August 11, 2013
Shares of Marchex (MCHX), one of our top client holdings, rose 17% last week as the company reported Q2 results that showed its core mobile advertising business gaining traction. Adding new customers and distribution partners during the quarter, MCHX delivered 23% top line growth, though only 5% EBITDA growth due to increased investment in product development and engineering talent.
Marchex remains a misunderstood and underappreciated stock, precisely the type of small-cap company where we like to invest client capital. We believe that prospects and trends for performance-based mobile advertising are increasingly bright, company execution is improving and MCHX valuation remains very reasonable at approximately 1x 2013E revenue and 9x 2013E EBITDA, even attributing no value to the non-core Archeo assets. The balance sheet is debt-free with $19 million of cash, tax assets are shielding some taxable gains and management is properly incentivized; it owns 34% of the MCHX equity. Ultimately, we think Marchex will attract the M&A attention of a buyer at some point in future.
Archeo, Marchex’s web domain business, has been separated from the core mobile advertising business for reporting purposes and management says a tax-free spinoff to MCHX shareholders remains on track for a Q4 distribution. However, given the recent sale of certain Archeo assets, the need to update financials and SEC filings to reflect such divestitures and the fact that Archeo is a no-growth business with little transparency into its prospective standalone valuation, it now seems more likely that Marchex management could take an alternate route to creating value from the Archeo assets. We believe that any scenario that delivers $70+ million of value for MCHX shareholders by the end of the year – about $2 per MCHX share -- would be a superior outcome to a separately traded Archeo.
We are keeping our eye on profit margins at the mobile advertising business and would like to see some margin expansion as the Archeo distraction is removed and the core business scales. Due to partner-sharing economics, Marchex won’t likely ever be a 25% or 30% margin business but if it can get to 20% with the top line growing at double digits, this could be a business valued at $1 billion in 3-4 years, up from $175 million today.
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