September 21, 2012
This piece was posted on SumZero, an idea-sharing website for portfolio managers.
Marchex is a Seattle-based digital marketing agency with a core business focused on mobile call advertising. Marchex's value proposition to clients is that its proprietary technology drives inbound mobile phone calls to businesses on a pay-per-call basis and its accompanying analytics enables precise data collection and analysis. The call advertising business remains relatively undeveloped despite the obvious benefits to businesses that an incoming phone call delivers.
The core business at MCHX should do $120m of revenue and $17m of adjusted EBITDA in 2012 and I am looking for $135m and $23m in 2013, solid double-digit growth in both revenue and AOCF.
MCHX's capitalization shows 37m fully diluted shares at $3.50 per share = $130m market cap less $16m cash (adjusted for an upcoming deferred payment related to a 2011 acquisition) for an EV of $114m. Valued purely on a cash flow multiple of the company's core business, MCHX looks to be trading at less than 5x 2013 AOCF. Inexpensive but not ridiculously so for a relatively unproven business opportunity until one considers the hidden assets, the 4% dividend yield, the equity shrinkage and the prospects that MCHX may be a seller of the company in future.
1) Hidden assets: MCHX owns a portfolio of Internet domain names that date to an acquisition that the company made in 2005 for $164m. The size of the portfolio is believed to be close to 200,000 URLs, though certain domains have been sold since MCHX began incrementally liquidating the portfolio in 2009, including an undisclosed amount in the most recent quarter for $3.3m. The domains currently generate a modest amount of advertising revenue and cash flow for MCHX with almost no management oversight required.
We believe that MCHX management is actively exploring strategic alternatives to harvest value from the domain portfolio (and certain other non-core assets) and an announcement could be made within the next few weeks and almost certainly by year end 2012. We fault management for its historic lack of disclosure with regard to the specific contents and value of the domain portfolio but herein lies an investment opportunity. With low transparency and recognizing that about $30m of cash has already been extracted from the domain portfolio, we are merely speculating on an outcome. But if MCHX can realize 50% of the original value of the domain portfolio, or $82m, in a bulk sale, proceeds would represent $2.21 per MCHX share. At the original purchase price of $164m, the market is currently ascribing negative value to MCHX's core call advertising business. A possible deal structure could see MCHX retaining a minority stake in the non-core assets, receiving a meaningful cash payment and maintaining further upside in an actively managed NewCo.
2) Another hidden asset of perhaps $1 per MCHX share exists in the form of $45m of deferred tax assets on the balance sheet. This is real cash - not NOLs dependent on offsetting future profits.
3) The company has retired about 30% of its shares outstanding since late 2006 and a 2m share authorization remains active. Further, top management has 10b-5 share purchase plans in place and CEO Russell Horowitz has purchased about 75,000 shares since July and has pledged to buy $1m of stock..
4) The company recently raised its dividend to 14 cents per share to yield 4%. The company pays investors to wait while it seeks to unlock value from its non-core business and ramp its core business.
5) Given that smartphones now penetrate north of 50% of mobile users (and are ubiquitous among the under-30 crowd), mobile advertising is an increasingly relevant place to be. If MCHX can prove its technology platform and advertiser relationships to be of sustainable and increasing value, this is an easily digestible acquisition for Google or Microsoft in 2014 or beyond.
Negatives are dual classes of stock, an unnecessarily complex story and a management team that has lost credibility among investors. At $3.50 per share, the stock is washed out -- massive shareholder turnover occurred during Q2 and Q3 of 2012.
In conclusion, this is an overlooked and misunderstood company whose value could easily double and maybe even triple in 12-18 months if management can successfully unlock value, eliminate the distraction surrounding the non-core assets, drive the core business and effectively rebuild credibility in the investment community. At $3.50 per share, downside risk seems very low.
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