Mike Compton is founder of BlueCut Capital. Utilizing a value-based approach, BlueCut seeks to consistently generate positive absolute returns through disciplined security analysis, identifying situations where security mispricing is large and risk is minimal.
We had the opportunity to ask Mike about his highest conviction holding in his portfolio, and he chose online advertising service provider ValueClick (VCLK), which competes in this increasingly consolidated field with Google (NASDAQ:GOOG), Yahoo (NASDAQ:YHOO), Microsoft (NASDAQ:MSFT), AOL (NYSE:AOL) and smaller players like Omnicom (NYSE:OMC) and WPP Group (NASDAQ:WPPGY).
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Seeking Alpha (SA): What is your highest conviction stock position in your fund - long or short?
Mike Compton (MC): ValueClick (VCLK) is my highest conviction idea and largest long holding. VCLK an independent, performance-based digital marketing company with a market cap of just under $900MM. Their platform provides affiliate marketing, lead generation, comparison shopping, and technology to advertisers and publishers of content.
When you aggregate all of ValueClick’s portfolio, they reach over 80% of all internet users on a monthly basis. This is roughly in line with the number of eyeballs Google and Yahoo get per month.
SA: How much is this an “industry pick" as opposed to a pure bottom-up pick?
MC: I initially became interested in the company from the bottom-up. ValueClick is a cash flow story which is supported by industry trends. In my worst case scenario, they will generate an 8% free cash flow yield this year.
SA: Why do you think ValueClick was passed over in the big round of acquisitions in this sector a couple of years ago?
MC: ValueClick was passed on in the acquisition binge because its business was messy (it still is). I had always been of the opinion that a financial buyer would be the only interested party due to the FTC investigations, a lack of focus resulting from acquisitions, and Google as a competitive threat. However, given the current valuation and cash flow situation, I view this company as equally attractive to financial or strategic buyers.
SA: What sort of growth do you expect in the online advertising market overall, and what do you believe VCLK's market share will be?
MC: We believe that the market opportunity is substantial, with internet ad spending growing from $28b in 2008 to roughly $60b by 2012, driven by e-commerce (Interactive Ad Bureau and BC estimates are even higher). ValueClick has an audience the size of Google and Yahoo, reaching 150m+ unique users per month (comScore). With respect to their market share, it's difficult to quantify. Our assumptions compound their growth at half that of the 20% CAGR of the overall market to achieve our target.
SA: In the core units at VCLK (Ad Serving, Affiliate, and Display units), can you break down which appears most/least capable of growth, and why?
MC: We see the most growth in the display segment, with the potential to do $100m in revenue as ad spending catches up to consumer’s internet consumption. Forrester Research estimates 35% of media consumption is internet based, while only 12% of ad spending is internet based. ValueClick’s performance based model is positioned to benefit from this secular growth.
SA: Can you talk about valuation? How does valuation compare to the competitors?
MC: The valuation is cheap, dirt cheap. The EV/EBITDA multiple is less than 5x 2010 estimates. The earnings multiple is 1/3 of the online marketing group and 1/2 that of the e-commerce. Now, is this a value-trap? I don’t believe so, and here’s why:
1) The Street cash flow models assume linear growth. As digital ad spending trends become more visible, estimates are going in one direction… and it isn’t down.
2) $100 million in Free Cash Flow for FY 2009, which doubles to $200+ million by 2012. This sounds ambitious, but it may be understated.
3) $2+/share in cash, no debt, and $100 million of operating credit capacity provide the ability for ValueClick to ride out any Macro events that push out the coming tidal wave of internet ad spending. If you think tidal wave is bold statement, consider what happens as conglomerates start wholesale shifts in their marketing budgets. We’re on the cusp of a shift toward targeted messages, with quantifiable results, being the norm vs. the exception. Does Procter & Gamble do this overnight? No. Will they demand it? Yes.
SA: What is the current sentiment on the stock? How does your view differ from the consensus?
MC: Sentiment in the stock is relatively neutral. Disappointing results out of the lead generation business has soured investors’ appetite for the stock. Rewind two years and the Street was touting this company as one of the best plays on internet advertising’s secular growth. I believe this view will again become consensus.
SA: What catalysts do you see that could move the stock?
MC: ValueClick is an acquisition target. Microsoft, Yahoo, News Corp, Time Warner, or an ad agency could all use some help in the online advertising arena. ValueClick's platform offers a quick vehicle to get exposure to this space. Financial buyers have to be looking at this as well. Buy it, keep the Ad Serving, Affiliate, and Display units and sell off the rest. Forget the vertical sites (they are trying to build their own content), chuck the lead generation, and keep the core. We aren't talking about a big deal for these guys, less than $1.25b.
Also, stabilization in the business units will promote an upward bias to Street estimates. The cash flow generated by VCLK is attractive, but analysts don’t stick their neck out on a name where “visibility” is limited.
SA: What could go wrong with this stock pick?
MC: Google is a serious threat on two fronts. They control the algorithms that impact search traffic for VCLK’s comparison shopping business. Secondly, they have a similar platform. This is why the multiples are out of line with the industry. However, I believe a more pronounced than expected online ad cycle will develop, and ValueClick will participate in this trend.
SA: Thanks, Mike.
MC: My pleasure.
Disclosure: BlueCut Capital is long VCLK
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