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Company Background

interClick Inc. (ICLK) is an exciting, small-cap internet company poised for substantial growth in the second half of 2009 and into 2010. ICLK operates a next-generation internet advertising network which utilizes behavioral targeting advertising to provide unprecedented Return on Investment (ROI) and scale for its advertising customers.

From June 2007 to December 2008, ICLK grew twice as fast as any other ad network. Revenues, which were $22.4 million in 2008, are expected to scale above $40 million in 2009 – a minimum increase of 79%. Management has already raised guidance three times this year and the odds seem good that the company will do so again in early August, when Q2 numbers are released.

Most importantly, ICLK’s current growth trajectory points to an explosion in earnings in Q409. Add it all up and ICLK appears to be at an important inflection point with its business – one which could translate into a much higher stock price in the next 12 months. The key is for management to deliver on its ambitious growth plans.

Behavior Targeting Backdrop

Faced with one of the most challenging economic environments in years, advertisers are demanding more bang for their internet-advertising buck. Ad budgets, already constrained by cost cuts, have become very focused on the ROI of their precious ad dollars. In an effort to increase their ROI, advertisers are being drawn in large numbers to data-driven, behavioral targeting (BT) companies such as interClick, which are proficient at beating their ROI targets.

In a survey taken by Jupiter Research, 15% of online advertisers utilized behavioral targeting in 2006. This percentage rose to 18% in 2007 and 25% in 2008. For 2009, Jupiter anticipates the trend increasing to 50%, giving it a formidable new market share to compare with other more-established forms of online targeting like geographic, demographic, and contextual ads.

Over the past few years, no one has been able to figure out which sources and types of data are most valuable, how much data is worth, and how best to monetize it. With the majority of first generation BT ad networks relying on their own proprietary databases, most of these networks have been unable to integrate new data and inventory, which forces them to lower their prices, and in turn, leads to consistently lower ROIs.

Enter interClick. As the first ad network to successfully aggregate multiple third-party data sources with its proprietary technology, ICLK has differentiated itself from its competitors by offering advertisers a higher ROI. To put it simply: ICLK delivers the right users to the intended targets. Through its collaboration with third-party data sources Bluekai and Bizo, interClick’s ad network has been able to achieve a higher lift for advertisers, and thus, a higher return on ad expenditures.

ICLK’s ad network recently delivered outstanding results for shoe retailer SKECHERS. In a recent analysis of its internet ad campaign, SKECHERS found it achieved a 786% return on ad spend with interClick, as opposed to a 463% return with Audience Science, 386% with Adconion Media Group, 234% with 24/7 Real Media, 161% with ValueClick, 147% with Burst Media and -76% return with Quake. Now advertisers are good at math but with ICLK they don’t need to be: 323% over the next leading ad network is an easy equation to surmise.

interClick's Growth Kicks Into High Gear

With a secular change in ad spending taking place and its recent gain in market share, interClicks revenues have risen smartly over the past two quarters. Furthermore, revenue growth has recently begun to accelerate. In Q1, revenues grew 136% year-over-year from $3.6M to $8.4M. What is particularly noteworthy is that Q1 is typically the company’s slowest quarter of the year, yet revenues were essentially flat on a sequential basis compared to 2008’s seasonally strong Q4.

Such revenue growth sets the stage for an explosive second half of 2009. With revenues set to grow to over $10.5 million in Q2, I have modeled for very strong sequential growth in Q3 and Q4. Last year, 63.4% of its revenue came in the second half of the year. Assuming the same percentage of total revenues were to be achieved in 2H09, this would imply Q3 revenues of $12.5-13M and Q4 revenues of $16.5-17M.

Now the story gets really interesting. Should my model prove to be correct, I expect to see a surge in profitability in Q3 and particularly in Q4. I feel this way for these reasons:

  • While management has guided gross margins (GM) to remain in the 47% range, I think that GMs can and will trend into the low-to-mid 50% range, and possibly higher, by Q4.
  • With OPEX holding steady and becoming a smaller percentage of revenue with each passing quarter, expect a surge in profitability in Q4, on the order of 5 cents-a-share.
  • Should management deliver and ICLK continues its strong growth in 2010, I see a strong possibility of $0.22-0.25 in EPS for the year. My 2010 EPS estimates will move higher if GMs successfully trend into the mid-60% range by next year.

My confidence in ICLK is rooted in the dramatic improvement seen in its operating results for the past 5 quarters. The biggest positives include:

  • Gross margins have increased for five quarters in a row. Most recently, in Q109, ICLK was able to increase its GMs 900 basis points sequentially to 47%.
  • EBIDTA margins have improved in the past two quarters. EBITDA margin of 2% in Q4 2008 expanded to 11% in Q1 of 2009.
  • GAAP profitable in Q1 2009.

Balance Sheet

interClick recently completed a secondary offering of $2.5M, successfully shoring up its balance sheet. The company has a very good relationship with its creditor company, which has already expanded its credit line numerous times.

At this point, ICLK appears to have enough capital in place to scale its business to a $15-20M quarterly run rate before it would potentially need to raise additional capital.

Management with a Vested Interest

Insiders currently own a total of 20M shares, representing half of the outstanding share count. Insiders recently participated in the secondary offering at $1, giving management an added incentive to deliver strong earnings growth.

CEO Michael Matthews has an impressive pedigree, having previously sold an internet company in the mid-‘90s for $320M. Because of this, Mr. Matthews has extensive contacts within the internet industry and an in-depth understanding of the short and long-term dynamics of the BT ad sector.

CFO David Garrity worked as an equity research analyst prior to joining interClick. Due to his extensive experience on Wall Street, Mr. Garrity is well-versed in the market expectations for a growth company scaling its business. With Mr. Garrity overseeing ICLK’s financials, expect the company to steal a page from Apple’s (NASDAQ:AAPL) playbook and “under-promise and over-deliver” in the coming quarters.

Analyst Coverage

21st Century Equities recently initiated coverage of ICLK and has a current price target of $2. Their estimates seem too low, but were recently revised higher. MDB Capital began coverage on ICLK last week and gave the stock a $3.25 price target.

Look for additional analyst coverage as ICLK’s growth profile continues to get discovered by the Street in the coming months.

Risks

ICLK’s auditors have yet to remove the “going concern” label from the company books. While management expects this to be removed in the next few months, certain investors may be unwilling to commit funds to ICLK until this label has been removed.

Management may be unable to deliver on the bottom line as revenues scale up to $15M a quarter. Increased spending on new hires and technology upgrades could push back the company’s big increase in profitability until 2010.

The economy could double-dip, forcing the credit markets to tighten up once more. In an environment like this, ICLK’s creditor company might balk at increasing its credit line.

While management believes ICLK’s first-mover advantage and recent technology upgrades give the company a 12-18 month lead on the competition, nothing is for certain in the tech space.

interClick is an illiquid bulletin board stock and institutional investors tend to shy away from BB equities. While I am expecting a NASDAQ listing in the first half of 2010, there are no guarantees that a listing on a major exchange will occur.

Conclusion: Expect Big Things from ICLK Over the Next 12 Months

After digging into this story for the past month, my analysis leads me to believe that ICLK could be a big winner in the second half of 2009 and in the first half of 2010. With earnings set to explode by 200% in 2010, the stock seems undiscovered and undervalued at current prices, trading for 11x 2010 earnings estimates.

While ICLK will require patience – the story has yet to be discovered by the market – I feel confident that longer-term oriented investors with a high tolerance for risk will ultimately be rewarded with substantial gains over the coming months.

DISCLOSURE: Long ICLK.

Source: interClick Comes of Age: Expect Big Things