Will Family Trees Make Green for Ancestry.com IPO?

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Ancestry.com has filed to go public, and will try to raise around $75 million. Despite a large pool of potential customers, Morningstar equity analyst Larry Witt thinks the company will struggle to sustain growth. The genealogy firm, which offers a subscription service for people to research their family histories, could also have trouble separating itself from competitors. Here is Larry's full take on this low-interest offering:

"Over the past 12 years, the company has digitized, indexed, and put this content online, creating a vast database of information for its subscribers. Ancestry.com also allows its subscribers to post the family trees they have created (along with photos, historical documents, written stories, and audio clips) for others to view. In fact, the company's registered users have shared more than 9 million family trees over the past three years. Because this makes the service more valuable to others, we think Ancestry.com could benefit from a network effect over time.

"Despite a business model that does not require a lot of capital, Ancestry.com's operating margins have remained fairly low (less than 10%). While some of the company's operating expenses (R&D, G&A) should scale over time (assuming sales increase), we think other costs will remain high. The cost of acquiring content could actually increase if competitors emerge, as competitors may try and lock up exclusive deals for content (although most of it is free). Additionally, marketing costs are bound to remain high, as the company needs new subscribers every year. The company's annual churn rate is greater than 50%, as there is no reason for most subscribers to renew once they have completed their research. Another factor that could prevent significant margin expansion is the low barriers to entry with this business, which could put pressure on pricing. Although Ancestry.com has a head start on the competition, another competitor could gather, index, and sort the same content. With similar content and distribution (the Internet), a price war could follow.

Ancestry.com has built a respectable, niche business with an emerging network effect. But we are skeptical that there is a large, untapped pool of customers that would be interested in the service, potentially making it difficult to sustain revenue growth. On the other hand, if there is significant interest in this type of service, there are few barriers to entry, and it would be difficult for the company to differentiate itself from the competition."