Chit Chat Stocks - Spark Networks (Ticker: LOV) Not So Deep Dive

Episode Date: March 28, 2023

Spark Networks (Ticker: LOV) is a publicly traded company that operates several online dating platforms, experiencing strong revenue growth amid the pandemic, but facing competition and risks associated with user data privacy and security. At the end of the month, we will publish an Arch Capital episode that will cover the company: Match Group. Listen closely as Brett and Ryan go through the history, financials, and future prospects of Spark Networks. Enjoy the show! ****************************** This episode is sponsored by Stratosphere.io, a web-based terminal for financial data, KPIs, and more. Try it out for FREE or use code “CCM” for 15% off any paid plan. Sign up here: https://www.stratosphere.io/ ****************************** Subscribe to our Substack to receive free show notes and charts that go along with every episode: https://chitchatmoney.substack.com/ Want updates on future shows and projects? Follow us on Twitter: https://twitter.com/chitchatmoney Contact us: [e-mail] Timestamps Company Background | (3:18) Industry | (14:07) Management & Ownership | (17:54) Balance Sheet | (23:38) Earnings | (29:36) Valuation | (34:11) Our Analysis | (36:06) Disclosure: Chit Chat Money hosts and guests are not financial advisors, and nothing they say on this show is formal advice or a recommendation. Brett Schafer and Ryan Henderson are general partners and portfolio managers at Arch Capital. Arch Capital and its partners may hold securities discussed on this show. Learn more about your ad choices. Visit megaphone.fm/adchoices

Welcome to Chit Chat Money. On this show, host Ryan Henderson and Brett Schaefer interview industry experts and riff on the world of investing. As a quick reminder, Chit Chat Money is a CCM Media Group podcast. Ryan and Brett are also general partners at Arch Capital, and Arch Capital may have positions in the securities discussed in this podcast. Anything discussed on Chit Chat Money by Ryan or Brett or any other podcast guests is not formal advice or a recommendation. Now, please enjoy this episode. Welcome into Chit Chat Money. My name is Brett Schaefer, and I am joined by my co-host, Ryan Henderson. Today is our Tuesday Not-So-Deep-Dive episode where we analyze

one stock by covering its business model, ownership, financials, and future growth opportunities. After listening to this episode, we hope you get a better perspective on the company that we are covering today. And for this week, we are covering Spark Networks. Full disclosure, this is a tiny company that we, I can safely say,

will never invest in. But it is going to be a great... Hey, hey, hey, never say never. Just a little spoiler for them. But it is going to be a great case study on identifying red flags, identifying bad businesses, and comparing it

to the other companies within the online dating universe, which is very important. You got to know who your competitors are if you're going to invest in one of these other companies. But first, today's episode is presented by Stratosphere, the best web-based research terminal for company-specific metrics like KPIs and segment revenues. Stratosphere has clean data for KPIs, segment data that is triple-checked for accuracy, and beautiful data visualizations. Ryan is bringing up the one for Spark Networks right now, which I was actually wondering whether they were going to have this company on there

because it's a German micro cap, but Stratosphere spans the globe with all the companies they offer here. And little did we know, they have all the Spark Network stuff. Now for S&P 500 companies, for top companies in Canada, for NASDAQ 100 companies,

Stratosphere is going to have specific company KPIs for their paid plans that are extremely useful. For example, for someone like Match Group, which we'll be covering next week, they will have stuff like paying users, ARPU, all lined up for you where you can't find anywhere else. If you want to try Stratosphere, it is... Well, not all of their products are free,

but you can try it for free and get a lot of the features. Or you can go to one of their paid plans. They have various different offerings. sign up using code CCM, get 15% off. We think it is a great place to start. Whether you're a small investor, you just want to start out with a free plan or a professional and think like us, you would utilize some of their historical data and KPI offerings. It's great. All right, Ryan, I think that's enough on Stratosphere. We'll be using some charts from them throughout the episode. why don't you

describe what Spark Networks is because this is a hodgepodge of small dating app properties I'm going to go ahead and rebuke is rebuke a word?

refute I think you're meaning you're going to refute me? yeah I'll look up the definition right now but continue I think I'm using rebuke properly here i'm gonna rebuke what you said google says express sharp disapproval or criticism so sharp disapproval all right sharp maybe not that sharp but i will say slight rebuke you said we are never going to invest in this company i will say that is not necessarily true businesses can

change there there's very i would say it's like certainly within the realm of possibility that we could be an investor one day. So maybe at its current state, we're not interested, but- They got to fix about 12 things first. There were, I found a lot of value out of studying the business because we own another online dating company,

Match Group, which we'll be talking about next week. And there were a lot of lessons to be taken away and maybe like advantages towards Match Group that I hadn't previously noticed. So, but let's talk about Spark Networks first. So they own a number of online dating properties, like you mentioned. They target mostly the 40 plus age demographic.

And then they also have certain faith-based dating properties. So like religiously affiliated dating apps. I think Christian Mingle, JDate, which is for the Jewish community, stuff like that. But they are, and I believe I'm still correct in the stat, they're the fourth largest online dating company by revenue. They've come down slightly as Bumble and I believe as Grindr have both continued to grow, but they are still one of the largest in aggregate. And so let's look at their properties one by one.

their biggest, their premier property is Zoosk. They acquired this in 2019 for approximately $258 million. Zoosk has a website and an app, and it functions fairly similarly to Hinge in terms of profile creation process, the target demographic that they're going after. However, users pay for, I guess different features with Zoosk so in Zoosk's case you have to pay in order to message people which I find a little interesting

I was looking at basically like what do you get with the subscription and you can match with people but you can't message them unless you pay yeah I made a profile for the anecdotal evidence section no big deal and I'll give out my anecdotal evidence positive and

negative for Zoosk when we get there Okay. But yeah, they really are going after serious daters generally. And they were at one time a pretty big dating property in terms of the overall online dating market. They operate in more than 80 different countries. And my guess, based on current numbers and how much they account for Spark's revenue, is that they have just under half a million monthly average paying subscribers. They account for 50% of Spark Network's overall revenue. And in 2021, Spark Networks, I believe, had around 870,000 average paying subscribers. So I'm just backing into the math there. The second big property that they have is called Elite Singles.

And it markets itself as, this is in quotes, the go-to dating site for single, educated, and busy professionals. You have to apply to become a member on Elite Singles, and they have to manually approve you. Bit of an interesting story. The interim CEO of Spark Networks, Chelsea Grayson, who stepped in recently, and Brett will talk about her in a second, but she was on this interview and said she applied to be on Elite Singles and her profile was vetoed initially or it wasn't approved, which maybe is a problem. But it may have been like they thought someone was pretending to be her or something like that, you know. But she had to call her like CTO and say like, hey, like, you know, put me through on this app. And so kind of interesting, but that's the process is it's a membership-based, basically you have to be approved. And then it's still a freemium model, but the premium accounts are much more costly at around $60 per month. Elite Singles is a decently sized property. They account for 27% of Spark's overall revenue.

And then the third largest is Silver Singles. This function is pretty similar to Elite Singles, just in terms of the app mechanics or the user experience. But it's catered to 50-year-olds or older. So Match Group recently launched a direct competitor, which is called Our Time. They have the exact same target demographic. They say 50 years old or higher, and they have kind of, I don't want to say displaced, but they're currently beating out SilverSingles.

If you look at the SensorTower data in terms of where the apps are ranking, our time is outpacing SilverSingles. But SilverSingles was launched, I want to say, in like 2018. And there's a chance that I think both those, they don't explicitly state it, but I imagine both those could be growing just because I think the number of daters that age probably continues to grow given that mobile adoption is kind of slower for that segment. Or earlier. Yeah. Yeah. Excuse me, later, not earlier. Yeah. The fourth one here, this is a really small percentage of revenue, but basically the three businesses that are somewhat relevant are Zeus, Galit Singles, and Silver Singles. The last one here is Christian Mingle. Well, I shouldn't say the last one, but

This is exactly what it sounds like. It's a dating site for Christians who really prioritize their faith as a part of their dating life. The other two that I think are important are JDate and Jswipe. JDate used to be bigger than it is today. It's a leading dating site targeted specifically for Jewish singles. However, it's really web-based, and Jswipe is basically the same, except it's a mobile app experience. So it kind of skews a little younger, but really, those apps are not only competing against other Jewish dating apps, they're really competing against the big apps, Tinder, Hinge, because you can almost not necessarily explicitly filter for Jewish people, but on Hinge, you state your religion. You can state your religion, so if it matters to you, you can kind of filter manually through that. Other ones, all these account for less than 1% of revenue combined. So these are really tiny, but eDarling, this is very similar to Zeus, but it's focused solely on the German market. It used to

be bigger than it is today. So it's kind of shrunk in relevance. Another one here, this is kind of unique, albeit superficial. It's called Attractive World. Here's a quote from their description. It's the only leading dating site that lets its members decide who gets in. So if individuals want to join, they first have to impress the attractive world community. Wow. Sounds like a great way to get your network effect going. Yeah. That's sarcasm.

Anyway, and then there's LDS Singles, which is just the dating service for members of the Church of Latter-day Saints or Mormons. And then CrossPaths, this is basically Christian Mingle just for mobile. So it's a number of different properties. Like I said, though, the big ones are Elite Singles and Zoosk. Um, history though, Spark Networks was technically formed in 2017 through the merger of two online dating businesses. One was a German-based company called Affinitas and then Spark Networks. Affinitas was founded around 2008 by an investor consortium, which ended up owning eDarling.

Like I said, it was a little bigger at the time. Spark Networks was the owner of only religious dating sites. and those had been around for quite a long time. So Christian Mingle was built in 2001. J-Date was built in 1997. J-Date was, yeah, if you're a Value Investors Club reader, go check out some of those old posts. We'll talk about this later.

J-Date was a big property for them and what a lot of investors were talking about is their key golden asset. Now it's only 2% of revenue. Yeah, exactly. Last thing here, after the merger, they listed the combined stock on the New York Stock Exchange American, NYSE American, shortly after they moved it to the NASDAQ. A year later, so 2019, they acquired ZUSK for $258 million. Potentially, they saw this as like – I'm just going to – why don't we just talk about what maybe they were thinking at the time of the acquisition.

Do you think they saw this as a life vest, something that could save the otherwise declining businesses? Yeah. It's interesting why they acquired it because during, I remember the management at the time, I think sent out a shareholder letter or at least it was right around the time when they acquired Zoosk or I don't know if it was in between the announcement and the closing date, But it seems like they wanted an entrant into the North American market for a general dating app.

They also wanted something that was popular in many countries around the globe. I think when I looked up Zoosk, it said they were used in 80 different countries. And I'm in South America right now. When I tested it out, there were people using it. It's not like one of those that we've tested out throughout this show that aren't on here. For example, when we're using Hinge down here, there's no one on there. well, it's really just people that are foreigners from countries that use it. So maybe that was their thought, that they could globalize this thing.

But as we'll talk about later, it hasn't gone very well. Yeah, I agree. You want to hit the industry landscape? Yeah, this one will be simple, and I'll give maybe some numbers around, or at least a little more context around the rankings versus the other apps that Match Group is pushing to compete with them. So we'll give the overall numbers again, in case someone hasn't listened to our other dating app episodes.

on Grindr and Bumble, which if you like this episode, definitely go listen to those as well. Really, as we close out with Match Group, we'll give an overall just comprehensive overview of the dating app industry. And then for the newsletter, we'll have some interesting charts on the revenue per share, their net debt, and how that all changed right around the Zoosk acquisition. But if we look at global industry spend, we estimate it to be around $5 billion. dollars they're going to spark networks revenue they make up around four percent of global industry spend so even though they are what did you say the fourth biggest dating app group

worldwide match group is going to be over 50 of revenue and then bumble is growing much quicker and is a large chunk of that as well so it's dominated by a few key players at the top if you look at competition zeus competes with the mainstream data applications if we look in the United States. It is currently ranked 20th in downloads on the Google Play Store versus one through three for the big three generalized dating apps. And that's Tinder, Bubble, and Hinge. And this is within the dating category. I use the Google Play Store because for some reason, the iOS store does not have a dating category. So some apps aren't within their lifestyle category. It gets a little bit confusing on there. So I think Google Play is just a bit better.

now if we look at their older apps uh they are losing in downloads to match and stir and what's the old one called our meat ryan our time our time yeah that's a good name i gotta say um and then stir is a new one it's a single parent focused app for match group and that's you know there's going to be some younger people on there as well but generally that's going to skew a bit older than these generalized dating apps that are targeting kind of people under 30 Then if we look at the religious-focused apps, they're losing to their competitive peers as well. I believe Match Group owns Upword, who is outranking,

and that's a Christian-focused one. That's outranking Christian Mingle. And then there's some others as well that I don't need to get into. So if we look at those and we look at the KPI charts that I'll provide in the newsletter and that we're going to talk about today, it is really no surprise to see the Spark Network's portfolio losing in almost every download competition right now. Maybe I'll just give some numbers here. Just one of them. If we look at their platform registrations,

which is an interesting metric they give out, that basically is how many people signed up for all of their properties within a given year. In 2017, they had 8.45 million. After acquiring Zoosk in 2019, they hit 12.7 million. And then 2020, 14.8 million downloads. But now in 2021, one, it's only 13 million registrations. So they tried to, I guess, they brought on something twice as big, which should have propelled them if they were going to be growing up to 20 million probably registrations a year, once you say Ryan, but they're moving all the way in the opposite direction and almost all the user value, I guess you describe it from the Zeus, excuse me, it's very hard to say, Zeus acquisition is just going in the complete wrong direction. Does that make sense

when I say platform registrations. Yeah, and you can see that in the goodwill impairments. There's been goodwill impairments every single year that's been them impairing the estimated value of Zeus. Yeah, mainly Zeus. All right, we'll talk about more Zeus and kind of the numbers there and the earnings and stuff like that.

But let me hit management and ownership. A bit tricky here because they're basically, I've described them as in limbo right now. I mean, the stock's below $1 a share. We're at a market cap of, I'll reference later, about $25 million. But in January, board member Chelsea Grayson was appointed as CEO. I think it's interim, but basically she's leading the company right now. The previous CEO was Eric Eichmann, who managed the company since 2019.

The press release had the typical corporate speak of every executive transition. Oh, Eichmann's spending more time with his family and other initiatives. Oh, we really appreciate his time. Grayson says stuff like, I'm really excited to lead this growing portfolio of whatever, a high quality portfolio of Daniat properties. But I think it's pretty clear

that Eichmann got fired for performance because of how bad things have been going at Spark Networks. Now, if we look at the 2021 proxy, their 2022 one is not out yet. So we're a bit backdated. We do not know how Grayson will be compensated as an executive.

However, if we look at their standard stuff, executives get really, or excuse me, their compensation for executives that were there in the past, they get the standard base salary plus variable incentives plus stock options trifecta for almost every executive suite these days, or at least the ones that are using compensation consultants. As you would hope though, the performance bonuses based on the financial incentives were not earned in 2021. And when we go through the numbers, You'll see that that's pretty clear. However, executives like Eichmann earn close to their full bonuses on, quote, individual performance targets. And here's one of the criteria that I found that was shocking. We'll move on here. We don't need to bash them, but they got paid a lot. So I think they can wipe away their tears with their millions of dollars. here's the quote

for why Eichmann got one of the reasonings in the proxy statement for why Eichmann got paid out one of his individual performance bonuses launched two new and differentiated social features on Zoosk in 2021 that's just incredible that they thought

well congratulations you launched two features you updated the product yeah you did your job we look at base salary Aikman got a base salary of $625,000. So fairly high for a company this size, but not crazy given the revenue.

Yeah, you know, their, how would I describe it? Earnings have been negative for a while, but you know, you gotta pay yourself. I'd say that's pretty overpaid. Yeah, it's overpaid. I mean, that's pretty overpaid given the fact that they, you know, sort of break even profitability-wise.

Like you're just going to give them this money for doing their job. It's funny how we look at $625,000 for this job. We looked at too many that I get paid $10 million for no reason. And this is just a comparison because it's a micro cap. Yeah. I mean, like, okay. I was looking at Sundar Pichai recently.

He's been granted probably more than a billion dollars worth of stock in Alphabet over the years. I think that, I look at that and I don't think he's overpaid. I look at $625,000 for helping launch two new features on Zoosk. Well, the base salary would have been drastically overpaid. Yeah, the base salary would have gotten paid anyways. This is that those performance bonuses got paid on top of the base salary. So it's even more. Yeah, we'll get through further here.

The ownership is interesting, specifically because of how small the market capitalization is. You can look at the table, but the two important owners right now, but I saw in Whale Wisdom in the proxy state would be Osmium Partners and First Manhattan Company. If I was interested in Spark Networks, I would be researching who both these funds are because they own a huge chunk of the stock. 18.6% is Osmium, 9.7% First Manhattan. And then if we look at combined directors and executive officers, we're at 4.7%. There are, I think, two board members that are big investors that have 2% of the company around there. And yeah, besides that

pretty standard stuff, they're in a bit of limbo. The compensation stuff I don't think matters because it's all about what Grayson, I guess, is incentivized to do. And I think what was a little bit of a low light is I saw that Grayson, who again is the new CEO, own no shares as of the 2021 proxy filing. So if I was someone that owns Spark Networks and was looking to get acquired, which we'll talk about later, they are looking to get acquired. I would maybe want her to have some skin in the game here to try to get the best out of that stock that she owns. What do you think? Yeah, I agree. Her past, she's been interim CEO, or maybe it was real CEO of True Religion and American Apparel

and I think well both those ended up eventually getting acquired but she's kind of a bring it to acquire yeah

been viewed as like a sell your business specialist she was on the board though previously so I don't know I'm not sure what

expertise she brings to the online dating business but I think it's more for looking at a strategic sale 100%

yeah The other thing I'd say is Osmium partners, I believe they have been selling because they were the owners of Zoosk or big owners. So they've just been like their lockup expired and they've just been constantly selling ever since. Yeah. And that can maybe be what's driving the stock down even further. I saw in the latest 13F that I just picked up on Whale Wisdom that Osmium has been consistently selling. All right. Balance sheet, Ryan.

We got an interesting one here. I also saw, yeah, I'm glad you picked this up. there's some weird things with this debt agreement that are really going to be screwing over shareholders. Yeah, 100%. So I'm deciding to start with the balance sheet. We usually start with earnings, but I think it's really important to start with the balance sheet here because you look at the market cap of the business and it's something like $25 million and you think, oh, this is pretty cheap. But the enterprise value is about four or five times that. So it's very important to look at the balance sheet. Let's talk about the assets first.

they have $13 million in cash. Over the last 12 months, they've generated about just north of $20 million in adjusted EBITDA. Like I've said this before, I typically don't pay attention to adjusted EBITDA for a non-levered company, but because I believe that is largely the money they can pay back lenders with, it's important in this context. However, there was one sort of reconciliation between gap earnings and adjusted EBITDA that I don't think, that I think is real. What was the foreign exchange? So my thought here is if- They add that in the definition? Yeah, my thought here is you can't pay back the debtor, your lenders, with money you've lost in foreign exchange.

With the old exchange rate? Yeah, they're not going to just say, hey, yeah, you can use the one from 2020. Go right ahead. Right, because the cash just isn't there to pay them. So I'd maybe back that out. And that was a big hit to them this year. They are still a fairly international business, even though most of their revenue comes from North America. But let's talk about the liabilities. So in order to finance the acquisition of Zoosk, Spark took out a $125 million senior credit facility. Brett's showing that the net debt position here was basically zero until 2019. This was – I mean, we can look back on it now and say it was a bad move, but that's because we know the results of Zoosk. However, it's been converted into a term loan, which today has a carrying value of $95 million. So just comparison purposes, $95 million in debt, $13 million in cash, so a heavily net debt position. However, the debt has been refinanced a number of times. Going into 2022, the rate was basically LIBOR plus 8%, which is expensive. And there were some covenants that said they could not go past a 4.25 times net debt to EBITDA ratio. However, in August of 2022, they refinanced again to A, expand that leverage ratio, but there's also some interesting points in here, which I find just odd. So here's the quote from the recent 10Q.

Well, the creditors are probably happy, but go ahead with the quote. Yeah. So it says, the amendment revised certain financial covenants associated with the quarterly leverage ratio and requires the company to maintain quarterly leverage ratio no greater than six and a half to one through December 31st, 2022, and six and a quarter to one for the quarter ending March 31st, 2023. The remaining quarterly leverage ratio did not change. And then it also says, the amendment also requires the company's minimum marketing spend for 12 consecutive month period ending at the end of each fiscal quarter, commencing with the fiscal quarter ending December 31st, not to be less than $80 million. There's a required $80 million marketing spend. Within the debt agreement. Yeah. I think this is interesting.

did you also pick up that they're requiring them if they generate excess cash flow to it all go back to paying down the loan so i think the creditors really have them well i don't want to say the word um they have them by the whatever you know people can make the analogy they got a tight grip on this company yeah they're in charge and they're basically saying look you're going to spend the marketing so you can get the so you can keep this thing afloat and any cash you generate is paid back to us, which as someone who would potentially be owning the common stock, that doesn't sound very great. No. Yeah. And it's an interesting point you bring up. They require them to spend a minimum of $80 million in marketing. That goes to show

that this business does not advertise because they want to, because they want to grow. They advertise because they have to in order to generate any sort of cash. And so opposite of Grindr, we saw that really Grindr is kind of in a place where they've never spent on marketing and have been able to grow. And it's like when people look, that's not the hamster wheel of marketing is not, I think there's just a difference, I think, between some of these dating apps. I'm having trouble explaining it. We'll maybe talk about it more in the match group episode.

Some of these dating apps get on the hamster wheel of marketing, but some of them escape. There's a few that escape. You know what I mean? Well, eventually the network effects takes over and you grow without needing to spend money yourself. But that is not the case for Spark Networks. As of the latest update, the effective interest rate on their debt was 12.6%. It is variable. It will likely expand if rates continue to rise.

They're in a tough situation. No way about it. They are going to pay any cash. they generate back to their creditors here. But let's talk to the earnings. First of all, say they delayed their 10K posting, red flag. Sort of. They're kind of at the end of the line with the auditors.

So, you know what I mean? They're last in line when they send their stuff in. They're going to do Apple first. So I wouldn't say it's a terrible... Well, it's also maybe because of the acquisition of the new CEO. So let me just say, it's not my number one red flag here, but it might be hit with a different company. Yeah.

Yeah, I suppose. But they haven't released their fourth quarter numbers yet, which is a bummer, but it should come out March 30th. Today is March 24th. You'll be listening to this, I think on March 28th. So it'll be right after this, if you want to take a look at it. But over the last 12 months, they've drawn $200 million in revenue. On that revenue, they've generated about 38% gross margin.

I find that crazy. Here's why, though. I was really confused on that. They include marketing spend and cost of revenue. That's why. It's a weird definition, but yeah. I know that's like an accounting, probably an accounting nuance, but for them, that's kind of interesting

because maybe it is a cost of revenue. Yeah. Yeah. Maybe it's because of that credit agreement. Who knows? Yeah. But either way, I kind of, it's not a big deal, but that's kind of, it's almost like, okay, if 38% and then we got to spend on product development and employees. And you still have app store fees. Right, right. Well, I'm saying after the gross margin. Yeah. All right. $35 million net loss for the year. A lot of that's due to heavy goodwill impairments. Operating cash flow was negative $1 million over the last 12 months. Adjusted EBITDA, I already mentioned it, to $22 million positive, which is good for their lenders. but it's keep in mind they've still got a lot

more than half that is foreign exchange reconciliation so it's not great I wonder what the debt would be trading at if it was publicly available well I wonder if yeah I don't know but I wonder if

any of their debt is payable in the currencies which they earn oh gosh we'd have to have looked at that That's too much in the weeds. I don't know. Because that would have been included in...

I mean, the lenders would have included that in their ratio. If they backed out foreign exchange, they would have been outside their required leverage ratio. Yeah, I'm guessing it's going to be USD, but it also could be Euro, just because they have that German presence. But they've been moving everything really to North America. Except for their workers.

They're all in Berlin. But as for the most recent quarter, revenue was down 11%. Half of that decline was due to foreign exchange. They did have $8.3 million in adjusted EBITDA. So pretty solid. A third of the market cap right there. That's true. I mean, if you're looking at just headline numbers,

their market cap to quarterly adjusted EBITDA for the most recent was like three or four times. But there's debt on the business. So I would not look at it like that. The important stat here, Zoosk average paying subscribers grew by 3.4% year over year. This was, I mean, this drives the majority of the business.

Subscribers have been in free fall or slow decline for a while now. So to see this, I think that's a big positive. And in my opinion, it makes the business a little more attractive potentially if they're able to sell this thing.

Yeah, that was the biggest highlight I saw when looking at their conference call. Yeah. The other thing, they said across the portfolio that they had 11% higher subscription conversion. So, number of users that subscribe. But if users are declining and the same amount of people or the same people are paying, your subscriber conversion goes up. So, that might have led to it as well. Yeah. They're like, hmm, what number can we make look good? All right. Let me move to valuation. Just as for any reference here on those, people are probably wondering about the

cashflow numbers and with the goodwill impairment. Because I was confused as well when looking. I was like, why is the cashflow conversion so much better than the net losses? And well, it's the goodwill. So I summed up all the free cashflow. And this is basically just the standard definition you take. Operating cashflow minus CapEx. We're not including acquisitions here. So this is basically all the excess cash that they generated. But besides that, they took outside capital and shares to buy Zoosk for $258 million. And since 2017 through 20, the first three months of 2022,

they've generated $26 million in free cash flow. So hasn't really moved in the right direction, but I guess they're around break even somewhat. But once you include the Zoosk acquisition, it's been very capital destructive or excuse me intrinsic value per share has been uh quite destroyed all right quick evaluation multiples market cap today is 24 million dollars add on that 80 what'd you have ryan 82 million i had 82 million from stratosphere let's say 82 million doesn't really matter enterprise value is 106 million dollars ev to sales is 0.49 so say 0.5

And then I went with EV to operating income. I wanted to just do some estimates. Basically, if you think this company can recover, it's pretty clear they could hit 10% profit margins and probably 20% if they were well-run and things were humming along, which is basically a complete 180 from where we are today. If they had an EV to operating income at a 10% operating margin, it would be 4.9. And then if it was a 20% margin, it'd be 2.4. So if they can get any sort of sustainable margin things are looking okay but remember that they still have to pay that heavy interest payment so we look at that general pe they'd probably still be trading like 20 times all right anecdotal evidence ryan any thoughts i know you are a uh in a relationship so maybe we

don't need to say any anecdotal evidence here but yeah i don't know if you downloaded the apps and got permission or something like that uh decided not to ask permission don't have to go through that dispute so um i just googled or i just youtubed um like zeus tutorials like demonstrations of the app and there's a couple of them um so i got a decent lay of the land as far as how the app goes it feels to me like zeus and really all the religious dating apps that they have Over the last five years, three to five years, Hinge has been probably the fastest growing dating app, at least in the US, where Spark Networks earns the majority of their revenue. And they've just, for one, they've gone after the same demographic as Zoosk. But the religious part that you can put in there on your Hinge profile, I think there's so much more incentive.

if you're a user or a data that cares a lot about your faith or your religion to use Hinge because you can manually filter through the people because you can easily see their religion and there's more supply.

Maybe it's premium only where you can switch through. I'm not exactly sure because I always have that watch button on there. Where you can actually filter specifically? I think it's for paid only, but I can't remember exactly. But yeah, that's a great point. I think I agree with you that the growth of Hinge has disrupted a lot of these legacy models that

were kind of hanging by a thread. And now maybe the network effect on some of these other businesses are totally unraveling. I downloaded Zeus. Like I said, I'm in Latin America. And I guess it's one of the countries where it operates in. And the app, I won't mince words, is a complete shit show. Not because there wasn't any people on there. There seem to be people on there. Maybe they're fake accounts i don't know but it's clearly an inferior product i had no idea how to they didn't first they didn't have a tutorial second i didn't know how to like what what to even do i'm maybe you said you got matches and you couldn't find them right no no they said i had matches i don't think i actually had any because i only clicked a few people and then i couldn't

find them yes because they gave me that notification they said you have matches come get your matches are waiting come get them and i had no idea where they were kind of just disappeared on the app then there's like one button that says click to pay for be a subscriber and you have no idea what you're getting so it's just it's it's terrible i mean it's terrible it's i couldn't have had a worst experience where... And here's the thing with these apps is you can get a lot of registrations. I mean, they get millions of registrations a year. You kind of get... If you're on top of the app store, that's kind of where people go for finding new ones or search on Google and you can pay for SEO. People are going to download it, but you have to keep them around and you have to make

it as easy as possible to understand because you want even the... I'm going to try to... This is not you want the dumbest person out there and the smartest person of all types whoever speaks any language to understand how it works and if no one understands how zeus works they're just gonna quit and then your network effect breaks what do you think about that as just being a giant low light for me yeah i mean like user interface and user experiences it's something we don't talk about that much but it's a huge part of success in online dating space um we'll talk about it being mobile for tinder really yeah and especially in mobile you see it with even even their own brands like they've instead of like converting christian mingle and maybe there's a christian mingle app

but instead of like converting some of these like web-based dating properties to apps they're like going after it just via a totally different brand like you kind of have to be mobile native and have a really good understanding of how people like uh interface or how users act on a mobile app and yeah if you just don't have a grasp on that you're gonna constantly get the ridiculously high churn yeah yeah i agree all right future growth opportunities again for a company that as we'll talk about in the highlights and low light sections, or maybe some of the other section, maybe let's just address it now. They, for more context, they have said they're explicitly looking for a buyer. They've said that since last summer, they bought in Chelsea Grayson, or excuse me,

brought in Chelsea Grayson as someone to get them acquired. The stock is down about, I think, 75% since then. So that's what we're referencing when we talk about that. And that's kind of the context we have for the future growth opportunities because they're in a bit of a limbo period right near. But Ryan, yeah, why don't you go and let me bring up the stock chart just for any viewers. Talk about what the future growth opportunities? Yeah, go through your future growth opportunity.

Yeah, I mean, I'm trying to put myself in the CEO chair here. I would not know what to do. Obviously, what they're trying to do is sell the business. I don't know if they want to auction off their properties one by one for

how much they can, however much they can. Maybe you try to run the business entirely for cash and pay off your lenders, which is what the lenders have basically contracted you to do. So I don't really know. I will say, if Zoosk turns around somehow, if they begin growing subscribers on a regular basis, and maybe it's just the overall tailwind just propels them this could be this could have some of the best returns of all dating apps over the next three years oh i mean equity could yeah the equity could be a 10 beggar for sure now the likelihood of that i will say is quite low in my opinion but the upside is there and

when we look at those subscriber numbers i think the big concern i have is just how much are they pouring into marketing for zeus right now and is that kind of an artificial you know house of cards that they're propping this thing up with. But yeah, my future growth opportunity, let me just go through it. I think really the only way out of this death spiral besides an acquisition is you have to bite the bullet and modernize the UIs, the user interfaces,

the user experience, and you have to differentiate your assets from the services with the clear lead on smartphones, which again, smartphones, mobile apps, among people under 35, which we would refer to as the big three, plus Grindr, I guess, big four, potentially, sort of.

This will require pain, right? You got to hire software engineers. You're going to have to pay them a lot of money to get good ones. You got to fix all this technical debt. You got to get rid of all the, you got to get better anti-fraud and scam tools,

which when I looked at reviews on the app stores, their apps had terrible reviews for fraud. And that is a big problem among dating apps in general. But most of the companies can get it, you know, they're not going to be 100%,

but they're a lot better than what it seems like some of these apps are doing, especially like Zeus. I mean, earnings are going to take a big hit in the short run. I don't know how they would get the liquidity to do this. And maybe they don't. Maybe they're in a tight spot because they don't have the cash. But eventually, they could get to the other side and build up a portfolio of niche dating apps that can work well for these target markets.

And I think there would be a business model there. But I don't know if it's possible to have this be done as a public company. I think they might need to be acquired by a private equity firm and then enabled to have this happen what are your thoughts I mean yeah but like if you're a private equity firm but you take this risk these things are so

hard to turn around I at the right I don't know if at the right price would you I don't know basically zero out you'd zero out the equity yeah

which like that's probably not very optimistic for shareholders. I mean, you have to swallow $100 million in debt. Yeah, that's the big thing. I think they would be able to make this pivot potentially

if they got a good management team in there. If they didn't have this debt, but they do. It's the reality. Okay, highlights and lowlights, Ryan. What did you like, dislike about this one? I know our lowlight section here

could be 10 things long, but I think I limited mine to three as well. Yeah, I'll maybe actually try to make my lowlights more succinct. But my highlight is they are improving the subscriber number at Zeus. Now, I don't know if they're massaging this number in any way, but if that is genuinely turning around, first of all, maybe, maybe someone buys out the overall stock at a premium

if they think that Zeus is growing once again. The other thing, if they choose not to go with a buyout offer and Zoosk actually still grows and maybe they generate more than enough cash to pay off the lenders, I've said it before, this will be a multi-bagger for sure. But that requires a significant improvement in the business. low lights for me though I'm going to steal a quote from a comment I saw there's been a couple value investors club write ups on Spark Networks

there's been like 10 over the last 10 years yeah and a lot of them I think missed the ball but one of the comments basically it was someone who had been a shareholder before he says Spark is a roll up of inferior brands and with each

acquisition we're told now we are at scale yet it's never at scale. This has happened every time. He adds, they need huge advertising spend to keep the new users. The marketing spend is bearish, not bullish. They need it to survive. I think it's totally right. This is what a subscale online dating business looks like, and it's not pretty. Nothing. Okay. There's nothing about scale, about owning two separate ones that gets you to scale. It's all about individual app getting to scale it doesn't matter tinder versus angela are actually competing with each other bumble and are competing with each other but the companies can leverage their ownership of them and kind of

massage what part of the marketplace they're going after and once they hit that scale once they hit that um kind of threshold then you can get there but it doesn't matter if jay date and christian mingle have some sort of users the users don't overlap especially especially those by definition they don't overlap and there's the biggest cost here aside from performance marketing for for spark networks is the cost to develop the apps yeah so if you spend if you have i would so much rather have one successful digital property that costs 10 million dollars to build that has let's call it 50 million monthly active users then 10 of those apps that reach the same size

and all cost the same to build. Yes, exactly. It's a huge difference in operating leverage. And so, I mean, this is exactly what you get when you have a bunch of subscale brands is it costs money to grow. The network effect doesn't grow the platform for you. And because you have to spend money to market,

you really don't have I think enough to reinvest into developing a competitive platform there's just like it's the it's the

the operating leverage cuts both ways in the online dating business here's what's interesting is I'm gonna sound like a dating app bull which I am

but it's amazing that these apps aren't dead yet it's amazing how Zeus could be dead. It's amazing how it's like they're trying to kill it. It's like they're trying to kill it

and it's not dead yet. It's amazing how there's not many different steps you would make from your app design to kill an app than what they did at Zoosk. And yeah, it's slowly dying, but it's taken a while. It's weird how these things can kind of linger around for a long time. I mean, even

eHarmony has users still. I think that's just an interesting note. it is weird I mean you know half a million people still pay yeah

why I don't like the only theory that I could come up with for why these people still pay

is that these are like daters that have like 20 different apps and they pay for every one oh they have they have a lot of disposable income yeah

it's interesting maybe there's nothing about this okay maybe it's in line in america maybe it's in europe but like there's nothing about this plot any of these platforms that are better than hinge if you're a dater yeah or or any of the big the say the other four ones um or bumble like yeah badu bumble tinder hinge uh grinder if you're lgbtq you have those you download those and you go wow these are way better they have way more people but i'm gonna pay for

zoos it doesn't make much sense to me so i don't really get it but hey it's there but anything else before we move on to mine i think you can make any business survive for a while with enough performance marketing dollars yeah yeah so maybe that's what's happening all right uh you have any other low lights you want to hit or do you just nope i'll go to mine no go for it okay yeah my highlights um their their spc has been free i mean it's actually kind of important where all their potentially delivered securities will not best uh or or if they do have the potential the best you're gonna have a five bagger where the average strike price right now is four dollars and 77 cents current stock price is below one dollar uh b there is the possibility of a buyout

at a huge premium like ryan mentioned if zeus even just stabilizes they'll get acquired for probably 100 100 million dollar market cap something like that which is a four-bagger from here but to be clear and i hope we've been negative enough because this is a micro cap and we never want to pump you know sound like at all like we're pumping a micro cap because we're not at all this is only a possibility it's a small possibility and it's really a lottery ticket um other highlights they said they were it's sort of a bittersweet highlight they said they reduced their fraud on their platforms by as much as 80% of some of their brands.

It's definitely not a bad thing, but also you're kind of admitting that there's rampant fraud on your, on your stuff. So there is all these, but yeah. Yeah. But I think looking at the reviews, it is much,

much worse at Zeus than the others. But yes, to be fair, there is stuff at Tinder, Bumble, hinge grinder as well. My low lights from the words of management here. Here's a quote to kind of show how bad Zeus has been quote.

Since we acquired Zeus, subscribers declined every quarter for three years until last quarter that is not confidence inspiring for an acquisition that valued zeus at 258 million dollars um since 2017 like i said the entire spark network has generated cumulative free cash flow of 26 million dollars the return on zeus has been heavily in the red uh so far uh here's the other low light is they're hyping up that they're going to spend more money on marketing in North America, which my first thought, my sarcastic

brain just went, yeah, that market is not crowded at all. That's what my immediate thought was. You're going to lose. It's not going to work. Well, if you were required to spend marketing, how would you paint it? I guess that's true. Hey, we have to. That's not very confidence

inspiring either. They're trying to put a positive spin on it. Yeah. And then last one I had is I could list a dozen lowlights here. But in reality, almost every important thing we look at, business model strategy, user experience, nurturing acquisitions, financials was a big lowlight. And this is by far the worst business we have ever looked at under our not-so-deep-debt format.

On the flip side, though, I think this is an interesting discussion question. How do you think about Spark Network's seeding share to apps like Grindr, Bumble, Tinder, et cetera? and can that be relevant for those companies as maybe these if this company goes bankrupt and these apps kind of disappear is that helpful is that nice for these uh i guess it's only four percent of the market but is that good for the competitive landscape for them maybe i mean it's it's probably small in terms of like users like if all these users converted over probably want to make the big platforms that much

bigger, but maybe all Zoosk's users would make Hinge bigger, but think about this almost like the tobacco space where anyone could make a cigarette.

Maybe the tobacco space isn't good. The barriers to entry are low. The barriers to success are insanely high, especially now that you have all these insulated players with tons of scale. it would be really difficult to replicate these platforms. It blows my mind that Hinge was able to climb that wall.

Well, they wouldn't have, I mean, well, one, their UI is amazing, but they wouldn't have been able to do that unless they were under Match Group because they wouldn't have had the funding and Match Group really got that monetization engine going for them by copying all their products. I think what's interesting, yeah, there is a high barrier to success here.

And I think a lot of people talk about the bear case for the dating apps in general and maybe the ones that are popular today. And we'll talk about this on the Match Group episode as well, is that there has been historically a lot of disruption within the online dating space. But I think the big reason for that was the smartphone. And when there was a new platform shift, all the old platforms got disrupted.

And when you look at the popular dating apps that started as mobile apps, first Tinder, then Bumble, then Hinge, Badoo, I guess actually Badoo was first, and Badoo has been mismanaged. Grindr. None of those have been disrupted yet. So I think the key is if there's a platform shift that allows the avenue for disruption. But again, we could be totally wrong. We'll talk about this further

on the Match Group episode. All right. Both case, Ryan, what do you think? Or any follow-up there, but maybe save it? I don't know. Yeah. No. Both case for me is buyout. Problem is everyone knows they're looking for one, which

I don't know. It just doesn't seem like Who buys it? Yeah. Private equity. There's no reason. Obviously, Match Group has looked at them and said, it's just not worth it. We can kill them ourselves.

We'll buy their users by building our own product, which they've done. So it would have to be private equity. But at the same time, if you're private equity, and it has to be someone with enough money to pay for the debt, uh is it it doesn't seem very like they're trying to sell themselves you know the assets are struggling they can just do the same due diligence we did you know there's uh these are dwindling businesses i know get insights into all the cockroaches that are on the sec filings

i mean you have to believe that you can like firmly turn this around i just don't see how you get a premium when you're begging people to buy you. Yeah, that's a great point. My bull case, though, is the only upside I see as well is a private equity firm buying out some of these assets. What do you see the likelihood of that happening

is? Handicap it right now as, well, it'd be totally off, but I'd say my probability on that is that it gets bought out with any sort of value for the equity holders. I say 30%.

I'd probably go lower. Lower? Yeah, probably. But a number. It doesn't matter, but a number. Okay, if you just put like, maybe you're right, maybe 30%. Because if you just X'd out the debt, let's assume whoever bought it just pays the lenders in full. And then you pay, let's call it $40 million for the equity.

So you paid $140, $130 million for the whole property. How much do you think this business could generate cumulatively in cash if they just ran it for profits? How much do you think it could generate cumulatively in cash for the next five years? Conservatively, I'd be optimistic. $50 million? I think $100 million could be possible

if it doesn't just continue to just hemorrhage users. Yeah, it's tough to say. I'd have to know more about their marketing, how it works. Yeah, I don't know. I guess there's the possibility that there's a buyout premium. Yep. All right, bear case for you, Ryan. I think it's obvious, but let's talk about it. Yeah, I mean, they're just unable to pay their lenders over time.

That's really the big one. and this business ends up owned by the lenders or ends up in bankruptcy, that feels like the most likely outcome right now. That's what the market's pricing in, yeah. I mean, yeah, my bear case is things just keep moving in the same direction regardless of this one quarter of Zeus growing their subscribers.

I mean, things don't still look bad. The downside was zero at 1,000% higher from here, and it's still zero after the 90% plus drawdown. I think it's extremely likely shareholders get zeroed out here. And I think it's a great lesson in microcap investing, or not microcap investing, but analyzing a microcap. They're going to be sticky. there are some you know we like deep when we go to microcap we kind of like deep value

and that's what our hunting ground is and you could describe this potentially as a deep value maybe but this is not there are certain characteristics we look for with microcap deep value and this is not this had none of them so yeah no it didn't

the death was like the kiss of death yeah there could be something here if they didn't have that but either way is still unownable because it's just clear these properties are irrelevant. All right. I don't think we have

a more or less interested because we're both less interested. Hold on. Let's talk about stock. Oh, closing thoughts, Ryan. I would maybe go more interested. Maybe.

It would obviously take some seriously big changes, but let's say, what if you saw big subscription growth at Zoosk over the next couple quarters and Zootop?

if cash flow doesn't look good I don't care about subscriber numbers because I can juice that with the marketing budget yeah honestly the whole marketing thing the debt just throws this whole thing off but if there was a debt I'd be more interested if they survive and they can

make Zeus a modern dating app then there's potential but that's a long road ahead okay stop for next week as we close out the dating app episode or excuse me theme is going to be match group we own it in the arch capital fun. We're going to go through that specialized episode where we kind of go through our analysis, our bull and bear cases, and what we're looking at for reasons to buy, reasons to sell,

all that good stuff. Remember to subscribe to the newsletter to get the charts that go along with this episode. Watch us on YouTube or Spotify and give us a review on Spotify or Apple Podcasts. We are not financial advisors and anything we say on the show is not formal advice or recommendation. We are general partners at Arch Capital and clients may hold securities discussed in this podcast. Thank you all again. Hopefully, this was a good lesson in studying microcap companies. We'll see you all next time.