Description
Investment Thesis
The investment opportunity here
is to purchase a company composed of two high quality businesses (30-40%
margins, recurring revenues with no customer concentration, strong growth, and infinite
returns on capital) for 10.3x after-tax FCF, or 7.4x EBITA. Furthermore, I believe that profits are
poised to grow at a rapid 20 – 40% annual rate over the next 5 years (near the
upper end over the next couple years).
The company is managed by a long-term oriented, entrepreneurial CEO that
is highly motivated with 35% ownership of the outstanding shares.
Overview
Jupitermedia operates two
distinct businesses: Jupiterimages, the 3rd largest global stock photo agency,
and JupiterWeb, an online media business that operates B2B websites primarily targeting
IT and business professionals. Jupiterimages
generates around 80% of profits, with the remaining 20% coming from JupiterWeb.
A stock photo agency is
essentially the primary middleman that sells photos to image buyers on behalf
of 3rd party photographers.
In Jupiterimages case, they actually own 75% of the images they sell;
however, the remaining 25% are sold on a more traditional agency basis, with
royalties being paid to the 3rd party photographers. Customers include: advertising agencies, book
and magazine publishers, newspapers, in-house creatives, web publishers, etc.
Before proceeding, there are
a few terms specific to the digital images business that should be explained. First of all, there are two primary licensing
models in the industry, rights-managed and royalty-free. Images that are sold on a rights-managed
basis are typically higher quality and have defined terms of use (e.g. the
image can be used on billboards in the US for the next 2 months). Images that are sold on a royalty-free basis
are typically of lesser quality and grant the buyer unlimited usage of the
image for a single fee. Far less common
in the industry, Jupiter also uses a third model, subscriptions, where they
provide unlimited access to a defined collection of owned images for a monthly
fee. Technically, these images are
royalty-free images, such that the buyer’s monthly fee grants unlimited access
to all of the images in the collection.
Why is this an excellent company?
First and foremost, this is
an excellent company because both of their businesses are high quality. Both digital images and online media are
reasonably stable businesses, possess 30-40% operating margins, generate essentially
infinite returns on capital, and have attractive future growth profiles. Digital imagery, which is 80% of the
business, is particularly attractive due to its barriers to entry; having
sufficient scale is crucial as a significant quantity of images are required to
satisfy the needs of image buyers (buyers need to be able to find very specific
images, as quickly as possible).
Secondly, these quality
businesses are run by a motivated, entrepreneurial CEO – Alan Meckler – who has
a history of creating significant value for shareholders. He founded his first company, Mecklermedia,
to create and operate a collection of niche magazines and tradeshows. Started in 1971, the business did not really
take off until 1994 when the company raised equity capital and began to focus
on the potential of the Internet. The
business was sold only 4 years later in 1998 to PentonMedia for $300 M.
PentonMedia did not want
Mecklermedia’s web assets, so Meckler purchased 80.1% of them for $18 M to
launch what has evolved into Jupitermedia today. Within Jupitermedia he purchased an IT market
research business for $250k, which he built and sold for $11 M. Capitalizing on the experience he gained
running Mecklermedia, he also built an IT events business which he has also
since sold for around $40 M. His most
significant investments within Jupitermedia have been the cumulative
acquisitions of over $200 M in digital image collections. Athough this business is still in its
infancy, I believe that he has continued to create significant value in this
business as well.
Alan Meckler is an ideal CEO
to be partnered with. He owns over 35%
of Jupitermedia’s common stock. He has a
proven record of creating shareholder value in building media and trade show
businesses. Importantly, these are exactly
the kinds of business that he expects to continue creating and developing
within Jupitermedia. Finally, he runs
the company with a long-term focus and does not hesitate to make investments
that lack immediate payoff.
Why is this an attractive price?
Valuing the digital images
business at 10x next year’s EBITA and the online media business at 11x next
year’s EBIT yields an overall enterprise that is worth $10 - $11, making the
current price ~30% discount to this intrinsic value. Here is a breakdown of this valuation:
Jupiterimages $265.7 M
JupiterWeb $139.2 M
Net debt ($54.0 M)
Amortization tax shield $18.2 M
Total $369.1
M $10.35 / share
The company has a substantial
amount of intangible assets that have been created through the acquisitions of
numerous image libraries over the last few years. These assets are amortizable for tax
purposes, and because the aggregate value of these intangibles is so large
relative to Jupiter’s enterprise value, the value of the effective tax shield
is somewhat material to valuation. The
$18.2 M was calculated via present value analysis, similar to how one would
value a net operating loss carryforward.
Also, note that I have loaded
all of the corporate costs into the valuation of Jupiterimages. Arguably some of these costs could be shifted
to JupiterWeb, but it would have an inconsequential impact on the valuation.
While a 30% discount using
these fairly conservative multiples is attractive, this valuation does not
adequately account for the significant growth the company is likely to realize
over the next 5 years. I believe that
Jupitermedia will ultimately prove to be even more valuable than this analysis
indicates. This is the case because I
expect the company to grow profits over the next 5 years at a 20 – 40% annual rate,
which is certainly a far greater rate than a 10x pre-tax multiple accounts for.
Over the next 5 years, I
think that the company will be able to drive annualized revenue growth of 10 - 15%. Due to the economic model of Jupiter’s images
business which benefits from very high incremental margins, this revenue growth
will translate into substantially greater EBITA growth. More specifically, 10 – 15% revenue growth
should translate into 20 – 40% EBITA growth across the company. Even very modest top-line growth (4-5%)
should be able to generate double digit EBITA growth from current levels. If you apply 10x multiples to EBITA several
years out assuming 20-40% growth, this would suggest that the company trades a
discount to intrinsic value that is significantly greater than 30%.
How can this company drive 10%+ revenue growth?
The company should be able to
grow revenues over the next 5 years at a double digit rate
due to the attractive outlook
for the low-end of the images market and a number of company-specific
initiatives. Focusing on the images
business first:
a)
Overall industry
growth of 4-6% with Jupiter positioned in the highest growth areas
The market for stock imagery
has historically grown at a 4-6% rate.
This growth has been driven by both price (stock image agencies with
scale have developed at least modest pricing power) and volume (usage of
imagery as compared to textual content has increased, and new platforms that
require images have emerged, such as the web).
While growth in the high-end of the market may moderate somewhat going
forward, the low-end of the market – which is Jupitermedia’s bread-and-butter
and where they believe they have #1 market share – is likely to grow well in
excess of the overall industry. Considering
that a substantial portion of the growth in the media business today is on the
Internet, this should not be surprising.
Web publishers and advertisers do not want high-end imagery; they
require images with relatively low detail to ensure fast page loading
times. With 85% of Jupiter’s images sold
on a royalty-free basis, around 30% of which are sold through particularly
value-priced subscriptions, Jupiter is essentially competing in the highest
growth areas of an overall market that has grown around 5% annually.
b)
Addition of a
direct sales force less than 2 years ago and its continued development
A significant source of growth
will come from the fairly recent addition of a sales force and its continued
expansion. It is important to remember
that Jupiter had not entered the digital images business until 2003. As a result, until March 2005, they had
absolutely no direct sales force; all of their sales were either transacted
online without assistance or flowed through 3rd party distributors. Getty, as an example, uses a sales force both
to generate new customer accounts and to support existing client
relationships. Jupiter acquired a 50-60
person sales force from Creatas, and have since doubled the size of this team. Furthermore, this doubling in size did not
occur until the end of Q1 of this year.
Several image buyers that I
have spoken with have emphasized the importance of the regular contact that
they receive from Getty. While having a
sales force is obviously more important for Getty’s higher-end mix of customers
(such as high volume ad agencies), the development of Jupiter’s 20 month-old
sales team should spur growth in both customers and image volume per
customer. In the most recent quarter, we
can see the early results of this investment as direct sales were up 19%.
c)
Gradual
conversion of 3rd party distribution to direct sales (~20-25%
growth)
In addition to adding new
customers and increasing volumes, growth in direct sales should allow Jupiter
to gradually bring the business that they currently sell through 3rd
party distributors in-house. Jupiter
sells through distributors, for the most part, in markets where they
historically have not had scale. As
awareness of the Jupiterimages brand continues to grow globally, they are
increasingly able to move into new markets on a direct sales basis. This is still a sizeable portion of their
images business, around 20-25%, whereas Getty obviously does not require any 3rd
party distribution. Converting this
portion of their business to direct sales is significant to growth going
forward due to the sizeable margins (~50%) that distributors earn. The gradual elimination of 3rd
party distribution should approximately double the revenues that Jupiter
realizes in nearly a quarter of their images business, which represents a
20-25% revenue growth opportunity based on the current size of the business.
d)
Significant
opportunities for international growth (~20-25% growth)
Images tend to have very
broad geographic appeal, thus presenting the company with significant
international growth opportunities.
International is approximately 35% of the images business today, whereas
it is over 50% for Getty (48% of Getty’s business comes from the Americas, which includes Central and South America).
Building this business is a matter of continued advertising in
international markets to build the Jupiterimages brand among potential
customers, and increased direct sales efforts in international markets. Getting international to 55% of image
revenues represents a 45% revenue growth opportunity for the company. It should be noted, however, that a portion
of this growth should come simply from the aforementioned conversion of 3rd
party distribution to direct sales.
Sparing you the math, getting the international business to 55% of
revenues is around a 20-25% incremental revenue growth opportunity based on the
current size of the images business (this excludes the growth from converting
distribution to direct in international markets, which was accounted for
earlier).
e)
Marketing
investments today will yield revenue growth through increased market share
Over the last 3 years, Jupiter
has assembled an image agency from the acquisition of numerous image
collections, with a couple of the key pieces (such as Creatas and PictureArts)
having been added to the company just last year. Although the company will likely look to make
additional image acquisitions where sensible, they feel that they finally have
sufficient quantity and variety of content to satisfy the needs of most image buyers. Being able to address the needs of most image
buyers yet only having 4-5% market share is significant. The principal reason why the company’s market
share is this low is because the Jupiterimages brand is so new. As the company continues to market the brand,
and more image buyers learn about Jupiter, they will become increasingly likely
to include Jupiterimages in their future searches for images. Getty has commented that Jupiter has been
advertising aggressively in trade publications, which is something that they
haven’t really seen before from other competitors.
In particular, they have
significant room to grow in the higher-end portions of the market. They had some rights-managed images from the
Comstock acquisition in April 2004, but it really wasn’t until last year that
they added a decent quantity of rights-managed and higher-quality royalty-free
content. Being so new to the higher-end
segment of the market, they are still developing the relationships with RM
image buyers, particularly ad agencies.
Several of these acquired collections were previously distributed by
Getty, and now Jupiter is obviously the only distributor. Considering that image buyers tend to be
loyal to large, high quality collections that they have used before, Jupiter
should be able to: retain many of these customers, capture the margin that
Getty was earning in the previously 2-tiered distribution, and introduce a lot
of these new higher-end accounts to the Jupiterimages brand. As a result, although the company has less
than 1% of the high-end market presently, the CEO has stated that he believes
they can grow this to 5% over the next 2-3 years. While I would hesitate to make such a bold
prediction, I think it is indicative of the types of opportunities that the
company sees in this portion of the market.
f)
Growth from other
media categories: video/film and music.
In addition to images,
Jupiter has been building businesses in both royalty-free music and video. Video, in particular, is presently losing
money. There is not any good data on
market size for stock footage or music, but they are relatively small markets
today, growing quickly, and Jupiter arguably has greater share in them than
they do in images. They are likely close
to being #1 in royalty-free music, and are likely #2 in stock video footage to
Getty. Although the film business is too
small for Jupiter to breakout, it has been growing at double-digit rates for
Getty. Similar to stock images, there is
a significant value proposition to using stock footage; for example,
advertisers can create TV commercials for hundreds of dollars (compared to $5 –
30k if a production firm is used to shoot original footage). Although insignificant to the company today,
I think both of these markets are likely to grow rapidly, well above the growth
in digital images, and will eventually develop into highly profitable
businesses.
g)
Revamped search
engine should provide a catalyst for near-term revenue growth.
An effective search engine is
a particularly important feature for stock photo agencies. Jupiter, for example, has over 7 M images
from which image buyers must search through to find one or two images that
match their very particular requirements.
Furthermore, the non-textual nature of images prevents the indexing of this
content from being fully automated. As a
result, people are needed to manually “keyword” images: keywords are assigned
to each image in the library from a standardized list.
The importance of a quality
search engine is somewhat obvious. If
potential buyers are unable to find what they are looking for quickly, they
leave. As Jupiter has cobbled together
their image business through a series of acquisitions over the last 3.5 years,
they have historically had a very bad search engine. Search result pages would take 7-9 seconds to
load, images were not ‘keyworded’ effectively, and there were poor options for
filtering the search results.
In July, the company finally
implemented a new and improved search engine.
The company believes their search engine is now on par with Getty, and
customers that I have spoken with that have used the site recently have noticed
the significant improvement and agree with this view. Management still sees an opportunity to
improve the existing search engine through better keywording. Given the recency of the launch of the new
search engine, I don’t think the company has fully benefited from its
impact. In the long run I would not
expect any of the major image agencies to benefit from having superior search
technology; however, replacing a terrible search engine with one that is on par
with competitors should provide, at least, a catalyst for near-term growth.
h)
Market
fragmentation positions image agencies with scale well for growth
Although Getty (revenues of
$800 M) and Corbis ($250 M) are both much larger than Jupiterimages ($105 M),
the rest of the market is very fragmented.
In fact, Jupiter’s next closest competitor is less than a quarter their
size. All of these tiny, fragmented companies
combined account for approximately 54% of the ~$2.5 B stock image market. This is important because Jupiter’s market
share gains do not have to come at the expense of their much larger competitors
in Getty and Corbis; it is more likely that they come from the rest of the
market, which lacks the scale that the top 3 players have.
As for why the market is still
so fragmented considering the advantages that agencies with scale have, it is
important to remember how relatively recently the industry had started consolidating. Getty, the market leader by a wide margin,
did not begin rolling-up image agencies until 11 years ago. Furthermore, the market has evolved
significantly. Image agencies didn’t go
digital until 5-6 years ago; prior to that, image buyers flipped through
catalogs of printed photos that the agencies mailed out (in addition to the
sale of image CDs). While I’m sure that
certain niche collections will be able to maintain their share of the market, I
doubt that that share in aggregate is anywhere near the current 54%. While some of these collections will be
acquired by the top 3 players, I expect that a number of them will simply lose
share over the coming years.
Lots of growth drivers, but how can this company drive
10%+ revenue growth?
As detailed above, Jupiter has
a number of growth opportunities, some of which are easier to quantify than
others. As a baseline, the industry has
historically grown at around 5% annually.
Considering that Jupiter is particularly focused on the low-end of the
market, which has the greatest growth prospects, using a 5% organic rate of
growth for Jupiter’s existing business is conservative and provides for some
pricing deflation in the industry.
Furthermore, the conversion
of business from 3rd party distribution to direct sales is expected
to provide a 20-25% growth opportunity and increased penetration of
international markets is expected to provide an additional 20-25% growth
opportunity. Combined, this represents
around 40-50% cumulative revenue growth from new business in largely international
markets (70% of the 3rd party distribution revenues are in
international markets). Both of these targets
are achievable within a 5 year timeframe, which thus yields around an
additional 8 – 10% growth annually.
Organic growth in existing business
of 5% with 8 – 10% annual growth from new international business yields around
13 – 15% annual revenue growth. This
doesn’t take into consideration, however, the new business that I expect them
to win domestically – which is arguably the largest growth opportunity for the
company. Although it is difficult to put
a precise number on it, the combination of: finally having a direct sales force
to market Jupiterimages, the growing brand awareness that has been achieved
through significant marketing investments, and key search technology that has
been dramatically improved in the last 6 months is likely to generate a
significant amount of new domestic business.
Furthermore, the 40 – 50% international growth opportunity was derived
assuming a mature level of international penetration based on the current size of the domestic business. If the company is able to take market share
domestically for the reasons I have articulated, the size of this international
growth opportunity would similarly increase in proportion, and would thus
represent a much larger revenue growth opportunity than the 40 – 50% that I
have specified.
Taking all of this into
consideration, it is hopefully clear why I think that 10%+ revenue growth is a
very achievable goal for the company over the next 5 years. Obviously if management execution is smooth, pricing
in the industry is robust, and my expectations pan out, there is significant
upside to this number and revenue growth can realistically be much greater (i.e.
15% - 20%). That said, I think that 10%+
revenue growth is a conservative growth target and accounts for the unavoidable
hiccups along the way.
Significant operating leverage magnifies the impact of
10%+ revenue growth
While 10%+ revenue growth is
certainly attractive, what makes this particular investment opportunity so
compelling is the operating leverage, which should lead to substantially
greater growth in profits and cash flow.
Similar to Getty Images,
there is meaningful operating leverage in the sale of incremental
rights-managed images. Because
additional image sales require only a royalty to be paid to photographers plus
minor amounts of sales support, incremental margins on rights-managed images
are 50%+. Unlike Getty Images, however,
Jupiter actually owns 75% of the images that they sell. As a result, these images don’t have
royalties attached to them and thus possess 85%+ incremental margins. While the sale of an additional owned image
through the website is technically pure profit, an 85% incremental margin
provisions for both sales support and an allocation for overhead. Although digital images is already a fairly
high margin business – $37 M in EBITDA at around a 35% EBITDA margin – the
margin expansion will be further leveraged by around $20 M in corporate
overhead.
Put another way, the overall company
currently has an EBITA margin of around 24% and both businesses have very high
incremental margins. Incremental margins
in the images business, which is 80% of profitability, should be at least
75%. That 75% is loosely calculated as:
they own 75% of their images and earn 85%+ incremental margins on them, and
they pay royalties on 25% of the images, and earn at least 50% incremental margins
on these.
From these incremental
margins, it is hopefully clear how 10-15% revenue growth will translate into
20-40% EBITA growth across the company for several years into the future.
What about the online media business?
Although I have focused on
the images business as it generates the majority of cash flow, the online media
business is also a very attractive asset that should see meaningful revenue
growth over the next 5 years, with similarly high operating leverage.
There are several factors
that should drive growth in this business over the next few years. First of all, management admits to having
underinvested in the business. This is
not surprising as the company has been obviously distracted over the last 3.5
years as they raised and deployed a significant amount of capital to build the
Jupiterimages business. Over the last
few years, the online media business has seemingly been run on auto-pilot. Management has announced that this is about
to change. While it is impossible to
quantify the impact of management investing more time and money in this
business, there are a number of things that they can and will be doing to grow
the business. Among them, they will be
implementing various improvements to some of the existing sites that have
become stale, creating a few new sites, and potentially making a few small
dollar amount acquisitions.
Secondly, given the IT focus
of their web sites, the launch of Microsoft’s Vista
should be a tailwind for CPMs. The new
Vista OS will launch during the first half of 2007, and is expected to trigger
a PC upgrade cycle. Jupiter’s key
advertising customers are largely IT companies that will need to be advertising
their new products during this important time.
The final growth lever is
that management intends to grow their online media segment through the creation
of an events business. While the
ultimate success of an events business is obviously an unknown, as mentioned
previously, the CEO has had great success in the past building precisely these
businesses. Importantly, it is a low
risk investment due to the low capital intensity of the business (no physical
capital and negative working capital) and the skewed risk/reward
proposition. An event that is a failure
could lose $100-150k and would potentially be scrapped if there was no
potential. A successful event, however,
has the potential to do several million in revenues with 50%+ operating margins,
and could be held on an on-going basis. Given
the significant success that Meckler has had in the past creating events and
trade shows, this represents a significant growth opportunity for the company
with minimal risk.
As mentioned earlier, I
valued this business at 11x the current EBIT run-rate. It should be noted that in a sale to a
strategic buyer, I believe the company would likely be able to fetch a higher
price than this. Online media is highly
sought after, and this has been reflected in the multiples that acquirers have
paid. Somewhat recent examples include:
-
IGN, acquired by
News Corp for $650 M, which was 80x EBITDA and 11x revenues
-
iVillage,
acquired by NBC for $619 M, which 38x EBITDA and 6.5x revenues
The closest comparable public
competitor would be CNET, which trades for around 33x EBIT, 16x EBITDA, and 3.8x
revenues. CNET has grown at a decent
rate, however, they also have more of a consumer focus (which is arguably a
more competitive market than B2B) and have had their valuation impacted by some
company-specific issues, which includes option backdating. Given the valuations that acquirers have paid
and the substantial opportunities for improvement, if Jupiter put their media
business up for sale, I would be surprised if it didn’t sell for at least 15 –
20x the current EBIT run-rate. As a
result, I think that the 11x multiple that I have valued this business at is
very conservative.
What is the market missing?
I think that the market has
failed to understand several aspects of the business.
Starting with the most
recently reported quarter, the stock declined around 35% after results were reported. The quarter itself was not that bad, however,
their sales to international distributors missed management estimates
significantly. This miss caused
sell-side analysts to downgrade the stock and significantly reduce estimates,
due to a lack of “visibility” in sales to distributors.
This reaction seems peculiar
considering that:
-
Sales to international
distributors are only approximately 13% of revenues and are a lower margin
business due to the ~45-50% revenue share with distributors.
-
Selling to
distributors is an undesirable, non-strategic business, which the company is
likely to replace over time with direct sales.
-
This was only the
first quarter that distribution revenues have missed management’s estimates.
-
Management had no
explanation for this miss, which suggests that the quarterly performance may
just be a temporary anomaly. I think
that one logical explanation is that international distributors might simply be
cutting their business with Jupiter now that they see them gearing up to sell
direct internationally.
-
The 14%
sequential revenue decline in distribution revenues was on top of an unusually
strong quarter. Distribution revenues
were actually flat on a year-over-year basis.
-
They went so far
as to say that international sales (a significant chunk of which are sales to
distributors) have been strong so far in October and November on the quarterly
conference call.
I think that a number of
other factors have conspired to drive shares down to these very attractive
levels. First of all, after missing
estimates last quarter, management stopped giving earnings guidance. Previously, management had been providing
rolling 12 months forward guidance, which was 46 – 50 M in EBITDA when they last
gave their guidance on the previous quarterly call. For comparison, the comparable run-rate
EBITDA figure that I have valued this business using is only 36 M, so clearly
management would seem to agree that there is considerable near-term upside to
the current run-rate earnings power.
Upon having guidance pulled, rather than think for themselves, sell-side
analysts have essentially thrown their hands in the air and assumed that sales
to distributors will continue declining sharply, thus preventing the company
from achieving any meaningful revenue growth.
Even odder is that sell-side models that I have seen have simultaneously
slashed the operating leverage in the business, which for some reason will be
far more muted going forward.
Compounding the declines in expected EBITDA is that analysts now view
the company as being more risky and thus value the company at a lower
multiple. The notion that the company
has become more risky due to a lack of near-term “visibility” in sales to
distributors is downright silly and obviously only presents more risk for
sell-analysts whose job it is to precisely guess next quarter’s earnings.
Furthermore, the true
profitability of the business is obscured by a number of accounting charges
that serve to make GAAP income appear low.
The most significant of these charges, amortization of intangibles from
prior acquisitions, should amount to around 11 M next year, which is ~30% of
the company’s 36 M in adjusted EBITDA.
These amortization charges are largely taken to reflect the diminution
in value of acquired images. Like most
other intangibles acquired through acquisition, including these charges in the
analysis of on-going profitability is double-counting. The company already expenses through the
income statement the cost of creating new photos to refresh the image library.
The second of these charges,
stock-based compensation expense, is significant larger than the actual
economic option expense due to the nature of the accounting standards for recording
stock-based compensation. More
specifically, sell-side models have generally extrapolated the current
quarterly accounting charges to arrive at around 4 to 4.5 M next year. This is a surprisingly large number when one
considers that the company has permanently reduced their option granting, which
is currently only around 2.0% - 2.5% of the outstanding shares annually. These are fairly modest option grants for any
company, let alone a company that is growing as rapidly as Jupiter is. The reason why the accounting charge is so
much greater than the economic expense is because the current accounting
charges are severely skewed by options that were previously granted at strike
prices that are now significantly above the current share price. The grant for this year, for example, was
struck at $15.50, which is more than 2.5x the current share price. I will spare you the details of my Black-Scholes
model assumptions, but I calculate that the on-going economic option expense is
only around 1.5 M, which is quite a bit lower than the 4 – 4.5 M that the
company will be taking for accounting purposes.
Furthermore, because the share price has declined so significantly, the
company has relatively little over hang from stock options that are currently
outstanding.
The final charges that are
currently distorting current earnings are the numerous investments that the
company has been making, such as those in royalty-free video. While it is not possible to precisely
quantify the magnitude of the losses generated by these ventures, based on management’s
comments on the most recent quarterly call, I believe they amount to around $3
M, which is close to 10% of EBITA.
The last aspect of the
business that I think the market may not fully understand is the degree of
operating leverage in the business. When
management was spoon-feeding sell-side analysts guidance it was easy, but now
that guidance has been pulled, expectations for operating leverage have been
muted, as I mentioned previously. I
think the problem here is that there really isn’t a truly comparable company in
the public markets. There is only one
other stock photo agency that is public, Getty Images, but the reality is that
Getty has a much different business. In
terms of operating leverage, the most important difference between the two
companies is that Jupiter owns 75% of their images, compared to Getty who pays
royalties on almost all of the images that they sell (excluding their
relatively small editorial business, which is an entirely different animal and
isn’t as scalable). Furthermore, because
Getty’s images are relatively high quality, they have a significant mix of
rights-managed content, which have the highest royalty rates (i.e. variable
cost). As a result, although Getty
certainly has a scalable business such that they can grow profits at 1.5x the
rate of revenues, Jupiter’s business is significantly more scalable and should
allow for profits to grow at 2 – 3x the rate of revenue growth.
Risks
While I do not think that
there is any one significant risk to the company, there are several smaller
ones that should be considered.
a)
A deflationary
price environment in royalty-free images, due to the micropayment model
I think that one of the
biggest risks to the company is a deflationary price environment in the
royalty-free market. For the industry to
have historically achieved 4 - 6% annual growth, pricing growth has clearly been
reasonably robust at around 2 - 3%.
While 2 – 3% pricing is hardly gouging customers, there is the potential
for some disruption in the royalty-free market as a new licensing model known
as “micropayments” continues to grow rapidly.
Images sold through micropayment sites are essentially very cheap
royalty-free images ($1 - $5 per image) that have been contributed by amateur
photographers. With royalty-free images
averaging around $200 / image, a concern is that a mix shift will erode pricing
in the industry. I do not believe that
this disruption is a significant concern.
First of all, although
micropayment pricing is obviously very low today, I believe that it is
inevitable that the quality images that are posted on micropayment sites today
will increase in price significantly over time.
Not surprisingly, photographers are wealth-maximizers, and so a
photographer is not going to sell a photo for $2 that he can license through a
traditional RF model for $200; because photographers are paid a percentage of
the revenues, their interests are aligned with the stock agency they partner
with to receive the highest possible dollar amount per image.
Secondly, this is very much
analogous to what happened to the industry when the royalty-free licensing
model was born. Getty, for example,
started selling royalty-free images in 1998, when pricing was much lower. At that time people worried that royalty-free
would erode their rights-managed business, but with the benefit the benefit of
hindsight we know that this did not happen and that royalty-free images
increased in price over time and carved out their own niche in the market.
Additionally, the reality is
that this will likely end up being only 10 – 20% of the industry. It is difficult for photographers to address
the needs of image buyers without having a budget. Photographic equipment, access to models, and
other costs associated with conducting a photo shoot all require money. Perhaps more importantly, genuine
photographic talent is needed, and apparently this is largely lacking on
micropayment sites today. The common
theme that I have heard from image buyers is that while the quality of the
photos is good relative to the cost of the images, the quality on the sites is
very uneven and so it can take a lot of time to find an image that is worth
buying. Being able to find suitable
images quickly is probably the most
important criteria that I have heard from numerous image buyers.
Furthermore, although the
micropayment model is currently booming and doing very impressive volumes
(Getty’s iStockPhoto sold 2.5 M images last quarter), this hasn’t led to any
pricing deflation in the royalty-free market yet. In fact, it is quite the opposite; in a
relatively soft imagery market, royalty-free pricing has actually been strong. Given their significant market share, Getty’s
results provide the best view of pricing in the industry, and over the last few
quarters while rights-managed pricing has declined (6% in Q4, 3% in Q3),
royalty-free pricing has increased (small growth in Q4, 6% growth in Q3). Furthermore, the pricing growth has been
supplemented by strong volume growth in RF (double digit volume growth at Getty
in Q4).
Finally, I should note that
Jupiter already owns a 49% stake in a micropayment site (which they are
increasing to 95%) as well, so that whatever market niche this licensing model
eventually reaches, they will be participating in it.
While I’ve argued that the
new micropayment model will not have a significant impact on the RF market, I
do believe that anytime you have this much disruption in an industry it
warrants being cautious. If you run
through my numbers again on how the company can grow revenues at a double-digit
rate over the next 5 years, you will notice that I’ve left a sizeable buffer to
account for these sorts of risks, and so this target should be achievable even
in the face of significant pricing headwinds.
b)
Getty taking
market share in the subscription business
Jupiter’s subscription products
comprise around 25% of their images business.
It is a good niche for the company as they have an estimated 50-70% of
the subscription market. Getty finally
launched a subscription product last year called Creative Express. That said, Getty has thus far not had any
impact on Jupiter’s subscription business.
In fact, the subscription business continues to set record revenues each
quarter, and year-to-date it has grown by 28% over last year. The risk here is Getty eventually launching a
more competitive product and taking market share. There are a few reasons why this should not
be a significant issue.
First of all, to achieve the
price points that are offered in a subscription product, you need to have
ownership of the images; having to pay a royalty on each image for every
subscription would destroy the economics.
Because Jupiter has such a large collection of owned low-end images,
this has given them a huge advantage and allowed them to offer subscription
products with vastly more images in them.
Secondly, Getty is not pushing this product as hard as they can because
given the lower ASPs in subscriptions, Getty is hardly eager to cannibalize
their higher-priced, highly profitable royalty-free business. Furthermore, the market is likely only 50 -
60 M today, so the reality is that it is probably not a big enough market yet to
justify an investment above what Getty is already spending here. Nonetheless, Getty obviously has a dominant
position in the industry and they continue to create content (i.e. own more
images) which will allow them to improve their subscription offering over time.
c)
Leverage
Although the company has some
debt, I believe there is limited-to-no financial risk here. First and foremost, leverage levels are very
modest relative to cash flow. Debt to
EBITDA is only 1.6x, and this falls to 1.3x if you use forward EBITDA. Furthermore, this ratio actually understates
the free cash flow that Jupiter has available to service and retire debt since
a large portion of their EBITDA is shielded by tax-deductible amortization.
Secondly, the business itself
is stable with fairly recurring revenues, high margin, and not capital
intensive.
Finally, the business is
reasonably divisible and several pieces could be sold to raise cash without
affecting the rest of the company. The
entire JupiterWeb division, for example, could be sold, or even just individual
sites. In the images division, they
could also sell individual collections without impairing the rest of the
business. I would not expect any such
asset sales, but the company certainly could if they ever needed to raise
capital.
The flip side of this risk is
that the business is arguably under-leveraged.
The modest amount of debt that they currently have could potentially be
retired over the next couple years if they chose to. The business can arguably support debt that
is 4-5x EBITDA, which thus presents the company with yet another potential
lever that can be pulled to increase shareholder returns.
Catalyst
When the company reports earnings next quarter, shows analysts that the sky isn’t falling, and resumes providing guidance, I would expect the stock to react favorably.
Continued solid growth in the images business should also propel the stock, and a few successful events/trade shows would get investors excited about this new avenue of growth for the company.