Intriguing Long-Term Opportunity in India's

| About: India (REDF)

Excerpts from Gilford Securities analyst Ashish R. Thadhani's recent note to clients on India Limited (NASDAQ:REDF):

REDF: $197M EV Presents Intriguing Long-Term Opportunity

Investment Conclusion. Due to inconsistent near-term growth in the core India Online advertising segment, we are reducing our estimates: fiscal 2008 non-GAAP diluted EPADS to $0.19 on revenue of $33 million (13% YoY growth) from $0.20 on revenue of $34 million; fiscal 2009 non-GAAP diluted EPADS to $0.27 on revenue of $42 million (30% YoY growth) from $0.30 on revenue of $47 million; and fiscal 2010 non-GAAP diluted EPADS to $0.37 on revenue of $53 million (27% YoY growth) from $0.40 on revenue of $60 million. Our estimates imply compound revenue/EBITDA/EPS growth of 26%/50%/24% in calendar 2007-09. We are also lowering our target price from $17 to $13. In 12-months, this would correspond to 35x forward EPS and an enterprise value of $320 million. Notwithstanding recent estimate cutbacks, the current $197 million enterprise value should draw support from key strategic assets, i.e., the iShare video distribution platform (1.5 million monthly visits trail only YouTube in India) plus access to a base of 63 million registered Internet users.

3Q08 Results. Non-GAAP diluted EPADS of $0.05 vs. $0.08 a year ago on revenue of $8.5 million (10% YoY growth) met our $0.05 estimate on revenue of $9.1 million. The shortfall in revenue was offset by lower-than-projected operating expenses. Results reflect a slow recovery in the India Online advertising segment (54% of revenue), which recorded 7% QoQ growth vs. our 25% expectation. Still, Rediff posted an operating deficit of $0.3 million (-3.8% margin) – in line with our -$0.4 million estimate (-4.4% margin). Cash stood at $59.6 million (or $2.00 per ADS) compared with $59.1 million on September 30.

In October, management indicated that expanded choices and occasional irrational behavior were slowing client decision making. More recently, Rediff has faced pricing pressure from performance-based ad clients (one-third of India Online advertising revenue). Steps underway to accelerate revenue growth involve enhanced search capabilities, and behavioral tracking algorithms for improving ad performance. Meanwhile, client-count jumped unexpectedly (up 45% YoY) while growth in key user metrics outpaced rivals – with the notable exception of Google (source: comScore).

Business Model. Rediff generates core revenue from the sale of advertising space on its site. Online advertisements comprise banners, links and event sponsorships. The company targets India’s top-200 corporate advertisers across key consumer categories through ~100 sales and marketing professionals. Clients include Citibank, Hewlett Packard, Hindustan Lever, ICICI, Microsoft, Monster,, Pepsi, and others. Rediff charges a fixed fee for a given time period or guaranteed number of impressions (CPM model); or a variable fee based on click-throughs (suitable for SME clients with limited ad budgets). Consumer offerings consist of e-mail (in 11 Indian languages), news, search and an online marketplace. Through an editorial staff, contract journalists and syndication/aggregation from multiple sources, provides content on popular subjects: news, business and personal finance, movies, sports, health, food, books, games, astrology, contests, lifestyle, etc. Fee-based services include e-mail; wireless messaging (revenue is shared with major operators) and ring-tone/game downloads; matchmaking and astrology subscriptions; and commissions from independent electronics, apparel, jewelry, flower and other merchants. The U.S. publishing business (non-core) includes a weekly newspaper catering to the Indian community. Rediff derives revenue from classified advertisements and subscriptions.

Investment Overview. REDF is the largest India Internet play listed in the U.S. Using a portal interface, it provides a comprehensive spectrum of services/content geared to online advertisers and the Indian community worldwide.

  • Rediff is positioned to benefit from rising online ad spending (1% of the online/offline total), overall Internet usage (~5% penetration at present) and new consumer e-commerce services (pending a more reliable payment/fulfillment infrastructure).
  • Attractive attributes include a strong brand (management believes that Rediff holds a 25-33% share of the online advertising market in India and clients include virtually all major advertisers); leading site traffic (note 60+ million online users – driven by the e-mail offering); a business model with inherent operating leverage (fiscal 2005-07 revenue growth outpaced headcount by an 8:1 margin); experienced management (CEO Ajit Balakrishnan has a background spanning IIM and three decades in the advertising industry); and meaningful insider ownership (48%).
  • To attract users and advertising clients, Rediff is developing a range of innovative offerings: web-based e-mail with enhanced features and mobile phone access; VOIP-enabled Instant Messenger also available on mobile phones; search/comparison tools covering popular categories such as shopping, travel, jobs, matrimony and ring-tones; social networking, content sharing and auction platforms; and online classified listings targeting the under-penetrated SME segment. Branding initiatives comprise direct, indirect and online marketing plus a nationwide TV campaign.
  • The online advertising model is inherently scalable and we note that Rediff turned profitable in September 2005 on quarterly revenue of $4.4 million. Rediff completed its $57 million IPO in June 2000 at $12.00 per ADS. The balance sheet was strengthened by a $44 million follow-on offering in November 2005 at $15.86 per ADS. Although management has dismissed recent takeover speculation, we believe that Rediff could command a premium from a strategic suitor in the future, e.g., Google, Yahoo!, Microsoft or – proponents of wireless/Internet convergence may argue – local heavyweights Bharti Airtel and Reliance Communications.
Principal risks include the following:
  • Competition from Google (NASDAQ:GOOG), Yahoo! (NASDAQ:YHOO), MSN (NASDAQ:MSFT) and AOL (NYSE:TWX) could require stepped-up investments and pressure future profitability – or result in the loss of a major client.
  • The current valuation renders REDF vulnerable to a correction in the U.S. markets. In our view, this is explained by the vast market opportunity, room for upside surprises, scarcity value and an embedded longer term takeover premium.
  • Insiders have the ability to exercise significant control over all matters requiring shareholder approval.