Description

Recommendation

We are recommending a long position in shares of Solocal Group SA.  The shares currently trade at 5.6x our projected 12 month forward EBITDA and 6.5x our projected 12 month forward net income.  We value the shares at 0.94 Euro (6/30/15 price target) vs. the 7/11/14 trading price of 0.62 Euro, representing ~52% upside. Solocal Group SA publishes online and printed directories in France and internationally. It also publishes editorial content to assist users in making searches and choices. While the Company’s traditional printed directories business is in secular decline, the Company’s online businesses represent ~65% of the group’s revenue and profitability and are growing. The internet segment is focused on leveraging the internet to drive localized commerce and services. Ultimately, the internet segment acts as a customer acquisition engine for its clients as 70% of visits translate into a contact for its advertisers/customers.  Examples of some of the verticals serviced by the Company include: 

Solocal’s internet properties have developed substantial scale and a solid competitive position within the local French advertising market.  The Company boasts a monthly reach of 52% from both fixed and mobile devices and generates 1.3 billion visits per year for all the sites of the Group.  We note that ~70% of the Company’s visits translate into a contact for Solocal’s customers.  Additionally, Solocal is the #1 local internet player in France and the 6^th/7^th most visited company overall in the country.  The Company boasts 30% share of the local French online advertising market, 650 thousand clients, and manages >10,000 Facebook pages. The Company is also number one in France in terms deal activity, ranking number one in deal activity for 46 out of 58 main cities in France. We expect the Company to be well positioned as online/mobile media continues to take share from traditional print.  We believe mobile in particular represents an attractive opportunity for the Company as mobile traffic is growing at ~20%/year vs. 5%/year for non-mobile.  Additionally, there are opportunities for improved monetization in mobile as the Company’s mobile segment represents ~30% of traffic, but only 10% of revenue.

We believe a few issues have deterred investors from the Company and potentially masked the value of the business:  secular decline in print business masking the value of the online segments, restructuring plan masking profitability and impairing revenue growth in online, and an extremely levered balance sheet. 

• Print Decline:  The Company has exhibited negative revenue growth in each of the last three years, -2.1%, -3.2%, and -6.3% in 2011 – 2013 respectively.  However, we believe the secular decline in the printed directories business (~15% – 17% annually) is masking the growth in the online segment (7% 2011, 8% 2012, 2% 2013).  We expect the combined company to exhibit revenue growth as the print segment diminishes in importance over time.  The Company is targeting for online to represent >70% of revenue in 2015.  We also note that the internet segment alone generated $267M in 2013 EBITDA implying an EV/EBITDA multiple of 7.0x. vs. ~10x forward EV/EBITDA for Eniro’s print and online businesses despite Eniro having exhibited lower overall growth and having less exposure to online. 
• Restructuring Initiative:  The Company has been undergoing a “digital transformation initiative” for the past 18 months with the focus of realigning its sales force and shifting the Company from a paper focused to a digital focused organization.  The Company will invest ~170M Euro over three years in investments such as new IT systems, websites/apps, and a realignment of the sales force. We expect the transformation to cost ~3% points of margin through 2016, but expect margins to return to the >40% levels in 2017 and beyond.  In additional to the incremental costs we believe the restructuring initiative adversely affected sales in 2014 as Q1 revenue declined 3% vs. the prior year.  This was largely driven by the restructuring initiative as nearly 300 sales staff (~20% of the workforce) recently departed due to the realignment. We note that the Company continued to experience growth in online traffic, implying that the revenue the decline was driven by monetization. While the Company has not guided to any cost savings as a result of these initiatives they are guiding to a return to consolidated growth in 2015 as a result of the program.  This implies a >7% online growth to offset greater than 15% declines in print.  We are somewhat less optimistic modelling flat online revenue growth and a 6% decline in overall revenue growth as print declines accelerate. 
• Financial Leverage:  Solocal was highly levered at 3.7x Debt/EBITDA (2013 EBITDA) prior to its June 2014 capital increase.  The Company raised 440M Euro via a rights offering in June 2014, where proceeds of ~400M Euro where used to reduce debt.  Pro-Forma for the capital raise the Company’s leverage levels have been reduced to 2.8x Debt/EBITDA (2013 EBITDA).  Additionally, the capital raise extended maturities on most of the Company’s debt to 2018 – 2020.

Valuation and Financials

We value the company using a discounted cash flow approach.  Key assumptions in our model are as follows:  9% unlevered cost of capital, 3% perpetual growth, 44% terminal year tax rate, non-internet businesses rapidly decline and cease to contribute in 2019.  Below we post a summary of our financial projections. 

Risks

• Struggling French economy and advertising market
• Increased online competition
• Financial leverage
• Continued print declines
• Execution of reorganization plan
• Spotty track record of making estimates

Catalyst