Looksmart Is Worth More Than Its Cash

Jul. 2.12 | About: LookSmart Group, (LKST)

After the market closed on Friday afternoon, a third party offer to purchase all outstanding shares of LookSmart, Ltd. (LOOK) was announced by Peek Investments LLC (hereinafter "Peek"), a consortium of two of the largest shareholders of LookSmart. Peek gave LookSmart management a notice that it intends to commence a tender offer for all outstanding shares of LookSmart at $1 per share. What happens next should be very interesting for several reasons:

1) LookSmart had a net $1.28 per share in cash as of the latest reported quarter and likely still has north of $1.20 per share in the bank.

2) LookSmart still has assets that are arguably worth $10-$15m more than the cash on the books.

3) There are potential buyers who would likely see significant strategic value in LookSmart's non-cash assets

Each of these reasons is discussed in greater detail below:

1) LookSmart had a net $1.28 per share in cash as of the latest reported quarter and likely still has north of $1.20 per share in the bank. The chances of this group acquiring a majority of the shares at $1 are pretty remote (it certainly won't get my shares), but I might start listening when the price gets 30-40% higher. I think we will ultimately see this unfold, and at a minimum, we will see the same group offering a higher price to gain control of LookSmart. Even if that occurs, I may not be willing to sell all of my LookSmart shares, as I would like to see what a different management team could do with what appears to be substantial latent value.

One interesting thing that could materialize on this front—the LookSmart Board of Directors recently authorized a $1m share buyback. Given that LookSmart stock only trades about 26k shares per day (10 day average) and that the company's large cash position makes it easy to put that plan into action, the BOD could use the recently authorized $1m share buyback authorization to push the stock higher than the existing $1 price, making the offer all but moot. Given the relatively low volume usually traded each day, they could just put in a limit order to buy 200,000 shares at up to $1.00—that would equal only one fifth of what has already been authorized and I would be surprised if the company could get the entire order filled.

In fact, given that its pure arbitrage at any price is lower than the company's cash position, it is not out of the realm of possibility that management could make that bid $1.20 or so, thereby making any bid south of there nearly irrelevant. Obviously there are some restrictions on how the buyback can be executed, but I believe its still fair to say that this offer can quickly be made less than attractive if the BOD decides to use its buyback authorization to "up the ante" next week.

2) LookSmart still has assets that are arguably worth $10-$15m more than the cash on its books. Among the most obvious are:

- An Ad Network that has had several million dollars in upgrades and enhancements since being named one of the top ad network platforms three years ago. It still processes about 2 billion queries per day and transacted 101 million paid clicks in the "awful" Q1 that was just reported. This is still a significant ad network platform and arguably among the best of the tier-two (everything below Google Inc. (NASDAQ:GOOG) and Bing) players in the space. Not just the technology, but a tried and true operating network such as LookSmart's should have some value for a buyer; it is hard to imagine a scenario where it would be valued at less than seven figures and it seems that some scenarios could emerge that could push that value closer to eight.

- Intellectual Property: LookSmart owns search and keyword advertising patents and/or patent pending applications that pre-date Google's emergence as the search and advertising titan that it is today. Given the recent developments in the search advertising related patent litigation involving Google (See Vringo/IP versus Google), there may be increasing interest in this aspect of the LookSmart asset holdings. Additionally, LookSmart still owns the search technology that powered the old WiseNut search engine, even though it sold the WiseNut name several years ago. There was a time a decade ago when this technology was believed to be the best challenge to Google's search superiority and many unique aspects of WiseNut were later adopted by Google, Ask.com, etc.

- Net Operating Losses: LookSmart has net operating losses in excess of $180m, though only about $25-$30m of the NOLs would likely be useable over the next 10 years if Looksmart is acquired. Still, $25-$30m in NOLs could be worth $10-$15m to a purchaser under the right circumstances.

- Nasdaq Listing: This is not something we are used to seeing in recent years, but the Facebook IPO flop could make it more difficult for all but the most attractive technology companies to tap the public markets. This could lead to private companies seeking a listing through the old reverse merger route. Again, it is rare to see this occur with a Nasdaq-listed company, but there is still a level of prestige that is worth something and the LookSmart corporate shell alone might be worth seven figures. If that sounds a little far fetched, consider the Adknowledge business, why it might desire access to a more liquid acquisition currency over the next few years, and how difficult it might be to place a traditional IPO in that same time frame. Of course, Adknowledge comes to mind as it has been a consolidator of search ad networks, and it would actually be among the players who might see the greatest strategic value from a LookSmart acquisition.

- Going concern with well-established industry connections and customers, and what is likely a $16-$20m annual top line run rate (extrapolating the awful and seasonally slow Q1 results gives us the low end of $16m, presumption of higher results in the seasonally better Q2-Q4 gets us to the higher end).

3) There are potential buyers who would likely see significant strategic value in LookSmart's non-cash assets. I am willing to concede that we are unlikely to realize the full potential of these latent assets in an acquisition scenario, given where the business is today. However, I do believe we will ultimately see a bid materialize that will allow shareholders to more fully realize some part of that value. Peek's offer officially puts LookSmart in play and we may see other bidders emerge, particularly if it appears that LookSmart's assets might be acquired anywhere near the valuation of the initial offer. There are a number of potential strategic buyers who could emerge and/or should be interested in acquiring the assets of LookSmart, including InterActiveCorp (IACI), Adknowledge and even News Corporation (NASDAQ:NWS).

InterActiveCorp is the one that would likely have the most interest as it was one of the biggest users of the LookSmart ad network. Within the last two years, Interactive used a white-labeled version of the LookSmart ad network platform for the sponsored listings across many of its properties. IACI could easily do a cash or stock deal to acquire LookSmart and probably generate enough value from its own wholly owned web properties to justify paying more than double the current offer on the table from Peek.

The same case could be made for News Corporation. Adknowledge has been a serial acquirer of advertising properties, with its acquisition of Miva's ad network probably the best comparable transaction available in terms of the ongoing business, and I believe that most industry insiders would agree that LookSmart's technology platform is head and shoulders above what Miva had when it was acquired for $11.6m in 2009.

In summary, I do not believe that Peek Investments LLC will be successful in its bid to acquire LookSmart in the absence of a significant increase in the amount offered. However, this offer has officially put LookSmart "in play" and I believe that other bidders and/or circumstances will emerge to push the valuation for any LookSmart acquisition substantially higher. While the ultimate acquisition of LookSmart may occur at a price that does not reflect the full potential value of its assets, I believe it will be substantially higher than the current price offered and I would be surprised if the market action over the next few weeks does not push the shares to a level that will make the initial bid unattractive.

Disclosure: I am long LOOK, IACI.