On Thursday, November 1 Marchex (MCHX) announced that it planned to place its non-core assets into a new company called Archeo and spin it off to shareholders in 2013. On the same day, Marchex released third quarter operating results that showed the company's core call-based advertising business generated revenue of $29 million and adjusted EBITDA of $3.6 million, its best quarterly performance in more than a year.
For the first time, management provided some much-needed transparency to the non-core portfolio, which consists primarily of more than 200,000 web domain names. It revealed historical prices for its top 500 sale transactions that have totaled more than $30 million to date (including exterminator.com for $520,000 and matrimony.com for $500,000) and posted a sample roster of a few hundred of its owned domain names (including beijing.com, singleparent.com, autolender.com, moviedownloads.coom, refinancing.com and podiatrist.com). A link to Marchex's historical domain name disposals is here.
Marchex bought the web domain portfolio for $164 million in 2005 and CEO Russell Horowitz said on the company's quarterly investor call last week that he believes that its value remains in the "nine digits." The link to the call is here.
In an interview last week with a domain trade journal linked below, Horowitz likened the domain portfolio to "an oil field under the desert" and indicated that Marchex (via the spun-off Archeo) will finally focus on creating value from the domain portfolio after a period of semi-dormancy. (here)
Yet at $4, MCHX shares have gone nowhere since last Thursday's announcement, giving the company an enterprise value of $134 million ($151 million market cap less $17 million of adjusted cash). MCHX is returning cash to shareholders in the form of a 3.5% dividend yield at the current stock price and a share repurchase program that has retired 30% of outstanding shares since 2007.
For investors with a 12-month investment horizon, we believe that MCHX shares are significantly undervalued. A compelling case can be made that the company is worth $6 per share today and as value is unlocked from Archeo and the profitable core business makes further gains in the attractive mobile advertising segment, a share of MCHX today could be worth $7 of two companies by the end of 2013.
Let's assume that Marchex proceeds with a spin-off of Archeo in the first half of 2013, though it's possible that the announcement puts the assets in play and stimulates an offer that Marchex cannot refuse. Either way, let's discount Horowitz's subtle "nine digit" suggestion by at least 50% and put a $50 million value on Archeo. The NewCo looks to be on a pace to generate $25 million of revenue and perhaps $6 million of adjusted EBITDA in 2013, assuming an incremental few million dollars of expenses attributable to being a standalone public company. But Archeo will probably trade more based on asset value than cash flow, given that it's likely to be liquidating the domain portfolio over time.
We think the distribution to MCHX shareholders may be .25 shares of Archeo for each MCHX share, suggesting 8.2 million Archeo shares outstanding. A $6 share price would value Archeo at $49 million. But probably not for long since it's likely that Archeo will pay a 60 cent per share annual dividend, indicating a 10% yield. It seems plausible that as Archeo's story is communicated, assets are liquidated and a 10% yield attracts income investors, the Archeo share price would rise. Looking out a year from now at perhaps an $8 share price for Archeo, the yield would be 7.5% and its market cap $65 million. In that case, if current MCHX shareholders hold their distributed Archeo stock, the value to current MCHX shares, including Archeo dividends in 2013, will be about $2 per MCHX share.
Marchex's core call advertising and analytics business will likely generate $110 million of revenue and $11 million of adjusted EBITDA in 2012 and we think double digit growth is achievable in 2013. Projecting $126 million of revenue and $17 million of adjusted EBITDA next year seems reasonable - management has said it believes 20% EBITDA margins are the longer term objective. Much of the company's cash generation is free cash flow as the business requires very little capital, there is no debt to service and contingent payments associated with a 2011 acquisition are now completed.
As a valuation comparable, Millenial Media operates in an adjacent space in the mobile advertising segment and carries a $1+ billion enterprise value with a revenue base about twice that of Marchex and only slightly higher 2013 adjusted EBITDA expectations (though with faster growth than Marchex). Millenial's valuation looks rich at about 5.5x annualized Q3 2012 revenue but if we use a blended valuation estimate for Marchex of just 2x annualized Q3 revenue and 9x 2013 adjusted EBITDA, that yields $184 million or about $5 per MCHX share.
As further support, Marchex has $45 million of deferred tax assets on its balance sheet and a intellectual property portfolio that could appeal to an online advertising giant like Microsoft, Yahoo or Google someday.
Using $5 per share for Marchex's core mobile advertising and analytics business plus $2 per share for the Archeo spin-off yields $7 per MCHX share in 12 months, well above the current price. That's too wide a gap for a company in a growth industry and whose value proposition is becoming clearer.
Additional disclosure: Twinleaf Management LLC manages high-net worth investor accounts with long positions in Marchex shares.