While the equity markets have largely recouped losses from the Brexit vote, uncertainty remains. Yet, these six small and medium cap tech stocks, Pandora, XO Group, Match Group, IAC, Shutterfly and HSN, are Brexit-proof and poised to outperform in the second half of this year. For the most part, these companies have zero to minimal exposure to U.K./Europe and are therefore free of currency translation risks and the potential for longer-term macroeconomic disruption from Brexit.
We recently changed our tune on Pandora and upgraded the shares to a buy after being neutral on the stock for the past few years. We now believe that there is a greater probability of Pandora building a successful and differentiated on-demand service while increasing the value of the core business. Users' appetite for paying for music streaming is increasing and Pandora is poised to capture share cost effectively. Moreover, Pandora's multi-pronged model reduces the risk of dependency on the core business to drive shareholder value. After being negative for several years, the music industry participants we speak with have turned positive on Pandora. Further, we believe Pandora's rich technology, its user interface, and large user base, make it a compelling acquisition target with interest coming from large Internet, media and telecom services. Pandora has zero exposure to Europe. We have a "Buy" rating on Pandora with a $16 price target.
Formerly The Knot, XO Group is an online wedding and pregnancy planning marketplace, and a legacy Internet business that has been successfully turned around by new management. The model has strong operating leverage and free cash flow generation, and is unique in that it has low capital requirements and low customer acquisition costs. Plus, the balance sheet is clean with $3.50 per share in cash and zero debt. Value drivers include a large $130 billion market, a developing fast-growing 100 percent gross margin transactional marketplace, a growing local online advertising opportunity, and a national online advertising growth opportunity.
First quarter 2016 revenues and adjusted EBITDA outperformed our estimates for the second consecutive quarter on strength in the transactions business. Organic revenue growth was in the double-digits and margins expanded. A transition to a new customer relationship management system is expected to impact local sales productivity this year, which should pressure local online advertising results. However, XO still sees itself achieving its target of double-digit overall growth and adjusted EBITDA margins of at least 20 percent in the back half of this year on strength in the transactions business and good operating leverage. At 10.5 times 2016 EV/EBITDA, the shares trade at a discount to other e-commerce and online media companies. XO has zero exposure to Europe. We have a "Buy" rating on XO Group with a $21 price target.
IAC has been a notable under-performer this year, even relative to Match Group, where it owns a majority stake. The shares trade at a 23 percent discount to our intrinsic valuation of $74 per share. Moreover, the current trading price implies that the core business is valued at $700 million versus our $2.2 billion valuation, including $1.4 billion for HomeAdvisor alone. This mispricing is due to model complexity, low confidence that search will recover, skepticism that Match can deliver against management expectations (high short interest) and lack of understanding of the key assets, specifically HomeAdvisor.
In addition to expected continued strong growth at HomeAdvisor, we see additional catalysts that should drive the stock over the coming year:
- The management team is becoming more transparent about the drivers of the various businesses and is making executives more accessible to investors;
- The company is repurchasing its stock;
- The eventual spin-off of the Match Group shares to shareholders; and
- Match Group's shares remain undervalued (+16 percent upside) with this upside to be driven by Tinder and growth resumption at Match later this year.
While the publishing/application businesses are under-performing, they generate cash flow that could be used to fund other businesses and acquisitions. IAC's exposure to Europe, ex-Match, is in the mid-single digits. We have a "Buy" rating on IAC with a $74 price target.
Though Match Group shares have performed well since the rough patch after its first earnings report as a public company, we still see meaningful upside for the stock, driven by Tinder, which we believe continues to grow subscribers and monthly active users at a strong pace. Meanwhile, App store fee reductions, especially from Google, should generate a lift in EBITDA, and Tinder should also benefit from more monetization options to come. Further, advertising is on track for year-end.
There are still pockets of investors who are unconvinced of Tinder's potential or in the ability of the Match brands to overcome the mobile conversion issue or follow the turnaround at Meetic, the European dating site. We understand that, given the heightened competitive landscape, individual dating brands that are under-performing, management missteps (missing guidance in the past when under IAC), and of course the share price reaction following the fourth quarter 2015 earnings report. As results are reported this year, we believe those fears will wane as the mobile conversion issue is solved, Tinder monetization increases, Tinder moves towards its aspirational goal of doubling paid members, and advertising kicks in.
The recent nugget from management that paid features on Tinder reduces churn compared to other Match brands refutes the bear thesis that Tinder's demo of millennials are hesitant to pay for dating or that churn rates are high. While Match does have meaningful exposure to Europe via Meetic, its revenue exposure to the U.K. is small at 3-4 percent. However, given the rapid growth of Tinder across Europe and given that the online dating model is not as economically sensitive as others such as advertising, we see Match weathering the impact of a recession in the European region better than others, if in fact a recession ensues. We have a "Buy" rating on Match Group with an $18 price target
Shutterfly is unique in that there is an outstanding offer to purchase the company from a private equity firm. The exit of the activist investor and the new Amazon-trained CEO Chris North, in our view, does not alter the acquisition story for Shutterfly. So far this quarter we have seen very little reason from our checks to believe that the competitive landscape has become more challenging for Shutterfly and the second quarter report is likely to be solid. The first quarter saw strong growth from the enterprise business, which continues to outperform our expectations, and also good operating leverage.
Core consumer revenues did miss our expectations, but that was likely due in part to the unlimited free prints promotions tied to the mobile app, which had the effect of driving 1 million downloads of the Shutterfly App. Adjustments to the deferred revenue contribution in second quarter 2015 could mean a rebound in the consumer growth rate in second quarter 2016. Plus events such as Mother's Day, Father's Day, and graduations should drive traffic to Shutterfly in the second quarter. The upside to our price target is lower than other names in the group but with an open bid for the company keeping a lid on the share price and the potential for rebound in consumer revenues, the shares could be re-rated higher. Shutterfly has zero exposure to Europe. We have a "Buy" rating on Shutterfly with a $52 price target.
While technically not an internet stock, internet/mobile drives 44 percent of HSN's TV shopping segment revenues and 70 percent of the cornerstone segment's revenues. The stock has been an under-performer this year, facing a challenging retail environment. The shares are down 4 percent year to date vs. up 3 percent for the S&P 500 and flat performance for the Dow Jones Retail Index. HSN has, however, outperformed its closest peer, QVC, which is down 6 percent year to date.
The team is focused on returning both segments to healthy sustainable growth rates through investments in key brands and product categories, and is managing costs effectively to deliver better adjusted EBITDA growth, which has occurred in the past two quarters. Efforts such as the warehouse automation initiatives and reductions of inefficient headcount at both segments should lead to further above consensus adjusted EBITDA quarters.
The TV shopping stocks have been caught up in the weakness of overall retail stocks but they are unique in that they offer investors more sustainable top-line growth rates and have in the past outperformed traditional retail in both good and bad times. The customer base is durable and has high disposable income in addition to high repeat usage and high retention rates. Compared to traditional retail, the models are low capital intensity, have higher EBITDA-to-free-cash conversion rates, and have very little advertising expense. HSN has zero exposure to Europe. We have a "Buy" rating on HSN with a $66 price target.