The 411 directory service is an $8 billion per year business that has recently received much attention from the venture capital community as well as several large technology companies, with new entrants including Microsoft's (NASDAQ:MSFT) 1-800-555-TELL , AT&T's (NYSE:T) 1-800-YellowPages and Google's (NASDAQ:GOOG) 1-800-GOOG-411.
The most significant among independent companies in the space is Jingle Networks, which claims to have already taken over 3% of the market. While it is difficult to place a hard valuation on the value of Local.com’s patent that appears to cover the monetization model that appears to be used by each of these players, we can certainly take note of the valuation accorded to Jingle Networks of $150 million + in its last round of venture capital financing. We note that this round of financing occurred at a time when Jingle Networks was not profitable and had taken only about 1.5% of the total market for 411 directory services.
While we recognize that the value of Local.com’s 411 directory service patent is difficult to ascertain, we do believe it is considerable when viewed in light of the valuations accorded to nonprofitable startups in the space that are 25% higher than Local.com’s current market cap. Further, it makes the case for an acquisition of Local.com by large technology companies who are moving aggressively into that space (Microsoft, Google or AT&T) that much stronger.
We noted in a previous article the appeal of Local.com to the likes of Google, Yahoo, Microsoft and Yellow Pages companies based on the previously announced patent covering local search. We have taken note of subsequent commentary that speculates on the enforceability of that patent and feel that we would be remiss if we failed to remind readers of the debates that swirled around the enforceability of the very broad and far reaching patents that were granted to Qualcomm and remind investors that it was upon this “wall or worry” that the stock achieved much of its meteoric rise.
This is the very reason that we made the allusion to Qualcomm in the first place. Whether or not and to what degree the patents will ultimately be enforced is open to speculation either way at this stage. We simply feel that a company with a market cap that is a fraction of what a larger player might pay to own these patents and a market cap that is even lower than what might be earned annually in a single licensing agreement with a major search player is the kind of risk/reward scenario most investors seek diligently.
We view the recent “patent driven frenzy” (per Barron’s article) in trading of Local.com’s stock to be a very positive development for the company that has ancillary benefits well beyond the obvious value of the significant gain in market capitalization that has occurred. One of the largest items on the expense side of Local.com’s income statement is its cost of traffic acquisition, where it pays very significant sums each quarter in a “pay per click arbitrage” that seeks to profit by earning ad revenue that exceeds its cost of acquiring that visitor or at least gives a positive enough Local.com search experience that the visitor returns as a direct navigation visitor (i.e. types in "www.local.com" instead of using a search engine to find them) in the future.
Local.com spends millions each quarter on a “per click” [PPC] or “per impression” [CPM] basis to acquire these visitors. Over the past week, the trading frenzy in Local.com shares has resulted in repeated mentions of Local.com on CNBC, Bloomberg, CNNfn and other financial news outlets and the stock has received favorable exposure as one of the top performing Nasdaq stocks in each days listing of such in every newspaper in the US that offers such stock listings. The value of this additional exposure to the demographic seeking such news is considerable in light of the relatively small size of Local.com’s search operations, the likelihood of significant gains in direct navigation traffic that could result and Local.com’s increasingly efficient engine for monetizing the increased traffic. Local.com would typically have to pay millions of dollars for such direct navigation brand building exposure.
We continue to believe that the company will ultimately be purchased by one of the larger players in the search or directory space. Based on recent action in the marketplace along with commentary from executives and analysts, it appears that Local.com management would give favorable consideration to offers in the $200 million range. Considering the valuations given to other companies in this space, the potential value of its intellectual property, the traction it seems to be gaining with its core operations and the infancy of the markets it serves, we hope that management will require something substantially higher than that.
Disclosure: Author is long LOCM
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