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QuinStreet: Poised To Grow Margins With QRP Catalyst

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About: QuinStreet, Inc. (QNST)
by: Jackson Fogarty
Jackson Fogarty
Tech, Growth, growth at reasonable price, software
Summary

QuinStreet's 11% profit margins will improve with the company's new QRP product.

Management expects over $100M in revenue from QRP in the next few years.

Carrier diversification will be important to minimize risk: QuinStreet currently derives 22% of revenue from Progressive Corp.

Company Overview

QuinStreet (QNST) lays claim to the term ‘pioneer’ of performance marketing. With a history of over 20 years, the company specializes in delivering clicks, leads, inquiries, calls, applications, or customers to its clients. This performance marketing strategy is attractive to QuinStreet’s clients, who pay solely based on tangible execution. QuinStreet operates in financial services, education and home services. M&A is a big part of the business model: the company has acquired three companies since 2018 (AmOne, CCM, and MBT) primarily to increase its number of customer relationships. Although digital ad spend has been down during the pandemic, the macro-shift toward online advertising is resolute. QuinStreet is well-positioned to profit from this transition as long as management can successfully increase margins.

Business Model

QuinStreet's business model is fairly simple. The company is paid a commission for its marketing performance on a per-quote basis. The variable model runs very few fixed costs as the cost of revenue is largely media-based. When revenue drops, so too does the company’s largest cost. Unfortunately, this low-risk model returns less than favorable margins. The company has TTM gross margins of 11%. Management plans to increase these margins by divesting its unprofitable businesses and rolling out SaaS-like products. Additionally, the company plans to continue its heavy emphasis on growth-oriented acquisitions. On the 2Q 2020 Earnings Call, CEO Doug Valenti remarked:

We plan to narrow our focus to a smaller number of our best-performing businesses and market opportunities and to restructure to align resources and efforts with those areas...We also expect faster margin expansion from top-line leverage on a smaller cost base and a heavier mix of businesses with SaaS-like margins

These plans will need to be monitored by investors over the next few months as the changes begin to be recognized. If the plan is followed through successfully, QuinStreet will prove to be undervalued at its current price.

Financial Highlights

The last few years have been rocky for QuinStreet. After increasing revenue by 35% YoY in 2018, the top line grew just 13% in 2019 and is expected to grow just 7% at the end of the fiscal year in July. This volatility in top-line growth has led to a wavering stock price, as shown below:

Zimlon Insurance Company Analysis

As shown in the graph, QuinStreet’s earnings have been up and down and it is reflected in the steep declines in price. Breaking down its revenue, financial services represented 77% of total revenue in Q3 FY2020. The majority of other revenue comes from the education vertical, representing ~12% of revenue. Financial services grew 15% YoY in the most recent period, while education showed meager 4% growth. The company has struggled to gain ground in education since 2019 when it lost Dream Center Education Holdings, which represented upwards of 20% of revenue. Client diversification remains a risk for QuinStreet as Progressive Corporation (PGR) represents 22% of net revenue. One strong positive for QuinStreet is its balance sheet. The company has upwards of $97 million in cash on hand, representing 17% of its market cap. This gives management a cushion if ad-spend falls off temporarily due to coronavirus. It also may allow management to pursue acquisitions or develop new products to increase margin.

Catalyst

Although the company hasn’t grown its top line favorably over the last few years, it has an exciting catalyst which management expects to grow margins. The QuinStreet Rating Platform (QRP) is an enhanced workflow system designed to vastly improve the sales efficiency of carrier partners and their agents. Carrier partners will get much better workflow management and control, ultimately allowing them to reduce costs. CEO Doug Valenti cited on the Q3 2020 Earnings call that QuinStreet has the most end-to-end integrations with the biggest carriers, allowing them to provide agents with accurate and timely quotes. Although the product has not been completely rolled out, Valenti said the pilot company realized upwards of 40% lift in productivity.

The most exciting part of this catalyst is the SaaS-like margins. Management expects QRP to have 80% gross margins and rise steadily with use. Valenti also noted that the pipeline for the product is extremely deep. In the Q3 2020 Earnings Call, he had this to say regarding QRP:

Launched QRP clients already represent over $6 million dollars in estimated annual revenue opportunity once fully ramped. Signed and near-signed clients (not yet launched) represent $12 million of additional estimated annual revenue opportunity. The balance of clients in the advanced pipeline (not yet at signing stage) represents $36 million more of estimated annual revenue opportunity. That means we believe we already have line-of-sight to over $50 million of estimated annual QRP revenue. We believe the full pipeline and market represent an estimated revenue opportunity of well over $100 million per year.

The excitement for this catalyst is evident in the management's rhetoric. The company has yet to recognize revenue for the product, but expect to do so sometime in the next few months. Until then, investors can rely on the testimonial of Tom Lyons, Chief Operations Officer of Plymouth Rock Management Company of New Jersey:

QRP will help us improve response time to client inquiries while preparing the most competitive insurance quotes possible. We view QRP as a mission-critical enterprise workflow management application that should significantly drive our business value to customers and help us expand sales.

It should be clear to investors that QRP is a great opportunity for QuinStreet in the near future. The product offers great reward to carriers and their agents, and will allow QuinStreet to improve upon its poor margins. Management expects to see 8-digit revenue from QRP in FY2021 which is just shy of 15 months from now.

Risk

Aside from the bright future surrounding QRP, the company has a few risks. As mentioned earlier, 22% of its revenue is derived from Progressive Corporation. Although no other companies represent more than 10% of revenue, this heavy reliance on a single company could be reason to worry. Progressive currently has a strong balance sheet, but further virus implications could force the company to reduce ad-spend. Doing some simple math, a 50% reduction in ad-spend would wipe more than 10% of QuinStreet’s revenue. This is a very real risk and deserves to be recognized in any financial projections.

Another risk lies in the company’s business model. Management has promised to continue to pursue acquisitions. While the company certainly has enough cash to do so, the underlying principle is cause for concern. One bad acquisition could prove costly to a growth company like QuinStreet. Investors will be putting their trust in management, relying on them to choose the right acquisitions at the right cost.

Valuation

Given the risk of decreased ad-spend from Progressive and/or other carriers, any valuation deserves two scenarios. A DCF model captured both scenarios. The following table shows the inputs and assumptions of the model:

5-Year CAGR

QRP Revenue Growth

50%

Other Revenue Growth

10%

QRP Gross Profit Margin

80%

Other Gross Profit Margin

11%

Operating Expenses (% of Revenue)

10%

Tax Rate

20%

Growth rate in perpetuity

2%

WACC

7%

Beta

1.25

Risk-free Rate

2%

Market return

6%

The above assumptions were present in both scenarios. In the first scenario, FY2021 revenue (consisting of Financial services/Education/Other) decreased by 10% from FY2020. The effect of the loss on earnings is somewhat diminished by QRP revenue which represented $10M in 2021, in line with management guidance. Discounting the 2025 value back to present, the model returns a price target of $12.25. This should be viewed as a baseline price target.

In scenario 2, FY2021 revenue has no growth, followed by 10% growth in subsequent periods. This results in a price target of $13.83, representing 35% upside from the current price. It should be noted that both models incorporated QRP revenue as management guided, forecasting for 8-digit revenue in FY2021. QRP revenue tops out around $50M in 2025 in the model, although management foresees revenue reaching $100M in the future. As seen in the chart below, profit margins will steadily increase as QRP gains ground in the market.

Zimlon Insurance Company Analysis

As the company becomes more profitable with QRP and other SaaS-like products, the stock price is sure to follow. Both of these scenarios were relatively conservative and thus clearly exhibit a considerable margin of upside for investors.

Conclusion

To sum up, QuinStreet is an undervalued company with room to grow. Revenue growth has been up and down in recent years, but the impending QRP product will rejuvenate the company’s earnings. Keen investors will notice QuinStreet trading at an absurd 38 P/E ratio. Normally this high of a ratio would be cause for concern. However, QRP promises to lift earnings over the next few years and management remains focused on growth-oriented acquisitions. The successful combination of these two will result in a profitable business worth more than 35% of its current share price.

Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it. I have no business relationship with any company whose stock is mentioned in this article.