Interclick: Turning The Profit Corner, Part 2

|
Includes: AABA, CNVR, GOOG
by: Marty Chilberg

Did you ever listen to Paul Harvey deliver his radio broadcasts? He was such a treat with his ever-present "Page Two" and "...the rest of the story". It always felt like we were getting information just beneath the surface, requiring a little digging to unearth. Similarly, once a set of screens identify possible speculative investments the real work begins.

First up, let's look at the overall market for interClick (ICLK). The relevant market for ICLK is domestic non-premium display advertising. Here are two tables to help us back into that space.

May-09 ThinkEquity WW Online Advertising

Revenues ($B)

2007

2008

2009E

2010E

2011E

2012E

2013E

Premium

$18.6

$18.8

$16.0

$17.4

$19.2

$20.7

$21.9

Nonpremium

3.1

4.1

4.8

6.0

7.8

9.5

11.4

Display total

$21.7

$22.9

$20.8

$23.4

$27.0

$30.2

$33.3

Search

19.9

24.9

25.8

28.7

33.1

38.2

43.5

Other

7.1

6.6

6.4

6.9

7.6

8.4

9.0

Total online adv

$48.7

$54.5

$53.0

$59.0

$67.6

$76.7

$85.8

ThinkEquity commentary:

We continue to expect non-premium display advertising to be the highest-growth segment of the online advertising market in coming years, based on superior fundamentals including inventory and pricing growth...We expect a strong recovery for the category in 2010, with growth of 26% to $6.0 billion.

IDC Domestic internet advertising market ($B)

Q1

%

Q2

%

Q3

%

Q4

%

CY

2005

$ 3.0

22%

$ 3.2

23%

$ 3.5

25%

$ 4.1

30%

$ 13.8

2006

$ 4.4

23%

$ 4.6

24%

$ 4.7

25%

$ 5.4

28%

$ 19.1

Y/Y

47%

44%

34%

32%

38%

2007

$ 5.5

23%

$ 5.7

23%

$ 6.1

25%

$ 7.0

29%

$ 24.3

Y/Y

25%

24%

30%

30%

27%

2008

$ 6.7

25%

$ 6.6

24%

$ 6.6

24%

$ 7.1

26%

$ 27.0

Y/Y

22%

16%

8%

1%

11%

2009

$ 6.3

24%

$ 6.3

24%

$ 6.5

25%

$ 7.2

27%

$ 26.3

Y/Y

-6%

-5%

-2%

1%

-3%

2010

$ 7.0

$ 7.2

Y/Y

11%

14%

Reported results from GOOG, YHOO, and ICLK, etc support these numbers. So, it appears safe to conclude that the market for internet display advertising is indeed growing nicely again, creating a 20+% tailwind for ICLK.

Taking look at the display ad network space, it is a crowded, competitive market where everyone is parroting the same mantra. This parody (warning: some profanity is used) is hilarious because of how uncomfortably true it is. How can a potential investor possibly believe anyone when everyone makes the same claims? Parse the commentary in the video and you'll quickly grasp why. Scalable, transparent, data optimized, integrated, predictive, maximized ROI. It's the holy grail, and with no independent validation, it appears everyone feels justified claiming it.

What does interClick say? They join the cacophony by stating:
- They were the first truly transparent network.
- They don't believe in the blind network approach.
- They are a technology platform with media as the product.
- They deliver scale while providing better data integration, reporting, analysis and segmentation capabilities than anyone else.

The dirty little secret that no one mentions is that all advertising networks use the same algorithm. That implies that this is a commodity business. But why then would some ad networks fail, some limp along and still others gain share? The answer must be in the data and how well it's integrated in the platform . The old acronym GIGO (garbage-in, garbage-out ) comes to mind. Data drives audience targeting which improves ROI. This is a digital arena and data is what drives success.

Take a look at page 9 of the interClick presentation (here.pdf). Having a dozen or so 3rd party data sources in diverse categories ranging from socioeconomic to psycographic appears impressive. Unfortunately, most investors, myself included, can't objectively determine if this is truly differentiated from other networks. So it's time to turn elsewhere to find support for who's got the secret sauce.

Reported revenues by ICLK paints the picture more objectively. Compare ICLK revenues growth to the above market data:
- CY09 revenues grew 158%
- Q1-10 revenues grew 69%
- Q2-10 revenues grew 103%
- Q3-10 revenues grew 84%
Only one conclusion can logically follow. ICLK is taking market share from competition.

Client retention and recurring client revenues have been discussed on company conference calls. On the last call, management disclosed the following
- Existing clients spend about 3 times more than new clients representing 70% of Q3 revenue.
- New clients signed during Q3 increased from prior quarters.
- Advertiser eCPM was the highest in company history.
- Q3 impressions totaled 13.1b up 35% Y/Y.

Actions speak louder than words. Revenue growth, client renewals and new client signings tell us what customers believe. Revenue is growing at double the rate of impressions. This company is growing market share. Management was confident enough on the last call to state that they expect to grow faster than the rest of their market for the foreseeable future.

interClick has just turned the profit corner, which means profit per revenue dollar is quite low. Even ignoring that, the valuation today is attractive:
- Secular growth approximates 25%. The ThinkEquity table above says the WW market is growing at 20-30% for the next 3 years and if ICLK continues to gain share they will grow faster.
- CY11 analysts estimates range from a low of $0.20 to a high of $0.30 with consensus at $0.24 per share.
- That puts the CY11 PE multiple at 22x or below the target rate of 25%.
The beauty of investing in newly profitable companies, though, is that growth in earnings will be substantially higher than that of revenues. CY10 net income looks to be about 4% of revenues. The CY11 net income margin should expand nicely. Without guidance this is still guesswork, but I'm pegging it at 9-11%. That still leaves substantial headroom. This company looks like it should improve to over 20% in time which drives the profit growth rate to over double that of revenues. That's where this type of speculative play really pays off.

Another approach for valuing these types of companies just turning profitable is the multiple of forward revenues. A public comparable, VCLK is currently trading at around 3 times revenues. Business Insider used a similar 3 times forward revenues multiple when valuing similar private ad network companies AdKnowledge and Turn Media. As I write this, ICLK is undervalued at about 1 time CY11 revenues.

As mentioned in my first article on interClick, speculative investments aren't for everyone. The stocks are volatile with above-average risk. That said, risk can translate into reward for investors that are willing to do some research, hopefully identifying tomorrow's market leaders.

Disclosure: I am long ICLK.

About this article:

Expand
Want to share your opinion on this article? Add a comment.
Disagree with this article? .
To report a factual error in this article, click here