Digital River: Little Downside With Significant Upside

Jun.15.12 | About: Digital River, (DRIV)

Digital River (NASDAQ:DRIV) $14.86. Price target $21-28 (up 40-90%) June 12, 2012

Digital River is a provider of ecommerce and marketing solutions to a variety of companies. Despite generating significant cash flows and growing revenues, the stock has performed poorly and now trades at significantly low valuation levels. While concerns about the fundamentals of the business do exist, I feel that DRIV has significant upside, with limited downside at its current stock price.

Stock Characteristics

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Price (6/11/12) $14.86
Shares 34
Market Value $499
Cash $797
Debt $354
Enterprise Value $56
Avg. Volume (NYSE:K) 138
Short Interest 9%
Dividend 0.0%
Consensus P/E 2012 12.2x
Consensus P/E 2012 (excl cash) 1.4x
Consensus P/E 2013 10.9x
Consensus P/E 2013 (excl cash) 1.2x
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Synopsis:

  • DRIV has been beaten up over the past several quarters due to slowing growth and higher costs. However, I believe the stock is a good buy at this point with limited downside and significant upside.
    • Roughly $14 of net cash, for a cash flow positive business, that is growing.
    • DRIV has a diversified customer base (with the exception of Microsoft (NASDAQ:MSFT), which just extended and expanded its contract with through March 2014. Microsoft generated 28% of revenues in 2011 (here).
    • Significant net cash levels provides strong support. Management has shown a history or stock repurchases, and have indicated they will do so again.
    • Recurring revenue base. While business has been light recently, and management warned about a European slowdown, revenue is based on the transactions of customers, and generates revenues on a recurring basis.
    • Management has indicated that they can scale down the cost structure, if necessary, in order to preserve positive cash flows.
    • I'm not the only one who believes there is large value here.
    • Soros Fund Management disclosed a 10.13% stake in an amended 13G filing, up from 7.98% previously reported on 3/29.
    • Windows 8 is rolling out for Microsoft in H2 2012, and could generate enhanced revenue growth for DRIV.
  • To be clear, I don't believe this is a stock that will show significant growth for many years to come. But I do believe it is a stable company that will experience small growth, and will continue to generate cash levels, that is currently trading well below fair value.

What They Do:

  • DRIV helps customers deliver cloud commerce and marketing solutions, including the basic commerce functioning of sites, as well as assistance and intelligence to increase traffic to client websites.
    • DRIV's services include design, development and hosting of online stores and shopping carts, store merchandising and optimization, order management, denied parties screening, export controls and management, tax compliance and management, fraud management, digital product delivery via download, physical product fulfillment, subscription management, online marketing including e-mail marketing, management of affiliate programs, paid search programs, payment processing services, website optimization, web analytics and reporting, and CD production and delivery.

Why Is The Stock So Cheap?

  • Management has disappointed the street with guidance the last couple of quarters, regarding both revenue growth as well as margins. In its most recent quarter conference call (May 3), they wouldn't officially reaffirm annual guidance, only saying they saw no reason to change the guidance. A bit confusing, and may have contributed to some of the stock sell off. But now it makes sense: They announced an extension of the Microsoft contract and officially reaffirmed guidance.
    • Revenue growth may not be as bad as the street fears. Roughly 80% of revenues come from enterprise commerce, which they expect to grow 6-7% in 2012. While the other 20% of revenues are support (shareware, email marketing, etc.) which is expected to decline 12-16% in 2012. As the enterprise commerce grows as a portion of total business, the revenue growth should start to look better.

Revenue Growth Issues

  • Management has disappointed the street with guidance the last couple of quarters, regarding both revenue growth as well as margins. In its most recent quarter conference call (May 3), they wouldn't officially reaffirm annual guidance, only saying they saw no reason to change the guidance. A bit confusing, and may have contributed to some of the stock sell off. But now it makes sense.

So Why Aren't I Running for the Hills?

  • Because DRIV is trading at close to zero enterprise value now, and they have the ability to cut costs in order to reduce operating expenses. Thus I see the downside risk to be limited, and the company a prime candidate for private equity, or a turnaround.

So Where Do I think the Stock Could Go?

  • I generated a price target of $21-28. I used a variety of methods to come to this range. For example, using the 2012 revenue guidance of $405 million, and using an EBITDA margin range of 10-15%, and an EBITDA multiple of 6-8x. Given the significant gross margins, there is a lot of sensitivity to the model. However, given its ability to lower costs if necessary, I believe the current net cash level of roughly $14 serves as a very conservative support level.

You can see the company's May 3 quarterly earnings report here.

Please see full disclosure here.

Disclosure: I am long DRIV.

Additional disclosure: Contributor, and/or funds that he manages, is long DRIV.