Description

Long XLM. Perennial value trap finally has a catalyst. Target 100%+ upside in 12m. Smallcap idea for PA.

XLMedia (XLM) is a classic AIM value-trap. It has screened cheap for the last decade and has probably burnt a long line of investors thinking “this time will be different”. It was written up on VIC at 164p in 2018 and again at 62p in 2019. Today it is trading at 10p and I’m going to argue this time will be different.

It has had many of the hallmarks of a classic AIM cash incinerator. Affiliates/SEO marketing – check. Israeli tech company – check. Small UK company planning to enter the US market – check. Picks and shovels play on US gambling legalisation – check. Ill-timed acquisitions – check. Buybacks at prices multiples above where it currently trades – check.

XLM has a cornerstone investor in the Mitterrand family office (Premier Investissement) with a 28% stake. These guys have shown an incredible optimism / capacity to suffer over the years, blessing various terrible capital allocation decisions and resisting calls for a sale. My guess is that XLM is a small position for them so they have preferred to keep rolling the dice on turnarounds rather than crystallising a loss. I speculate they may have had a personal affection for the original founder too (he stepped back in 2019).

However it seems they have finally had enough and have appointed a restructuring CEO to liquidate the assets. Hence the investment proposition can finally move from value trap to crystallisation.

Brief company overview

XLM originally operated affiliates websites and digital lead generation platforms for the European gambling sector. Gambling operators would pay them for sending customers either on a cost-per-click or rev share basis. This biz was highly cash generative and grew nicely during the 2010s. Then it got hit by regulatory change in the Nordics and changes to the way Google/the internet works. The first period of value-trap status occurred as mgmt/investors came to gradually accept the biz model was permanently impaired rather than just going through a soft patch. For example the company spent c$30m on share repurchases in 2019 with the share around 70p, mistakenly thinking this was a cheap price vs 2018 when the share traded >100p. The founder stepped back in 2019.

This happened to coincide with the start of hype for sports betting in the US. Plus the ZIRP bubble period. The company (presumably blessed by Premier Investissement) appointed a new CEO with an ambitious plan to capitalise on this new market. There were several other AIM companies caught up in this hype around that time (some readers may be familiar with GAN plc). XLM raised $36m of equity at 40p share and made several acquisitions of US sports media websites during 2021. In total they spent c$75m. In hindsight this was poor capital allocation. XLM paid multiples on inflated earnings. The main asset of value acquired was the Saturday Football properties focused on college sports.

Post-ZIRP the US sports betting players have cut their marketing budgets and XLM revenues declined. The CEO was abruptly replaced and the current incumbent, David King, was appointed in April 2022. King appears to have been chosen as a “turnaround specialist”. His previous role saw him stablise and then liquidate the troubled JPIMedia group (owner of the UK “i” newspaper), eventually selling assets in several transactions during 2018-20, with the “i” being sold to the Daily Mail. A new Chairman, Marcus Rich, was also appointed. Rich has held several roles within digital publishing, most recently overseeing the sale of Time Inc to Future plc (both companies owned portfolios of special interest media assets).

The new mgmt team were granted c7m options tied to both TSR compared to the FTSE 100 AIM index and absolute share price targets. The awards have a 3yr vest plus a 2yr holding period. To receive any award XLM must perform inline with the median index constituent (25% vesting) with 100% vesting at upper quartile plus an undisclosed absolute price target. At the current price XLM has underperformed the index by c15% so it is unlikely management would be paid on their options unless investors make money from here.

Liquidation process

The new mgmt have taken various steps to cut costs and realise shareholder value. The board has been reduced in size and remaining members took a pay cut. Broking relationship with Berenberg was terminated. Headcount reduced. Some legacy personal finance media assets were sold in 2023. Then in March 2024 the company announced the sale of all its European assets for $37.5m plus up to a $5m earnout to Gambling.com (GAMB). This sent the shares up +c100% on the announcement. This has faded in recent months, shares are +c60% currently. I believe this is due to uncertainty around tax/other cash leakage (discussed below) and negative headlines hitting the broader gambling affiliates space.

The only remaining assets within the company are the US sports betting properties acquired for c$75m plus cash and liabilities. The company will use the proceeds of the Europe disposal to pay the remaining earnouts on the US sports assets, pay for taxes, restructuring costs, and then return the excess cash to shareholders in Q4 2024. Commentary on the last call indicated that buyback/tender offer was more likely than special dividend. At the most recent results the company also wrote down the value of the US assets by $57m. Whilst much of this writedown was necessary, they may also be incentivised to kitchen sink to minimise tax. They disclosed in the annual report they used a punitive 25% discount rate when calculating the writedown. They previously wrotedown the European assets to below the level at which they were eventually sold.

Where do we stand today? With 276m shares outstanding assuming all RSU/PSUs vest (conservative as some may not vest, current shares outstanding is 263m) and a share price of 10p the company has a market cap of GBP28m or USD35m. Financials are in USD. There are two key questions for determining value from here. 1) what will be the tax and other cash leakage on the already disposed European assets, and therefore how much cash can they distribute in Q4 and 2) for how much can they sell the US remaining assets.

1) The company has so far received $20m of the European assets consideration. They will receive a further $10m in October. With the final $7.5m plus potential $5m earnout received in 2025. Mgmt have indicated once they receive the $10m in October they will take a view on cash leakage and return some capital in Q4. Per the last call:

We will then see further $10 million in end of – well, at the beginning of October. And we charge – once we have received the bulk of those revenues and once we have completed all our tax work, as we did say, there will also be confirmationally level, if any, of tax payable on the transaction and that work is obviously across multiple jurisdictions. That work is ongoing. We don't expect that to be substantial. But until we finish the work, we can't be definitive. And therefore, we think it will be most suitable to wait [indiscernible] (00:24:24) including the $4 million payable again in September [note: refers to legacy earnout liability on US acquisitions] and then we'll be in a position to make an initial payment.

The question of whether it's dividends or buyback, we actually have lots of inbound information from a number of shareholders. But in the event they would prefer to see a tender offer, we are taking advice, of course, on what the best options are. The sense we have from our shareholders is dividends is not the most attractive way to return funds. It would either be through buyback or through tender offer. And nearing the time, we would obviously confirm which route we are proposing to take. So, this is primarily about getting our ducks in a row. As I said before, getting our allowances cleared, getting clarity what the cost need to bring the business into size for the future and then making a significant distribution in quarter four to shareholders. If full, we think with a capital sum rather than an income sum.

Yeah. I think the only thing to add is we want to firm this up and we'll update people on the mechanic in July when we do the interims because we'll have done, as David said, most of the pre-work up to that point.

I am assuming the following EV walk, based on some pointers provided by mgmt in a paid research note.

I am assuming mgmt want to ensure the company is at least cashflow breakeven this year. So based on their comments that they will wait until the second chunk of consideration is received, we could pencil a worst case cash leakage of $16m. This would result in a ~breakeven FY24 cashflow after factoring the other known line items. Based on the quote above, and as a % of the total consideration, I believe this is very punitive. Even so, this would result in an EV adj of c$12m net cash. Assuming no leakage and receipt of the additional $5m earnout would result in a blue sky EV adj of c$33m net cash. For valuation purposes I assume somewhere in the middle, for $27m net cash as the base case. On that basis we create the company today at a maximum of $23m EV and as little at $2m. Base case c$8m EV.

This brings us to 2). How much are the US assets worth? We have the following triangulations. They were acquired in 2021 for $75m. This year they are guided to generate $5m of EBITDA including corporate costs, with further cost reductions expected in FY25 as the ongoing restructuring is annualised. The European assets were sold for 5.7x EBITDA ex earnout or 6.4x inc earnount. Or 1.6-1.9x revs. The smaller personal finance assets were sold in 2023 at 1.4x revs.

In calls mgmt have mentioned there are several interested parties. I believe an obvious acquirer could be Better Collective (BETCO). BETCO is currently engaged in rolling up niche digital sport media assets. BETCO currently trades at 10x EV/EBITDA.

Stripping plc costs and the CEO/CFO roles could add $1.5m to the US assets EBITDA. You can then debate what synergies a scaled buyer could extract. A further $1.5m would be ~5% of revenues, which seems achievable for HR/legal etc. That gives a synergised EBITDA of at least $8m. If BETCO or a similar acquirer would pay 5x that is $40m, which would be equivalent to 1.4x 2023 revs. There should hopefully minimal tax leakage given the assets were acquired for $75m. That more than covers our maximum create EV, and would offer around 100% equity upside to the base case. Equivalent to 19p+/share.

I believe the current mgmt believe the company is worth substantially more than this. They indicated they were unwilling to consider takeover approaches when appointed to the role since July 2022, as an acquirer would have felt anchored to a “typical” takeover premium of say 30-50% rather than reflecting full value to the assets. You can also backsolve to their option package of c7m options. 19p share is only £1.3m between senior mgmt. In fairness the CEO is getting paid $425k base salary so he is not going hungry. But I suspect when he signed up for a 2-3 year turnaround he would have wanted to target more than $425k annual plus a share of £1.3m. I would happily take a 100% return, but think you can dream of 25-30p in an upside scenario. A buyback at the current shareprice would magnify the gain the US disposal. Appreciate there will also be winding up costs, time value of money etc but I think a base case using 5x a reasonable synergised EBITDA plus buffer on European tax leakage gives room for some slippage. You can tweak the assumptions but I have tried to demonstrate that the up/down looks quite decent here.

Finally to exit this value trap we are assuming that someone will provide us with exit liquidity. So is it credible to believe someone will buy the US assets? The affiliates industry has been hit on the 5^th of May by a change in the way Google treats the media partnerships business model. You can see this reflected in the share price of XLM and peers BETCO and GAMB since then. Here is the CEO of GAMB explaining this business model:

The bet you need to make here is that the value of XLM’s wholly-owned sites will endure or even increase in a world where media partnerships are demphasised. This view has been expressed on each of the BETCO/GAMB/XLM calls. Below is an extract from XLM’s most recent call. I think this change makes it more likely BETCO would be interested in XLM assets.

Do you think the most recent Google update will have a positive effect on the [indiscernible] (00:27:28) for a potential buyer? [ph]

 yes. It's very early days, yes. And I think you would have seen announcements from some of our affiliate competitors. We are seeing upticks in the rankings of our owned and operated profit – offices. You'll be aware over time that there's large media players who come into the marketplace. Indeed, we work with one or two ourselves, but there are a lot number of other very large media players in the US. They obviously have very, very strong authority and therefore, Google ranking. And therefore, they have a very strong presence in all the markets in which they present their content, and that has had in short-term historically an impact on the visibility of some of our own and operated sites.

We're talking about things like Sports Betting Dime [indiscernible] (00:28:19), etcetera. The changes that Google implemented over the last couple weeks has definitely resulted in an increase in visibility of our pages and all our websites. And, indeed, some of our smaller partners – we have obviously a very broad range of partners, some very large ones and some medium and, indeed, some very small. We've also seen similar significant improvements in the rankings of some of the pages of number of our partners too.

So there is definitely a potential significant improvement in the value of our owned and operated properties as a result of the Google changes. And, of course, there is no [indiscernible] (00:29:07) owned and operated revenue stream.

Too early to call, if I'm honest, in terms of how that will impact in terms of improving performance either on these number – small number of partners who have been affected and indeed how much impact it will have in terms of positive impact. But we are tracking that very closely. We're working very closely with partners who have been impacted. We are working very closely with partners who have not. All of them are seeking our guidance and support. So, we think net-net-net [indiscernible] (00:29:41).

Next catalyst could be the interims in July where they are expected to update on the capital return mechanic. Beyond that we await news on the US assets likely later this year.  I note Tetragon/Polygon (Reade Griffith) also acquired a 5% in late 2023 around 9p. No insight which fund that is held in, but if it were through their EU special sits fund it could suggest someone smart there has looked at this situ and come to similar conclusions.

Appendix – relevant comments from XLM management

Mgmt imply they seek more than traditional control premium:

Yeah. I mean, the – we had conversations about the full PLC disposal. The dilemma was really threefold. One is people were pegging the price to the share price with AIM generating probably a 45% premium where we were quite clear that the asset value of the business was significantly greater than the aggregated share price. Secondly, the assets were clearly the incoming identified separation, so partners were more interested in the individual assets. And the third component is we felt we could deliver significantly more shareholder value with the sale by doing it as an asset sale rather than the full PLC sale as we proved with the European one where we got two times market cap.

Mgmt imply the US assets should attract premium multiple vs the recent European sale:

Thanks, Marcus. The next question has come in. Do you think the USA assets are working more than the EU assets? I think it's always – well, not entirely appropriate for us to be attributing estimates of value. Other than to do so is full part of the formal [indiscernible] (00:33:12) and valuation review using the appropriate tools.

So, clearly, the value of the European assets reflected the shape and nature of the market and the value to that buyer at that time. I personally think these assets are good assets with significant potential, as I've already said. Market is increasingly competitive. But as a result of these recent changes, our owned and operated assets, which there are things that are on the balance sheet, their valuation could and would improve if their [indiscernible] (00:33:49) result of these recent changes. But I must say we remain very enthusiastic about the potential both of them in trading terms, but also in value terms for the USA assets.

Mgmt imply they are hopeful to receive the earnout on the European assets:

That $5 million of earn-out is based on the business in Gambling.com's hands achieving certain revenue performance levels. Again, we have some visibility clearly of how that's performing at the moment, and I can say that for the first month we are very pleased with the trading performance of the business that is now owned by, obviously, by another party.

And if that were to continue, then we would expect to see some form of payout from that. But at this moment, we have to wait until the full year is out at the end of this financial year, the nine months, and that will ultimately determine what the payout from that earn-out is. We don't – we no longer control, obviously, the revenue stream, but we continue to support them. And as I said, we believe that performance is good so far

Catalyst

July interims

Q4 cap return

US asset disposal