Archive for September, 2010
Groove Portfolio Focus Stock #2
Atrinsic (Nasdaq: ATRN)
Market Cap $6.28 million
Buy the Cash, Get Undervalued Media Business & a Call Option on Streaming Music For Free
We are adding Atrinsic (Nasdaq: ATRN) to the GrooveVC portfolio and recommend that community members invest additional risk capital at this time. We do not believe community members should sell any portion of existing VTRO holdings to make this investment.
While there is significant execution risk inherent in the current situation, we believe that Atrinsic’s assets are worth substantially more than the current market valuation even in a liquidation scenario. At today’s closing price of 30 cents per share the market cap of Atrinsic sits squarely at $6.28 million, which is about $1 million below the cash on the balance sheet at the end of the most recently reported quarter. While we know that the company’s investments in several businesses may continue to burn cash for a few quarters, we feel that the $7.3 million in the bank at June 30 + income tax receivable of $3.5 million and the fact that the company has no debt means that investors buying at today’s prices are essentially getting the non financial assets for free. We believe that Atrinsic’s status as a micro cap penny stock, several unprofitable quarters in a row, executive turnover and Nasdaq minimum bid price issues have caused investors to throw ATRN’s significant operating assets out with the bathwater. Additionally, we see the potential for investors to own a piece of what could be the only publicly traded pure play in the streaming business model that the music industry seems to be moving toward. Given today’s market valuation for Atrinsic, we feel investors are getting a very valuable ($20m+) marketing business plus what essentially amounts to a free call option on the growth and/or consolidation that will surely occur in the online music space. There are actually several scenarios that could play out that we believe could allow investors at current prices to earn exponential returns. Several potential catalysts include:
1) Investor recognition of the Value of Atrinsic Interactive or Sale of the Assets – In 2008, Atrinsic was formed by merging a rapidly growing mobile media business called “New Motion” with a long established business in the online marketing business called “Traffix”. Traffix was a Nasdaq listed company that paid a dividend of around 5% per year and had a market cap of approximately $57 million. The Traffix business remains nearly intact (less the unprofitable lead gen businesses that were recently shuttered) in what is now called Atrinsic Interactive (AI).
AI’s “SendTraffic” operations were named one of the Top 10 search marketing agencies in the US for 2010 by AdAge. AI also operates the Rocket Profit affiliate program which has been picking off major accounts over the last few months including Ctrip, BrickHouse Security and others. This segment currently has a revenue run rate of approximately $25 million. The search marketing space is consolidating rapidly with several of the top 10 search agencies being acquired over the last 6 – 9 months. This has caused takeover premiums to soar with valuations pushing revenue multiples much higher than what has historically been the norm – Hearst reportedly paid 3x revenue to acquire iCrossing and Dentsu reportedly paid an even higher premium to acquire the smaller Innovation Interactive operations. While historical trends suggest these digital agencies might usually fetch closer to 1x revenue, we have ascribed what we believe is a conservative acquisition valuation for AIM in the $15 – $20 million range. but recognize that it could be higher in the current environment. In any case, we believe that one potential catalyst for ATRN shares could be investor recognition of the value of this operating division or similar recognition by one of the many players in this space that are buying market share.
2) Investor recognition of Asset Value in Atrinsic’s Media Division – Atrinsic’s Media division operates several consumer oriented mobile and web based subscription services in music, gaming, sweepstakes, surveys and commerce/lifestyle verticals. Key properties include the recently relaunched Kazaa music business, Gator Arcade and ringtone.com. Atrinsic is currently the exclusive marketer of Kazaa in North America in a unique partnership with Kazaa’s owners that essentially allows ATRN to retain 50% of its profits. We see the Kazaa business as having great potential for growth and feel that its potential is not reflected in ATRN’s current market cap.
The other two biggest parts of Atrinsic’s Media Division are Gator Arcade and Ringtone.com. These two businesses have two hundred thousand paying subscribers combined and we believe that these two businesses alone are worth more than the current market cap of $6.28 million. We note that the Ringtone.com business alone was valued at $6.75 million back in early 2008 – BEFORE the significant increase in market penetration by smart phones and the increased consumer spending on mobile media that we see today. Thus, we believe that investor recognition of the value of these businesses under the Atrinsic Media umbrella could be a catalyst for ATRN shares.
3) Acquisition of Kazaa – ATRN is currently the exclusive marketer of Kazaa in North America and they retain what amounts to 50% of profits. Several factors lead us to believe that Atrinsic may buy Kazaa outright. Recent investor presentations as well as management’s discussion on quarterly conference calls have been heavily slanted towards Kazaa and suggest that much of management’s attention has been focused on growing the Kazaa business. Given that they do not own it and only retain 50% of the profits it seems unlikely that they would put so much of the company’s resources and management’s focus on the one segment of the company that is not wholly owned unless they were giving serious consideration to buying the remaining portion that they do not own. Additionally, we note that current Atrinsic co-ceo Andrew Stollman was the president of Traffix prior to its acquisition by Atrinsic and that Traffix had a similar relationship (marketing agreement where profits split 50/50) with a small online music company called EZtracks. After a couple of years of working together in nearly identical 50/50 profit split arrangement, Traffix acquired the remaining 50% interest in that venture. We think there is a very strong likelihood that Atrinsic may do the same with Kazaa and believe that such a deal would put ATRN on many new investor’s radar screens and the current market cap does not come close to reflecting this potential.
We believe that anything that causes investors to take a hard look at the assets owned by ATRN will be very positive and the Kazaa part of the story could be the most significant. Investors in ATRN at today’s valuation are essentially paying for the cash and getting what amounts to a call option on the online streaming music business via the Kazaa asset. If this business is the blockbuster we think it could be, ATRN investors will enjoy a significant repricing of its shares as either the cash flows from the business push the shares higher or (in the acquisition scenario) one of the larger players decides to take down one of the longest standing brand names in the space.
We recognize that there remains significant execution risk in the ATRN story. The company may burn through another $5 – 6 million before reaching profitability with the Kazaa business. However, we believe the the company’s cash balance, tax refund and cash flows from the AI business should be enough to allow them to operate until Kazaa reaches profitability. If the recent shuffle in the executive suite continues this would add signficant execution risk. Also, if a deal to purchase Kazaa occurs, it could result in significant dilution for existing shareholders. However, we note that the existing market cap is only $6.28 million, so even if they did a deal offering 50% ownership in ATRN to take down the other half of Kazaa (which strikes us as being a little on the high side given the value of the assets underlying this stock), it only amounts to about $3 million worth of additional stock.
We believe that while the execution risk in the ATRN story is significant, the current valuation vs. the value of the company’s assets suggests an attractive risk/reward scenario for GrooveVC community members. Additionally, a consumer focused company like ATRN can benefit handsomely by the addition of several thousand “engaged” consumer/’investors who subscribe to their services (Kazaa, Ringtone.com, etc.). If our community’s influence added just 4,000 users to the Kazaa music service subscription rolls, it would add close to $1 million per year in additional revenue for ATRN.
In summary, our due diligence leads us to believe that ATRN represents the kind of situation that the Groove VC community can profit from simply by investing, consuming and promoting –
1) investing (purchasing shares in ATRN)
2) consuming – subscribing to the Kazaa music service.
3) promoting – tell investment groups, friends, family, etc. about the opportunity to profit from their music service by joining the cause of investing, consuming and promoting.
The liquidation value of the non Kazaa assets (Atrinsic Interactive , Ringtone.com and mobile gaming business) could be well over $20 million, which is more than 3x the current market cap. Add $7.3 million in cash, $3.5 million in income tax refunds outstanding and what could potentially be the blockbuster – the stake in Kazaa and you begin to see why we believe that Atrinsic could be a 10 bagger from current levels within 12 – 18 months.
One year ago last week, we went live with the GrooveVC website and presented the first stock recommendation (Vertro – Nasdaq: VTRO) to our community. One year later, Vertro stock is trading up 74% from where it was trading when we first introduced it (23 cents adjusted for r/s = $1.15 price when introduced). More importantly, we feel that management’s actions over the past year have put Vertro in the position to grow substantially from where it is today, both in terms of its operations and its stock valuation. From an operational standpoint, we are extremely pleased with where we find Vertro today and expect to see Vertro complete its first full year of profitability soon. We expect that we will soon see the stock price move to better reflect the company’s results and begin to reflect Vertro’s future prospects. For this reason, we feel that investors currently holding the stock should continue to hold their shares and those with the ability to purchase more would do very well to do that at current prices. As more investors become familiar with the Vertro story, the stock will trade substantially higher than today’s prices. We believe that wider investor recognition of the Vertro story will be coming soon.
Since inception it has been our intention to periodically introduce new investment opportunities to our community. These investments will share the same characteristics as our first recommendation, in that they are small cap companies, they are undervalued relative to their assets and/or prospects, their results are driven by products sold to consumers and they are small enough that a group of several thousand consumers using their service and telling their friends to use it could make a difference. We have received several recommendations from community members of stocks that fit this profile and we are currently in the due diligence process with several potential additions. We expect to complete this process over the next 30 days and introduce a second stock at that time.
Please note that we do not recommend selling shares of Vertro to invest in our new recommendation. We could not be more bullish on the near term (3 – 6 months) prospects for Vertro and thus we believe investors should instead seek to invest additional capital in the new company or seek another source of funds. We will continue to focus our efforts on Vertro in addition to any other companies we introduce to the community.