Cutting Rediff.com's Estimates Again

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

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REDF: Estimates Cut Again, Investor Patience Wears Thin

Investment Conclusion. With slower short-term ad spending in key segments (financial services, IT recruitment and travel) delaying a return to operating profitability, compounded by non-operating adjustments (interest income and tax-rate), we are sharply reducing our estimates as follows: fiscal 2009 non-GAAP diluted EPADS to $0.17 on revenue of $39 million (21% YoY growth) from $0.27 on revenue of $42 million; and fiscal 2010 non-GAAP diluted EPADS to $0.27 on revenue of $49 million (25% YoY growth) from $0.37 on revenue of $53 million. Our estimates imply compound revenue/EBITDA/EPS growth of 21%/39%/6% in calendar 2007-09. We are also lowering our target price from $13 to $10. In 12-months, this would correspond to 30-35x forward EPS. Still, we believe that the current $131 million enterprise value should draw support from certain strategic assets: an active base of 9.5 million Indian Internet users, the popular iShare video sharing platform (trails only YouTube in India) and leadership in the Personal Finance category (MoneyWiz boasts more unique visitors than Yahoo! Finance and the local CNBC affiliate). Upfront bandwidth and marketing investments should be rewarded, over time, with rising ad revenue from a strengthened online platform.

1Q09 Results. Non-GAAP diluted EPADS of $0.03 vs. $0.04 a year ago on revenue of $8.3 million (up 22% YoY) missed our $0.06 estimate on revenue of $9.4 million. Shortfalls in revenue (-$1.1 million) and interest income (-$0.2 million) were only partially offset by lower- than-projected operating costs (+$0.6 million variance). Results did benefit from diminished seasonality in the India online advertising segment (60% of revenue), which posted 58% YoY growth. Rediff recorded an operating deficit of $0.6 million (-7.0% margin) compared with our –$0.1 million estimate (-0.6% margin). Cash stood at $54.7 million (or $1.87 per ADS). Importantly, unique users surged 13% between March and June vs. 6% for the overall market – and outpaced competitors Google and Yahoo! New developments include expanded search capabilities (e.g., schedules and reservation status covering 20K buses and the Indian railway system), social features (e-mail feeds from sites such as Facebook and Orkut) and launch of an external developer program for building applications across Rediff properties.

Business Model. Rediff generates core revenue from the sale of advertising space on its www.rediff.com 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, Naukri.com, Pepsi, Shaadi.com 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, Rediff.com 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 significant operating leverage; 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 (GOOG), Yahoo! (YHOO), Microsoft (MSFT) or – proponents of wireless/Internet convergence may argue – local heavyweights Bharti Airtel and Reliance Communications.

Principal risks include the following:

Competition from Google, Yahoo!, MSN and AOL could require stepped-up investments and pressure future profitability – or result in the loss of major clients.

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.

ANALYST CERTIFICATION

I, Ashish Thadhani, certify that all the views expressed in this research report accurately reflect my personal views of the subject companies. I certify that I have not and will not receive compensation with respect to the issuance of this report.