If you read the tea leaves, it's obviously the right thing to do. --KIT Digital Chairman Kaleil Isaza Tuzman, on the changes in the board.
KITD shares took a tumble, Friday March 23rd, 2012, after the company made an announcement that clearly shocked the market. The bombshell announcement, which sent the shares down 25% by the close of that day, to a multi-year low, included:
- Kaleil Isaza Tuzman, its enigmatic Chairman and CEO, would relinquish his CEO role,
- The company would commence a CEO search and,
- Four directors of the company had resigned.
The company also mentioned that its 10-K would be delayed, and was expected the week following the announcement.
Just a week or so before, KITD had reported fourth quarter 2011 revenues of over $70 million and FY 2011 revenues of over $214 million. It also reported it was operating cash flow positive and projected 2012 revenue of over $320 million and "cash-based adjusted EPS" of $1.35 to $1.45 per share. With a price per share of under $7, an EV/Forward Sales of under 1 and gross margins 78% and increasing, the market is screaming "toxic waste." The company is projecting revenue growth of over 30% with much of the revenue predictable from recurring streams, yet it is being valued as if it were a dying business. What's the catch?
First, the resignation of CEO Tuzman is not a small matter for the company monogrammed with his initials. In 2007-2008, Tuzman became CEO of a company called ROO Media through a complex arrangement with a corporate entity called KIT Capital. In 2008, ROO Media was renamed to KIT Digital. (account based on last 10-K filing) Tuzman image has always hovered larger than life on KIT Digital, a fact he alluded to in the conference call following the March 23rd announcements. He remains a major shareholder with a 6.2% stake in the company.
Tuzman gave the following reasons for his resignation:
A. "We want to create the right environment over time for operational expertise and excellence to come into this company in the form of a permanent CEO."
B. "I'm some of you I'm sure will be happy to hear this, given that I'm kind of sometimes a lightning rod personality, and it's a love him or hate him type of dynamic -- from a public market perspective, I'm going to take a step back in some of that interaction, and I think really enable the Company to get to its next level of development from a communications perspective in the market."
C. "..there is a very significant strategic process going on that we've done our best to disclose within the correct boundaries. And we need to be very careful, as a company that thinks that it's extraordinarily undervalued, to make sure that we are appropriately handling that situation, which the Special Transaction Committee of our Board has been so attentive to. And I'm doing, now, everything within my power to support the transaction committee to make sure that we are being appropriately responsive." [Quotes from transcript of 3/23/2012 conference call provided by KITD Investor relations].
Although Tuzman said that he wasn't "going anywhere," the announcement did raise doubt about his commitment to the company that bears his initials. Also notable was the fact that three other board members, management insiders of the company resigned, though apparently they are also not going anywhere since the conference call clarified they would continue in the management positions.
Finally, an independent director, Santo Politi, also resigned over "disagreement" with other members of the board. The market reaction shows that these actions, along with the delay of the 10-K, created a lot of FUD about the company that has been discounted into the stock price.
KITD's comparable competitor, recently public Brightcove (BCOV), has trailing revenues of $63 million (FY2011) and a market cap of $589 million compared to KITD with trailing revenues of $214 million and a market cap of $309 million (market cap figures as of market close on 3/27/2012). If the market is, indeed, overreacting to the announcements than KITD could be a gold-mine for investors able to stomach the volatility from the announcements.
To do this, an investor would need to make a bet on whether the company's explanations are credible and whether current and future management could continue to steer the development of KITD towards future growth and profitability. We pose some questions regarding recent events with plausible answers or best guess opinions.
1. Why did independent directory Santo Politi resign?
This is not really something that the company could answer on behalf of Politi. It is notable that Santo is a VC that had become a director in 2011, I believe as part of the KickApps acquisition. What was the disagreement with Politi. Reading between the lines of the conference call, we find the following statement:
We are grossly undervalued as a company. That being said, we have to respond appropriately to inbound interest, and especially to inbound interest that has a certain -- that is bona fide, and that comes in a certain way, especially when you wouldn't have formed [the Special Transaction Committee] if that wasn't the case.
So it appears that KITD got an offer, or at least an overture from a bonafide party. It is possible that the board disagreement was related to responding to this overture. This is in itself, is hardly bearish, especially if management and board believe the company is significantly undervalued given its current share price.
2. Is Tuzman committed to the company?
In his own words:
I'm still, I believe, the second-largest shareholder in the Company; I've bought my shares in the open market. I've had shares issued to me as a manager, but the vast majority I bought in the open market, as my life savings in the business. I want to support the committee as best as possible in making sure that we have the best possible outcome, whatever that is to this process.
Again, here is referring to the Strategic Transaction Committee and the undervaluation of the company. I do not see a lack of commitment on Tuzman's part, and his interests are certainly aligned with shareholders given his significant person stake. However, it seems like a somewhat anxious and premature move for him to remove himself from the CEO role? Wouldn't it have been better to roll up the sleeves and build value for the next couple of years and let the market take care of itself. It is clear that this has been part of the debate. (Tuzman: "I'm sure, strong differences of opinion. About whether -- oh, enough already. I'm tired of seeing KIT Digital at this valuation. They should just sell. There are shareholders to say, that's ridiculous; take a long-term view and look at this two years forward, and kind of drown out the noise and it will work itself out.")
3. Will the10-K be released on time and would it contain further surprises?
This is part of the hundred million dollar (in lost market cap) question following the announcement. The 10-K notification of late filing with SEC states that the delay is "to allow for verification of intangibles valuation and completion of other items related to accounting for acquisitions completed in 2011." This is what management stated on the call as well.
So far the management story is plausible. If they can follow up with the 10-K in a timely manner and it has no material change in revenue/net cash the stock may well recover most of its post-announcement losses.
And if the company can minimize the drama and stick to the knitting, shareholders may well be rewarded with valuation comparable to competitors. At about 9x trailing revenue, similar to Brightcove's current valuation, KITD could be valued upwards of $30 share. A PEG of 1 and ultimate net margins of around 15-20% which appear achievable, would also offer up similar valuation numbers. (A detailed valuation model is left to a future article.)
That would make it screaming buy instead of the toxic waste the market is valuing it at, largely because it does not yet fully trust Tuzman and the management. But to know which it is, we may have to keep reading the tea leaves for now.
Disclosure: I am long KITD.