Description

Idea: Long (QNST) – Quinstreet

Price: $4.50

Valuation Range: $5-10 (11%-120% upside)

Description:

Quinstreet is a leader in online performance marketing and operates a number of lead-generation websites catering to the education, financial (auto insurance, credit, health, life), and business to business markets.  They are paid to deliver a qualified lead to their client which converts to a sale resulting in an attractive ROI for QNST’s client.  QNST’s generates traffic through organic search, and search engine marketing. 

(For additional info: Scott737 did a writeup on QNST on Sept 12, 2011. http://www.valueinvestorsclub.com/value2/Idea/ViewIdea/57072)

Thesis

• QNST’s business has struggled tremendously for the last 4 years.  From a high of $25 in early 2011, it has fallen to all time low of $4.50. (We believe the bottom is in.)
• QNST has spent several years investing in new verticals (auto insurance being the most important), and retooled the Education offering to first stabilize the business and now reinvigorate growth but at the expense of current margins.
• While adjusted EBITDA has not yet returned to previous margin levels, the core profitability of the business remains intact and has been reduced only because of further investment to re-accelerate growth.  The inflection point when the top-line revenue growth allows for rapid margin expansion is drawing near.
• Early indications are that the investments are starting to bear fruit and business has begun to turn the corner and will start to show sequential growth.
• Appears that very few people are paying attention to QNST these days.  Q3 2014 transcript was all of 4 pages with zero questions asked, and Q4 2014 transcript was 8 pages with only 1 person asking a question.  Apathy = opportunity?

We might be jumping the gun a bit as we are calling the turn before it is fully reflected in the financials, but what we’re seeing with the announcements, insider transactions, and expected improvement, as well as the basement valuation, gives us some gumption to get this out in front of the community.  As we detail some of the facts below, what impresses us is the rapid growth they are seeing with several new initiatives (albeit much off a low base).  This is the first time in 4 years where it sounds like they have the right product set and the right positioning and at the same time their core markets (insurance/education) seem to be starting to stabilize.  The CEO buying some stock in the open market (even though he owns 12% of the company already) could be a decent signal that at least he truly beleives the corner is close to being turned.

Recent Results/Data Points

• Financial Services Vertical – largest growth opportunity
  • Over the last few years, Financial Services Vertical had been negatively impacted due to the lack of availability of high quality media at acceptable margins, which was caused by changes in search engine algorithms and the acquisition of media sources by competitors
  • They’ve addressed these issue by broadening the product offering (enhanced click, lead and policy products) which has improved monetization and opened up higher value media.
  • Check out their core site: www.insurance.com
  • In Auto Insurance – 50% of revenue is already coming from recently launched products announced in Q3 2014.  Expect y/y growth in Auto by Dec quarter.
  • Have long established relationships with the top auto insurance carriers
  • Investing heavily in Auto because it is single largest addressable market opportunity, and have a strong position with clients, products, and other assets.
  • Expect all financial services client groups (auto, mortgage, credit, health, life insurance, deposit accounts) to show growth – first time in 5 years
    • A big part of the turnaround thesis rests upon their ability to successfully penetrate the auto-insurance vertical.  QNST has spent considerable time and money developing products (click, policy, click to call) that have resonated and should continue to be attractive to insurers.  If QNST cannot execute here, or insurers ad budgets find better ROIs, or if quality traffic cannot be found at attractive margins…then this company will stall and won’t take flight.
    • Based on the early success QNST has had here, and the huge ad-budgets that insurers have and the increasing amount spent online, there is a great opportunity for QNST.
    • We have calls out to several insurers and will report our findings in the comments as we get them.
• Education Vertical remains a mixed bag. 
  • For-Profit Education Vertical has been under tremendous pressure as that industry has collapsed, dramatically cutting marketing spend and changing the approach to convert leads due to regulatory pressure.
  • QNST shifting to higher quality products (higher qualified, higher intent leads) to the for profit schools which are still in demand. The schools still operating still have to find students, and given the regulatory environment they cannot be as aggressive trying to convert leads…so a higher intent/higher quality lead fits with the new policies.  This has allowed QNST to maintain stable pricing (they actually increased average prices 5% over the past year).
  • QNST continues to gain market share due to their strong platform, longstanding relationships, and ability to focus on higher quality. 
  • Business remains profitable, but challenging.
  • Education click products – grew 47% in 2014, and expect to grow 100%+ in 2015 to $11mm. 
  • Non-Profit-Edu grew by 50% in 2014 to $10mm, and expect to grow 45% in 2015.
    • They’ve found some early success approaching non-profit schools looking to grow enrollment and are willing to pay for the high quality leads QNST can provide.
• Brazil Education – grew 100% to $2mm in 2014, and expect $4mm in 2015.
• Expect EDU vertical expected to be down single digits in 2015. (For-Profit down 10%, while non-for-profit and international show growth).
  • This business has been in decline for a long time and under a lot of pressure.  What reason do we have to believe that the end of that decline is now?  The company has in the past expected the decline to slow only to see it decline further. However, what seems clear is that For-Profit and Not-For-Profit education is not going away, and if it is not going away they are going to need to find cost effective ways to obtain new students.  As long as QNST’s model remains one of the better ROIs for these schools, there is a business here.  Perhaps it stabilizes at this level or maybe 10% lower, but not 50% lower from these levels…And once it stabilizes, as long as the Fin Services business grows as they expect, the overall company should show decent growth and expanding margins.  
• Misc
  • Mobile – revenue from mobile grew in 2014 by 50% to $30mm.  Plan to grow again by 50% in 2015.  Rev per visitor in mobile is on par with desktop.
  • Call center revenue – grew by 100% in 2014 to $21mm.  Plan to grow by 45% in 2015.
  • Partnerships with large media companies grew from $700k in 2013 to $11mm in 2014.  Plan to grow 50% again in 2015.
  • New partnership with Bankrate – matching traffic from QNST network with some Bankrate clients.
  • Social Media – grew 77% in 2014 to $6mm, and plan to grow 40% in 2015. 
  • Based on the guidance they’ve provided for these areas above:
    • Represents $76mm of 2014 revenue = 27% of total revenue.
    • Expected to grow to $115mm in 2015.
    • If the total revenues for the business remain flat, that means the rest of the business would need to decline by 20% y/y which seems unlikely.

• Q1 2015 Outlook - $70mm revenue, and EBITDA low single digits – continue to transform the business and invest in revenue growth initiatives.
  • All businesses except auto are contributing such that QNST could generate 20% adjusted EBITDA, but would be at expense of pursuit of important initiatives in auto to return the company to growth.
    • Meaning, if they wanted to steady state the business margins would be higher than they currently are running.
    • Company expects to deliver y/y revenue growth for 2015.  This will be the 1^st year of y/y revenue growth since 2011.

Segment Details:

• Education – 40% of revenue - $27mm Q4 2011 (lfq)
  • Peak Rev: $47mm (Q4 2011)
  • Low Rev: $27mm (Q4 2014) (-42% decline peak to trough)
• Financial Services – 40% of revenue - $27mm (lfq)
  • Peak Rev: $49.8mm (Q1 2011)
  • Low Rev: $26.5mm (Q2 2013) (-46% decline peak to trough)
• Other/B2B – 20% of revenue - $13.3mm (lfq)
  • Peak Rev: $15mm (Q1 2012)
  • Low Rev: $11.5mm (Q4 2013)  (-23% decline peak to trough)

Competitive Advantages

• Sound financial management – able to scale business up/down and maintain profitability at various revenue levels.
• Solid balance sheet - $120mm cash, $77mm debt.
• Long standing client relationships
• Scale:
  • ability to spread technology/platform investment across verticals,
  • deep client relationships,
  • ability to invest in new product lines/verticals,
  • diversified revenue stream

Risks

• Does QNST have any sustainable advantages in mobile, and how does the value add of lead generation change in mobile?
  • For now they appear to have a model that is working and monetizing at a decent clip, , but it is something to watch and further research.
• Education business remains challenging, potentially forever so.
  • Definitely a real possibility.  They’ve worked very hard to stabilize the entire vertical as the For-Profit segment has been clobbered.  If this business can simply stabilize and show 0% growth (+/-) but the Financial Services sector grows as they expect, the overall business will do very well.
• Google Algorithm changes can impact their traffic in negative ways.
  • This has happened in the past.  They are aware of it, and focused on improving content and partners so further changes will could be positive for QNST’s organic traffic.
• Current momentum in the business stalls and they keep investing aggressively to drive revenue growth that never comes.
  • The stock would have further downside from these levels if that is the path that is taken.  One mitigating factor is the potential for an go-private transaction to then unleash the cash flows.
• Business has permanently changed: the cost of media vs. the value delivered has been squeezed and the reason for the margin deterioration is not due to greater investment for growth but rather due to a structural change/competition.
  • This is certainly an argument one can make, but I have not yet seen definitive proof that this is accurate.  Granted, we haven’t seen definitive proof that it is not accurate either.  Clearly segments of the company’s business have come under pressure, but other areas have remained strong and new areas carry attractive growth and margins.  Time will tell.  Where you come out on this question really determines if you think this is a potentially attractive turn around or a value/trap dying business.
• New Entrants
  • Every once in a while new people enter the market and blow a ton of money on media to get lots of traffic that doesn’t necessarily convert, but during that time the cost for the media that does convert well increases and QNST either must face margin pressure or lower revenues as they refuse to chase traffic.  Luckily, these new entrants’ business models are not sustainable and when they leave again QNST remains.

Management Team

• Doug Valenti (CEO) – owns 5.3mm shares outright (12% of company)
  • Founded QNST in 1999
  • Has recently acquired (through open market purchase) 32,000 shares at $4.60

Cash Flow Characteristics

• Despite the large investments in development and media in the business, and the pressure on the top line, the company delivered $18mm in operating cash flow, $10mm in Free Cash Flow, and $15mm in normalized FCF in 2014.
• Historical Normalized FCF:
  • $61mm in 2011 – 15% margin
  • $54mm in 2012 – 14.7% margin
  • $40mm in 2013 – 13% margin
  • $15mm in 2014 – 5% margin
  • Revenues fell 30% over this time period and the company invested aggressively in the last 18 months in new products/media which has pressured margins/cash flow.  Despite those declines and investments, they’ve still generated cash, and trade at a 7.5% FCF yield.  When the investments start to pay off, FCF margins should expand again.

Valuation/Estimate

• Market Cap: $200mm ($4.50 stock price)
• Net Cash: $46mm ($122mm cash, $77mm debt)
• EV: $153mm
• Adj FCF (ltm): $15mm

• Rev (est FY2): $305mm (4% CAGR)
• Adjusted EBITDA (est FY2): $48mm (16% margin)
• EV/EBITDA (est): 5x (hardly an expensive multiple)
• EV (est): $244mm
• Cash Generation over 2 years (est): $35mm
• Market Cap (est): $328mm
• Price: $7.50
  • Expect normalized FCF to approach $30-40mm/year in 2-3 years. At our estimated valuation the Normalized FCF yield would be near 8-11%, hardly an expensive level.

A Not-So-Good Case

• Growth doesn’t materialize: Business continues a 2-5% yearly decline
• Management re-optimizes to run for cash flow.
  • One could argue if optimizing for cash flow then 20% EBITDA and 15% FCF margins are possible.  But let’s go with 10% FCF margins.
  • Revenue: $280mm$28mm FCF
  • Declining 5%/year.  After 3 years $24mm cash flow.
    • Capitalize at 15% = $160mm
    • Plus current cash: $46mm
    • Plus 2 years cash generation: $50mm
    • = $256mm market cap
    • $5.81 stock price. (30% upside)

A Worst Case

If growth doesn’t come, and management keeps pouring money down the hole…then you could imagine that FCF falls to 3-5% margins (or worse).  At 3% FCF margin, doing similar calculation as above: $100mm market cap = $2.50 stock price (40% downside).  I imagine then the management team would pay up, do an LBO and then re-optimize for cash flow.

A Best Case Scenario

• Growth re-accelerates to 10-12% CAGR top line
  • Would require strong growth from Financial Services (primarily auto), stable to slightly growing Education, and normal growth from B2B.
  • Rev (est FY2): $350mm (4% CAGR)
  • Adjusted EBITDA (est FY2): $60mm (18% margin)
  • EV/EBITDA (est): 6x
  • EV (est): $360mm
  • Cash Generation over 2 years (est): $40mm
  • Market Cap (est): $450mm
  • Price: $10.00

Financial History

Sample list of Quinstreet Domains

• www.insurance.com
• www.carinsurance.com
• www.insure.com
• www.onlineeducation.com
• www.moneyrates.com
• www.onlinedegrees.com
• www.myonlinenursingdegree.com
• www.campuscorner.com
• www.worldwidelearn.com

Quotes from Recent Earnings Calls:

Q3 2014:

“Now, before I turn the call over to Greg to discuss the financials in more detail, I want to recap where we are in auto insurance. This is exciting stuff, at least to us. We've talked for the past couple of years about the range of challenges we've been addressing in that important market and about the progress we've been making. Most of that progress has been incremental and largely defensive given the narrow footprint of insurance product, the need to rebuild and update the complex policy product from acquired assets and the competitive environment.

By contrast, the launch of the three new products this past quarter represents a dramatic – represents dramatic progress and a step function increase in our addressable market. The products put us in position to turn back to offense. We're excited to be at the point where we can now confidently spend aggressively on marketing and media to grow those products and that business. I believe this was a major turning point for us in auto insurance and as a company. Revenue growth is key to increasing shareholder value and to returning to margins and cash flows more in line with historic levels.”

Q2 2014:

“We are making more progress faster on more important initiatives than at any time in company history. That progress is not yet driving top line growth because of the large scale and persistence of the market challenges we are facing and working to offset, and due to the naturally earlier stage and smaller scale of the growth initiatives, but our efforts have significantly dampened the effects of the challenges”

“Now, finally, as of this quarter, our full range of complementary

new products in Auto Insurance will all be launched including recoded, more flexible and usable policy flows, new competitive lead products, expanded call and call center capabilities and an important new version of our historically

core, click product. We have client commitments for all of these products and I have personally visited many of our biggest Auto Insurance clients over the past month to confirm their enthusiasm, strong interest and demand. With these pieces in place, we're now able to push forward efforts to ramp our Auto Insurance business, add scale in earnest. I do not expect to see much of an inflection and impact on the top line from those efforts in the current quarter, but I do expect to begin to see it in fiscal Q4 and beyond and what we expect to be an accelerating pace”

Catalyst