No Consolidation Needed For YuMe - It Could Be Worth $1 Billion In A Few Years

Jul. 8.14 | About: YuMe, Inc. (YUME)

Summary

YuMe is severely undervalued given the lack of industry knowledge of retail investors.

YuMe could be a $1 billion market company by 2017.

The industry will continue to grow at 20% CAGR for the next five years.

Recent Seeking Alpha articles on YuMe, Inc. (NYSE:YUME) have talked about the consolidating ad technology industry given recent acquisitions by Google (NASDAQ:GOOG), Facebook (NASDAQ:FB), and Twitter (NYSE:TWTR). My long position in ad technology stock YUME has more to do with the long-term prospects of the industry and the company, which I believe has a strong competitive advantage and may be the leader of the sector.

eMarketer projects that 2014 worldwide digital ad spending will be $137.5 billion, which include desktop and laptop computers, mobile phones and tablets. Of that $137.5 billion, $6 billion is projected to be digital video and is projected to grow more than 40% this year and 20% CAGR for the next five years. I think eMarketer's growth rates are conservative given positive revisions and because we haven't reached worldwide saturation of smartphone and tablets devices.

Every time there is an opportunity to invest in a new and fast-growing tech industry, many retail investors are slow to grasp what the companies do, how they will grow, and when they will make money. VC firms and angel investors are doing us investors a favor by taking significant risks filtering the companies that may not survive, or acquiring companies before doing so in the public markets. Nevertheless, new industries always go through four phases, as follows:

  1. Investments leading to a proven concept (15 to 20 companies)
  2. Growth (10 to 15 try to prove which is the better of the bunch)
  3. Acquisitions (they either merge with each other or a big company acquires)
  4. Major players (two to three) and "niche but respectable" companies (two to three). At this point, the companies with perhaps inferior management, products, or balance sheets (could be a combination or one of the three) will be left to die, given the major players are crushing them in the market.

Right now, the ad tech industry is at the end of phase two and into the beginning of phase three given the small acquisitions that occurred in the past six months, as Charles Moscoe pointed out in his article. Nevertheless, at this point in the game an investor has two choices to make money in the industry:

  1. Buy a basket of stocks (lower returns but less risk)
  2. Select the right stock that will be the winner longer term (the major player in phase four)

I am not a big fan of No. 1, so I decided I would start my work by looking at each and every single company in the industry. Below I listed all of the public companies that are in the industry, as well as some financial metrics to show you which -- on the surface -- is the cheapest of the group.

Industry Comparisons

Name of Company

Ticker

Stock Price

2014 Sales*

2015 Sales Growth*

2015 EPS*

P/E Ratio

Enterprise Value

2014 EV/Sales

Rubicon Project

RUBI

$12.24

113.M

31.10%

-0.14

NA

437.85M

4.85

Millennial Media

MM

$4.21

345.20M

16.40%

-0.18

NA

378.09M

1.34

Rocket Fuel

FUEL

$25.74

430.10M

56.90%

.32

80

813.99M

2.94

Marin Software Inc.

MRIN

$10.74

97.50M

19.80%

-0.60

NA

288.75M

3.48

Criteo SA

CRTO

$37.18

295.00M

32.20%

0.65

NA

1.82B

2.66

Tremor Video

TRMR

$4.23

163.12M

24.70%

-0.15

24%

141.78M

1.00

YuMe

YUME

$6.01

195.30M

26.40%

0.27

NA

144.02M

0.89

Click to enlarge

*Estimated by Yahoo Finance

There is no perfect formula for investing in a fast-growing industry because the first to start or the fastest growing doesn't mean it will be the ultimate winner -- think MySpace, Friendster, and Facebook. Now, it could very well be that all of these companies get acquired, but if they don't we have to assume we are betting on the right horse.

My Method for Picking the Right Horse

I like to look at the following factors:

  1. Management Team (quality and track record)
  2. Product/Technology (strong competitive advantage, strategy that makes the most sense)
  3. Valuation (cheap, growing, and profitable with high margins)

Of all of the companies from the list above, the company that came closest to all three metrics was YuMe.

Management Team: The management team's track record is solid considering their ability to grow a previously difficult and complex-to-scale business.

Technology: YuMe is one of the only companies in the space that has an all-screen strategy and can minimize fraud as well as track and segment their audience, given they receive their data through an SDK (software development kit). Other companies in the space rely on cookies or are too reliant on one segment, such as 100% smartphones. I decided YuMe was the best fit for me given their all-screen strategy and diversification.

Valuation: When looking at fast-growing companies, you always have to look out two to three years out because the current year will always show a muddled picture. Nevertheless, I think EV/sales is a good metric in judging the price today. But I would look at revenue growth rates, expansion of margins, and P/E for the future as YuMe is projected to be profitable next year (potentially this year, as per Needham analyst Kerry Rice).

After researching the industry and YuMe, I created a five-year forecast of how the company will be able to grow in terms of sales, EBITDA, and net income. I believe a "mature" state for this business would be at least five years away given the revenue growth rates and expansion overseas, which is growing in the triple digits as of the last quarter and will continue to exceed expectations.

2014*

2015**

2016**

2017**

2018**

Revenues

200 M

260 M

325 M

405 M

505 M

Growth Rate

32%

30%

25%

25%

25%

EBITDA

6M

25M

48M

73 M

100 M

EBITDA Margin

3%

10%

15%

18%

20%

Net Income

-

11M

32.5M

52.5M

70M

Net Income Margin

0%

4%

10%

13%

15%

Shares Outstanding

32.37 M

32.8 M

33.25 M

34 M

35 M

EPS

0.00

0.34

0.98

1.52

2.00

Click to enlarge

Notes

*2014 numbers are on the high end of Yahoo 2014 estimates as I believe the analysts and company are way too conservative. I believe they will exceed expectations given the popularity of the FIFA World Cup and mid-term elections in the fall of this year.

**2015 to 2018 -- Revenue estimates are my personal assumption, given the growth rate of the industry and YuMe's organic growth in international markets. Margin estimates were an assumption from where the company projected the company could reach over time. The high end mentioned by the CEO was 22% EBITDA margin, but I don't think we get there until after 2018.

I used a lower tax rate for 2015 and 2016 given the net operating loss carried forward that the company has. After 2016, I maintained a lower rate of 30% given international revenues and profits.

What Is YuMe Worth Today and in the Future?

What value would you put on a company that is growing at a CAGR of 25% for the next five years and expanding EBITDA margins to around 20%? I think a company with this profile should be selling at 1.5x to 2X EV/sales and at least a 20x P/E. This means this would take YuMe to the following share prices for the next five years:

2014 EV/sales of 1.5x-2x = $9 to $12 a share (P/E not used here because of fast growth rate)

2015 EV/sales of 1.5x-2x = $17 to $24 a share

2016 P/E of 15x to 25x = $15 to $25 a share (P/E used here given higher margins)

2017 P/E of 15x to 25x = $23 to $37 a share

2018 P/E of 15x to 20x = $30 to $60 a share (lower P/E range used given more mature business)

For those who think I may be too optimistic, consider that Tube Mogul -- which will IPO next week -- is being valued at 4x sales for 2014, making it one of the richest among peers. At its current growth rate and continued margin expansion, YuMe may become a $1 billion market cap company by 2017. With today's current enterprise value at $144 million, the return on investment with YuMe at today's price is just as good -- if not better -- than the VC and angel investors, without taking significant risk given its proven business model, excellent management team, and technology.

Disclosure: The author is long YUME, TRMR. The author wrote this article themselves, and it expresses their own opinions. The author is not receiving compensation for it (other than from Seeking Alpha). The author has no business relationship with any company whose stock is mentioned in this article.