Caris & Company analyst Tim Boyd addresses clients on the addition of Blue Nile (NILE) to the S&P 600 Small Cap Index. His note follows:
NILE will be added to the S&P 600 Small Cap Index, replacing Lone Star Steakhouse & Saloon (STAR). The official replacement date has not yet been announced. We note that while NILE is already a member of the Russell 2000, the S&P 600 has more stringent requirements for inclusion. In our view, this highlights NILE’s long-term financial viability.
The S&P 600 currently has a total adjusted market cap of roughly $550B. Based on NILE’s current market cap of approximately $550MM, this implies that NILE will receive an index weight of roughly 0.1%. While it is difficult to estimate what kind of impact this will have on the shares, we note that Google (GOOG) shares rose 14% between the announcement of its inclusion in the S&P 500 [March 23rd,2006] and the replacement date[March 31st]. On the one hand, NILE shares may not enjoy as much of a boost since the S&P 600 is not as widely replicated as the S&P 500; on the other hand, NILE could get an incremental pop because of the large short base [28% of the float, by our last count].
We reiterate our 2*/Above Average rating and $40 price target on NILE shares. Our target valuation is based on a combination of P/E and EV/EBITDA frameworks.
P/E: we apply a 30x multiple [1.3x our LT growth assumption of 23%] to our 2008 pro forma EPS estimate of $1.33 to arrive at a $40 target.
EV/EBITDA: we apply a 18x multiple [0.8x our LT growth assumption of 22%] to our 2008 EBITDA-per-share estimate of $1.94 to arrive at a $40 target [adjusting for $5.50 in YE08 cash-per-share].
Potential risks to the achievement of our price target include: [1] decelerating revenue growth; [2] minimal international presence; [3] a challenging online marketing environment; [4] rising diamond and precious metal costs.
