The Long Case For Greenfield Online (SRVY)

| About: Greenfield Online (SRVY)

Brian Gaines Newsletter Value Investor Insight carried an interview May 26th with Springhouse Capital manager Brian Gaines (pictured left), whose fund focuses on undervalued small cap stocks. Springhouse Capital has generated an average net return of 29.6% per year since its launch, versus a 13.9% annual for the S&P 500, according to Value Investor Insight. Here's the segment of the interview in which Mr Gaines discusses his position in Greenfield Online (SRVY), which was trading at $16.80 at the time of the interview (chart here):

...tell us about Greenfield Online [SRVY].

BG: Greenfield is an online survey business. They have one of the largest databases in the country of survey takers, people who have given their demographic information and have agreed to be available to answer surveys. Greenfield’s target customers are 2,500 market-research firms, who hire Greenfield to help them create the surveys and then assemble the panels of people to take them.

The competitive dynamics are positive. The five primary competitors in North America control about 80% of the market, and Greenfield is the leader. There are barriers to entry in the expense, technology and expertise necessary to build and manage the panel databases. At the same time, Internet polling continues to take business from more traditional mail or phone options. The days of trying to get responses on the phone or mailing surveys with dollar bills inside are numbered.

Greenfield’s stock has also had a rough ride since the company went public in 2004. Why?

BG: When it first went public, everybody loved it and the share price went as high as $24. They then proceeded to make overpriced acquisitions – which is what companies with high stock prices do – which they didn’t integrate well. At the same time, too much capital flowed into the business and pricing collapsed. We first bought around $7 and then bought more when it proceeded to go to $4.50.

With the shares now trading at $7.75, it would appear they still have work to do.

BG: In September of last year they brought in a new CEO, Al Angrisani, who had turnaround experience in the marketresearch business, most recently with Harris Interactive. We almost always consider the fresh perspective a new CEO brings as a positive. He took a heavily options-based package – at $6.30 per share – so his interests are aligned with ours. We’ve found him to be very talented, willing to cut costs and focused on the right things for shareholders.

His focus so far has been on reducing expenses – he took $7 million in annual costs out of a business that is estimated to make $20 million in EBITDA this year – and on eliminating unprofitable business. The business has stabilized and he’s now turning his attention to building revenues.

Are the numbers showing any sign of turnaround yet?

BG: Not in terms of revenue growth, but the first quarter did show significant cost savings and the fact that the business has stabilized. Management is being very cautious not to overpromise, which leaves the market uncertain. That’s fine with us, because that’s what’s keeping the stock down. As the results show up over the course of the year, we’ll be rewarded.

How are you valuing the company?

BG:We also look here at valuing the parts of the business – the U.S. survey business, the European survey business and a comparison- shopping business in Europe, called Ciao, which they acquired when they expanded in Europe.

The North American survey business did $2.6 million of EBITDA minus capex in the first quarter of this year. The business isn’t particularly seasonal, so we think they can do $10 million for the full year. Given that the returns on invested capital are fantastic, there’s little reinvestment needed, they are the market leader in a business unlikely to see further entrants and pricing has gotten sane, we think this business deserves at least a 10x multiple. That makes it worth $100 million, or $4 per share.

The European business earned $1.5 million in the first quarter, so we believe $6 million for the full year is very achievable. The competitive dynamics are similar, so we think it’s also worth a 10x multiple, which comes to $2.40 per share.

The comparison shopping business, Ciao, is a hidden gem. It did $1.5 million in EBITDA less maintenance capex in the first quarter. Revenue grew 80% in 2005, margins are 40-50% and they have the #1 position in Germany. If you straight-line the first quarter and say they earn $6 million for the year and then apply an appropriate 15x multiple to it, that’s worth $3.60 per share. We think Ciao will earn $8-9 million in 2007, so that valuation is conservative.

You’re not counting on any growth?

BG: Not in the U.S. or Europe, which we consider a free option. They are starting to expand in Asia and we put a value of about $1 per share on that.

So we can make a very clear case for a value of around $11 per share. On top of that, we see several upside options: U.S. and European growth picking up, a higher multiple as the turnaround is recognized, Asia growing faster than we are counting on, and Ciao getting sold for a big price. There are a lot of ways to win.