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Is Dolan Media A Fast Growing, High Margin Software Stock In Disguise?

|Includes:Dolan Co (The) (DOLNQ)

Dolan Media (NYSE:DM) has had an ugly couple of years. After spending $200+ million to buy NDEX, its foreclosure services business, government intervention brought foreclosures to a virtual halt causing the consolidated EBITDA to fall from $90 million in 2009 to just $30 million or so this year. Similarly, its legacy business information business, while still cash generative are shrinking and generally unappealing to most investors. However, underneath it all lies Discover Ready, Dolan's rapidly growing, cloud-based legal discovery business which is on track to do $100 million in revenue this year, up 20% year over year, while generating 25-30% EBITDA margins.

Earlier this year, Dolan began the process of divesting its troubled businesses which should allow management to de-lever the company and focus on the continued growth of the legal discovery business. When the market realizes that Dolan's Discover Ready is a fast growing, cloud services company with a strong position in the legal discovery business, I expect that shares could rise 3 to 5-fold (valuation will be discussed below).

The restructuring began last year as Dolan was cutting costs within its NDEX business which served the foreclosure market. Despite the cost cuts, Dolan was unable to bring the business up to profitability given the declining market. The company has divested a large part of its loss making NDEX business for $17.5 million and has restructured the rest such that it expects it to be EBITDA breakeven. It sounds like management is open to divesting the remainder of the business.

Similarly, there doesn't seem to be much of a future for the business information business which does legal publishing such as foreclosure notices. While the business certainly isn't sexy, it does throw off $8-10 million in EBITDA and could probably be sold for $50-60 million.

This brings us to the legal software business. The e-Discovery market is large ($4-5 billion) and growing at a double digit rate. Market growth is fueled by process automation at law firms in order to save money. In short, Discover Ready facilitates the electronic transfer and organization of documents used in the discovery process. These services save their clients time & money and tend to be pretty sticky which account for the high profit margins. Here is a snapshot of this segment's performance over the past few years and a conservative forecast of what we can reasonably expect to see going forward:

Discover Ready

       
 

2011

2012

2013e

2014e

2015e

Revenue

77

87

100

115

130

Revenue g

 

13.0%

14.9%

15.0%

13.0%

EBITDA

21.0

20.0

27.0

32.2

39.0

Margin

27.3%

23.0%

27.0%

28.0%

30.0%

           

Now that NDEX has been sold and the business information business is presumably on the block (on second quarter call, management intimated that 'parts' of this business are for sale - in my opinion/experience, if parts are for sale, the whole thing is for sale at the right price), the company should be able to cut its debt by 50% from the $142 million reported June 30, 2013. Further, we can expect at least $30 million of free cash flow generation, bringing debt down to just 1.0x 2015 estimated EBITDA.

As such, the market will then have to put a value on a well-positioned, fast growing cloud based legal services business with a strong balance sheet. This is a complete 180. I think a major re-rating is inevitable. For what it's worth, I think a name change (to Discover Ready) could help facilitate a change in the market's thinking. Here's a sum-of-the parts as we sit today:

Discover Ready

383

12x 2015e EBITDA; adjusted for 10% minority interest/discounted 10%

Business Information

50

assumed sale at 5-6x EBITDA

NDEX

 

15

 

Less:

     

Debt

 

-140

 

Preferred

 

-20

 

Corporate o/h

-75

7.5 mn *10

+NOLs

 

50

150 tax to be deferred

+DLNP

 

10

1.2x BV; 3x earnings

Value to Equity

273

 
       

Shares o/s

 

31

 

Value per share

$8.80

 

Note that after simplifying the business, it is reasonable to expect that holding company costs would decline though this requires management to fire themselves which is unlikely. This would add another $1-2/share in value. The above SOTP is messy. Post-divestiture, what I expect we will see come late 2014/early 2015 is something that looks more like this:

EBITDA

39

 

less: corp overhead

-3.75

assumed to be cut 50% following divestitures

less: capex

-5

 

Less: interest

-2

on an assumed $40 mn in debt post divestitures/2014 debt pay down

pref div

-1.2

 

Free cash flow

27.05

Note DM will not pay cash tax for 10 years given large NOLs

     

Shares o/s

31

 

Free cash/ share

0.87

 
     

Multiple

Share price

 

10

8.73

 

12.5

10.91

 

15

13.09

 

17.5

15.27

 

20

17.45

 

With shares trading in the low 2s, I think Dolan Media has the potential to be a 4-10 bagger over the next two years by executing a few simple steps. Similarly, with private equity buyers for assets like Discover Ready and willing at 2-2.5x revenue, I think shares have extremely limited downside.

I'm long DM.

Disclosure: I am long DM.

Stocks: DOLNQ