📍TL;DR

Insurance marketing firms like MediaAlpha have seen their stocks soar in 2023.
The catalyst hinges on an anticipated rebound in carrier acquisition spending; MediaAlpha has struggled amid sharply reduced profitability in the auto space.
But a ~$1.2 billion enterprise value prices in a rebound — and then some.
After this rally, a short of MAX works well if the cyclical swing doesn’t happen — and should survive even if it does.

One of the odder things that has happened in an odd 2023 market is a massive rally in companies that provide marketing services for the insurance industry:

source: YCharts

MediaAlpha , which runs a two-sided platform serving the industry, has been a particular beneficiary. Shares are up 63% year-to-date, including a 12% rally on Friday following the release of Q4 numbers on Thursday afternoon.

For both MAX and the group more broadly, there’s logic to some level of optimism despite ugly recent results. 2022 was a brutal year for insurance companies, who in response significantly reduced their marketing budgets. At some point, the spigot will again be turned on, allowing providers like MediaAlpha to return to growth.

The problem is that these rallies increasingly look like they’ve already priced in the best-case scenario. For MediaAlpha in particular, there are plenty of reasons to be skeptical that the best-case scenario will ever arrive. That in turn creates an attractive opportunity to fade the big YTD rally.

source: MediaAlpha website

Introducing MediaAlpha

MediaAlpha operates a two-sided programmatic ad exchange serving the insurance industry. Insurance companies acquire the information of prospective customers, which are supplied by publishers and, occasionally, insurance companies (more on this in a moment).

source: MediaAlpha S-1

Most of the business is transacted directly online: “clicks” (recognized when customers click on an advertisement) drove just over three-quarters of total transaction value in 2022, while phone calls accounted for 15% and leads about 10%.

Property & casualty (mostly auto) accounted for over half of 2022 transaction value; health insurance just over one-third; and life insurance 6%. The remainder comes mostly from travel insurance.

MediaAlpha was founded in 2012. Two years later, White Mountains Insurance took a majority stake in the company. In 2019, White Mountains as well as MediaAlpha executives cashed out a portion of their ownership through a transaction with Insignia Capital. The company then went public in October 2020.

The Long-Term Bull Case for MAX

That IPO did quite well, even by the standards of a roaring bull market. Investors clearly saw a long runway for growth ahead.

Relative to legacy lead generation firms like eHealth or Everquote , MediaAlpha seemed to have built a better mousetrap. Those companies largely built their own websites for insurance shoppers, paid Alphabet unit Google for traffic, and then sold the resulting leads mostly to insurance agents. Historically, this is the type of low-value business that has delivered poor returns for shareholders.

In contrast, MediaAlpha focused more on the direct-to-consumer insurers. This alone provided a potential tailwind. As MediaAlpha noted in its S-1, Progressive and GEICO had grown from an estimated 23% of auto premiums in 2013 to 30% in 2018. Further movement of the industry to the direct model — with some agent-driven companies like Nationwide launching their own direct brands — promised a tailwind for MediaAlpha's growth.

So too did the insurance industry’s relative lack of digital advertising. Per MediaAlpha, about 21% of the industry’s marketing spend is executed online — roughly one-third the level seen in the economy as a whole.

With leading scale and existing relationships with most major insurers, the case was — and probably still is — that MediaAlpha should grow revenue for years to come.

The Cycle Turns

Early on, it seemed like MediaAlpha indeed was on that path. In 2020, for instance, transaction value increased 46%, revenue 43%, and Adjusted EBITDA 35%. After the second quarter of 2021, management noted in the shareholder letter that transaction value had more than doubled in just two years.

But results stalled out in Q3, then turned negative in Q4. 2022 proved to be a disaster. For the full year, transaction value fell 28% and revenue 29%; Adjusted EBITDA plunged 61%. That reversal in the business led to a swift and steep reversal in the stock:

source: finviz.com

But MediaAlpha management has framed the steep decline as being driven by changes in customer behavior rather than any issues with the company’s business model. The explanation from the company has been that auto insurers faced a so-called “hard market”. They were hit hard in 2021 by rising costs (among them, sharply higher replacement expenses owing to supply chain disruptions) and in many cases couldn’t get regulatory approval for higher rates. They thus pulled back on marketing spend to get their financial houses in order.

Management isn’t making the story up. Progressive, for instance, had a brutal stretch starting in the second half of 2021. Third quarter earnings that year were barely positive, as Progressive’s combined ratio cleared 100 (up 12.6 points year-over-year).

And there are signs that the market is starting to turn back in the right direction. Rate increases are getting approved, and on the Q4 call MediaAlpha cited one major customer that has returned aggressively to customer acquisition. History suggests (though this environment is truly unprecedented) that others will follow.

Whether the “hard market” ends in 2023 isn’t clear at the moment. But from a mid-term perspective, the precise timing perhaps isn’t all that important. At some point, industry conditions will normalize, which means customer acquisition spending will return, which should allow MediaAlpha to return to growth.

It’s that cyclical optimism that likely (at least in the most generous interpretation) has driven the stock higher, despite the fact that results haven’t yet improved. In Q4, for instance, MediaAlpha saw revenue fall 23% and Adjusted EBITDA drop 32%. Q1 guidance suggests more pressure, with transaction value down 18-25% and Adjusted EBITDA expected to grow modestly at best.

The Valuation Problem

The problem with the rally to this point is that even if the bull case is correct, it’s largely priced in. Relative to 2022 results, MAX looks almost absurdly expensive, at more than 50x Adjusted EBITDA1. That doesn’t even account for $59 million in stock-based comp, against a reported figure of ~$22 million.

Again, the cycle is likely to turn. But the problem is that MAX looks expensive relative to peak earnings as well. Shares trade at 18x the midpoint of full-year 2021 guidance given after Q2 of that year — before the auto insurance market turned sharply south.

In the context of the growth that MediaAlpha was posting at the time, and given an attractive long-term opportunity, 18x perhaps doesn’t sound that high. But in fact, that multiple looks potentially stretched, for a few reasons.

The most important is that MediaAlpha itself sold a huge slug of equity for a far lower multiple back in 2019. Insignia took a 21.6% stake in the company (by units) at a valuation in the range of $300 million2. That's about 9x 2018 Adjusted EBITDA ($32.1 million, per the S-1) and ~7x the 2019 print.

It’s not as if MediaAlpha needed the cash. In fact, it didn’t even get the cash: as noted above, the investment went entirely to cash out insiders whose units were repurchased using the Insignia investment. Nor was the business struggling. Chief executive officer Steve Yi said on the Q2 2022 call that transaction value in the property & casualty vertical had increased 80% in 2018, as the business emerged from yet another “hard market”.

That expected 2021 EBITDA in retrospect looks like it was a peak. In the S-1, MediaAlpha noted that GEICO had increased spending 82% in two years, and Progressive 28%. Management has admitted that the novel coronavirus pandemic boosted pricing, and lower combined ratios (thanks to sharply reduced miles driven amid work-from-home and other trends) allowed insurers to get more aggressive with their spending.

Relative to normalized and/or mid-cycle EBITDA, MAX is likely trading at 20x-plus EBITDA. The price to free cash flow multiple might well be past 100x accounting for dilution (even accounting for the fact that this is an exceptionally capital-light business). Again, even if the cycle moves in MediaAlpha’s favor over the next couple of quarters, it’s difficult to see the valuation here becoming notably attractive.

Is MediaAlpha Different?

Historically, paying up for growth with this group has led to massive losses. EHTH and LendingTree both are down 90%-plus from all-time highs.

SelectQuote went public at $20 in May 2020 and even up 262% YTD trades below $2.50.

At this point, the risk in the group presumably should be evident to the market. (Admittedly, YTD performance suggests otherwise, but we’ll get to that.) The case for MAX stock might be that the company is different. It’s not a traffic reseller like its rivals, but a true platform with a touted focus on transparency.

Problems At MediaAlpha

But a closer look suggests that MediaAlpha really isn’t that different. It too operates websites that buy traffic and sell leads. One of them is ObamacarePlans.com, which has faced multiple complaints that it misleads customers.

source: npr.org

It even served as the centerpiece of an article arguing that search engines should be operated as a public service.

source: currentaffairs.org

As for the advantage of the platform model, there’s been no sign of it of late. MediaAlpha’s results have been worse than most peers. After Q2, Yi explained the divergence by noting that those peers focus on agents instead of direct sellers, who are less likely to pull back (and whose advertising subsidies from insurers stay stable in all environment). But MediaAlpha also has promised a big move into that agent channel, which so far has shown no apparent success.

Meanwhile, there is evidence that end customer weakness in the automotive vertical is not the only issue here. After Q2, MediaAlpha guided for a strong Q4 in the health insurance market; transaction value actually was essentially flat year-over-year. (Executives touted the performance anyway.) The travel vertical was 10%-plus of revenue before the pandemic, and even with a huge rebound in U.S. air travel of late is now just 3-4% of the total. Life insurance transaction value fell in 2022; the company blamed fewer searches in a more normalized post-pandemic environment, but even that explanation only provides more evidence for the thesis that 2021 performance was an unsustainable peak.

This isn’t a terrible business. It might be a better business than legacy rivals in the space. But MediaAlpha also has gross margins in the mid-15% range. It’s not some cutting-edge business transforming its industry. It shouldn’t be valued as such.

What Goes Wrong Here

Admittedly, arguing that the stock is overvalued is not necessarily the same as calling for a short. The one key risk to shorting MAX here is that the story driving the stock higher may last for a few quarters before it disappoints (assuming it disappoints at all).

That said, we’ve already seen many similar early 2023 rallies fizzle out in recent weeks (including gains in the broader online advertising industry, exemplified by the U-turn in Unity Software last week). Again, this is a company valued in excess of $1 billion trading at over 50 times Adjusted EBITDA. And there doesn't necessarily seem to be that much to keep the rally going at this point, with earnings reports across the group now largely in the books. MAX already has raced well past the consensus Street price target, and despite the post-Q4 rally it’s difficult to see nearly enough for analysts to play catch-up too aggressively.

To be honest, we’d understand a short of pretty much any stock in the space. The history of value destruction, the likelihood that 2021 performance was unsustainable, and still-present macro issues among end customers all underpin reasonably attractive short cases. For various reasons (including cost to borrow) MAX looks like the best choice of the bunch. We may be a bit early, but we see a real likelihood that this rally reverses, and maybe sooner rather than later.

As of this writing, Vince Martin has no positions in any securities mentioned.

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1

MediaAlpha stock actually provides ownership of units in the operating company; adjusted for units outstanding (~63M), market cap is just over $1 billion, and net debt is $167 million.

2

A press release at the time said the valuation was $350 million, but figures from the S-1 imply a $290 million figure. Given that Insignia was given downside protection, including a put option, it’s likely the headline valuation mirrored those of most private companies in providing the most generous interpretation possible.

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