Rocket Fuel (NASDAQ:FUEL) was slammed on 08.06.14 after reporting an in-line quarter but dramatically lowering future guidance. In addition, the company announced the acquisition of [X+1], an expensive purchase that will take some time to nurture.
The reduction in revenue estimates was enormous by any standard. After reporting revenue of $92.6M for Q2 the company lowered revenue estimates for the year by $33M.
Here's how the numbers look:
- Original Guidance 2014 Revenue: $428M
- Q2 Revenue estimate: $90M
- 2H Revenue Estimate: $263M Growth of 78% YoY
- Updated 2014 Guidance Revenue: $395M (mid point for Rocket Fuel only, no acquisitions)
- Actual Q2 Revenue: $92.6M
- Updated 2H Revenue Estimate: $224M Growth of 54% YoY
Investors have been wowed by the triple digit revenue growth that Rocket Fuel reported in 2013 and the super high growth seen in Q1 of this year. The Street has been lulled into believing that FUEL's artificial intelligence is robust enough to propel revenues at above market growth rates. However, guidance for 54% revenue growth in the second half imply otherwise.
Management's excuses of agencies taking programs back in house and concerns over the quality of page views do not strike me as issues that can be fixed quickly. The numbers below illustrate the draconian slow down in revenue growth:
YoY Revenue Growth:
- Q1 14A = 95%
- Q2 14A = 78%
- Q3 14E = 57%
- Q4 14E = 52%
One might hope that FUEL's acquisition of [X+1], which was reported coincident with the quarter, might help increase growth. After all, most technology companies are allowed to squander highly valued shares in order to acquire hyper growth. Alas, [X+1] grew revenue at a much slower rate than FUEL, despite a much smaller base. [X+1] grew revenue 35% in 2013 to $72M and is expected to grow 20-25% in 2014 according to FUEL management. However, annualizing the expected $20M contribution to Q4 14 from [X+1] would imply a much lower growth rate for 2014. Perhaps Q4 is a seasonally weak quarter for [X+1], but annualizing the $20M in revenue implies $80M in annual revenue, growth of only 11%.
Not only will [X+1] dilute FUEL's revenue growth rate, but its gross margins are significantly lower than FUEL's. At 25% versus FUEL's 49%, blended gross margins will decline going forward. Losses will also increase with [X+1] expected to contribute ($3M) in adjusted EBITDA losses for Q4 versus the ($6.5M) in adjusted EBITDA losses expected to be generated by FUEL on a stand-alone basis for the entire year. It is important to note that management had previously forecast an adjusted EBITDA profit of $4.5M for FUEL.
Lastly, FUEL must use $100M of its precious cash to help pay for [X+1]. The additional 5.4M shares that will be issued for the deal are now worth only $92M, $38M less than they were when the deal was brokered.
Slowing revenue can be tolerated if the company is still making money and the stock is valued appropriately. Unfortunately FUEL falls short on both these requirements. In the first six months of the year the company has lost $21M, almost double the $12M lost in the prior period, despite revenue being up 80%. Unfortunately for FUEL, these GAAP losses are mirrored by negative cash flow from operations. FUEL's cash flow from operations (NASDAQ:CFO) was negative ($6.2M) for 2013 and negative ($5.9M) for the first half of this year. Cash consumed was even higher after adjusting for capex required to run the business and funds spent on software development.
At the end of June, FUEL had $203M in cash and $27M in debt, resulting in net cash of $176M. $100M of this cash will be used to pay for [X+1], leaving the company with $103M in gross cash and $76M in net cash after the deal. FUEL's cash burn in the most recent quarter was $18M. Based on management's guidance it does not seem likely that FUEL will begin generating positive cash flow in the near term. At the current rate of cash burn, FUEL has roughly 6 quarters left of cash. While a year and a half is an eternity to Wall Street, FUEL will need to find some way to finance its growth, whether it be diluting current shareholders with another secondary or increasing its debt.
While FUEL's stock is down 75% from the euphoric levels in January of this year, it still sports a market cap of $620M or 1.6x revenue. The stock will likely drift lower until the company shows some better than expected quarters, something I don't see happening until mid 2015.
Disclosure: The author has no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. 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.