Marin (NYSE:MRIN) is a well positioned, fast growing small-cap SaaS company, which is currently trading at a bargain price. As of today, Aug 19, 2014, the company is trading at a share price of $7.78. This translates into an enterprise value of 1.98x LTM revenues. Compared to other SaaS companies, and considering the company’s high growth rates, this valuation is a bargain.
The company has recently been downgraded by Goldman Sachs from buy to neutral as well as by TheStreet from hold to sell. However, insiders have been busy purchasing stock for more than $1 million in the last days. In particular, experienced board members and venture capital investors have purchased significant stock.
Here on Seeking Alpha, Charles Moscoe posted a positive article on this company, with which I basically agree. In this article I’d like to take an in depth look at two questions:
• Why is the market undervaluing the company and what is it missing
• What the company’s success factors are and on which risks investors should focus
Why does the market value the company at such a low price?
When a company is valued at a low price, there must be a reason. In Marin’s case, there are two apparent reasons. One reason caused the company to trade at a continuous low EV of around 2.4x LTM revenues for quite some time now. The second reason caused the stock to fall more than 10% after the company’s earnings call on 6 August.
Let’s have a look the first reason, the rationale for the continuously low valuation.
Marin is a SaaS Company, which means that Marin’s offering is not sold as a product but as a service. The revenues, which the company generates from a customer, are distributed across those years, in which the customer pays a subscription fee. However, to generate those future cash flows, the company needs to invest today. Today, Marin is spending huge amounts of cash to acquire customers. Marin needs a significant sales force. Their sales cycle from initial contact to close ranges from one to nine months. It will take a certain time until Marin earns back the investment for the acquisition of that customer. After Marin has earned back its investment on acquiring a customer however, each customer is highly profitable for the company.
The negative cash flows that result from this investment in customer acquisition seems to scare investors away. For example, TheStreet downgraded the company on July 30 to ‘sell’, referring to the increase in negative cash flow and low return on equity as a reason. I believe that this is in line with what a large part of the market thinks.
Yet, negative cash flow and low return on equity are indicators, which do not take into account the specifics of Marin’s business model. They are lagging indicators, which do not tell us much about a company that invests today’s money in future cash flows. When we analyze this company we should focus on metrics that are more appropriate for a high growth SaaS company, which we will do further down below.
Now, next to the continuously low valuation, the company’s valuation dropped after the most recent earnings call as of Aug 7, 2014. This happened because the company recently saw a decline in sales growth rates. As Marin’s CEO, David A. Yovanno, pointed out in the call, they saw some weakness in bookings, some expansion in sales cycles as well as some delays in the productivity ramp up of sales executives in the last quarter. The management team believes that these issues are “self-inflected and not an indication of the market opportunity we are pursuing, our products or competitive landscape”. The team has taken action and is working on sales and operational processes.
The key question here is, whether this decline in growth is caused by internal problems or whether the market causes it. Internal problems can be controlled by a good management team, which is in place. The company has both an experienced executive team, as well as an experienced board. External problems however cannot be controlled by management and thus present a bigger risk to investors. It would have a bigger impact on the company, should the slowdown be driven by the market. We will explore the impact, which this could have further down below. In order to do this properly, we should first get a good understanding the business model of the company. If you are already familiar with the business, please feel free to jump to “Metrics”.
Value add of Marin’s offering
Marin Software is a Software as a Service company, which benefits from the shift of advertising budgets to digital advertising and from the increasing complexity of the digital advertising space.
The digital advertising market is becoming increasingly fragmented. In the past, companies and advertising agencies could focus their efforts on search and display advertising. Today, advertisers who want to target their audience efficiently have to juggle with advertising on several search engines, plus social media platforms like Facebook, LinkedIn and Twitter. This creates complex workflows for the execution of campaigns, and it requires tracking and understanding metrics across many channels and add units.
In response to these challenges, MRIN offers three types of solutions for big advertisers:
• Marin’s reporting and analytic tools help advertisers measure campaigns across multiple advertising channels
• Marin helps advertisers execute their campaigns by automating tasks across multiple advertising channels
• It helps them optimize their campaigns for maximum revenue across multiple channels
Marin’s positioning and competition
As discussed above, MRIN is a fast growing SaaS company, which is investing heavily to acquire a customer base and build leadership in its market space. Due to this high growth and heavy investment, we do not have many reliable historic metrics that could help us determine Marin’s future prospects. The factors, which determine its long-term success, are basically the requirements of its customers and the value that Marin’s offering generates for those customers. Understanding how these customers tick and how they perceive the Marin’s products is therefore key to assessing this business. A number of authenticated reviews are available on Marin’s software. While a limited number of reviews is not representative for a whole market, they do help gain a better understanding of both customer requirements and of Marin’s positioning.
Marin and Kenshoo seem to be two of the dominant players in the market. Other competitors were only rarely mentioned in the reviews. They include Adobe Systems (NASDAQ:ADBE), Double Click (Google (NASDAQ:GOOG)), and Acquiso.
The reviews show that the key purchase criteria for products in this market are i) the quality of analysis and reports that if offers and ii) the simplicity of the user interface.
The competition seems to be carried out around the simplicity of use of the platforms as well as on its features, which the companies are constantly upgrading. Marin and Kenshoo each seem to have their unique strengths and weaknesses as regards product features. Each player is constantly improves its offering, since this is quite a dynamic market.
Customers are positive on Marin. According to the reviews, Marin offers a very intuitive layout, which is easy to customize. Marin’s strength also seems to be the efficient handling of workflows across different channels (e.g. activating campaigns, editing bids, change landing sites or performing analysis). Its customer service and training are also very well received.
This is a dynamic market where each company is improving its offering all the time. The key players seem to compete head-to-head. Yet thanks to switching costs, there are some protections for existing players. Several reviews mention that transitioning from one supplier to another requires a learning curve. Marin’s platform needs to get integrated into the customer’s business. Also, Marin mentions in its filings, that a sales cycle may take up to nine months, since customers undertake a significant evaluation process. This confirms that the platform is not commodity products. As long as a company does not screw up and a competitor has only a marginally better offering, switching is most likely not worth the effort for customers.
The necessity to integrate with third parties offers some additional, while probably minor entry barriers.
Marin and its competitors enable customers to use various major advertising platforms and publishers, such as Google or Bing, through one single interface. To develop that offering they need to be integrated with those platforms and publishers. However, as Google and the likes constantly change their APIs, Marin needs to respond quickly to any changes. From the reviews it becomes clear, that major search engines like Google, Yahoo (NASDAQ:YHOO) and Bing seem to be working closely with Marin because of Marin’s size. This should enable Marin to implement changes quicker than smaller competitors.
As explored above, Marin invests today’s cash and human resources to generate future cash flows. This investment is successful, as long as each customer is profitable for the company in the long term. A customer is profitable, when his acquisition costs are lower than the net profit his generates over his entire relationship with the company (customer lifetime value). This means that the longer the customer will stay with the company, the more the company can invest to acquire him. Let’s have a look at both:
Customer lifetime value:
Understanding the company’s products and customers can help us determine how likely customers are to stay with the company in the long term. The reviews, which were solely positive as well as the above mentioned switching costs ,give us some comfort on that side.
Also, Marin provides information on the revenue retention rate, which indicates how profitable an acquired customer is in the long term. The revenue retention rate is calculated by dividing this period’s revenues by prior period’s revenues for all customers that are customers in both periods. While the retention rate fell below 100% in 2013, it was up again above 100% in the last quarter, which is a positive sign.
Efficiency of customer acquisition:
Detailed figures on customer acquisition cost are not available. However, what I would like to see in such a company is some form of organic growth. That means ideally the sales and marketing cost stay stable or decrease over time while the revenue growth increases due to partial organic adoption by customers. Let’s compare Marin’s year on year revenue growth with the marketing spend as % of revenue from the prior year. While throughout 2011 to 2013 marketing spending as percent of revenue has remained steady, revenue growth has decreased from 89% in FY 2011 to 30% in FY 2013. In the last quarter, we see that quarter on quarter revenue growth rates have stabilized at close to 5%, however this was only due to the acquisition of Perfect Audience. Without the acquisition, quarterly growth rates are down at 3%. While this reduction of growth rates can be somehow natural, it raises questions on whether competition might have increased and/or the market might have become more saturated. A change in the market environment would have implications for the company’s track to reach profitability in 2015.
As discussed above, the last earnings call as of Aug 7, 2014 shed some light on these questions. David A. Yovanno has pointed out the weakness in bookings, some expansion in sales cycles as well as some delays in the productivity ramp up of sales executives in the last quarter. Management’s statements in the earnings call, indicating that these are internal problems, are plausible. However we don’t know for sure what caused the slowdown of growth and the extension of sales cycles. I have seen extensions of sales cycles indicate economic uncertainty on the side of customers in other industries. Those uncertainties can result in decreased budgets of customers in the mid term. While Marin generates revenues from subscriptions, customers usually have no or a relatively low fixed monthly fee. The majority of revenues are generated through a variable fee. As a result, Marin’s revenues depend on the spending of advertisers, which is closely linked to the economy. A downturn would affect Marin’s revenues accordingly. It would have an impact on their timeline to break even and on their cash requirements accordingly. Without having first hand access to Marin’s customers it is difficult to build an assessment of this risk. However I believe that the company’s low valuation and its otherwise excellent positioning compensates for this uncertainty if an investor is willing to face some risk.
Marin is a strongly growing company with a solid value proposition and which seems to be well perceived by its customers. The stock is trading at a bargain valuation right now.
As described Marin faces some short-term challenges with a short-term decline of growth rates. If these declines are caused by internal weaknesses in scaling the company, as assumed by management, then there is little reason to be worried. The company has an experienced executive team as well as an experienced board, which is taking action right now. Internal factors are more controllable than external factors. However, as described, this slowdown of growth rates could also be caused by decreasing budgets of customers or by increased competition, which would have a larger impact on the company.
As a result, I believe that the company provides an interesting opportunity for any investor who has a either a good inside understanding of the current shape of the advertising space or who is willing to take some risk in return for a good upside opportunity with this undervalued company.