Autobytel (ABTL)

Summary

We focus on smaller companies with Ft. Knox balance sheets and large & sustainable free cash flow yields and we are typically seeking a mid-teens FCF yield or higher on an unleveraged basis.  The objective is for the sustainable FCF to eventually drive up the share price to a more reasonable valuation, through share buybacks, debt reductions, dividends, or accretive acquisitions.  Obviously, it is important we have a management team that cares about shareholder value.  We also focus on small and micro-cap stocks because there is a much better chance to find an attractive investment opportunity which is under-followed or undiscovered.

One micro-cap stock we like is Autobytel (ABTL), a small automotive marketing services company in the U.S.  ABTL assists automotive retail dealers and manufacturers in marketing and selling new and used vehicles to consumers through its programs for online lead referrals, dealer marketing products and services, and online advertising programs and data products.

ABTL has an attractive asset-light business model with limited capital expenditures and working capital needs and ABTL is generating strong free cash flows as its management team has thus far driven an impressive turnaround in the business from the depths of 2008.  New management took over late in 2008 and in 2008 ABTL generated close to negative $22m of free cash flow (we define as cash from operations less capital expenditures).  In 2012, ABTL generated close to $5m of FCF.  ABTL has about 9m shares outstanding at about $4.30 per share for a market cap of about $37m.  ABTL also has a strong balance sheet with a net cash position of about $10m at Q1 of 2013 for a total enterprise value (EV) of about $27m.  ABTL is currently trading near a 17% unleveraged FCF yield with decent prospects for growth in revenues, adjusted EBITDA, and FCF in 2013-14.  We believe ABTL could generate $6m to $7m in FCF per year in 2013-14 and trade for 10x FCF plus $20m or more of excess cash by year end 2014, or an EV of $90m or $10 per share, or 120% more than current price of $4.30 per share.

ABTL internally generates most of its revenues from leads it provides to auto OEMs and dealers and is one of the largest suppliers of auto leads in North America, supplying about 4.2m leads in 2012.  CEO Jeff Coats was on ABTL’s Board and became CEO in late 2008.  Faced with large losses and negative cash flows, Coats and his team aggressively reduced cash operating expenses from $68m in 2008 to $24m in 2012.  They also shifted the business model to focus on lead generation and, specifically, internally generated leads - in 2008, ABTL purchased over 90% of its auto leads from third parties and resold these leads to its OEM and auto dealer customers.  In 2012, ABTL generated about 70% of its auto leads internally and purchased about 30% from third parties.  The result has been a more value-added, proprietary business model and improved gross margins, with gross margins improving from 28% in 2008 to 39% in 2012. 

In Q3 of 2010, ABTL completed an important strategic acquisition of Cyber and Autotropolis (two companies purchased together) for approximately $17m.  Cyber and Autotropolis were one of ABTL’s largest suppliers of auto leads and the acquisition dramatically enhanced ABTL’s internal lead generation capabilities.  We think ABTL will continue to seek to enhance its internal lead generation capabilities as these leads are the highest quality and it retains control over its own destiny by generating leads internally.

ABTL is the largest supplier of auto leads to several of the major OEMs including Nissan, Toyota, and GM.  For several OEMs management believes ABTL supplies close to 50% of the leads they purchase.  Leads purchased by OEMs are then distributed to their dealer base.  In 2012, leads sold to OEMs represented about 70% of sales and leads sold directly to dealers represented about 30%.  ABTL usually receives $18 to $23 per lead generated with an average of about $20 per lead.  Management estimates that ABTL auto leads represented about 4% to 5% of total auto sales in North America in 2011-2.  Importantly, they believe the OEMs recognize their auto leads as among the highest quality in the industry, or the highest closing rate. 

ABTL’s lead generation capability has consistently improved over the past four years under the new management team – in 2009 ABTL supplied 2.7m leads of which 90% were generated externally; in 2010, ABTL generated 2.9m leads of which 46% were generated internally; in 2011, ABTL generated 3.9m leads of which 65% were generated internally; and in 2012, ABTL generated 4.2m leads, of which 70% were generated internally.  The acquisition of Cyber and Autotropolis in Q1 of 2010 clearly established ABTL as the largest generator of auto leads.

ABTL has also focused on improving its lead quality, including validating each lead (make sure name, phone number, email address is real, etc.), so that customers are not paying for poor quality leads.  Over the past 18 months, ABTL has worked with R.L. Polk, a research firm, which has developed research showing that ABTL’s leads have a closing rate of about 23% as compared to the industry average lead closing rate of 8%, so almost three times the industry average.  ABTL has recently started taking this data to auto OEM and dealer customers to increase market share and improve pricing.  We believe this process has only recently been started and is not yet fully reflected in ABTL’s results.

We believe auto OEMs and auto dealers (as well as many other advertisers) are becoming increasingly surgical about how they are spending the vast of dollars they invest in sales and marketing.  Auto leads that companies like ABTL generate are a much more targeted investment than television, radio, and newspaper ads.  We expect auto advertising dollars to continue to shift towards more focused expenditures like purchasing auto leads.  Furthermore, we think ABTL’s focus on high quality leads and carefully “scrubbing” these leads before selling them to auto OEMs and dealers is a significant value-add process that helps entrench ABTL’s competitive position.  We believe the structure of the decision-making at the dealers and OEMs is such that auto leads must be sold account by account.  We think this is good for ABTL because the value-add to these customers makes it hard for a large player like Google to simply dis-intermediate out ABTL’s position.  In effect, the dealer and OEM relationships of ABTL are a strong barrier to entry.

We also believe ABTL is well-positioned to potentially benefit from a continued rebound in the auto industry over the next couple of years as pent up demand continues to drive improving total North American auto sales in 2013-4.

Other Segments

Auto lead generation is the primary driver of ABTL’s revenues, generating about 95% of total revenues in 2012.  ABTL’s two other revenue sources in addition to its auto lead generation business: financing leads and advertising.  ABTL generates financing leads for subprime borrowers who have credit issues, acting purely in an agency role.  ABTL also generates revenue from advertising on its flagship autobytel.com website.  In 2012, ABTL’s advertising revenues were about $3.5m or about 5% of total revenues, as compared to $3.8m in 2011, or about 6% of total revenues.

Financial Results for Q1 of 2013

Q1 revenue was $18.3m or up 9% versus $16.7m in prior year, as ABTL realized double digit increases in auto lead volumes, with 15% growth in retail auto lead revenue and 11% growth in wholesale auto lead revenue. 

ABTL’s results in Q1 2013 were directly tied to the strategic investments the company is continuing to make, including enhanced customer acquisition and high quality lead generation activities.  The result has been greater market recognition, a growing customer base, and increased revenue.  In Q1 2013, ABTL delivered approximately 1.2m auto leads, which was up 13% over prior year and 12% sequentially.  71% of leads were to wholesale channel and 29% to retail channel.

Strong cash generative business model and attractive FCF yield

ABTL has a highly cash generative business model which is asset-light with limited capital expenditures and working capital needs and a high ROIC.  Furthermore, ABTL currently trades at an attractive 17% unleveraged FCF yield, with decent prospects for near term growth in FCF in 2013-14.  ABTL has a high ROIC business model (over 100%) based on adjusted EBITDA versus the investments in net working capital and net PPE.  Consequently, with even modest revenue growth, we think ABTL can generate significant incremental FCF from current levels.

Strong Competitive Position

We think ABTL has a strong competitive position in the auto lead generating business.  We believe ABTL is the largest supplier of auto leads to OEMs and dealers in North America.  ABTL internally generates over 70% of its auto leads which gives it an important competitive advantage.  Further, ABTL is laser-focused on high quality leads which are critical to building long-term relationships with OEM and dealer customers.  ABTL has the largest distribution network for leads in the industry.  We believe its long-term relationships with OEM and dealer customers are an important competitive advantage.  AutoUSA, a subsidiary of AutoNation (AN), and Dealix are ABTL’s two largest competitors in the auto lead generating business.  Both companies purchase most of their leads from third parties and this gives ABTL a significant competitive advantage.  Edmunds.com and KBB.com also generate auto leads.

Excellent Turnaround by New Management Team Since 2008

We believe ABTL’s management team, led by CEO Jeff Coats, has completed an impressive turnaround to date, rebounding from a very difficult situation.  Operating expenses have been reduced from $68m in 2007 to $24m in 2011 and 2012, not an easy feat.  Further, the business model has become much stronger as ABTL generates close to 70% of leads internally today versus under 10% in 2008.  This greater value-added position gives ABTL a much stronger competitive advantage and has resulted in higher gross margins, from 28% in 2008 to 40% in 2012.  Also, ABTL has built a strong distribution network and excellent relationships with auto OEMs and dealers.  Finally, ABTL has focused intently on generating only high quality, more valuable leads, which have much higher close rates than industry averages.  Management completed an important strategic acquisition with Cyber and Autotropolis in 2010.  Lastly, ABTL is continuing to upgrade its flagship Autobytel.com website with proprietary video and written content, such as over 500 YouTube Videos with five-minute video demos of specific autos. 

Auto Industry Trends Towards More Focused Advertising Spend

We believe the huge advertising and marketing dollars which auto OEMs and dealers spend will include an increasingly large share for more focused investments, like purchasing auto leads from ABTL and others, as a supplement to the television, radio, and newspaper spending these industry players currently make.  We would expect these large advertisers/marketers to become increasingly surgical and more efficient about how they investment their marketing dollars.  There is evidence to support this thesis and we think it will increasingly favor niche focused marketers like ABTL.

Recognition of Superior Quality of ABTL’s Auto Leads

ABTL’s auto leads are much higher quality than the average industry leads.  We believe the Polk study which indicates a 23% closing rate for ABTL leads as compared to the industry average of 6% to 8% closing rate will help increase ABTL’s market share and improve its pricing as auto OEMs and dealers gradually recognize the greater value inherent in these leads.

Potential Benefit from Rebound in the North American Auto Industry

The U.S. auto industry is rebounding from the severe downturn in 2008-10, when Retail U.S. Light Vehicle Sales dropped to 8.6m and 9,2n in 2009-10.  J.D. Power’s 2012 Retail U.S. Light Vehicle Sales were 11.7m with estimates for 2013, 2014, and 2015 of 12.2m, 13.3m, and 13.6m, respectively.  ABTL should clearly benefit from this auto industry rebound.

Attractive Upside Potential

In 2012, ABTL generated approximately $5m of FCF (cash from operations less capital expenditures).  We believe ABTL can grow adjusted EBITDA and FCF in 2013-14 based on increased lead volumes, stronger pricing, and sales growth on a relatively stable based of operating expenses.  ABTL’s gross margin rate was slightly down in Q1 due to investments in the website its traffic as well as enhanced lead sales capabilities.  We believe ABTL’s gross margin can return near towards the 40% level on a stronger base of sales in the second half of 2013.  We also think ABTL can maintain operating expenses fairly stable, resulting in the potential for significant operating leverage and incremental EBITDA and FCF.

We believe ABTL can achieve FCF of $6m-$7m in 2013-14 and the balance sheet could see incremental net cash of $10m+ over 2013-14 on top of its current $10m net cash position.  We believe ABTL could trade for $70m or 10x FCF in 2014 plus $20m of excess cash at year end 2014 or $90m or close to $10 per share, more than 120% higher than current price of $4.30 per share.

Potential for Share Repurchase or Dividends

ABTL currently has a $2m share repurchase program in place.  We believe ABTL’s management is well aware of the current depressed relative valuation of its stock and is taking this into consideration when evaluating potential acquisitions.  We believe that if JRN’s share price remains depressed and management is unable to find attractively priced acquisitions, there could be an acceleration of the share-repurchase program and/or a major dividend program.

Solid Balance Sheet and Expected Steady Build-up in Net Cash Position.

ABTL has a strong balance sheet with a net cash position of $10m at Q1 of 2013.  We believe management has positioned ABTL to generate $5m to $7m of FCF per year in 2013 and 2014 excluding dividends, share repurchases, or acquisitions.  Therefore, we think ABTL could end 2014 with a net cash position of $20m or more, over 50% of the current EV.  Alternatively, management may use the strong cash position to repurchase shares, pay dividends, or complete accretive acquisitions.  We believe management is considering acquisitions but is likely to be careful in deploying its excess capital.  Management completed a successful strategic acquisition in 2010 which dramatically strengthened the internal lead-generating capabilities of the company.  Further, management teams that have worked so hard to bring down the cost structure - operating expenses from $68m in 2007 to $24m in 2012 - are unlikely to chase non-accretive acquisitions.  We think the potential build up in net cash over 2013-4 will highlight the strong cash generating capabilities of the business model and attract investor attention to the stock.

Conclusion and Target Price

Based on 10x our FCF estimate of $7m for 2014 plus a projected $20m net cash position at year-end 2014, we believe ABTL could trade for an EV of close to $90m or $10 per share or more versus $4.30 per share today (+130%).  If ABTL continues to execute and its auto leads generating business performs as we expect, we think our target price can be achieved.  Further, ABTL’s auto lead-generating business has a well-established competitive position for online auto information and traffic as well as important relationships with auto dealers and OEM’s and could prove attractive to a strategic or private equity acquirer.