The Street Inc TST / 7/12/13 / $1.90 Close

Summary

The Street is at an interesting point in a transformation from ad supported free content to subscription based services.  Traditionally known for retail investor commentary and newsletters, they’re expanding their reach to include institutional investors through recent acquisitions of The Deal Pipeline and The DealFlow Report. There is limited downside due to a strong balance sheet and the company offers a free call option on the return of the individual investor.

Background

The company has ~$1.70 per share in cash with no debt, and is approximately cash flow break even, so as long as management doesn’t do anything stupid, the downside from ~$1.90 is limited.  Elisabeth Demarse was appointed CEO effective 5/1/12 and has done an admirable job over her first year at the helm.  Operating expenses are down ~20% over the past 2 years with much of that coming since she took over. 

Revenue composition is changing as a result of a steady decline in advertising revenue.  As Google and Facebook will attest to, mobile consumption is less profitable than desktop consumption and this change, along with programmatic buying and a surplus of ad inventory, has lead to a steady decline in TST’s ad revenues.  Ad revenue was almost $30m in 2008 and has declined to a run rate of $8-$10m per year.  Subscription Revenue has remained relatively flat (From ~$41 to ~$38m) over that time and appears poised to begin growing again due to a three pronged approach.

Evolution

The first approach was transforming the free site from a display advertising model to a gateway to paid services model.  They are heavily promoting their paid services to viewers who come to read their free articles.  They are using social media (Weekly YouTube shows, twitter, etc) to drive traffic to paid services in addition to giving users free “open house” previews of paid subscription based newsletters.  This appears to be working as new subscribers are signing up at a 36% higher rate in Q1http://www.valueinvestorsclub.com/value2/Idea/NewIdea2013 over Q12012 and they had the first quarterly growth in net subscribers in almost 2 years.

The second step is adding new products.  They provided individuals access to their proprietary ratings system (developed so brokers could provide “unbiased” reports to clients) for a nominal fee.  They successfully launched a dividend/income product in Q1 and have recently launched a Gold product.  These were due to demand from investors which may not be the best signal for Gold and Dividend paying stocks! Regardless of that, they plan to add more products where they see demand.

The final step is adding more institutional based content.  They acquired TheDeal.com in September 2012 and recently added Deal Flow Media.  These acquisitions are immediately accretive however due to acquisition based accounting with prepaid subscriptions, we won’t get to see the full effect on the financial statements until customers renew.  They were successful in passing through a 5% price increase on customers renewing in Q1 and plan on cross selling products, including potential ones gained from tuck in acquisitions.  I’d be interested to hear if any VIC members subscribe to any of these products and if you find them beneficial or not (quality of offering isn’t my thesis but would give me more conviction if they were great products).

Valuation

So what’s it worth?  I probability weight 3 scenarios and come up to a value of about $3:

1.) Downside (35%), $1.70.  I assume they earn enough cash to cover future acquisitions and it trades for cash.   

2.) Base (60%), $4.  This is a 50/50 mix of two valuation approaches.  I apply a similar EV/Sales multiple as the most logical publically traded competitor, ValueLine (VALU).  ValueLine has had steadily declining sales which are currently about 36m.  It has an EV of just over $70m, so call it EV/S of 2.  Apply this multiple to TST’s $50m in sales and you’ve got $100m EV.  Add in the $60m cash, divide by 34m shares, and you’ve got a value of about $4.70.  The second approach is EV/EBITDA.  They had EBITDA margins of as high 24% when they had much higher revenue (and cost structure) in the 06-08 timeframe. Let’s assume they can get back to and EBITDA margin of 10% (I believe conservative but this is my base case) on $60m in sales and apply a 6x EV/EBTIDA mutliple.  This gets you to a $2.75 share price.  Average the two and we get a value of about $3.70.

3.) Upside (5%), $8.  Digital Media companies can be valued as high as 4-5x revenues when investors start to see the potential upside from the leverage.  This gets you to a $9 share price.  Alternatively, 12x EBITDA (it traded as high as 25x pre GFC) with a 25% EBITDA margins (2007) on $60m in sales gets you to a $7 share price.  Average the two and $8 is my upside.

So $3 is my target, but really I see TST as a stock with very little downside and 100% upside assuming management keeps doing what they’ve done for the past 12 months.  And if management gets off track, large holders Cannell Capital and Raging Capital are the type of investors who are willing to step in and join the board to get things back on track.

Risks

This wouldn’t be complete without a Jim Cramer comment.  Cramer clearly drives a lot of traffic to thestreet.com and the Action Alerts Plus newsletter.  He’s also been a regular seller of shares. He’s clearly a key person to the firm, however I do not believe that TST would disappear without him.  I see the biggest risk of Cramer leaving as increased acquisition costs for new subscribers, a concern but not the end.  I have heard rumblings that Cramer tried to assert himself at board meetings and Demarse would have none of it, so there is the potential for a break at some point in the future.

Another risk is potentially wasting their cash on poor acquisitions.  The two they’ve made to date appear to be manageable and accretive, however they have said they plan on continuing to make acquisitions and there is clearly the risk that they make some bad ones.

Of course a downturn in the markets would not be positive for a financial media company, however TST is highly leveraged operationally to a pickup in revenue from individual investors coming back as well.