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Copperfield Research is the pseudonym of a research team focusing on publicly traded equities. As of the publication date of our articles, we may have long or short equity positions in the companies covered. We do not discuss unpublished reports, or provide any advanced warning of future reports... More
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  • SodaStream (SODA) - Sorry SodaStream Traders, Pepsi ALREADY Has A Partner

    In the wake of Coke's (KO) notable endorsement of Green Mountain (GMCR) as the in-home vending machine of the future, SodaStream's stock has jumped by 20% from its after hour lows Tuesday night. As is typically the case, investors/traders have shot first with the prudent questions and facts to follow later. This actually includes other short sellers whom we have a great level of respect for that are simply off the mark believing it is a fait accompli that Pepsi will partner with SODA. The linear assumption Pepsi must partner with somebody or risk falling behind in the home soft drink market is somewhat correct. While we certainly cannot rule out that Pepsi will partner with SodaStream, we believe anybody that has bought, or promoted, SODA stock in the last 48 hours has missed a critical fact that we have not seen in any sellside reports thus far. PEPSICO ALREADY HAS A PARTNER IN THE HOME BEVERAGE MARKET.

    It has come to our attention that Pepsi has quietly partnered with the European multi-drink in-home company Bevyz.

    (click to enlarge)

    It is somewhat understandable how investors have missed Pepsi's choice of partners, Bevyz is after all private and European, a combo that can often fall off the radar of most stock market speculators. And if you are buying SODA, you are speculating. The Bevyz dispensers (4 different models in total) provide cold drinks, hot drinks, as well as still and SPARKLING filtered water. Like the future Green Mountain Cold system, Bevyz uses a patented packaging technology that creates a consistent consumer experience. How committed is Pepsi to Bevyz? They have already made several of their most important brands available on the Bevyz system, including Pepsi, 7 UP, and Lipton Ice Tea. We would expect much more visibility into this partnership as Bevyz begins to commercialize their machines domestically.

    (click to enlarge)

    We cannot rule out the possibility that Pepsi will partner with more than one machine manufacturer. It would not seem logical that Pepsi and Coke will ultimately view in-home dispensers agnostically, the same way they view vending machines. They would still compete viciously for consumer mindshare, but the likelihood of consumers having separate dispensers for separate brands seems completely unreasonable. Green Mountain's CEO, Brian Kelley, seemed to understand this obvious dilemma and his remarks suggest there is a high probability Pepsi partners with Green Mountain as well. On its earnings call from February 5th, Brian Kelley was asked about Coke exclusivity, "So to me that tells me that they're [Coke] being exclusive to you, but you can sign on other brands. Is that the right way to think about it?" To this question Kelley seemed to unequivocally state Pepsi is in the works as well, "It is [exclusive]. Although, we're going to bring on the best brands. There are many, many cold brands in North America and in the system. And obviously, we can't bring on every brand at once. We want to bring on the biggest and the best brands, and that'll take a little bit of time as we cycle through it. But what you stated is accurate. And that's the way the platform has worked in hot. And that's the way the platform will work in cold. And it's because that's what the consumer wants." As a reminder in hot, Starbucks, Peets, as well as Dunkin Donuts sell K-Cups for Keurig, despite vicious competition among brands.

    While it appears to us that Green Mountain is aiming to serve all beverage brands with the vending machine analogy, it would also seem SodaStream has further removed any possibility of relevance with Coke and Pepsi. SodaStream has proudly taken every opportunity to incessantly insult and alienate the two beverage giants. Its own website explicitly antagonizes Coke and Pepsi with the slogan "Sorry, Coke and Pepsi." This was also a jab that was used in their unedited Super Bowl add which can be found on YouTube. Really, Scarlet Johanssen and a Super Bowl commercial? Levying insults and attacking Pepsi's business model would clearly be an odd way to treat a potential partner. Finally, as the Wall Street Journal pointed out yesterday in an article titled, "Secret to homemade Coke: Instant Cold, No Canisters", Coke is adamant that the key to the home market will be a system that is easy - meaning no dangerous and clumsy CO2 canisters.

    It seems the assumption Pepsi must rush to buy SodaStream is completely irresponsible given the facts in the market place. It was indeed Pepsi's CEO herself, Indra Nooyi who called rumors that Pepsi was interested in buying SodaStream, "completely untrue" the last time this rumor surfaced.

    If there is in fact no white knight, not only do SodaStream investors own a business with aggressive accounting, horrific forensic attributes, waning machine usage, a depressing Q4 preannouncement, but also now looming competition from Green Mountain and Coke. As we highlighted on two separate occasions when SODA was in the mid-50's and mid-60's, we think the model is in grave danger. With A&P up 41% in Q3 ahead of the Holidays, a big Q4 disappointment speaks volumes about the ROI on that spend. We believe SODA is in the unvirtuous cycle of slackening demand that can only be stimulated by more and more spending, which will have deleterious effects on profitability. America's growth, once the key to the bull story, has declined from 88% in 2012 to 65% in 1H'13, and likely under 20% in 2H'13.

    Based on the implied Q4'13 guidance and awful sell-through data, investors must hope any white knight shows up quickly before SodaStream is forced to share their Q4'13 results, discuss 2014, and file their 20F replete with details about their acquired distributors. With inventory out of control (43% inventory growth & DSO's at 86) in the last quarter, and negative cash flow from operations despite reporting adjusted profits, we believe SODA will be starting behind the 8-ball in 2014. Even if Pepsi had interest, given their shrewd reputation and existing bet on Bevyz, it would seem likely they let SODA bleed for a while - again if there was ever a scintilla of sincere interest in SodaStream. Whether SODA management actually confesses when discussing 2014 guidance remains to be seen, but there appears to be a two week window of hope before the proverbial rubber meets the road.

    Disclosure: I am short SODA.

    Tags: SODA, PEP, GMCR, KO
    Feb 07 1:16 PM | Link | 12 Comments
  • Web.com Group (WWWW): No Witty Title Needed With Business Inconsistencies

    IMPORTANT NOTE - IT WAS BROUGHT TO OUR ATTENTION THAT WE MADE AN ERROR ON THE A/R and ALLOWANCE ANALYSIS BY FAILING TO CATCH A NOTE DISCLOSED IN THE 10Q. WE DID INDEED MISS THE DISCLOSURE AND HAVE REMOVED THE SEGMENT FROM OUR BLOG. WE APOLOGIZE FOR FAILING TO SEE THE NOTE IN WEB.COM'S 10Q. THANK YOU FOR THE FEEDBACK CORRECTING OUR MISTAKE.

    (BEFORE READING ANY OF OUR OPINIONS BELOW, PLEASE MAKE SURE TO DO YOUR OWN WORK TO EITHER VERIFY, OR PERHAPS DISAGREE, WITH OUR ANALYSIS PRESENTED BELOW):

    We believe that investors in Web.com (WWWW), as well as the promotional analysts that have blindly endorsed Web.com's financial presentations, will soon have no excuse other than negligence for continuing to support the story. We believe that Web.com has misrepresented its growth rate, profitability, and business momentum by using creative financial engineering and liberal pro-forma reporting. We dissect several balance sheet items suggesting Web.com is a stagnant business, and possibly even in decline. We look at insider sales that inexplicably occurred less than 48 hours before a large convert offering was announced. Further, we examine its new Feet-on-the-Street model, which appears to be an imitation of ReachLocal's (RLOC) model, producing ARPU improvements with minimal economic benefit. Illustrating Web.com's challenges, we discuss the Facebook page of its local Houston market, which appears to be running well behind management's targets and lists client wins whose websites do not appear to be registered or designed by Web.com. And finally, we will debunk the argument that Web.com has produced meaningful economic cash flow from operations.

    Until very recently, Web.com has managed to escape intense scrutiny. Its short interest, net of arbed convert shares is negligible, while 10 of the 12 analysts that cover it rate the stock a buy. In recent weeks, two articles appeared in Seeking Alpha that did a commendable job highlighting some of the financial shenanigans and engineered earnings reports that have become a staple in the Web.com investment case. Any Web.com investor should read the two articles/reports to better understand the nature of the Web.com promote. They can be found here:

    http://seekingalpha.com/article/1732692-wwww-the-greatest-stock-promotion-story-ever-told

    http://seekingalpha.com/article/1732372-web-com-no-spider-will-save-this-web

    The reports were insightful, so we will not be regurgitating the topics discussed in those articles. Instead, we will focus on several facets of the Web.com story that have yet to be exposed. Based on the work we present herein, we believe the Board of Directors, has ample evidence to investigate how Web.com has been reporting adjusted earnings. Other balance sheet metrics are completely incongruous with a growing company, but have been masked by convoluted pro-forma reporting. The legacy Website Pros has managed to morph into Web.com (through the roll-up of Register.com and Network Solutions) receiving universal investor adoration. We believe that is about to change.

    Assuming our analysis proves correct, Web.com may soon find itself in a regulatory pickle, with a stock price that is extremely overvalued. Applying a generous free cash flow multiple inline with other slow growth TMT stocks, we believe fair value is approximately $6.00 per share, or 80% lower than where WWWW currently trades.

    Deferred Revenue - Distorting the company's growth and profitability

    After Web.com acquired Register.com, it began to report pro-forma revenue that added back a fair value adjustment to deferred revenues. Since the Network Solutions acquisition, Web.com's adjusted financial statements have been dominated by the extraordinary levels of 100% margin deferred revenue add-backs. We will not spend a lot of time on the distortions the fair value adjustments have caused (the Seeking Alpha articles do a fine job on this topic), but a few paragraphs on the deferred revenue adjustments are necessary.

    Both Network Solutions and Register.com offered multi-year pre-payment options to domain purchasers. GAAP accounting stipulates that a deferred revenue liability is credited (cash debited) to reflect these pre-payments. The deferred revenue balance translates into income statement revenue ratably over the life of the pre-payment (amortized). When Web.com bought these two businesses, it was required to adjust the deferred balances under purchase accounting to reflect the fair value of the acquired deferred revenue. As such, the acquired deferred revenue balance was adjusted lower when the acquisitions closed. Web.com believes that adding back the deferred revenue that was previously written down "helps management and investors better understand revenue trends."[3]

    To be clear, presenting fair value adjustments to deferred revenue is not unique to Web.com. Many serial acquirers that rely on a roll-up strategy use this technique. However, in the most recently completed fiscal year, Web.com used twelve total adjustments to bridge its GAAP results to its pro-forma tables. The most impactful adjustment has been adding back previously written down deferred revenue, which has created a fictitious profitability profile. Over the last eight quarters, the cumulative fair value adjustment to deferred revenues has been $132.9 million. During that same period, Web.com reported cumulative Non-GAAP Net Income of $151.5 million. Simply put, using the adjusted results that management puts forth results in 88% of Adjusted Net Income being attributable to cashless deferred revenue add-backs from bookings that occurred at Network Solutions and Register.com prior to being acquired. It is also worth noting Web.com adds back its tax accruals, which means the adjusted net income is also an untaxed figure.

    (click to enlarge)

    Source - Web.com SEC filings and press releases

    Deferred Expenses: The zero growth proof is in this pudding

    We believe that Web.com is not growing. It is our belief, based on a plethora of public filings, that Web.com may actually be experiencing declining organic revenue. It is our opinion that management launched Feet-on-the-Street to generate grossed-up revenue with very little associated margin to mask declining organic revenue (more on this later). One very telling metric yet to be discussed by analysts, bloggers, or especially Web.com management is that prepaid registry expenses imply Web.com is not growing.

    As discussed briefly in the last section, when Web.com receives an annual or multi-year pre-payment, there is a deferred revenue liability created on the balance sheet to reflect revenue that will be recognized in future quarters. The cash is paid up-front and is reflected on the asset side of the ledger as "Cash and cash equivalents." As the description implies, the deferred revenue liability later flows through the income statement as revenue. However, there is also a deferred cost asset called "prepaid registry fees." These prepaid fees represent upfront cash paid by Web.com to third party registries.

    Web.com is not a registry. Instead when they sell a domain, Web.com must pay a registry like VeriSign a registration fee. Simplistically, Web.com could be viewed as a middleman. VeriSign is the registry for .com and charged approximately $7.85 for each .com registration in 2012. Further, ICANN charges an $0.18 fee for each .com domain name registered in the generic top level domain (gTLD) that falls within its purview.[4] These registration fees are accounted for by Web.com in a similar manner to the deferred revenues. Web.com pays the registry (like VeriSign) when it registers a domain. If the domain is pre-paid for multiple periods, then a deferred asset is created (debit "prepaid registry fees") to reflect the Web.com cash out (credit "cash"). The deferred asset is then amortized ratably against the deferred revenues.

    (click to enlarge)

    Source- http://www.sec.gov/Archives/edgar/data/1095291/000109529113000005/wwww-2013331x10q.htm

    The accounting is straight forward. For example, on January 1, assume Customer XYZ buys a domain from Web.com for $20 and prepays for a full year. Web.com subsequently pays the registry (VeriSign) $16 for the full year up-front as well (these numbers are purely to illustrate the accounting). In this example, Web.com would recognize $5 of revenue in Q1 and defer $15 of the revenue (liability) to be recognized ratably. Web.com would also recognize $4 of costs to VeriSign, and defer $12 of costs (asset) to be recognized ratably (matched against the deferred revenues). The $15 of deferred revenue would be recognized ratably, as would the $12 of deferred costs, over the proceeding three quarters.

    Looking at the trend in deferred expenses, it appears Web.com has misrepresented its growth rate through creative accounting, while the actual organic growth rate of its domain registration business is zero. Web.com discloses its customer counts each quarter as well as its ARPU. These figures suggest a healthy grow rate. Its balance sheet does not support that story. Deferred expenses, which again "primarily consist of prepaid domain name registry fees that are paid in full at the time a domain name is registered", have actually declined year-over-year for the last three quarters. IF WEB.COM WERE ACTUALLY GROWING, THEN ITS PAYMENTS TO REGISTRIES (LIKE VERISIGN) WOULD ALSO BE GROWING. THAT IS NOT THE CASE. As can be seen below, the total deferred expenses have been declining. In the table below, we included the deferred expenses of Demand Media to illustrate the growth in its registrar business.

    (click to enlarge)

    Source - Web.com and Demand Media SEC filings

    Demand Media owns eNom, which is the largest domain name wholesaler. Unlike Web.com, Demand Media's deferred costs have consistently been increasing year-over-year. Demand Media uses an accounting treatment for prepayments that is identical to Web.com. We also checked with Tucows, a smaller domain registrar, and found similar language in its 10K.[5] Below is Demand Media's disclosure from its 10K.

    (click to enlarge)

    Source - Demand Media 10K (2012)

    Another disconnect is the inexplicable flat-line of Web.com's deferred costs from Q4'11 to Q1'12, and Q4'12 to Q1'13. In January 2012, VeriSign raised the .com domain price by 7%, from $7.34 to $7.85.[6] The .net domain price was raised by 10% from $4.65 to $5.11. As can be seen from the previous table, Demand Media's QoQ deferred expenses increased by 13% in Q1'12, which was primarily attributable to the VeriSign price hike. Unlike Demand Media, Web.com's deferred expenses only rose QoQ by 1% in Q1'12 despite the 7% and 10% price hikes from VeriSign. Demand Media actually discussed the price hikes in its 10K, highlighting the renewal rate changes set for 2013.

    In terms of the extended registry agreement between ICANN and VeriSign that was approved by the U.S. Department of Commerce on November 30, 2012, VeriSign will continue as the exclusive registry for the .com gTLD through November 30, 2018. The terms of the extension set a maximum price, with certain exceptions, for registry services for each calendar year beginning January 1, 2013 up to the smaller of the preceding year's maximum price or the highest price charged during the preceding year, multiplied by 1.07

    Demand Media's deferred expenses increased sequentially in Q1'13 by another 7%, while Web.com's deferred expenses actually declined. We have been unable to find a logical explanation for this decline other than Web.com is not growing. One potential explanation we explored was that large purchase accounting adjustments could have been made when the acquisition of Network Solutions closed. But the public filings make it clear this is not the case. On page 23 of its third quarter 2011 10Q, Web.com disclosed a pro forma consolidated condensed balance sheet.[7] This balance sheet clearly disclosed that approximately 50% of deferred revenues were "lost" via purchase accounting. Whereas the adjustments to prepaid registry fees were negligible (the minor adjustments reflect future cost increases as required by GAAP accounting). As such, the potential excuse related to carrying prepaid fees at a higher market value is not applicable.

    (click to enlarge)

    Source - http://www.sec.gov/Archives/edgar/data/1095291/000114420411061905/v238544_10q.htm

    If Web.com were growing its core business, then the fees paid to VeriSign would also be growing. This is not the case as evidenced by flat-to-declining prepaid expenses, supporting our belief that Web.com's minimal "adjusted" growth actually comes from accounting gimmicks.

    Insider Sales - Potential violation of insider trading laws & lack of Board oversight

    It is also deeply concerning that Web.com's CEO and CFO sold substantial percentages of their individual holdings hours before the $225M convert offering was announced. On 8/6/13 and 8/7/13, Web.com's CEO sold 250,000 shares, representing 23% of his holdings. Not to be outdone, Web.com's CFO also sold 100,000 shares, representing 31% of his holdings on 8/6/13 and 8/7/13.

    (click to enlarge)

    Source - http://www.sec.gov/Archives/edgar/data/1095291/000118143113043400/xslF345X03/rrd387592.xml

    (click to enlarge)

    Source - http://www.sec.gov/Archives/edgar/data/1095291/000118143113043401/xslF345X03/rrd387742.xml

    Just one day following massive sales by its CEO and CFO, Web.com announced a $225 million convert offering that caused the stock price to decline as much as 8.5% at its lows.[8] We expect management and the Board to argue the sales were part of a 10b5-1 plan. And of course these plans are intended to protect management teams by allowing them to sell stock according to a pre-established program, even during blackout windows. According to the Form 4 filings, Web.com's executive stock sales did occur under a 10b5 plan. However, the fine print of the 10b5 plans for Mr. Brown (CEO) and Mr. Carney (CFO) disclose that these plans were established on 6/7/13 (CEO) and 6/13/13 (CFO). As such, the plans were established several weeks before Web.com's quarter ended, around the time the quiet period would have officially commenced. If the Board of Directors, or either the CEO or CFO, had knowledge of the pending convertible issuance when the 10b-5 plans were established, then the sales would represent poor judgment at best and insider trading at worst. According to JD Supra Law News[9] and the SEC[10] (MNPI stands for material non-public information):

    Even if trading under a Rule 10b5-1 plan is set to begin after a specified point in the future (e.g., 30 days from adoption), the plan will not protect against potential liability if the insider is in possession of MNPI at the time the plan is adopted - even if the MNPI will have become public before the insider trades under the plan. (emphasis ours)

    Feet-on-the-Street (FOTS) - Grossed up Revenue and the optics of ARPU

    Web.com management has adeptly shifted its story from synergies, to cross-selling, to financial engineering, and now to ARPU increases. We believe the future driver of ARPU increases carries minimal economic value and is simply a function of low margin revenue being added to the business model. In 2012, Web.com began to emphasize its FOTS roll-out, which consisted of staffing eight initial cities with local sales people to sell small businesses Web.com services. According to its 10K, "the sales initiative is focused on selling the Leads by Web.com products and services."[11]

    Management's optimism about its FOTS opportunity has been so contagious that the sellside has focused much of its new bullish outlook on the future success of this supposed novel offering. In fact, on its Q2'13 earnings call, the majority of the Q&A was an exercise of analysts progressively getting more excited than the next in their projections. The exuberance was not lost on Web.com, with the CFO, Mr. Carney, refusing to back one excited analyst off of his $40 million forecast for FOTS revenue in 2014[12]:

    Nameless Sellside Analyst (buy rated): "Kevin, based on this Feet on the Street, if you do a quick math and kind of the numbers you are giving out, I am getting to like a $40 million annualized revenue number for 2014. Is that generally in the ballpark?"

    Kevin M. Carney: Okay. So I think on the Feet on the Street, I mean, I think that - I can't comment, really, in terms of sort of breaking down revenue contributions for the year. But I think the other things that you commented on are accurate.

    While the company has been very evasive quantifying the actual economics of its launched cities, we believe that the primary driver for the strategy is to simply deliver pass-through media campaigns that lead to chunky ARPU, yet minimal profitability. Said another way, Web.com simply becomes an agent for an SMB's marketing spend, which permits Web.com to run the campaign spend through its income statement as revenue even though its economic capture is a small mark-up on that revenue. But don't take our word for it, just look at ReachLocal, a company widely considered to be one of the largest existing FOTS models.

    ReachLocal has been targeting local SMB's for years with direct sales people that create advertising campaigns. These "feet-on-the-street" sales people are referred to by ReachLocal as IMCs, or Internet Marketing Consultants. At the end of 2012, ReachLocal had 824 IMCs in 60 markets. A closer look at ReachLocal's business would appear to make it interchangeable with Web.com's newest talking point - even down to its name. In ReachLocal's 2012 10K, the company states (emphasis ours), "We deliver these solutions to SMBs through a combination of our proprietary platform, the RL Platform, and our direct, "feet-on-the-street" sales force of Internet Marketing Consultants, or IMCs." But the similarities of this comp to Web.com don't stop there, other business model highlights for ReachLocal include[13]:

    · We use our RL Platform to create advertising campaigns for SMBs to target potential customers in their geographic area

    · In 2010, we expanded the RL Platform to include ReachCast, our full-service Web presence and social media solution, and in September 2012, we launched ReachRetargeting, a ReachDisplay product targeting local consumers who have recently searched for an SMB's business keywords as well as those who have recently visited their website

    · Empowered by the RL Platform, our IMCs, which are based in or near the cities in which our clients operate, establish a direct consultative relationship with our clients and provide our solutions to achieve their marketing objectives

    · We combine advanced, publisher-agnostic technology and an experienced, digitally sophisticated direct sales force to provide SMBs with a single, easy to use and cost-effective solution to acquire, maintain and retain customers using digital media. Our target market is SMBs that spend at least $5,000 per year on advertising.

    · In our experience, our Direct Local clients, a substantial majority of which we calculate spend from $500 to $4,000 per month, require face-to-face interaction that is consistent with the way the SMB has historically purchased offline media.

    Compare the model descriptions below for ReachConvert with the description of Leads by Web.com, which Web.com disclosed in its 10K is the primary selling objective of its FOTS sales force. See some similarities?

    · ReachConvert is a SaaS product that helps businesses manage their leads and convert more of them into customers. ReachConvert notifies the business of new leads in real time via text message, email or the ReachLocal mobile app, so that the business can follow up within minutes.

    · Leads by Web.com Leads by Web.com researches relevant keywords in the customer's industry to create ads designed to bring traffic to the website. When prospects search for a service, they are driven to a lead generation site to request a quote, and then leads are delivered to the subscriber's computer or phone for follow up.[14]

    ReachLocal is publicly traded and should serve as an obvious comparison for the FOTS opportunity at Web.com. However, almost all of the twelve analysts that cover Web.com fail to even reference ReachLocal as a comp. Why? For starters, there are 8 analysts that cover ReachLocal, all but one of whom is an Internet analyst. Of these eight analysts, only one, Gene Munster at Piper Jaffray, covers both ReachLocal and Web.com. JP Morgan actually covers both stocks, but their Internet analyst covers ReachLocal, and for some inexplicable reason a software analyst follows Web.com. But perhaps the more appropriate reason is that the comparison reflects very poorly on Web.com. In 2012, ReachLocal did $455 million of revenue, while Web.com generated $491 million. However, ReachLocal trades with a paltry EV/sales multiple of 0.6x, while Web.com has managed to command a SAAS-like EV/sales multiple of 4.7x. Clearly, it is easier to compare Web.com to a different genre of companies despite the obvious similarities between the two (on Web.com's new focus area).

    Aside from avoiding the obvious ReachLocal comparison for its FOTS opportunity, we believe that the ARPU benefits are severely misunderstood. Given the significantly higher ARPU that accompanies grossing-up an SMB's online advertising budget, we believe the ARPU "story" is not only misleading, but somewhat irrelevant when considering minimal margin benefit. However, as we have highlighted, management has gone to great lengths to emphasize the ARPU metric, despite the meaningless nature of the improvement. Mr. Carney declared on the last earnings call, "We were pleased with our ARPU performance during the quarter and expect ARPU to show continued sequential growth in the third and fourth quarters of 2013, as the incremental marketing investments we made in the first half of the year begin to fully impact the business." Below we illustrate how easy it will be for Web.com to move the ARPU needle with only a miniscule number of FOTS clients. If the salesforce can simply add 2 new customers per month, based on the other metrics management provided on its Q2'13 earnings call, we believe Web.com can grow ARPU by 1.3% for a long time by simply growing its FOTS clients by just 0.02%.[15]

    (click to enlarge)

    Source - Q2'13 Earnings Call metrics and Company filings

    Finally, we would encourage any investor interested in the Web.com story and its FOTS initiative to peruse the Facebook page of Web.com's Feet-on-the-Street Houston market -

    https://www.facebook.com/WebHouston

    It currently lists client wins, which appear to be running well below the 5 -7 that management has outlined. Further, several of the listed client wins did not even have websites registered, or even designed, by Web.com. If the Houston market is representative of the other 15 cities, we believe the FOTS story may be just that… a story.

    The Myth - "But the Cash Flows"

    The majority of the sellside analysts that cover Web.com are wildly bullish. Currently twelve analysts follow Web.com, of which ten have buy ratings and only two have hold ratings. Most of these analysts argue Web.com is cheap on the basis of earnings, EBITDA, or cash flow. Any intellectually honest analyst should immediately point out that Web.com's adjusted earnings are bogus. As we illustrated on page 6, over the last eight quarters, 88% of Web.com's "earnings" have come from non-cash adjustments to deferred revenue. This adjustment is 100% margin. Further, Web.com does not include a tax rate in its adjusted earnings. Nonetheless, if analysts actually included the net debt in the "P", the untaxed P/E would still be over 20x based on a stock price of $30. Using EBITDA is also a farce due to the 100% margin add-back of the deferred revenues.

    Cash flow would typically be a metric suitable for valuing a no-growth business like Web.com. However, Web.com's operating cash flow is extremely misleading. Very simply, Web.com's cash flows are nothing more than a fractional return on the dilution and leverage that were utilized to buy those cash flows in the first place. Think of it as paying one dollar to get twenty-five cents.

    Web.com spent approximately $730 million in 2010 and 2011 to buy Register.com and Network Solutions. The purchases were financed with $535 million of cash AND issuing 18 million shares of dilutive equity. In both transactions, the sellers were comprised of private equity groups that are not exactly considered stupid sellers. What has been the economic benefit to Web.com from spending $730 million? Based on the operating cash flow (prior to capex) from 2010 through the first six months of 2013, Web.com has generated $153 million of operating cash flow compare to the $730 million purchase price.

    (click to enlarge)

    Source - Company filings

    As the table above clearly illustrates, $535 million dollars has been spent, in addition to $189 million of equity, to buy two businesses that have thus far only generated $153 million of operating cash flow. To convey the degree of equity dilution, it is worth pointing out there were 26.6 million shares outstanding in early 2010, prior to Web.com's first acquisition.[16] Based on the company's full year 2013 guidance, the share count will have doubled to 53.2 million shares in a little over three years.

    But don't expect a balanced perspective from the sellside - the conflicts are far too great. Web.com has come to the equity and credit markets with nearly $1 billion of transactions in the last four years (including secondary offerings). The most recent term debt refinancing (creating financially engineered "EPS upside" for Q3'13) was another huge windfall for underwriters. It is no coincidence that the majority of the underwriters for the debt deal also have equity analysts that love Web.com's stock, including Citi (buy rating), Wells Fargo (buy rating), JP Morgan (buy rating), and SunTrust (buy). To their credit, the two other underwriters are not on the bandwagon (DB has a hold rating, while Goldman Sachs has not launched coverage). We undoubtedly expect a vehement defense from certain sellside analysts, after talking to the company of course.

    We do not believe that Web.com is going to zero. Assuming our suspicions outlined above are correct, Web.com may find itself in some trouble, but the businesses will not go away and the company should be able to service its debt under most scenarios. We do however believe the stock is 80% overvalued. Using Web.com's 2013 guided free cash flow, we believe an argument could be made the enterprise should be valued at a respectable 10% free cash flow yield (where other low growth TMT/Internet companies currently trade). This would value the enterprise at $1 billion, and adjusting for approximately $691 of net debt, the fair value of the stock would be approximately $6.00 per share.

    Source - Company Filings and internal analysis


    [1] http://finance.yahoo.com/news/com-reports-second-quarter-2013-200100411.html

    [2] www.sec.gov/Archives/edgar/data/1095291/....htm

    [3] finance.yahoo.com/news/com-reports-secon....html

    [4] www.sec.gov/Archives/edgar/data/1365038/....htm

    [5] www.sec.gov/Archives/edgar/data/909494/0....htm

    [6] investor.verisign.com/releasedetail.cfm?ReleaseID=591560

    [7] www.sec.gov/Archives/edgar/data/1095291/....htm

    [8] http://research.tdameritrade.com/grid/public/markets/news/story.asp?docKey=100-220u7139&provider=PrimeNewswire

    [9] www.jdsupra.com/legalnews/doj-and-sec-sc.../

    [10] www.sec.gov/divisions/corpfin/guidance/e....htm

    [11] www.sec.gov/Archives/edgar/data/1095291/....htm

    [12] Q2'13 Earnings Call Q&A

    [13] www.sec.gov/Archives/edgar/data/1297336/....htm

    [14] www.sec.gov/Archives/edgar/data/1095291/....htm

    [15] Q2'13 Q&A "Well, this is Kevin. I think, Sterling, we haven't given any specific numbers on a market-by-market basis in terms of what the portfolio of customers looks like and the revenue in the market. But I think some of the things David said I think are helpful and that you know, you're saying 5 to 7 sales people for market, selling one, two, in some cases more. But let say, two on average, one or two on average. And, at a current ARPU level of say a thousand dollars a month. I think you can quickly get to the math in terms of what an individual market and what 16 markets and then 50 - ultimately 50 could contribute in terms of new revenue contribution that's being added every month."

    [16] www.sec.gov/Archives/edgar/data/1095291/....htm

    Disclosure: I am short WWWW.

    Additional disclosure: Please read this Disclaimer in its entirety before continuing to read our research opinion. You should do your own research and due diligence before making any investment decision with respect to securities covered herein. We strive to present information accurately and cite the sources and analysis that help form our opinion. As of the date this opinion is posted, the author of this report has a short position in the company covered herein and stands to realize gains in the event that the price of the stock declines. The author does not provide any advanced warning of future reports to others. Following publication of this report, the author may transact in the securities of the company, and may be long, short, or neutral at any time hereafter regardless of our initial opinion. To the best of our ability and belief, all information contained herein is accurate and reliable, and has been obtained from public sources we believe to be accurate and reliable. However, such information is presented “as is,” without warranty of any kind – whether express or implied. The author of this report makes no representations, express or implied, as to the timeliness or completeness of any such information or with regard to the results to be obtained from its use. All expressions of opinion are subject to change without notice and the author does not undertake to update or supplement this report or any of the information contained herein. This is not an offer to buy any security, nor shall any security be offered or sold to any person, in any jurisdiction in which such offer would be unlawful under the securities laws of such jurisdiction.

    Tags: WWWW, RLOC, DMD, TCX
    Oct 30 1:22 PM | Link | 6 Comments
  • SodaStream (SODA) - Making Green Mountain (GMCR) Look Squeaky Clean

    Several months ago, we shared our opinion that SODA was buying its Italian distributor to provide a revenue and EBITDA boost through accounting shenanigans. Simplistically, SODA previously made sales into its channel, recognizing revenue. Then, they bought the distributor, assumed the inventory, and could re-sell the product, effectively recognizing sales two times on the same product. We believe this accounting treatment was the same methodology used in the past when SODA bought its Nordic distributor. Recall, on its Q2'13 earnings call, when management casually announced they had bought their Italian distributor, the company guided for a minimal impact from the transaction. To be precise, SODA guided for the transaction to add "$2 million" of sales in the second half of 2013. Also, they confessed (or blamed) that they had assumed $10 million of Italian inventory from the distributor they acquired. See below (emphasis added):

    Q2'13 Call from 7/31/13

    Jim Chartier: Good morning. The first question, how much did the acquisition of Italy add to your outlook for 2013 revenues?

    Daniel Erdreich (CFO): Yeah, it won't be that significant, it will be a couple of millions on top line and there won't be any impact on bottom line.

    ------

    Jon R. Andersen: Can I just confirm, on the Italian - the acquisition of the Italian distributor, your expectation is that will add about $2 million in the second half of the year to sales, no impact on the bottom line, and kind of $4 million on an annual run rate basis, is that the right way to think about that?

    Daniel Erdreich (CFO): That's right, Jon.

    ------

    Scott Van Winkle: Hi, thanks, good quarter. Most of my questions have been asked, but just a couple follow-ups. On net inventory, I think you talked about Italy maybe selling through some inventory, having to work through is it; is that referring to the $10 million of inventory you took on with the acquisition or more in store?

    Daniel Erdreich (CFO): No it's - the $10 million that was taken as inventory is the increase, is the main item of increase in inventory that we see in the account.

    -------

    As we pondered after the Q2'13 call - SodaStream had already recognized revenue on its sales into the Italian distributor, hence they could double count the revenue based on the purchase accounting methodology. If SODA was assuming $10 million of inventory, then presumably that was $21.7 million of prior sales SODA had recognized into this distributor (assumingcthe corporate gross margin of 54%). Therefore, future sales of this newly assumed inventory would effectively create a double-counting effect on revenue.

    SodaStream just reported its Q3'13 earnings and concluded its conference call. The stock is down about 6%, but will likely be down significantly more as investors and analyst digest the slew of issues. We do not believe the shenanigans we identified are understood, nor even responsible for any portion of the sell-off. Not yet at least. The stock is likely down because:

    • they missed the top line
    • missed Americas sales by a wide margin (with growth decelerating to sub-30% after growing 88% last year and over 65% in the first half)
    • flavor sales collapsed to only 7% growth year-over-year, while Americas saw flavor sales decline year-over-year
    • APAC declined by 21% year-over-year
    • DSO's jumped to 86
    • And inventory was up 43% year-over-year despite sales growth that slowed to 28.5%
    • And for the first time in many quarters, they were unable to raise guidance

    The lone bright spot appeared to be Western Europe, its largest region, which inexplicably experienced year-over-year accelerating growth. The region grew 43% year-over-year, which was a huge jump from the 21.6% reported in the first half. This, despite deceleration and/or declines in every other geography. We believe that the "surprising" growth in Western Europe can be attributed to its Italian distributor. Further, our analysis, which could of course be wrong, leads us to believe management has completely understated the Italian contribution. This acquisition alone appears responsible for the accelerating growth.

    On the Q3'13 quarterly call, the CFO unequivocally stated that part of the inventory jump year-over-year was due to $6 million of remaining Italian inventory. Based on the $10 million of initial Italian inventory disclosed on the Q2'13 call, we can conclude that $4 million of inventory was sold in Q3'13 (10-6=4). If we assume a gross margin inline with the corporate average, the $4 million of inventory that was sold would have resulted in $8.7 million of revenue contribution during Q3'13. Recall, management said on its Q2'13 call the Italian distributor sales would only contribute "$2 million" in the entire second half. This appears to be rather inaccurate.

    Turning back to the confounding acceleration in Western Europe growth, we believe net of our calculated Italian distributor contribution, revenue growth was inline. Western Europe delivered $75.5 million of revenue vs. $52.6 million in Q3'12. However, if we reduce the Q3'13 revenue by our estimation of the Italian distributor contribution of $8.7 million, then Western Europe would have delivered growth of 27% ($66.8 million vs. $52.6 million YoY). This still represents respectable growth, but would have turned a small overall miss in Q3'13 into a much more problematic miss.

    We continue to believe that SodaStream is playing extremely loose and fast with its numbers and communication. We also think they will be unable to grow significantly in 2014 without major door expansion OR by accounting shenanigans through another distributor acquisition. Should SodaStream buy another distributor, specifically its Japanese distributor, who as recently as last quarter SodaStream was putting more marketing muscle behind, then we think it will validate our concern SodaStream is "re-buying" revenue only to "re-recognize" it all over again. While investors, and especially sell-side analysts, will continue to hang on to the 2017 growth goals the company laid out at its analyst days, the cracks are showing. We look forward to hearing an explanation for the accounting inconsistencies around inventory and its Italian distributor appearing to be a far larger contributor than management has insinuated. However, we'll have to wait until the 20F to get an honest answer because the company does not file quarterly reports and we definitely don't trust the company's explanations.

    Disclosure: I am short SODA.

    Tags: SODA
    Oct 30 12:53 PM | Link | 5 Comments
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