Universo Online S.A. UOLL4
December 02, 2008 - 5:38pm EST by
louisc738
2008 2009
Price: 6.80 EPS
Shares Out. (in M): 0 P/E
Market Cap (in $M): 817 P/FCF
Net Debt (in $M): 0 EBIT 0 0
TEV (in $M): 0 TEV/EBIT

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Description

SUMMARY: UOLL4 is like a Graham play that is full of cash (80% of Market Cap) and offers a free option on growth. The company is trading at EV/EBITDA of 0.9x (2009), well below other alternatives in the sector. The shares were sold off amid the rush for the exits in Emerging Markets. Besides that, the market is tired of them due to the high amount of cash. Right now having cash is a huge competitive advantage for purchasing businesses that are cash strapped.

BACKGROUND

 I had submitted this idea before to VIC on December 11, 2007. Therefore please refer to my previous wtite up for more information. Below I will present brief comments on UOL.

The Company’s flagship portal in Brazil is organized into 42 thematic stations with more than 1,000 channels of news, information, entertainment, and services, representing a total of more than 7 (seven) million pages. UOL’s extensive interactive platform offers communications products, VoIP, Internet communities, security and search engine, among others. The company has 24 categories that have more than 1 million Unique Visitors/month, and the closest competitor – Terra (Telefonica Group) has only 15 categories.

It is a leading web Portal aimed to Brazilian market and Portuguese speaking people around the world. Besides that it has an ISP business with 1.8 million subscribers, the largest on-line subscriber base. UOL provides local Internet access in more than 3,000 cities throughout Brazil and 14,000 cities abroad. Besides that, the average time spent on UOL’s sites by the users is 1:09 hours (Set/08).

The company belongs to a leading newspaper group in Brazil – Folha de São Paulo, that provides some of its content, and the other big shareholder is Portugal Telecom. Folhapar, the group holding company, bought more than 10 million shares (8,3% of total shares) in the last two months amid market turbulence without moving the price.

UOL derives 66% (last year was 75%) of its revenues from subscription revenues related to Internet Access services (ISP), and the remaining is from online ads and other products. The company develops internally 80% of the portal’s content. A key point is that most of the investors view UOL as a simple ISP business, and additionally don’t believe that UOL can leverage its content and brand popularity to get more online ads. The company does not disclose its ads revenue in P&L line alone, and barter transactions. According to company, they have around 25%-30% market share of internet advertising in Brazil. I would like to enphasize that the Brazilian Telecommunications Law requires that everybody has to have an ISP subscription.

The company was voted as the preferred portal by InfoExame’s readers, a leading PC magazine in Brazil, with 44% of the votes. Terra (Telefonica) got 38% and IG (owned by Brasil Telecom) 18%.

The company’s management is careful on asset allocation; despite its huge cash pile is not doing any silly acquisition. They choose to develop inside company the new products instead of buying existing competitors, because the acquisition premiums used to be very high, because successful Mercado Libre’s IPO (ticker: MELI) and other related technology oriented companies in Brazil, such as: Totovs and Datasul. I spoke to Private Equity people and they told me that sellers are now more humble on price because there are not any other options to raise capital, if you need it to grow.

UOL has established a commercial partnership with Google, sharing revenues from traffic to Google’s search engine through UOL’s portal. It has also launched new products to attract more viewers/traffic, such as:

a)Shopping UOL: Online price comparison tool, which competes with BuscaPé/Bondfaro. It is the 2nd largest in the country.

b)PagSeguro: Online payment website, which is similar to PayPal and competes with MercadoPago offered by Mercado Libre (Ticker: MELI), and this has synergies with the UOL’s auction site TodaOferta.

c)UOL Megastore: Online music store, with the aim of generating traffic.

d)TodaOferta: Auction site, whichhas a different business model than Mercado Livre, a subsidiary of Mercado Libre (ticker: MELI). At TodaOferta, the sellers pay a fee for showing the merchandise and there is not a "success fee" as Mercado Libre.

e) UOL Host: At end of 2007, the company bought two small internet companies that offer hosting services, with that came 18 thousand customers. This service got high marks from “Info Exame” the leading internet/technology magazine in Brazil. Right now, UOL’s has close to 35 thousand customers, and with this got the 2nd largest market share. The leading company in the segment is LocalWeb with almost 180 thousand customers. UOL’s has almost 250 thousand e-mails that are used by small-businesses, which don’t have a website, so there is a huge untapped opportunity. The lowest cost for having a website is R$ 15,00 /month (around US$ 7,00/month). There are operational and business sinergies with this new business, because it uses the capacity of the datacenter that handles ISP’s e-mails and hosts portal’s content.

The IPO’s price was R$ 18.00 per share valuing the company at approximately R$ 2.1 billion or the equivalent to US$ 950 million on December 16th, 2005.

AUDIENCE

UOL maintained leadership in page views and time spent online among content portals in Brazil with 1,789 (1,608 Sep/2007) million page views, which means an increase of 11,3% Y-o-Y; and an average time spent online of 1h:09min:13sec – Sep/2008 (1h:05min:22sec in September 2007), according to IBOPE//NetRatings. Additionally the Unique Visitors figures reached 16, 2 million.

UOL Busca (UOL Search) ended September/2008 with 5,1 million Unique Visitors, mantaining the 2nd position behind Google, and last year in the same month achieved 4.9 million unique domestic search visitors, putting them  in second place in the IBOPE//NetRatings search rankings.

AUDIENCE Data

Metrics

Sep-06

Sep-07

     Var. %

Sep-08

     Var. %

Page views (million)

1.293

1.608

24%

1.789

11,3%

Unique visitors (000)

8.898

13.019

46%

16.225

24,6%

Unique visitors - search (000)

3.451

4.936

43%

5.106

3,4%

Reach (% of Brazilian Internet users)

65%

65%

n.a.

67%

2,0%

Time spent online (hours:min:sec)

    1:14:56

   1:05:22

-13%

   1:09:13

6,0%

Source: Ibope//NetRatings (portal audience, home panel, brand, excluding Internet applications).

UOL continues to maintain its leadership in audience amongst Brazilian portals (Globo, iG, Terra (Telefonica), YahooBrasil). This leadership is the foundation for advertising of sponsored links, banners and its advertising revenues are having a healthy growth.

GROWTH PROSPECTS

Growth of Internet Users. According to a report by Internetworldstats.com, the number of Internet users in Brazil reached 50 million in June/2008. This includes people that uses internet from all access places (home, work, schools, cyber cafes etc.).  Having grown at a compound annual rate of 15 % since 2002.

The Internet penetration (= Internet Users by total population) in Brazil is 26,1% (according to Internetworldstats.com – June 2008), which is still below Argentina 39,3% and Chile with 44,9%, however is higher than Mexico with 21,6%. Brazil’s internet market is bigger than the sum of Argentina+Chile+Mexico. Brazil is the 6th largest internet market in the world.

Looking at the internet market in Brazil, with more than 50 million users, and all these users with a 21-hour usage per month, we believe that these two factors, size of the market and number of users and the time they are spending on the web represent a high growth potential for portals with good content, therefore high traffic and brand recognition by advertisers, as UOL, going forward.

 Increased adoption of e-commerce among Internet users. We believe that the relatively high penetration of online banking and the large number of income tax returns filed online, as well as the popularity of online communities (e.g. Orkut) illustrate the willingness of Brazilians to adopt new technologies. E-commerce in Brazil is continue to grow, as we can attest based on data from ComScore Media Metrix that shows a growth of 24% (Y-o-Y).

BRAZIL RETAIL - ComScore Media Metrix

Type

Total unique visitors (000s)

March 2008 - Reach %

Total unique visitors (000s)

March 2007 - Reach %

Unique Visitors - Y-o-Y %

Total Internet Audience

all

      18.939

100%

     15.307

100%

24%

1 B2W (*)

e-retailer

         9.014

47,6%

        7.735

50,3%

17%

2 MercadoLibre

auctions

         7.952

42,0%

        7.440

48,6%

7%

3 BuscaPe + Bondfaro

price comparison

         5.722

30,2%

        4.767

31,1%

20%

4 UOL Shopping

price comparison

         4.083

21,6%

        1.205

7,9%

239%

5 Saraiva

e-retailer

         1.246

6,6%

           975

6,4%

28%

6 eBay

auctions

         1.237

6,5%

        1.165

7,6%

6%

7 Apple

e-retailer

         1.152

6,1%

n.a.

n.a.

n.a.

Source: Com Score Media Metrix

(*) Includes Submarino + Americanas + Shoptime websites.

The strenght of UOL’s brand and portal’s traffic can be seen on the table above, where it showed the largest growth (239% Y-oY) on Unique Visitors in the Retailing sector. Last year, it was well behind in the price comparison segment, however is catching up fast.
 
Low Internet Advertising Expenditures. According the newsletter “Meio & Mensagem”, who tracks the advertising expenditures by media in Brazil with the help of PriceWaterhouse Coopers, advertising aimed to Internet is having a huge growth, as can be seen in the table below. 
 

ADVERTISING SPENDING by MEDIA (BRL million)

Brazil

Acum.

Acum.

Acum.

MEDIA

Set/06

Set/07

Change %

Share %

Set/08

Change %

Share %

TV

7.482

7.855

5,0%

59,3%

8.968

14,20%

58,50%

Newspaper

1.988

2.191

10,1%

16,5%

2531

15,60%

16,60%

Magazines

1.018

1.057

3,8%

8,0%

1279

21,00%

8,40%

Radio

530

528

-0,4%

4,0%

648,7

22,80%

4,20%

Pay-TV

368

427

16,1%

3,2%

556,6

30,30%

3,60%

Billboard etc.

467

391

-16,2%

3,0%

415,8

6,30%

2,70%

Guides/Phone Lists

443

383

-13,6%

2,9%

343

-10,30%

2,20%

>>INTERNET

253

353

39,7%

2,7%

519,5

47,20%

3,40%

Movie Theaters

40

49

24,3%

0,4%

61,5

25%

0,40%

Total

12.589

13.234

5,1%

100,0%

15323

15,80%

100,00%

Source: Inter-Meios - Nov 26, 2008.

Internet share in Brazilian’s advertising pie is well below world averages, 2.7% against 7.4% in 2007, so there is a huge growth ahead. Besides that, Brazil spends comparatively a good chunk of its GDP in advertising.

FINANCIALS / VALUATION

 The company is profitable: Net Earnings for 9 Months 2008 is BRL$ 75,6 million and for all 2007 reached BRL$ 109,4 million.

We calculated an adjusted P/E where we simulatedthat the company distributes all of the cash (BRL $ 567 million), so we can show how low is UOL’s P/E ratio on the table below.

 

Estimated P/E - 2008

BRL Million

EBIT (9 months-2008)

57,0

(-) Income Tax

(10,5)

Adjusted Net Earnings (*)

47

Annualized Net Earnings

62

(*) Eliminated all interest income

from cash balance.


Market Capitalization

817

(-) Cash Distribution

(567)

Adjusted Mkt Capitalization

250

Adjusted P/E Ratio

4,0

Earnings Yield

25%

 
 
Considering that the Selic Rate is 13,75% (the basic interest rate in the Brazilian market), so UOL’s Earnings Yield is almost the double of the basic interest rate, which supplies a good cushion.
 
 Below we supply a kick valuation on UOL based on EV/Ebitda multiple.
 

EV/Ebitda Calculation

BRL Million

Number of Shares (million)

120,1

Price BRL$

6,8

Mkt Cap

817

(-) Excess Cash

-567

(-) Tax Credit

-112

(+) Swaps Payments Due

11

(+)Tax Debts Renegotiated

6

Enterprise Value

155

                   2008e

2009e

Enterprise Value

155

155

Ebitda

143

169

EV/Ebitda Multiple

1,1

0,9


UOLL4 is cheap because it is trading well below to other similar companies in other countries, which don’t have the same brand recognition and growth prospects as UOL. Recently RBC Capital Markets issued a report on USA/Canada Small Cap Online Advertising companies which are trading at an average EV/Ebitda current multiple of 4,8x. However, these companies don’t have a market position similar as UOL has in the Brazilian market, which is the biggest portal in Portuguese language.
 
Besides that, we run a DCF valuation with conservative assumptions in terms of sales growth, EBITDA margin drops to 16,6%, the perpetuity growth is 3%. The discount rate used was 15%. Therefore we get a value of BRL$ 13,50/per share, that means an upside potential of 97%.
 

UOL    P & L (BRL Million)

2005

2006

2007

2008e

2009e

Gross Revenues

564

634

716

791

883

    Subscription

457

485

525

510

517

    Advertising+Other

107

150

192

281

366

(-) Sales Deductions

(120)

(154)

(191)

(216)

(221)

Net Revenues

444

481

525

576

662

Net Revenues Growth

8,8%

8,2%

9,2%

9,7%

15,0%

(-) Cost Services Sold

(215)

(215)

(217)

(234)

(291)

Gross Profit

229

265

309

342

371

Gross Margin

52%

55%

59%

59%

56%

(-) S, G &A

(154)

(150)

(172)

(199)

(202)

(-) Depreciation

(22)

(33)

(44)

(43)

(63)

 Other Oper (Exp.) Revenues

24

20

17

0

0

EBIT before Non-Recur.

78

102

109

100

106

(-) Non Recurring

(24)

(20)

(17)

0

0

EBIT Recurring

54

82

92

100

106

(+) Depreciation & Amort.

22

33

44

43

63

EBITDA

75

115

136

143

169

Ebitda Growth

36%

53%

19%

5%

18%

Ebitda Margin

17%

24%

26%

25%

25%

We think that brand recognition as UOL enjoys (mainly for companies running sites or a community of sites) is an essential intangible asset and that today it is difficult to build this up from scratch. Brand (and image) takes on a strategic dimension since it provides audience figures or “natural traffic” that can be used by advertisers.

Catalyst

1) Uses his excess cash of BRL$ 567 million (US$ 243 million) to make accretive acquisitions. CFO told us that they have around 8 potential acquisitions in the pipeline.
2) Advertising revenues continue to growth despite the competition due its portal content, popularity among internet users and brand recognition by advertisers.
3) The company could be acquired by another media company due its preeminence among the Brazilian portals.
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