Thursday, December 08, 2005
Online Advertising: ValueClick vs. Google - (VCLK)
The online advertising sector can be broken into two symbiotic categories:
- Bait - just like in the offline world (e.g. NYTimes), these are companies that ostensibly are in the business of providing content, but derive all their revenue from advertising. Think Google search, CNet.com, Yahoo!, etc. There are many many bait pure-plays. They are usually called media companies. Note that content may also be sold on a subscription basis, which is a completely different model. If you confuse the two by thinking of them both as just 'media' companies, you won't see the completely different business models (wide and shallow distribution vs. narrow and deep, etc.) These companies make money by attracting viewers to their bait, and then getting paid by advertisers for some sort of access to those viewers.
- Infrastructure - these are companies that provide the tools so that clients are able to advertise online, and they derive their revenue from selling the use of those tools. Think Google AdSense, ValueClick, Yahoo!, etc. In the offline world, these are usually just called advertising firms. In the online world there are 3 primary models that online advertising infrastructure companies provide for clients to use for advertising, and they are distinguished by their pricing schemes. They are: pay-for-impression, pay-for-click, or pay-for-performance. Some history of those models is provided here. This sector, just as in the offline advertising sector, also includes companies that provide the tools for online marketing (ad layout and design, success/failure analysis, etc.), in addition to the ad serving infrastructure.
Enough background. I've talked about Google quite a bit (search this site). They are the current preeminent example of the pay-for-click infrastructure provider, although they also have a pay-for-impression branch. My view is that the online advertising sector will eventually progress from pay-for-click to pay-for-performance, just as it progressed from pay-for-impression to pay-for-click. A current leading example of the pay-for-performance model is ValueClick (VCLK). (Amazon.com is another successful proponent of this model, but they are backwards from an advertising company - they are really an advertising client, even though they provide the infrastructure themselves.)
Story: ValueClick is getting a lot of press right now from varied sources (raising a Buzz Patrol Alert for me). The online advertising sector in general is doing well right now, as ad prices have increased over the last couple of years. They are in the right sector at the right time, but with their model significantly different than that of Google, is VCLK getting any of that increased revenue?
Company: Reading through their "financial releases" is a slog as it is mostly useless marketing prattle and empty accolades. They clearly drink their own Kool-Aid. Fortunately the SEC demands some cold hard facts. The most recent numbers are for Q3 2005, ending 30 Sept 2005. $81.4M rev, up 87% Y/Y, operating earnings of $17.8M, up 105% Y/Y, operating margin of 22% ($17.796/$81.414), up from 20% in Q3 2004. Net income was $11.0M, or $0.13/share, vs. $0.09/share for a 22% increase Y/Y. They almost doubled revenue, did double operating earnings, but kept their margin almost fixed. That's the definition of a linear model. Their bottom line will grow at the same rate as their top line. It's a nice growth rate, but it's not the kind of synergies that Google shows, or what we typically look for.
For Q4 they are projecting rev of $112M, up 38% Q/Q. Linearizing that for the year ahead would give annual growth of a factor of 3.6 (1.38^4). On the other hand, they are projecting $500M revenue for 2006 (press release, not SEC filing), which is only something like 66% better than their $300M expectation for 2005. So clearly they do not expect to continue with 38% Q/Q growth - they expect more like 9% (66-38 = 28/3 = 9). They also project $0.12 EPS for Q4, which is close to Q3, so they don't expect a single penny of their 38% revenue growth to drop to the bottom line.
In fact, I'm sort of puzzled how it could be so bad. Their assets over the first 3 quarters of 2005 increased $293M, which is nearly all Goodwill, which could just go away when it gets written off some day. So assets haven't really changed, but liabilities have gone up 62%, almost all in accounts payable. That still almost balances with accounts receivable, so no big flag there. Cost of goods sold went from 30% to 28% Y/Y, confirming that their model is inherently at best linear. But worse, their operating expenses nearly doubled on every term (marketing, admin, technology), just as their revenue did. That means they have to work just as hard for every additional dollar as they had to for each past dollar. Linear model again. The big hit right now is taxes, because of which they only had 22% EPS growth instead of 100% EPS growth. Taxes are a hassle, but they're not operations, so that explains the discrepancies. No big flag.
Stock: It's had a great run since June from about 10 to around 20, and for the year the stock has moved about 50% (from $12 to $18). At an annualized EPS of ca. $0.48 that gives a P/E of 41, which is something like a market multiple of 2. That's totally reasonable given it's growth.
Conclusion: ValueClick is no Google, but it seems a solid play. If the high taxes lead to some short term earnings disappointment, with consequent stock price pull back, I'll be buying for the long term.
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6:58 AM
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