Saturday, April 21, 2012

I am still the easiest person to fool

I thought I discovered a gem when I spotted a company called Ancestry.com (ACOM).

It eventually turned out to be a dud but I learned a few important things along the way.
Key points:
  • Beware of rationalising doubts with superficial reasonings
  • Pride can cloud judgments
  • Don't ignore the market
  • Use a checklist
  • Scuttlebutt is important
  • Reflect and improve
As its name implies, it allows people to trace and discover their family trees and connect with family members. According to its website and annual reports, not only it maintains world's largest genealogy database, it has also been building up a huge collection of user-generated content about their family histories. Another website states that genealogy is 2nd most popular past time behind gardening. Ancestry.com has a subscription model. Users pay a monthly fee to access its database and connect with discovered family members.

Immediately, the following phrases popped up in my mind: "recurring revenues", "network effect", "zero margin cost", "moats",... A quick scan of its financial results brought up something too good to be true: A fast growing business with a market cap of $1 billion and ttm FCF yield at about 11%. Wow, a business with Facebook-like quality at a cheap price!

How could it not been discovered? I couldn't help but decided to look deep.

Then, I spotted something unusual. Short ratio was 10! That was nothing ordinary.  What was going on?

I found a couple of bullish articles on Barron's. Nothing looked alarming. I found some writeups on popular investing websites. It appears some investors questioned how much further it could grow and how long the users would keep their subscriptions once they had found what they were looking for. Could these explain the shorts?

Brushing the concern of the shorts aside, I decided to do a search on review sites like Yelp.com to see how satisfied the users were. Here I found my first lead of the real issue. This subsequently led me to more user reports on the Consumer Affairs website. The gist of the issue is:
  • Ancestry.com always charges its users upfront for the entire year even though its website implies fees are monthly.
  • They make it very hard, if not impossible, for you to cancel your subscription.
  • Subscription fee kicks in immediately right after the 14-day trial period. Again, it's almost impossible to stop it.
It also appears Ancestry.com has engaged in this practice for many years.

No wonder their receivable turns are that short. No wonder the platform is sticky. It handcuffs your credit cards to its cashier. This is at the borderline of being a scam.

What are the lessons here?

I am the easiest person to fool. When I re-trace my thoughts, I see a few dangerous signs.

When I initially read the claim that genealogy was the 2nd most popular past time behind gardening, I had a flash of doubt. Isn't family tree discovery an one-off thing? How can it be addictive like World of War Craft or Facebook? Is there really "re-play value"? But Ancestry.com's financials seem to indicate otherwise. And its publications paint a very rosy business. I treated them as "proofs" and suspended my skepticism.

Second, I was too eager to uncover "hidden gems". Now think about it, it's impossible Ancestry.com was  under the radar. It's sponsored popular TV show "Who Do You Think You Are" in the States as part of its marketing campaign. My pride clouded my judgments.

Third, you got to wonder why Barron's and other investors were not aware of this questionable billing practice. Probably the sell-side analysts with Barron's had the incentive to turn a blind eye to this...

What saved me from losing more than just a few hours of my times?
  • I didn't ignore the market. The market is usually very efficient. Re-assess my edge.
  • I went through my checklist.
  • I looked beyond the financials. I tried to understand the business from the customer's perspective.
  • I reflected upon my past mistakes. This post itself is a reflection. It's so crucial to learn and adjust.   

(Disclosure: no position)

2 comments:

  1. Actually, IMO, the first and most important mistake was "Brushing the concern of the shorts aside".

    These are usually the most well-researched investors in the market.

    ReplyDelete
    Replies
    1. Hi Pacioli,

      You are absolutely right.

      Delete