RBC Capital: Why the $7 million miss? The primary factor was a slowdown in the ramp of key clients including Symantec (NASDAQ:SYMC), Microsoft (NASDAQ:MSFT), and an unnamed client, which the firm estimates to be approximately $4M, $2M, and $1M respectively.
The roll-out of the renegotiated SYMC contract, which provides DRIV with global renewals, was said to be only a third complete, essentially unchanged from the end of Q1. Shifting resources on the part of both companies were to blame for the shortfall. MSFT business, which includes Office trial conversions and Vista, was said to be ramping slower than expected.
Is all the bad news out? That's likely for 2007, but the company has a challenging road ahead as it attempts to reinvigorate growth among its historically strongest customer, and grow Microsoft to the magnitude investors had originally hoped, all while balancing investments in infrastructure, which the firm feels is necessary for the company to increase operational efficiency and attract new customers.
RBC is lowering its price target from $58 to $50, and maintaining Sector Perform rating. Target reflects lowered outlook on the company's 2007 revenue and EPS growth expectations of 12% and 3% respectively (was previously projected to be 20% and 17% respectively).
Piper Jaffray notes that while disappointed with the lower than expected guidance, they believe DRIV's issues are more short-term in nature and not a reflection of the overall long-term health of the business. As such, they expect to see accelerated revenue and earnings growth in 2008 as these issues are resolved and DRIV sees greater contribution from Microsoft and Symantec. With shares down 15% after hours to around $44, DRIV is trading at 12x/9x 2007/2008 EBITDA, which PJ believes is attractive given our expectation of 20% plus LT earnings growth. Additionally, DRIV announced an expanded share repurchase program for up to $200M in common stock. At current prices, they would expect the company to be active in a buyback. The firm maintains Outperform, and lowers their target to $61 from $72.
Notablecalls: The warning should not come as a big surprise to investors as checks done by firms covering DRIV were showing subdued activity by MSFT. Jeffco was stupid enough to upgrade the stock on June 20 in face of this. There had been some talk of Symantec (45% customer) getting back on track, so this was probably the psychological trigger for them. Usually, Jeffco's no stupid operator but they sure did get this one wrong. It happens.
What's next? Investors have been expecting MSFT to become the main growth drivers for DRIV. This has yet to happen, as it seems Mr. Softee is approaching the e-commerce outsourcing channel very conservatively (in face of its largest product launch ever) to ensure they do not disrupt the traditional OEM and Retail channel partners.
RBC's Robert Breza has noted in the past that it took Digital River approximately seven years to build the SYMC relationship. While he does not expect Microsoft to take as long, he does believe the first couple of years are a learning process for each side (Digital River and Microsoft). Investors have front-end loaded the ramp in Microsoft and are disappointed.
This means DRIV may have one more tough quarter ahead, although on the conference call management noted their H2 estimates may prove to be conservative.
Given the 7 point haircut the stock got last night, I think DRIV may be a bounce candidate early on. But I would not overstay my welcome as I think there may be another 10% downside to this one over the next weeks as valuation continues to be quite high. But play the bounce first!
DRIV 1-yr chart: