Inuvo Is An Interesting Company But Needs Some Improvements

Mar. 22, 2022 10:08 AM ETInuvo, Inc. (INUV)2 Comments

Summary

  • INUV is in the marketing business, with one publishing segment and one advertising services segment.
  • The publishing segment, ValidClick, is unprofitable and is masked as advertising services when it actually is not.
  • However, INUV has been developing IntentKey, a promising technology trying to provide an alternative to the end of third-party cookies.
  • IntentKey has been showing great growth, but profitability is unclear given that INUV does not provide separate information for its segments.
  • Until IntentKey delivers profitability though, INUV is burning cash and has to finance it through dilutive share issuance.

Teclado Conceptual de las Cookies (rojo llave

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Inuvo (NYSE:INUV) is a marketing agency with offices in Arkansas and California.

The company has two segments, ValidClick and IntentKey.

ValidClick, a digital advertising dealer, is the main revenue driver, the legacy business, and is not profitable. IntentKey, an AI-enhanced contextual marketing solution, seems much more profitable and is the future of Inuvo. The product tries to solve the problem of the phaseout of third-party cookies by providing insights on contextual advertising.

The market for IntentKey is ripe because there is still not a clear alternative to third-party cookies in the digital marketing business. INUV claims that IntentKey has generated great results so far and that it is really prepared to grow. In fact, the segment has been consistently delivering 17% quarter growth for a year.

However, INUV is still unprofitable on a consolidated basis, and is burning cash at a rate of at much as $10 million a year. The company has financed its losses by issuing shares and although it has $13 million in liquidity and no debt, it may need to issue more in the future. Additionally, last quarter results show no change in cash balances, but at the expense of an important reduction of receivables.

We believe INUV is a great stock to follow as the post-cookie marketing industry accommodates to the new reality. One not very considered aspect is competition, but it tends to be lower in growing markets.

We also believe ValidClick is a drag to the business and should be pashed-out. Clear segment reporting separating ValidClick from IntentKey would be appreciated as well.

Finally, the company has decided to invest a significant portion of cash in marketable securities, that are already generating losses. Not only this but has moved some securities to not for sale and therefore those loses do not show in the income statement. We believe this is not conservative practice for cash management considering the not so great liquidity situation of the company.

Note: Unless otherwise stated, all information has been obtained from INUV's filings with the SEC.

ValidClick, legacy and unprofitable

According to the 21FY 10-K, ValidClick represents 70% of INUV's revenues, standing at $40 million for 2021. ValidClick is the business that composed most of INUV's operations between 2010 and 2018, when IntentKey entered its development phase.

According to INUV's reports, ValidClick is in the business of advertising placement. That is, INUV finds interesting websites where it can place advertising, and then sells those places to advertising aggregators, like Google or Yahoo! In addition, ValidClick has its own set of click baiting websites.

We believe INUV's description of its business is not completely accurate. INUV does not report how much revenue generated by ValidClick comes from websites not owned by INUV.

We suspect that most of ValidClick's revenue is generated by the websites the company owns and develops, which are not of great quality but rather click baiting information in different segments (travel, lifestyle, personal finances, etc.). The problem is that ValidClick has to spend all of the gross profits it generates and even more in paying advertising in other platforms to drive traffic to its own websites in order to sell the advertising it places in those websites.

ValidClick buys advertising to sell advertising, the model makes no sense and loses money. How much exactly is difficult to understand because INUV does not report separate segments. However, we do know that ValidClick generated $40 million in revenue in the last year, and that it had to spend approximately $32 million in marketing costs to attract traffic to its websites. We know this because INUV reports that most marketing expenses have this use.

That leaves ValidClick with a spread of $8 million as its contribution for the company, in order to pay CoGS, compensation and SG&A (not separately reported).

IntentKey, the key to the future

After acquiring NetSeer in 2017 and obtaining an UCLA developed AI context analysis patent with the acquisition, INUV started developing and launching IntentKey.

IntentKey is an AI powered, big data based context analyzer. The platform behind the products sifts through millions of websites and tries to relate concepts appearing on each website, like bed, sleeping, dog. This is of great use to generate context based marketing, say in the simplest case pillow advertising in a sleep quality blog, and in a more complex case earbuds in a blog discussing ways to prevent dogs from barking at night.

A competing alternative to the end of third-party cookies

Call it luck or vision, context advertising is one of the main competing alternatives to replace third-party cookie based advertising, whose phaseout has not a date but is almost certain.

With third-party cookies, the company placing the advertisement knows things the user did on other websites. So while visiting a blog about dogs the user gets advertising about lighters because he/she had been searching for lighters previously. Third-party cookies are one backbone component of digital marketing as it is right now.

The problem is that third-party cookies are increasingly being considered a violation of privacy. That is why third-party cookies were phased out by some browsers (Mozilla and Safari for example) while the phaseout in the biggest one, Google Chrome, was announced, but the effective date has been postponed several times.

The situation is relatively good for the enormous data collectors, like Meta, because first-party cookies will continue to be allowed. That means that a platform that knows a lot about the customer has a tremendous advantage.

The question is what happens to all the run-of-the-mill websites and platforms that provided great advertising locations but that will become blind. The easy answer is to use simple context, like offering pillows in sleep quality blogs.

A more complex answer has been proposed by first-party cookie aggregators, or identity aggregators. What these companies are proposing is to receive first-party data from different websites, tag them to a particular user but protect the user's privacy. The aggregator can then sell some of that data to advertisers. The problem with this solution is that privacy concerns and regulatory risks will move to the aggregators.

IntentKey solution, no private information required

As mentioned, IntentKey is just one AI, big data enhanced form of contextual advertising. Contextual advertising does not require private, user based information, but rather aggregate bulk data to generate insightful relations among things discussed in the internet.

Like we said, simple contextual advertising can be done with a piece of paper, just thinking about clearly direct relationships between websites and products. However, IntentKey's proposal is to find not so direct relations, among several different websites and products, in order to match the best possible contextual advertisement.

The great advantage of contextual advertising is that it does not need to know anything about the specific user visiting a website. The great disadvantage is that the advertising shown to the user may not be as good a match as user-based advertising is.

Therefore one of the key questions regarding IntentKey's usability is how good are its recommendations. In this respect INUV has made a lot of statements announcing that IntentKey's customer base is growing and very happy with the results. In fact the segment has actually grown at a compounded quarterly rate of 20% for the last year.

The market has not moved yet

The recent announcement by Google that it would delay the phaseout of third-party cookies for at least 8 months from its previously announced date signals that the advertising world is still not prepared for what is coming.

While changes like this take a long time to develop, a lot of people do not prepare until the change is imminent, triggering panic. According to a report by Adobe on Digital Trends for 2022, at least 38% of respondents say they do not feel prepared for a future without third-party cookies.

That obviously represents a great potential opportunity for INUV and its IntentKey solution. In an unknown point in the future, a few events may trigger advertisers and websites to quickly look for alternatives, and IntentKey might obtain a share in that expanding market. A bigger but less prepared advertising services company might try to acquire IntentKey in order to scale it and take a quick strategic turnaround.

Of course, up to this point all of this is speculation. As mentioned, contextual advertising is not the only alternative proposed to the problem at hand, although it is the only one that requires no privacy trespassing. But even if contextual was the answer, other bigger companies are working on similar solutions. Examples of these are Oracle Contextual Intelligence or IBM's Watson Advertising. Smaller competitors can also be found, like GumGum.

Regarding competition, INUV does not mention specific competing companies, but does mention that the industry has in their understanding high barriers to entry. Traditional industry development theory states that growing markets tend not to be very competitive as the expansion of the market allows each participant to grow independently.

In this respect we think that the growth rates shown by the business are a positive indicator, above all because the developments that will trigger the practical urge for alternatives to third-party cookies have not yet occurred.

Also, according to the latest unaudited conference call, from March 17th, INUV is increasing the diversity of its client base in several client industries and across different verticals of the marketing industry.

Without profits and cash balance, INUV is still operationally risky

As long as the company cannot generate a profit, INUV's shareholders will need to continue financing the company by diluting its shareholding base. In 2020 alone, INUV raised $15 million by issuing shares. By 2021, the company had to issue again, to obtain another $14 million in financing.

The result was that a company with 40 million shares by the end of 2019 now has around 120 million shares. And the process seems not to be ended, because INUV recently announced that it had amended its bylaws to increase the maximum number of shares available for issue from 150 million to 200 million.

INUV also signed an agreement with Alliance Global Partners, an investment bank, where the bank committed to purchase or collocate an aggregate of $35 million in shares. The agreement has not resulted in any share issuance yet.

Liquidity and dilution risk

Exactly how long can INUV go without issuing shares again. That is a question that greatly depends on management's conservativeness.

In this respect we do not believe that INUV's management was wise in purchasing $3 million of marketable securities out of $15 million in cash that it had.

INUV's cash was painfully delivered by diluting shareholders and is not plenty. Marketable securities like equities or bonds are not safe if liquidity needs arise. In fact, marketable securities are the least safe when most in need, during a recession or business downturn. The company has recognized a mark-to-market loss of $300 thousand on its $3 million security book, in less than one year. These losses can be seen in P&L directly as part of financing costs and inside other comprehensive income for the latest 10-K.

The company has an open credit line of $5 million for contingencies, although the price is expensive. The minimum interest rate on the drawn funds is 6.5%. Fortunately, the company did not make use of the credit facility during 2021 or 2022.

As December 2021, the company had $15 million in cash and marketable securities. Last year's cash burn rate considering working capital and investments in software was $7.5 million. Without considering working capital and investments, which are growth drivers, the company lost $2.2 million in cash flows last year, compared to $6 million in 2020. That at least the operations, without considering investments, are profitable, is a good sign. Last year's cash burn number can be further reduced by several means, including spending less on ValidClick.

However, investment needs to be financed with cash to deliver growth, so the company still needs liquidity. Considering no improvement in cash flow provided by operations and no decrease in investment in software and working capital, INUV would need additional financing by September this year or even before. This raises the problem of dilution, considering the price the stock trades at right now. As an example, another $15 million in financing at current prices would require issuing 30 million shares, or 25% of the current share base.

On the very negative side of things, if a recession hits the US economy and advertising expenditure is cut severely, INUV could face serious liquidity risks. Another associated risk is being delisted from NYSE, where the minimum share price is 20 cents.

How much is needed for profitability

As we mentioned, if we pair the $40 million generated in revenue by ValidClick in 2021 with the $32 million consumed in marketing expenses, we arrive at $8 million of net revenues coming from ValidClick. In the same period IntentKey generated $18 million in revenues.

The resulting $26 million in net revenues does not cover cost of revenue of $16 million, compensation of $11 million and SG&A costs of $7.2 million, which total $34.2 million, for a total deficit of about -$8 million.

The key question though, is how to separate those expenses, because INUV does not report them separately.

Let's build an assumption where we separate them according to revenue, which is just one way of doing it, but tilted the balance towards IntentKey because management has mentioned that it is less profitable on a gross basis, and more profitable on an operating basis. Assuming a split of 40% IntentKey and 60% ValidClick, given that they account for 30% and 70% of revenue, respectively, then $20.5 million of expenses would belong to ValidClick, which would be down $12 million of pre-tax profit. Meanwhile $13.5 million in expenses would be attributed to IntentKey, making for a $4.5 million pre-tax profit for this segment.

Of course the previous is simply an exercise but we tend to believe that ValidClick is a real drag on INUV's earnings, and that it should be, if not phased out, at least reduced in scale. We do not know exactly what the costs of phasing out ValidClick (in terms of severance, for example) might be. Management's strategy might be to allow IntentKey to absorb ValidClick's employees and resources, instead of just restructuring.

The problem is that with ValidClick continuing to drag on INUV's earnings, IntentKey would need to grow a lot, maybe doubling its size, before INUV is able to break even. That is without considering any additional unprofitable growth from ValidClick.

Conclusion

With the current business dynamics, INUV is a risky investment, burning cash in a not so great context that could turn for worse with a recession. The risk of dilution and possible delisting is real.

However, we think the company's IntentKey product may have a lot of potential, still being tested though. We would like the company to provide better reports regarding its different segments, and announce some efforts to phase out ValidClick. Without this, IntentKey's growth would be wasted in financing a bad business.

For the months to come, rather than growth in IntentKey's revenues, we believe news on ValidClick are more important. The reason is that the trigger for contextual advertising growth is psychological and could happen at any moment. Therefore it pays to be invested in contextual advertising, but with moderate risk. The fact that ValidClick is such a drag on earnings increases IntentKey's risk substantially.

Finally, our belief is that non third-party advertising is going to grow and that IntentKey is at least prepared to compete. Whether the segment growth is enough for every company to grow is a different question and will be clear as the year continues. Also, a general deterioration of the economy can quickly dry up marketing expenditure and put every company in the industry in dire straits.

If the company, by growing IntentKey or phasing out ValidClick, can at least deliver quarter based profitability, that would be another great sign. It would allow to generate a small cushion and to finance growth internally without diluting.

For those reasons, and although IntentKey seems promising, we prefer to wait outside of the fences. Best of luck for the company.

This article was written by

I am a Business Management student in Buenos Aires, Argentina. I specialize in global micro, small and medium size companies that trade in the US using a Due Diligence approach, scrapping for as much information as possible about the company, and making qualitative judgments. I speak five languages (Spanish, English, Chinese, Italian, Portuguese). I am a contributor for The Dividend Freedom Tribe. Homo sum, humani nigil a me alienum puto
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Disclosure: I/we have no stock, option or similar derivative position in any of the companies mentioned, and no plans to initiate any such positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

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