Description

ValueClick is one of the cheapest companies in the market today, yet is an attractive investment opportunity that deserves a much higher valuation.  On my estimates, VCLK's EV/2010E EBITDA multiple is 5.4x and its EV/2010E free cash flow multiple is 7.7x, which is a 13% FCF yield.  The company has no debt, lots of cash on hand, has high profit margins (27% EBITDA margin, ~20% FCF margin), generates lots of free cash flow (with almost no capital intensity / reinvestment needs) and has strong management who protected margins in 2008-2009 and recently resumed share repurchases.  I believe ValueClick is worth $16.00 per share, 62% above its $9.87 price.  That would be a valuation of 9.8x 2010E EBITDA and 14.1x 2010E FCF.  I expect VCLK's shares to rise to this level within a year or two through a combination of re-valuation and profit growth.

Despite recent operational problems at one of its segments and an M&A mis-step, I believe the company's outlook is pretty good, as it is exposed to long-term secular trends that should drive growth for many years, namely the continued shifts of retail sales to e-commerce and advertising dollars to the internet.  In other words, while the company is clearly cheap based on 2010E financials, I expect it to continue growing revenues and free cash flow well into the future.  So why is it so cheap?  I believe the drivers of VCLK's low valuation include simplistic EPS focus & P/E analysis that ignores lots of cash, recent divestitures that make VCLK's financial trends appear worse than reality, lots of non-cash charges driving EPS well below free cash flow, and investor neglect due to its small-cap size, lack of comparable companies and Wall Street internet sector analysts who only want to see high revenue growth & don't even glance at valuations.

Business Overview

ValueClick was founded in 1998 as an internet advertising company and did an IPO in March 2000, just sneaking in before the bubble burst.  In its early years VCLK did a number of cheap acquisitions of distressed companies to gain scale and breadth in its operations, making ValueClick into a U.S.-focused diversified online advertising & marketing services company.  VCLK now divides its business into four segments: Affiliate Marketing, Display Advertising, Comparison Shopping and Technology.  VCLK recently divested its Lead Generation business, which was lumped in with Display Advertising and called the Media segment.  One can think of VCLK as a small-cap internet marketing conglomerate, operating in four small niches.  This can make it hard to analyze what's going on and properly assess the businesses' prospects without a lot of work.  I rate one of the four segments "excellent" quality (Affiliate Marketing), two "good" (Display & Technology) and one "low quality" (Comparison Shopping).  The Lead Generation business was also "low quality" so its divestiture has improved overall quality.  I think a pre-occupation with the recent poor performance of the "low quality" businesses has overshadowed ValueClick's stronger businesses.  The better quality business hold leading market shares, are stable, and should continue growing for many years to come.

VCLK's Affiliate Marketing business is the largest in the U.S., as VCLK has said it is bigger than its three largest competitors combined.  ValueClick's Display Advertising segment operates one of the largest U.S. online advertising networks, reaching around 75% of U.S. internet users.  The advertising network stitches together many small websites that combine to give it a reach comparable to Yahoo's or AOL's large owned & operated content networks.    VCLK's Comparison Shopping site network is the fourth largest in the U.S. but has struggled recently.  These struggles have pulled down VCLK's consolidated financials and weighed on its stock price.  But Comparison Shopping generates just 23% of VCLK's 2010E EBIT and even if it that EBIT went to zero, VCLK's EV/2010E EBIT multiple would only rise from 5.4x to 7.5x, arguably still undervalued.  VCLK's Technology segment develops software that advertisers use to build & track their online campaigns; while smaller than competitors Microsoft and Google, it is valued by customers for being independent from them.

VCLK operates as an essential middle-man between its two sets of customers: advertisers and website publishers/owners.  VCLK offers advertisers what it calls performance-based services: targeted and measurable online advertising campaigns, generating customer leads, online sales and brand recognition.  The websites in VCLK's advertising networks get efficient and effective monetization of their online advertising inventory.

Most of VCLK's revenues are based on a performance-based compensation structure.  Rather than simply paying per advertisement viewed (CPM), customers pay based on cost-per-action (CPA), with actions being as clicks on ads or commissions on purchases.  Online advertising has been moving away from CPM impression-based advertising, which is low-quality and ineffective, to CPA, which is more targeted, effective and generates a higher and measurable return on investment for advertisers.  VCLK has led this trend, as its innovative IP & technology and database of internet user data enable VCLK serve its advertisers well.  However, this performance-based business model introduces volatility into VCLK's revenues, as a big part of revenues are commission-based and so are dependent on consumer spending.

ValueClick's businesses should see plenty of growth from commerce and advertising continuing to migrate to the internet.  Online advertising has grown rapidly in the U.S., growing 20-25% annually (until 2009) while overall advertising has grown around 3-5%.  Despite this growth, online advertising still remains under-penetrated relative to the time people spend online.  Forrester Research estimates that in the U.S. we spend 34% of media consumption time online but only 12% of total advertising spending is online.  In comparison, we spend 35% of our media consumption time on television and 31% of advertising dollars are spent on television.  As advertisers become more comfortable with this complicated new advertising medium, internet advertising spending should continue to rise to match time spent online.  This will be a major boost to ValueClick as its revenues are driven by consumer spending and advertising activity on the internet.  Similarly, e-commerce has grown at over 20% annually (until 2008) and as spending continues to migrate online, VCLK's businesses will benefit.

Affiliate Marketing:

VCLK's Affiliate Marketing business is its largest profit contributor, generating 46% of total 2010E segment EBIT (segment EBIT is prior to corporate expenses & shared costs).  It operates under the brand name Commission Junction (CJ).  CJ facilitates affiliate campaigns for over 1,500 advertisers and 50,000 website publishers.  Affiliate marketing is performance-based in that an advertiser enters into an agreement with a website publisher (the affiliate) who will advertise its products (in a more direct & involved manner than simple display ads) and be paid a percentage of any sales that result from traffic sent from the publisher to the advertiser's site.  The website publishers act as an outsourced sales force paid solely on commission.

CJ is a marketplace where advertisers list their target audience and commission offers and website publishers browse the offers and sign up to join an affiliate program.  CJ tracks the performance of each affiliate campaign, including tracking sales generated from traffic originated by the website publisher, tracking commissions generated, and paying out commissions to the website publishers.  CJ pays out most of the commission to the website publisher and keeps a small portion for its services (believed to be 10-20%).  Advertisers like this business because it carries a fixed ROI as they only pay out commissions when they make a sale.

Affiliate Marketing is a rock solid business where ValueClick holds long term competitive advantages based on its dominant market share and strong network effects.  Also its fairly small size perhaps allows it to fly below the radar of Google & Yahoo and avoid new competitors attracted to the business's high margins.  For these reasons, I believe Affiliate Marketing should grow in line with e-commerce and continue to generate a very high profit margin that should increase with scale.

Display Advertising:

ValueClick's Display Advertising segment ("Display") should generate $36.4MM of segment EBIT, contributing 26% of the total.  Display provides targeted and cost-effective online display advertising.  VCLK's display advertising network aggregates inventory (display ad spots on websites) from 15,000 website publishers in the U.S. and 20,000 worldwide.  These are mainly small and medium sized web content publishers.  These small publishers don't have the specialized knowledge or resources to cost-effectively sell their advertising inventory.  By aggregating these many websites, VCLK creates a network that can provide an advertiser with scale, reach and targeting capabilities.  The benefits of using ValueClick include its ability to deliver highly targeted audiences and utilize its wealth of data on behavior (time viewed, click-through, sales conversion) to optimize advertisement placement and maximize revenues.  ValueClick has about 15% market share of the online display advertising business.

ValueClick pays out about 50% of advertiser revenue to the owners of the websites in its ad network and keeps 50%.  This leads to a roughly 50% gross margin and around a 25% segment operating margin.  The business is fairly competitive but VCLK's margins have risen over time as its business has grown. 

The Display Advertising business's financials have historically been lumped in with Lead Generation.  When VCLK divested Lead Generation, it issued pro forma financials for Display Advertising.  These provided a clear look at the business for the first time and showed VCLK grew Display's revenues a bit in 2008 & 2009 (two very tough years) while cost cutting and operating leverage helped increase EBIT margin from 18% in 2007 to 25% in 2009.  I expect Display will grow a bit below 4% in 2010 to $140MM in revenues and generate a 26% margin, resulting in EBIT of $36.4MM.

Comparison Shopping:

I expect Comparison Shopping to generate $25MM of segment EBIT in 2010, or 18% of the total.  According to VCLK, the Comparison Shopping segment allows consumers to research and compare products from various online and/or offline merchants using company's proprietary technologies. This segment gathers product and merchant data and organizes it into catalogs on Web sites along with relevant consumer and professional reviews, and other relevant information.  ValueClick also operates a popular coupon and discount gathering website, couponmountain.com.  ValueClick entered this business through its 2004 acquisition of PriceRunner, and increased it in 2007 with the acquisition of MeziMedia, which operates the website smarter.com.  ComScore estimates that VCLK operates the fourth-largest portfolio of comparison shopping websites in the U.S.

Comparison shopping websites are a low quality and competitive business.  Just pay a visit to ValueClick's smarter.com website, then check out Shopzilla.com, Shopping.com, Yahoo Shopping and Google Product Search and you'll see what I mean.  The name of the game is to get consumers to come to your website to compare prices on a product and click on an advertisement leading to the website of a seller of that product (which some hopefully buy).  The Comparison Shopping websites make money by earning cost-per-click fees from the product seller's ads placed on their website.  For a comparison site that generates traffic on a "free" or "organic" basis, this is highly profitable.  One such site is cnet.com, which provides professional product reviews and research, which in turn drive traffic.  Lower-quality sites such as ValueClick's have to pay to generate traffic, mainly by buying search engine ads.  ValueClick then earns the difference between the cost to acquire traffic and the revenue that traffic generates.  This business model is sometimes called "click arbitrage" and I think it's clearly a low-quality business that doesn't provide much benefit to consumers or hold a sustainable competitive advantage.

ValueClick's Comparison Shopping business has taken big hits in 2009 and 2010 as Google & Yahoo have adjusted their search engine algorithms to the detriment of comparison shopping sites.  VCLK's comparison shopping business relied on both for monetization and as a result revenues fell 16% in 2009 and should fall another 16% in 2010.  Management believes it has stabilized the business at around $125MM of revenues and is optimistic it can grow it from there by improving content quality and reducing reliance on Google & Yahoo.  I am skeptical and project it to remain at $125MM in sales and $25MM of segment EBIT.

Technology:

            The Technology segment should generate 2010E segment EBIT of $13.8MM, 10% of the total.  The Technology segment offers technology infrastructure tools and services that enable advertisers and advertising agencies to implement and manage their own online display advertising and email campaigns.  These software tools also assist online publishers with management of their Web site inventory.  This segment offers technology to deliver Web-based enterprise management systems to advertising agencies, marketing communications companies, public relations agencies, and other corporate advertisers.  I think of this as the "do-it-yourself" segment of ValueClick's business.  If you're big enough or technologically savvy you can license VCLK's software and manage your own online advertising.

The Technology business is Valueclick's smallest.  It grew nicely until 2009 and generates the high profit margin expected of a software business.

Adding it all up:

ValueClick's four segments combine to a projected 2010 segment EBIT of $138.3MM.  Corporate and shared expenses are around $30MM so my consolidated 2010E EBIT is $108.7MM.  I should mention here that this is a "cash" EBIT and excludes stock-based compensation (which is very small) and amortization of acquired intangibles (so technically it's EBITA).  I should also note that in my projections, ValueClick's consolidated 2010 sales decline 18% from 2009 and EBITDA falls 16%.  This is partly due to the Comparison Shopping business's decline (which I believe will stabilize from here) and partly due to the divestiture of the Lead Generation business.  These scary-looking declines in revenue and EBITDA probably explain why VCLK's share price is so low.  I think I've made the case that in contrast to appearance, most of VCLK's businesses are high quality and have good growth potential.  I expect a return to growth on a consolidated basis in 2011 will help VCLK's valuation considerably.

Balance sheet & capital allocation:

ValueClick has never really borrowed money and has historically held a lot of cash on its balance sheet.  ValueClick currently holds $158.5MM of cash and another $54.8MM of long-term investments.  There are two investments: auction rate securities (ARS) backed by student loans and the note receivable from the sale of VCLK's Lead Generation business.  There are $22.0MM of ARS on the balance sheet with par value of $27.6MM.  The ARS are illiquid but of high credit quality so VCLK expects to recover par value by holding to maturity.  The Lead Generation note has a five year maturity and a $45MM par value but it is carried at its estimated discounted fair value of $32.8MM.  Both investments seem to be marked conservatively.

ValueClick's biggest uses of cash have been acquisitions and share buybacks.  Management expects to continue to do both.  VCLK's ability to buy back its shares has been limited by large earn-out payments from the MeziMedia acquisition, but those are now over.  VCLK still managed to repurchase $151MM of its shares in 2008 at an average price of $12.40 in 2008.  In 2009 it stopped buying back shares but in the fourth quarter resumed the buyback with a $35MM repurchase.  Buybacks have continued into 2010.  Given VCLK's low trading multiples, these buybacks are highly accretive.

Valuation & conclusion:

            ValueClick's share price is $9.87 and there are 85MM diluted shares outstanding, so its market cap is $839.3MM.  Its $158.5MM of cash and $54.8MM of investments reduce its enterprise value to $626MM.  My 2010E EBITDA of $116.7MM results in an EV/EBITDA multiple of 5.4x.  I estimate this level of EBITDA translates into $81.4MM of 2010 free cash flow.  That makes ValueClick's EV/FCF multiple 7.7x.  This valuation is far too low for what is mostly a high quality, growing business generating lots of free cash flow and repurchasing its low-priced shares.  I believe that a combination of a resumption of growth in 2011 and management's buybacks should boost VCLK's share price towards my fair value of $16, which is under 10x 2010E EBITDA and 14.1x 2010E FCF.  This would be a 62% return from the current price.

Catalyst

Return to growth of consolidated revenues, EBITDA, FCF in 2011.

FCF used for acquisitions that add earnings power or used for buybacks.