Vertro's New App Strategy a Game Changer?

by: John Gilliam

Vertro (NASDAQ:VTRO) has introduced a new App Store and AppBar strategy for its business that we believe will allow the company to earn significantly more revenue over the average ALOT user's lifetime. The company has built a very strong and growing business by offering a toolbar that historically has generated an average of about $1.50 - $1.60 for each user that cost the company an average of approximately $1 to acquire. We believe that the cost to acquire appbar users and operate the appbar service will not be materially different from the cost to operate and market the legacy ALOT toolbars, but the revenue stream produced over its installed lifetime could increase dramatically.

Vertro's ALOT monetizes its Appbar service through search results and sponsored listings provided by Google (NASDAQ:GOOG). If you apply the Google Network's average revenue per click (historically around 50 cents) and our assumption of Vertro's rev share (approximately 80%), you see that $1.50 - $1.60 in revenue amounts to somewhere between 4 and 5 clicks over the toolbar's installed lifetime. Obviously, there is a very broad range of prices paid for various search terms, but the point here is that the average toolbar user is not using that toolbar very often over the course of its installed lifetime. The most efficient way for Vertro's ALOT to generate more revenue is to find a way to make each new user "engage" with the toolbar more often and keep it installed/active longer. We believe that the new appbar will achieve both of these goals for the following reasons:

1) The new appbar is much more visually appealing and attention grabbing, causing it to stand out such that consumers might notice/remember it more often
2) There is enhanced functionality that allows consumers to add and easily access as many apps as they choose
3) There will be more apps offered and higher quality apps offered
4) The new ALOT PC app marketplace will offer paid apps

1) The new appbar is much more visually appealing and attention grabbing, causing it to stand out so that consumers might be more apt to remember to use it for web searches. We downloaded the new appbar into a browser with the Yahoo (YHOO) toolbar and the Google toolbar already installed to give us a visual "apples to apples" comparison laboratory. The ALOT appbar stands out in a big way, artfully taking the space available and highlighting the search functionality with a more prominent (taller, wider, more visually appealing) search box with labeling that is not distracting but lets you know what it is for in a way that's essentially a call to action. Additionally, each app on the bar is featured as a colorful graphic tab designed to both draw attention and remind the user of its purpose. It's kind of difficult to explain the Appbar's aesthetic and functional superiority effectively, but anyone who downloads the new Appbar to a browser that has an existing toolbar from Yahoo, Google, IAC (IACI) or one of the other companies offering toolbars should see what we think is a substantial difference - think not just GUI vs. text based DOS approach but an Apple-esque implementation of that approach. While it remains to be seen whether this new approach will be more apt to cause users to remember to use its search more regularly or to adopt it as their primary search tool, we believe that the potential is there for a substantial increase in the search utilization rates.

2) The sliding app feature will allow users to add as many apps as they want and still have them readily accessible. With the legacy ALOT bar, a user was somewhat restricted by the browser dimensions, where it allowed six or seven buttons depending upon which ones were chosen. The sliding bar works like the touch / slide movement on an iPhone, where you click the arrow and it slides the next seven apps and you can just keep sliding for the next seven until you reach the last app on the bar. Essentially, users no longer have constraints as to how many apps they can add and easily access for daily use.

3) There are hundreds of buttons available for the legacy ALOT toolbar, but we believe there will eventually be thousands of apps available in the ALOT app store and that those apps will be much more substantive in terms of adding value for end users. Not to disparage the currrent offerings of the legacy ALOT toolbar, but only a few of them are real applications (ie ALOT Radio, Facebook Direct, Email Notifier, To Do List, Web Snapshots, Say it) with many of the other buttons essentially just quick links to other services or websites. As we survey the burgeoning PC App landscape, there already are developers offering thousands of Apps built for the PC (the App marketplace offers several thousand) that could be repurposed to work on the ALOT Appbar, and we expect to see that number increase markedly over the next few months as Apple (NASDAQ:AAPL) rolls out its Mac App store and Google launches its Chrome App Store.

4) The introduction of paid Apps gives Vertro the opportunity to make up to 30% of each app sale, potentially creating a new high margin revenue stream. More importantly, we believe that people will regularly use an appbar that has applications that cost them something and this makes it much more likely they will make an effort to take their appbar with them if they change browsers, change computers or get a browser upgrade. This should help Vertro management acheive two primary goals - greater user engagement and increased life span per average toolbar/appbar user. The combination of increased engagement/usage and longevity almost certainly leads to higher average revenue per user. We believe this understanding will lead Vertro management to offer many of the top app developers the opportunity to earn 100% of the revenue for their paid apps as an incentive to get the best of the best and in full recognition of the long term revenue impact that could result from appbar users installing apps that they paid for. On the other hand, if management chooses to adopt the standard revenue share that Apple and others have used, where the company is able to retain 30% of the purchase price for each app download, they could conceivably earn more from this revenue share (30% of one $4.99 app would give Vertro $1.47) than what they historically have earned over the average toolbar user's lifetime ($1.50 - $1.60). Thus, regardless which approach is taken by management, we believe the addition of paid apps will have a substantial impact on Vertro's revenue going forward.

Thus, we believe the Appbar’s design and functionality will cause increased interaction with the apps themselves, which will result in more users opting to use the search feature more often and more users keeping the Appbar for longer periods of time. The greater interaction is key because we think it will make it more likely that an appbar user will remember to just type a query into his appbar search box rather than leaving the page he is on to go to Google for web searches. If a user begins to use one or some of the apps on his appbar every time he turns on his computer, he is that much more likely to notice and start using its search box. Also, we believe that a user who pays for an app will be much more likely to take steps to retain his apps if he gets a new computer, changes browsers or downloads browser updates, thereby increasing the installed lifetime. We believe that during the next 12 - 18 months the average legacy ALOT bar user with four or five clicks over its installed lifetime will start to outnumber newly acquired Appbar users who engage with their apps more regularly and who might use the Appbar as their primary search tool.

What if the increased interaction and longevity results in the average appbar user clicking just one more ad over the installed lifetime? Even just one more click on average could change the numbers dramatically for Vertro, as it could make the lifetime value (based on Google's average revenue per click example used above) go from $1.60 to something closer to $2, which would imply a 25 - 30% boost in revenue without additional operating or marketing expenditures beyond what they already were spending to acquire toolbar users. The impact of a 25% boost in revenue on the same expense base would be enormous. Using our Q4 estimate of $10.35 million in revenue and $9.3 million in total operating expenses, "one more click" takes you from a profit of $1.05 million, or 15 cents per share, to $12.9 million in revenue and $9.3 million in opex, which equals $3.6 million or 50 cents per share. Of course, we do not expect the Appbar to have a material impact on Vertro results until 2011, but we do feel that this example gives investors a clear idea of the impact the new ALOT appbar could make on Vertro's bottom line over the long term. Should this occur with an increasing number of users, it could result in the average user producing not just the "one more click" that would add 20% or more to Vertro's revenue, but potentially a mutliple of 3x, 4x or even 5x as many clicks over the average users lifetime, which would have a dramatic impact on Vertro's search revenue.

Will consumers start using the appbar for searching simply because it is more visually appealing? Probably not, or at least we would not expect to see enough of an increase in search utilization rates to move the needle based on the aesthetic enhancements alone. The key will be offering value added applications that become intertwined in a consumer's daily use that are so useful and/or entertaining that they become an indispensable part of a consumer's regular flow. How will Vertro be able to develop Apps that will achieve this? They will not necessarily have to - they will be able to use apps from third party developers, who will be developing PC apps for the Google, Mozilla and Apple PC app stores. Apps developed for those marketplaces could easily be repurposed for the ALOT app store and Vertro has the means to make such a conversion very appealing to a developer, by 1) offering a featured promotion to its existing 10 million strong user base, which might be more appealing to a developer than just getting added as one of 300,000 apps in a store 2) getting a featured position in Vertro's daily ad campaigns, where Vertro already spends more than $2 million per month to promote its ALOT toolbars/appbars and 3) Vertro could offer a 100% revenue share for those who offer the most desirable apps, or at least those who offer paid apps that Vertro sees as being so valuable to their appbar users that it will help to achieve the "indispensable" status described above. While Vertro could certainly benefit if they begin to earn 20 - 30% of each of those 99 cent, $1.99, $4.99 and $9.99 paid apps, we believe that Vertro might be able to create more long term value for shareholders by becoming a high margin "go to" distribution partner for developers and focus on getting all the best apps available for users who will then keep and use their appbars more often and for much longer than current users, thereby driving search revenue substantially higher over the long term.

Given the lean, predictable and disciplined approach management has taken with the company's operating expense structure, we do not believe that ALOT needs the kind of material improvement we expect to see from the new Appbar to continue its upward trajectory. The company has just completed its fourth straight quarter of GAAP profitability with the legacy ALOT toolbar/homepage model and we expect to see the company grow quarterly sequential earnings per share by more than 100% in Q4. Vertro's pristine balance sheet could reach a cash balance of more than $8 million by the end of next month and we expect the company to have cash flow of almost that much again in 2011. If Vertro's stock price stays anywhere close to its current trading range ($4.50 - $6), we expect there to be heavy pressure on management to start returning some of that cash to shareholders through a stock repurchase program. The $15 million-plus we expect to be available to the company from its current cash position and cash flow from operations during the next 12 months would allow the company to repurchase what is essentially the entire public float of 2.9 million shares if the stock continues to trade below $6 per share. While we have no illusion that the stock would stay that low for very long with the upward pressure on the stock price that significant company purhcases of shares would cause, we still believe that Vertro management has an opportunity to put some of that cash to work at a time when the stock price has yet to reflect the earnings momentum and growth that Vertro should be able to achieve during the next 12 - 18 months, and this will serve to magnify that earnings per share growth for investors.

We hope to see this occur sooner rather than later, as we believe the companies that stand to benefit most from the movement to bring App development and App stores to the PC will get more attention during the next month or so as Apple rolls out its Mac App Store, Google launches its Chrome App Store and Mozilla launches a PC App Marketplace of its own. Microsoft's (NASDAQ:MSFT) rumored $300 million offer earlier this month to acquire the largest privately held player in the PC Appbar space ( could cause other acquirors to take a hard look at the other players and Vertro is arguably the purest publicly traded pure play in the PC Appbar/App store space. Vertro's tiny cash adjusted market cap of $28 million and $40 million-plus search revenue run rate will make it an even more attractive acquisition candidate, drawing more attention during the next few quarters as this space evolves. Such attention, combined with the increased attention Vertro already is receiving from a growing cadre of individual investors promoting a "buy the stock/use the service" viral campaign (see "Shop ALOT on Cyber Monday" ) to drive customer acquistion and retention for Vertro, could move the stock higher (given its small float of only 2.9 million shares) before the company is able to begin buying back stock, thereby reducing the number of shares the company would be able to repurchase.

In summary, we believe the new Appbar is a gamechanger that will have a major positive impact on Vertro’s bottom line as we get farther into 2011 and that we could see a significant acceleration of Vertro’s growth rate as the company is able to be more aggressive in its customer acquisition campaigns based on the higher revenue generation by the new appbar users. We believe the cost to operate and market the appbar will not be materially different from the cost to operate and market the legacy ALOT toolbars, but the revenue stream produced over the installed lifetime could increase dramatically, propelling Vertro's earnings substantially higher. We believe this understanding will drive many new investors to take a closer look at the Vertro story and bid the shares up to a more reasonable valuation for a company with Vertro's earnings momentum, prospects for revenue growth, increasing cash hoard and potential valuation in an acqusition scenario.

Disclosure: Long VTRO, Long GOOG