Description

Below I describe an opportunity to buy into a good yellow page ad business that offers value to many potential strategic buyers plus one receives a free option on a potential niche software business. To obtain these businesses the market will PAY YOU $1,000,000. Anton613 wrote-up DAGM in January 2003 and his work should be read to more fully understand DAGM’s history.

I am updating DAGM today due to recent business developments, but also more importantly the chance to buy a niche ad business with zero competition at a negative value. One is essentially being paid approximately $1 million to own a yellow page business which I value at $6-$15 million minimum to a strategic buyer and to also own an option on a recently started 80% owned subsidiary which has plans to introduce a new software solution to the Yellow Pages industry.

Facts:

Directory Business

DAG Media, Inc. (“DAGM”) is in the yellow page business, which equates to the principle source of revenue for the company coming from the sale of ads. DAGM’s principal directories are the Jewish Israeli Yellow Pages and the Jewish Master Guide. Both directories are offered in New York and Florida, which are two of the largest markets where demographic data suggests many of the Jewish community reside.

On January 7, 2005, DAGM announced their intention to sell the directories business and has been trying to find a buyer ever since. The company sites the fact that the business would be more valuable to a larger buyer in the industry as well as the cost of SOX as reasons for the sale.

The sale of this business makes much sense to me as a strategic buyer could lower fixed as well as variable expenses to a much lower level increasing the value of the business. The acquirer could also increase circulation to other areas of the country with dense Jewish populations using their distribution channels. However, I think looking at DAGM’s niche business as an easy convert for a strategic buyer into their portfolio also has its flaws. The sales force needed to sell DAGM’s product as well as create the product must be knowledgeable of the Jewish culture and be able to tailor the product accordingly. This leaves the strategic buyer needing to retain, hire, or train specific individuals who are best suited for the job. The opportunity to increase distribution though is an easy means to add value.

At the end of the day, DAGM’s directories businesses have had the following operational figures:



Revenue Gross Profit Operating Income
2005 (9 months) $3.8 $3.3 $(.574)
2004 $5.9 $5 $(.411)
2003 $9.1 $7 $.420
2002 $6.5 $4.8 $(.600)
2001 $5.6 $4.1 $(.600)
2000 $6.2 $4.8 $(.300)

Revenue has fluctuated due to the fact that DAGM has bought and sold other businesses. The directories business has slowly grown and I estimate currently generates over $5 million of revenue annually. DAGM has yet to earn any significant amount and has operated at break-even, but gross margins have been quite satisfactory showing the overhang from a bloated SGA.

Furthermore, DAGM’s directory business has much higher gross margins than prior businesses they have owned. For instance, the 9 months ending 2005 has a gross margin of 87% while fiscal 2003 had a gross margin of 72% (when DAGM owned other businesses along with the directory business).

DAGM’s balance sheet is extremely strong with approximately $7.7 million of cash and equivalents and zero debt. DAGM has paid dividends this year which has lowered overall cash and expects to pay there final dividend January 5 of $.10/share.

Software Solution Business

December 5, 2005, DAGM announced the formation of a subsidiary, DAG Interactive, Inc. (“DAGI”), which will be held 80% by DAGM and 20% by Ocean-7 Development, Inc. (“Ocean”). DAGI is trying to introduce a “unique and innovative software solution to the online Yellow Page industry”. DAGI will be filing patents for the solution soon and once this is complete more details will be released about the venture. Ocean’s co-founder, Mark Alhadeff, has joined DAGM’s board and will be co-CEO of DAGI.

The basic software idea came from DAGM’s CEO Assaf Ran whom owns over 40% of the outstanding shares of DAGM, and Ocean will complete the production of the software in a partnership. It is my understanding that minimal amounts of DAGM’s capital will be used to fund the project as Mr. Ran is the idea and Ocean is the developer. Some shares of DAGM will be issued though.

To me this is interesting because some of the best entrepreneurial ideas come from people who are in a specific industry that see a better way to do things. Mr. Ran is in the trenches of the directory business and I expect success from this idea.

Overall, I view this subsidiary as a free option and assign no value to it, as there is little data to go off of. But I do not see it as a cash drain.

Valuation of DAGM:

A projected value of DAGM is by no means easy without clean numbers and one must add the fact that it is difficult to understand what a strategic buyer may be thinking. However, I think we can come up with some reasonable estimates since in fact we are getting this business for free.

Gross profit from my view is the cleanest way to view DAGM’s directory business, as SGA would be entirely different to a strategic buyer. We will also leave out the fact that a strategic buyer would be smartly thinking that circulation could be increased dramatically at a cheap cost if distribution is already set-up.

Given the above assumptions, DAGM’s directory business generates around 85% gross margins. SG&A at an already established yellow page business would be a fraction of what it is currently at DAGM. Using gross profits of $4.5 million annualized for the directory business in 2005, one can assume various scenarios of growth due to mass distribution and estimate various amounts for SG&A. I feel comfortable with a minimum value of $6 million (which I assume 10x earnings as value so you can easily do the math on what I think is reasonable for SG&A as a percent of revenue) and can easily get to $15 million to a strategic buyer. You are welcome to make your own assumptions using comparables.

Overall:

With the purchase of DAGM one receives an entity with $7.7 million in cash, a directory business worth $6-$15 million (could be more), and a free option on a potential niche software product for the yellow page industry for $6.7 million. Since there really is no arguing the cash on the balance sheet, one can only differ on the value of the directory business and whether the free option will become a cash drain. I argue the margin of safety is more than adequate to support various opinions on these matters due to the price paid being below net cash.

Furthermore, we have good management that has a lot at stake (CEO and founder owns over 40% of the shares) and the new subsidiary is also jointly owned making both parties striving for the same goal.

Overall, we have a business that is conservatively worth $14-$23 million selling for about $7 million. I see a high probability of 100% or more in upside within 2-3 years.

Catalyst

Value