Situation Summary: Infospace (INSP) has a market cap of $328 mm, cash balance of $250 mm, no debt, NOL carry-forwards of $800 mm, trading at EV/EBITDA of 3x and EV/free cash flow of 3x. There are three reasons to own this stock. (1) the huge cash position coupled with the fact that there is no cash burn provides downside protection (2) a rock-bottom valuation provides a floor and (3) any one of a number of events could unlock value. These include an acquisition, divestiture, liquidation, special dividend or a stock buyback.
Company Description: InfoSpace is a web search-engine company with a proprietary meta-search technology. This technology allows it to optimize web searches for users, aggregating results from most widely used engines [Google (NASDAQ:GOOG), Yahoo (NASDAQ:YHOO), Bing, Ask.com etc.]. Incredibly, at one point in time, InfoSpace had higher revenues than Google.
In 2010, the company generated $247 mm in revenues from three business segments. Around $215 mm or 87% was from the search business and $32 mm was from an e-commerce unit, Mercantila.com, acquired in May 2010.
Search revenues were derived from two sources. Approximately two-thirds were from distribution partners. Here, InfoSpace white-labels its search engine for ISPs and small businesses which are too small to be Google or Yahoo's customers. InfoSpace has around 100 distribution partners (e.g. newspaper companies, NASDAQ.com, Publishers Clearing House etc.). The economics of this business is that the ad revenue from clicks is collected by InfoSpace from Google, Yahoo etc and then has to be shared with the distribution partner. This is a low margin (~25%) business.
The remaining one third of search revenue is derived from the company's owned-and-operated websites -- Dogpile.com, Infospace.com, webcrawler.com and metacrawler.com. This business has significantly higher margins than the distribution segment because InfoSpace gets to keep ~80% of the revenue generated through clicks.
Mercantila.com is an e-commerce website which lost ~$5 mm in 2010 on revenues of $32 mm. You can visit the site and form your own opinion but to us, it looks like a run-of-the-mill web-store, selling patio furniture, baby cribs and similar whatnots.
Revenue Concentration: The company has long term revenue sharing agreements with Google, Yahoo! [now Yahoo!/Microsoft (NASDAQ:MSFT)] and other major search engines. Google and Yahoo! jointly accounted for 95% of InfoSpace's search revenues in 2007, 2008 and 2009, and 80% in 2010. The company recently renewed its agreement with Yahoo! and Google so that uncertainty is behind it now.
Historical Background: Until 2007, Infospace had three businesses (a) online search (2) online directory and (3) mobile. After being prodded by a large activist fund, in 2007 it sold mobile for $135 mm and online directory for $225 mm. With this cash, the company paid two large dividends to shareholders - $6.30 per share in may 2007 and $9 per share in January of 2008.
Management's Strategy: After having paid large dividends in the past, why is the company sitting on so much cash? InfoSpace has a stated objective of making an acquisition(s), in a related space to its web-business, in order to utilize its large NOLs.
In February 2009, it hired the ex-CEO of Value Vision Media (NASDAQ:VVTV) and only a year later, it announced his departure. It then appointed one of the board members as the new CEO. The company emphasizes this new CEO's acumen in M&A.
Earnings Power: InfoSpace's cash balance overwhelms the operating business side of the story. However, a quick review might be helpful.
You can see in the preceding table that EBITDA and free cash flow generation has been quite healthy except that the margins continue to shrink as the company grows the lower-margin distribution partner-based search business. Even if we back out the e-commerce acquisition, search business revenues grew 3% in 2010. Also, given that the company has no debt and pays nominal taxes due to its large NOL carry-forward, EBITDA minus Capex is the same as free cash flow.
In its Q4-10 earnings call (2/2/11), the company said this, "Now for our outlook, in the first quarter of 2011 we expect revenue to be between 57-60 million, adjusted EBITDA between 5-6 million and net income between 500,000 and 1.5 million from 1 to 4 cents per diluted share." It actually generated $62 mm in revenues and $7.2 mm in EBITDA in Q1-11.
In its Q1-11 earnings call, the company gave guaidance for revenue of $59-$62 mm and EBITDA of $6.5-$7.5 mm.
The point is that this does not appear to be a business which is fading away. The key is what this management can find to add to the mix and get back on a growth trajectory plus utilize the large NOL.
Current Valuation: Subtracting cash, company enterprise value is $78 mm or 3x adjusted EBITDA and free cash flow.
Value Unlock Argument: This is of course our opinion and you may disagree. There are two main ways to unlock value. One is for the company to make a sensible acquisition of a profitable business without overpaying. While we don't give a high probability to this, we take comfort fromt he fact that INSP has been careful about preserving cash.
The other is to pay out large majority of cash as a special dividend and sell the business to a strategic or financial buyer. If no one is willing to buy the two businesses or the contracts with Yahoo and Google are averse to a change of control, then we, as a shareholder, would be happy with owning the stub, given the free cash flow.
The math is simple. If the company paid out a $6 special dividend, it would create the stub for $3/share and the EV would still be $2/share. With EBITDA and free cash flow of $0.65/share, it wouldn't be a stretch to assume that a financial buyer or private equity firm could take the stub out for a nice premium.
Even without a catalyst, at 7x-8x free cash flow, the stock can be easily valued at $12-$13 per share.
Anti-Takeover Provisions: There is a staggered nine member board, divided into three classes, with overlapping three-year terms. At least 50% shareholder approval is needed to remove a director. Holders of at least 30% of shares are needed to call in a special meeting. A poison pill is also in place which is triggered by a certain threshold (15% is how we read it) of change in ownership.