Description

Business Description

YP Corp. (ticker “YPNT”) is a national Internet Yellow Pages publisher, headquartered in Mesa, Arizona. YPNT has completed the first stage of its turnaround with new management in place, a scrubbed client base, a 5% dividend yield and a $3mm stock buyback in place. New initiatives designed to recapture historic levels of subscriptions and heightened operating leverage should provide significant upside for the Company over the next few years. Its stock, pummeled from outdated concerns is poised to rebound as the turnaround is completed and this cash flow generator produces results that are recognized by investors.

The Company uses a model similar to print Yellow Pages publishers whereby it provides a directory listing on the internet free of charge but charges businesses a monthly fee for premium positioning and content. The subscribers’ listings appear at the top of the consumers search and include maps, directions, a mini web page describing the business and a click to dial feature that will instantly connect the business to any phone number designated by the consumer. For this advertising, subscribers are charged $27.50 per month. The main URL used by the Company is YP.com, but it also controls YP.net and yellow-page.net.

Most of YPNT’s subscribers are small businesses that deal directly with consumers. Unlike most print Yellow Page companies that sell advertising space by visiting or calling potential advertisers in their area, YPNT solicits advertisers almost exclusively by direct mail. Specifically, the direct mail program consists of a check mailer where the business receives $3.25 in the form of an activation check and thereby becomes a subscriber to the Company’s premium service.

In 2003, the online Yellow Page industry in the US totaled only about $0.45 billion compared to the print side of the business which exceeded $15 billion. However, the online segment is expected by the Kelsey Group to grow at 29% per year until 2008 while the print market remains largely flat. At that point the online segment would still only comprise 10% of all Yellow Page revenue. The value proposition for businesses is also much better when they subscribe to a premium online service that when they buy an ad in a printed book. The book is only distributed in a limited geographic area and is unlikely to be available to tourists or business travelers – both attractive target consumers. A print ad is also much more expensive, often costing several thousand dollars a year per book (and many business elect to be in multiple yellow page books because they draw customers from more than one local area), and contains less information and features than can be included online.

There are several competitors in the on-line Yellow Page space. These are the major ones listed below:

Yahoo currently offers the free product which does not allow for any business description and a preferred positioning advertisement with a small business description and logo for $25 (Tier 3), $40 (Tier 2) or $60 (Tier 1) per month depending on web page placement for a single city. This tiered pricing structure increases to $125 (Tier 3), $200 (Tier 2) and $300 (Tier 1) per month for an entire metropolitan area.

SuperPages.com (owned by Verizon) is a direct competitor and offers similar features to Yahoo. Above its free listing, the site charges $22 per month for a “basic listing” with an additional $70 per month for highlighting, font improvements and display color and size. It also charges additional fees for preferred placement, however my efforts to reach a sales representative to obtain this info as a potential advertiser was unsuccessful. I will update this information when it becomes available.

Dexonline.com (owned by Qwest) offers a series of tiers for its base online advertisement based on the size of the city that it serves. It ranges from $14 per month for smaller cities to $30 per month for larger ones. To add a promotion or offer to your listing costs between $35 and $50 per month in addition to the base costs. Preferred placements run from $667 per month from one state to $2,500 per month (not a typo!) for its entire 14 state region.

Switchboard.com is owned by Infospace. I have tried to use the site, but find that it provides unreliable search results (wrong states and cities when doing local restaurant search). It was also not clear how to become a preferred listing on their pages. However, I was able to get a sales representative to quote me a $99 per month fee for local listing.

The online yellow pages industry is for now and into the foreseeable future so under-penetrated that the expected 29% annual rate of growth should benefit all providers. In fact, it is quite likely that as mind share for this category grows, businesses will chose to list with several on line providers, much as they do with the printed books.


The inflection point:

Up through the first quarter of calendar 2004, YPNT was a prime example of this industry growth as it increased its paying subscribers to over 250,000 from 151,000 in March of 2003. However, on May 28, 2004, YPNT’s then Chief Executive Officer, Angelo Tullo, resigned as an officer and director of the Company. Mr. Tullo's resignation was prompted by the fact that on May 27, 2004, federal indictments were handed down alleging that the former management of American Business Funding Corp.(“ABF”), including Mr. Tullo, had engaged in fraud and conspiracy in connection with the factoring of receivables. ABF is not and has never been affiliated with or related to YPNT and the indictments did not relate in any way to YPNT.

Right after the resignations of Mr. Tullo, YPNT appointed Peter Bergmann to succeed him as Chairman, President and Chief Executive Officer. Mr. Bergmann had previously been an independent director of the Company since May 2002 and has extensive executive experience at ABC television.

Mr. Bergmann immediately used his new position to clean house at YPNT. He caused the resignation of the Company’s CFO and VP of Marketing. It turned out that the CEO, CFO and VP of Marketing had been hired as “consultants” through their own respective consulting firms. This enabled them to receive payments in excess of their ordinary compensation. All consulting agreements have been terminated and Mr. Bergmann and the new CFO Mr. Broquist are regular employees – not consultants.

Shortly after taking over, Mr. Bergmann and the current management team at YPNT implemented a rigorous verification procedure to confirm the order and obtain the information necessary to set the subscriber’s information up on line. YPNT also offers new subscribers a full refund for the first 120 days. This ensures that the service is truly wanted by the customer and removes much of the stigma often associated with check mailers. Note that prior to current management’s arrival, the standards for adding new subscribers were significantly lower which may have caused the historical churn rate to be quite high.

Then early in the third quarter of 2004, YPNT (NOTE: the Company is on a September fiscal year, for simplicity all references to quarters are on a calendar basis) was delivered a curveball by its billing partners, the Local Exchange Carriers (LECs). The LEC’s, many of whom compete with YPNT in the yellow pages business, imposed new restrictions on billing YPNT’s customers on the LEC billing statement. The LECs informed YPNT that they would not bill its subscribers until the Company could provide additional written confirmation from the subscribers that they wanted to keep the YPNT service. Since YPNT had about 250,000 subscribers and only some 10 customer service reps, it effectively became impossible to invoice a large percentage of its customers. Consequently, billable subscribers declined to 95,000 at December 31, 2004 from 253,000 in 2003.

Up to this point, over 90% of the Company’s subscribers were billed for the service on their phone bill. YPNT would provide the billing data to a billing aggregator who would then pass it on the appropriate LEC to bill their customer. In due course funds would be remitted to YPNT when the LEC’s customer paid their bill. This procedure had two benefits for the Company: it didn’t have to worry about producing bills or collecting payments and it was quite possible that subscribers didn’t even notice the monthly charge for the service on the bill. The drawbacks were high fees paid to the billing aggregator and the LEC, as well as high days receivable.

Following the LECs decision to suspend billing, management embarked on a comprehensive plan of confirming its customers and migrating them away from LEC billing to direct debit (ACH) billing from their checking account. Converting a subscriber to an ACH bill is an involved process during which YPNT obtains the customers bank account information as well as a signed consent to take money out of that account on a monthly basis. While this process is cumbersome, it ensures that the subscriber really wants the YPNT service and it eliminates the fees previously charged by the LECs and the billing aggregator. In fact, it has reduced COGS from 43% of sales in 2004 to a new run rate of 13-14%. This margin should continue to benefit from this trend until LEC billing is minimal.

Moving to the ACH billing process had the added benefit of freeing up working capital as days receivable have shortened significantly. At the end of June, 2005 YPNT was able to bill 64% of its customers via ACH while only 23% were being billed by a LEC. This has resulted in an increase in cash from $2.6mm at the 6/30/04 to $9.0mm at 6/30/05. The Company has begun to utilize this cash in the form of a $3,000,000 stock repurchase program. It also maintains a $.04 per share annual dividend, which gives the stock a yield of approximately 5% at current levels.

Management has stabilized the Company’s subscriber count which is now starting to show subscriber growth. It ended the June quarter with 106,500 customers for a net gain of 3,000 new customers despite the last LEC cutting off billing on 12,000 accounts. This implies a run rate of 15,000 net new customers a quarter without the benefit of management’s focus shifting from turnaround to growth. Part of this number is the reconfirmation of existing customers that were lost to the billing issue.

Finally, Mr. Bergmann has been drawing on his experience in marketing and has started to advertise YPNT’s product in several new ways. He has used selective radio spots in markets (Indianapolis and Kansas City) where the Company is doing its mass mailing to increase web traffic and sell through rates on its direct mail pieces. When compared to markets that did not use radio the initial results showed this exact outcome. However it is too early to tell if this will work on a larger scale.

As YPNT begins to rebuild its customer base, it has tremendous earnings leverage due to the software nature of its business and the shift to a lower cost billing method (ACH vs. LEC). Over the past several years, the Company’s direct mailing programs have generated very consistent results of about a 0.8% conversion rate. So for every one million checks mailed (the Company does this many every month) we can expect YPNT to add 8,000 new subscribers or 24,000 new subs per quarter. If we subtract customers at the historical churn rate of 3% per monthly (YPNT does not disclose its exact churn rate, but conversations with management have lead me to believe this is a good approximate number), YPNT should have a net increase in subscribers in excess of 30,000 in the second half of calendar 2005. This excludes the benefits of any recapture of customers lost to the LEC debacle. This will result in a doubling of quarterly EBITDA between June and December. In calendar 2006 we expect EBITDA will more than double to $8.2mm from $3.8 in ‘05. If we assume a conservative 10x multiple on the ’06 number, YPNT should have an Enterprise Value of over $82mm compared to the current $30mm.


Catalysts
With an industry growing at almost 30% per year, YPNT stands to benefit from maintaining its relative market share. However, there are several areas of potential upside to the assumptions listed above. The most significant is that YPNT has also recently started to use additional marketing methods to increase revenue and drive web traffic to its sites.

The Company has just launched a national accounts initiative. This program creates revenues based on a click through in addition to a monthly subscription model. YPNT is just starting to gain some momentum as they have recently signed such well known and diverse companies as Geico Insurance and 1800flowers. They have also been selected as the preferred yellow pages site by MyCity.com which will lead to increased traffic and click throughs beginning in October. I have not included any revenues from the national accounts program in my numbers since this is a nascent program that is hard to quantify.

The Company has begun testing radio advertisements in the markets where it is sending its monthly mailers. This marketing technique could result in an increase in the take rate in excess of the historical 0.8% per mailer. If the Company can get to a hit rate of 1%, EBTIDA in calendar 2006 would increase to $11.7MM ($2.5MM more than our current model) with a December quarter EBITDA run rate of $14MM.

Further, due to the new billing procedures where customers reconfirm their interest in the service, churn could be reduced significantly as the customers become more sticky. If churn drops by as little a 0.5% to 2.5%, EBITDA in calendar 2006 will grow to $9.7MM ($1.5MM above our current model) and have a run rate of $11.4mm.

Finally, YPNT has a large revenue opportunity in emulating its competitors’ premium pricing policies. This revenue stream will materialize when the Company’s web-traffic and customer base reach levels where subscribers are willing to pay for premium placement. We have obviously excluded this opportunity since it is speculative and hard to quantify.

I believe that using a 10x trailing EBITDA multiple to be appropriate. YPNT is currently trading at 10.6x its depressed EBITDA. With a demonstrated, growing, recurring payment subscriber base, low capital expenditures and working capital, and a highly leveragable business model, YPNT probably deserves a higher multiple. Comparable small capitalization internet and E-marketing companies trade at significantly higher multiples. According to a Bloomberg relative value screen such companies trade at an average trailing EBITDA multiple of 38x (17x current year EBITDA). Also of interest, these companies trade at an average of over 5x sales, while YPNT is only trading at 1.2x sales. At the end of Q1, 2004 (the last quarter before the problems) the stock was trading at 13.6x and 4.4x trailing EBITDA and sales, respectively. This was despite having a number of quality issues (i.e. self dealing).

The only comparable M&A transaction of an online yellow pages we have found was the sale of Switchboard.com to Infospace in June 2004 at 6.8x revenue and 40x EBITDA. YPNT has hired Jefferies to evaluate strategic opportunities until early 2006. We believe that once the Company is cleaned up and operating efficiently, it will attract potential buyers at a price that management would consider.

Our price target in 18 months (end of calendar ’06) using an exit multiple of 10x EBITDA is $2.14. This represents upside of 178%. Our forecast for revenues, gross margin, EBITDA and net income are shown below.


(Data for Fiscal Year, Sep 30) 2004 2005 2006 2007
Rev 57.2 26.4 36.9 46.4
Gross Profit 32.4 22.5 31.6 39.8
Gross Margin 57% 85% 86% 86%
EBITDA 14.8 2.5 7.2 11.3
Net Income 9.0 0.6 3.6 6.1
Subscribers 95,000 115,140 167,654 198,768
Numbers in $,000 except percentages and subscriber count

Catalyst

1. Improved earnings and cash flow
2. Sale of the business