and is not intended as a recommendation of particular securities, financial instruments or strategies to you. Before acting on any recommendation in this material, you should consider whether it is suitable for your particular circumstances and, if necessary, seek professional advice. Kessler follows Internet Software & Services and Internet Retail stocks for Standard & Poor's


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