WTF – Vertro Down 35%?????

February 15, 2011 at 4:13 pm Leave a comment

Vertro’s stock fell over 35% on between in trading on Friday and Monday as many investors scrambled to find an exit.  After reading the company’s pre-announcement and listening to the investor call that followed, I was left to wonder WTF………Where’s the Fire?  Vertro released metrics for Q4 2010 and pre-released estimated revenue and EBITDA on Thursday after the market close and I could immediately see the smoke.  Due to an issue with one of its toolbar distributors the company’s toolbar acquisition machine hit a bump in the road that caused the company initially to reduce the spend with that distributor and eventually to curtail the relationship altogether.  This issue combined with lower than expected (not a decline, but a less exaggerated seasonal pop vs. prior holiday seasons)  search revenues by the rest of its toobar/homepage user base is expected to cause the company’s revenue to decline by $200,000 from Q3’s record levels.  On Thursday after the close, management held a conference call to help investors understand what had occurred and what they did to remedy it.  Despite explaining that the issue was known and that the company was able to shut down the failing marketing channel before in impacted their margins too heavily.  it appears that many investors chose to sell off the stock as if the Vertro marketing machine were broken altogether.  Management made it very clear that they were able to shut off the increasingly unprofitable channel. While this will impact their toolbar base numbers for Q4 and cause Q1 to be a little lower than expected while they replace that portion of their user base, management also said that they expect to report a record quarter for EBITDA and strong operating cash flow.  The issues will likely push the company’s growth plan and numbers back a quarter and a half, so that they may not break through the $10m revenue level until Q2, but the company should remain solidly profitable throughout and continue to add cash each quarter going forward.The issues experienced by Vertro in Q4 highlight the execution risk in their model, but the results also reflect the flexibility and leverage the company has and its ability to change directions within hours if the productivity of the promotions they are running starts to decline. The company still has about $1 per share in the bank, its cash flow and earnings are strong    `

{could I leave this out}Where there is smoke there is fire…..?  We can all see that there is a little smoke here.  For over a year, Vertro management has given revenue and toolbar/user metric guidance that was summarily achieved and sometimes (like Q3) exceeded.  Thursday’s announcement was the first time they have come up short of their own estimate, as they had predicted a sequential gain in revenue from Q3’s blowout performance.  When the “bump in the road” occurred with one of the distribution partners, the smoke was real, but fire?  Is the model broken?  Will the company be unable to find toolbar/home page user distribution channels that can replace the busted one? On Thursda’s call, management indicated that they already have, though it has taken nearly three months to replenish the user base.

Historically, Vertro’s revenue for Q1 has usually trailed revenue from Q4, due to a seasonal uptick in search revenue during the pre-holiday shopping season and a very large increase in non search revenue that does not usually occur in Q1.We believe that this year will be no exception and expect that the distribution issues straddling the end of Q4 and beginning of Q1 will essentially set us back to Q3 2010 in terms of a toolbar/homepage user base from which we expect to continue the upward trajectory.  The implications of these factors for earnings and revenues are that we believe the company will probably book an EBITDA profit of about $500k in Q4 and the increased ad spend necessary to replenish the user base against what we expect to be a slightly lower revenue figure may cause the company to be at or just above breakeven in Q1 2011.  As indicated above, this sets us back about two quarters and lowers our estimates for 2011 as follows:

Revenue Non Ad Opex Advertising EBITDA
Q1 2011 $9,400,000 $2,800,000  $6,550,000  $50,000
Q2 2011 $10,300,000 $2,700,000 $7,100,000  $500,000
Q3 2011 $11,400,000 $2,700,000 $7,400,000  $1,300,000
Q4 2011 $12,000,000 $2,700,000 $7,100,000  $2,200,000

Totals = $43,100,000 $10,900,000 $28,150,000
Total 2011 Opex = $39,050,000
Total 2011 Adj EBITDA = $4,050,000 or $.58 cents per share
Current EV/CY 2011 EBITDA = 4x (Needham report used this metric and showed broad range of ecommerce and internet media companies and the average valuation ranged from 9 on the low end to 13.  Vertro comes in slightly below one half of the low end, which was usually just ISPs like Earthlink, etc.

Thus, we are reducing our estimates based on the issues above. We see the smoke, but see no fire here. We believe that the sell off in Vertro shares is way over done and that investors who can see through the smoke will be rewarded substantially. If the company has indeed corrected the issues, the stock will prove to be severly undervalued at its current trading price.  Vertro is a company that still has the potential to produce $45+ million in Google Network search revenue this year and it should easily exceed $50m in year 2012.  Additionally, we see three catalysts that could move the stock up substantially from current levels:
1)More retail analyst coverage
2)Acquisition Speculation
3)Board Approved Stock Buyback

Retail analyst Coverage – We think that there are several analysts who have taken an interest in the Vertro story, as investors beat the bushes to find stocks that are direct beneficiaries of the APP revolution.  Vertro’s unique business model, operating metrics and status as virtually “undiscovered” should make it an attractive potential addition to an analyst’s coverage universe and the pullback in the stock price makes the timing even more advantageous.

Acquisition – There are plenty of companies out there scrambling to find ways to grow their search advertising revenue including several very large players that have been aggressive acquirors as of late (AOL, INSP, IACI), all of whom reportedly have higher ad revenue share agreements with Google than Vertro (ie they could get 85 – 90% of click revenue vs. our estimated 75 – 80% for Vertro) and would be able to add content, distribution and value in many other respects that could make Vertro’s 10 million strong user base more profitable and larger. Investors need look no further than the recent acqusition of Answers.com to see the price companies are willing to pay to take down a chunk of Google Network revenue.  If a PE firm is willing to pay 6x Answers.com’s yearly Google Ad revenue, what kind of multiple would a strategic buyer with a higher Google rev share pay to acquire  a company that will achieve similar (in 2011) EBITDA but on a base of more than 2x the Google Ad network revenue that Answers achieved in the trailing twelve months before it was acquired. Might a company pay at least half that much ($63.5 million) to take down twice as much Google Ad Network revenue?  Such a price would value shares of Vertro at about $10 per share after Vertro’s cash is zeroed out.

Stock Buyback – It is my understanding that a significant cross section of the company’s largest shareholders have made it known that they would like to see the board move to make open market purchases of Vertro’s stock.  While there are likely some good investment opportunities out there in terms of technologies to augment the company’s new app centric focus, the large valuations we see accorded many of the start ups and VC funded players in this space suggest that there may be no better investment than Vertro’s own stock. We fully expect to see VTRO on track to achieve over $1 per share in Adjusted EBITDA in 2012 and forward, so we essentially have a consistently profitable model, with nearly $1 per share in cash in the bank, with strong and growing cash operating cash flows that is trading at a cash adjusted market cap equal to 2.5x 2011  EBITDA after adjustments are made to reflect the issues discussed here.WE believe that Vertro’s board will take this opporunity to start making open market purchases of Vertro stock. This has not occurred in Vertro’s history and we believe it will have a significant impact on the stock given the very small number of shares in the true public float, which we estimate to be just north of 3 million shares.  With the company’s cash in the bank of close to $7 million and the operating cash flows over the next 9 or 10 months of (conservatively) $4 – $5 million, the company could buy back the entire public float over the course of 2011 at current prices.  Of course, it is unlikely that the stock would continue to trade in the current range if the company does begin to buy back the stock, but we think the company would do well to repurchase as many shares as possible at prices below $6 per share.

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WTF – Vertro Down 35%????? March Update – Time to Buy More ATRN

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