Gaia: Misconceptions

Since our last article, Gaia(GAIA) has increased by over 20%, handily beating the S&P 500. However, we still think Gaia is substantially below fair value.

In our last article, we received a lot of criticism due to missing out some of the major points in the bear case, like churn or TAM. We'll address the concerns in this article. Since Gaia will be reporting earnings soon, we'll also give our projections for Q3.

Churn

Churn is obviously one of the primary concerns of every Gaia shareholder. We've done the math on churn after writing our last article, and we concede that it doesn't look good for Gaia, with churn last quarter being over one-fifth of their sub base and with it growing sequentially for the last 3 quarters.

Source: WY Capital calculations, Press releases, Earnings calls

The extremely high churn in Q2 is definitely concerning. It is not clear what caused churn to be this high in Q2, but Gaia did note in its earnings call that:

The impact of losses from our 65% plus growth periods on 2019 has been slightly larger than we originally projected, but we're starting to see improvements in the monthly retention of these cohorts as they continue to mature in tenure.

Source: Q2 earnings call

This means that churn from the older subscriber cohort that Gaia had acquired before 2019 was higher than expected and had caused the rising churn. This explanation wasn't satisfactory enough for us, so we emailed IR and got back this response:

it is simply the fact that it can take 12-18 months for the higher-churn subscribers we were bringing in during our higher revenue growth phase to leave the platform. we are nearing the end of that period, so the churn should start to look better.

Source: IR Email

If management is right, this means that the Q2 churn should be a one-time event and that as old, low LTV subscribers churn out, churn should improve significantly due to a better subscriber mix. Gaia is in the midst of a transition from lower LTV yoga subscribers to higher LTV Seeking Truth subscribers, after all, and as the subscriber mix shifts, it makes sense that churn should be reduced.

Based on management's guidance, we calculated the implied Q3 churn, as shown above, and churn is projected to improve significantly from Q2 to around 80.5k. Admittedly, one could argue that our estimate could be low, as CPA is likely to be slightly lower than Q2, but it's still hard to see a scenario in which churn increases after Q2.

The content

There continues to be significant criticism about Gaia's content and its addressable market in our last article. Again we want to emphasize that just because some people personally don't see the appeal of the content doesn't mean the content is terrible.

One channel which heavily promotes Gaia content and has a partnership with Gaia is Beyond Science, a channel which has over 2mil subscribers on YouTube. In fact, the guy behind the channel, Mike Chen, has his own series on Gaia.

Source: YouTube

Another indication of the strength of Gaia content which we didn't mention is the fact that hundreds of people are willing to pay $700-900 for a ticket to participate in a Gaia event (in fact, the event was sold out), and 99% of those that went for the event were willing to spend hundreds of dollars more on a live access annual subscription.

Our first full capacity event will be in October and as Jirka mentioned is already sold out. The only way for additional people to access this content will be with a Live Access annual subscription.

Source: Q2 earnings call

Path to profitability

We also learned more specifics about Gaia's path to profitability from IR. Firstly, we learnt that most of the capex over the next 12 months is going to consist of only content spend and product development spend.

with our slower growth, the only thing in capex will be content and product investment.

Source: IR Email

We also learnt that the non-CAC portion of S&M, together with G&A costs, are likely to be flat for the next few quarters as Gaia's headcount needs are stabilized.

we don’t need to add any headcount given the moderated growth plan.

Source: IR Email

This gives a significant amount of visibility into cash burn over the next few months. Our estimates for EBITDA are $2.7mil in the next 12 months. If you include $11mil of content spend and an estimated $5mil of product development spend, that leaves around $4.1mil left, and we believe this is an aggressive estimate. After this period, Gaia should start generating FCF.

Q3 estimates and valuation

We believe revenue should come in at around $13.7mil, in line with analyst and management estimates. Revenue is quite easy to predict for management as it tends to lag subscriber counts.

However, we believe that analysts estimates for profits of -$0.28 are far too conservative. This would imply a loss of $5mil, or an EBITDA loss of around $2.2mil, which is even lower than Q1, despite the fact management is shifting towards profitability. We estimate losses of $3.3mil, implying an adjusted EBITDA loss of $0.6mil.

Our valuation methodology remains the same. To be conservative, we assume Gaia should only trade at a 3.5x P/2019 S, or half of Netflix's multiple, and adding $40mil in PPE and the undisclosed investment would give a valuation of $229mil, or around $13 a share.

Risks

The main risk is that management could simply be wrong about churn or they could be giving an overly optimistic picture to shareholders. However, we believe two factors mitigate this risk. Firstly, this is a fairly high visibility business - SVOD, that has fairly predictable subscription revenue streams. Secondly, management has been buying shares furiously at the current prices, which indicates that it strongly believes that the business is undervalued.

Conclusion

Overall, we continue to believe Gaia is substantially undervalued and that analysts and investors are underestimating the visibility management has into the business. We think that Gaia will begin to be more appreciated by the market as it continues its move towards profitability.

Disclosure: I am/we are long GAIA.I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.