Regardless of what you think of LookSmart's historical missteps and its recent tendency to fall short of analyst's expectations, a confluence of events the past few days leads us to believe that LookSmart (Nasdaq: LOOK) is severely undervalued and that it should command a market valuation more than double current levels.
Looksmart closed Friday at $2.35 per share, just a little higher than its 52 week low of $2.16 per share. After the close of trading Thursday, the company released Q3 results that were not particularly sterling, but did indicate that the company finished the Q with $37.4 million in cash on the balance sheet, or about $1.63 per share. The bigger news was that LookSmart also announced a contract for the sale of FindArticles.com to Cnet (Nasdaq: CNET) for $20.5 million. Adding the proceeds of this sale to its current cash hoard will result in a balance sheet with somewhere in the range of $56 - $57 million in cash, equal to about $2.45 - $2.49 per share.
In addition to the fact that the company currently trades at a discount to its cash assets, the company also indicated that it intended to sell its popular furl.net website. While it is very difficult to know what type of price a third party might pay for furl, we are encouraged by the valuation management achieved in the sale of FindArticles.com. Further, we note that Yahoo (Nasdaq: YHOO) was rumored to have paid close to $30 million for Furl competitor del.icio.us two years ago. While any price we assigned to the sale of Furl would be highly speculative at this point, lets say for arguments sake that the company only gets one third of that ($10 million) for the Furl.net business. With the current shares outstanding at 22,900,000 that would an additional 44 cents per share in cash available to LookSmart shareholders, bringing the total Cash position to the $2.90 - $2.95 range.
With the closing or nominal sale of LOOK's other consumer assets and a sale of Furl, you are left with the company's core advertising business, which is comprised of its advertiser networks and publisher services clients. With the company's recent strategic reorganization and the "cost rationalization" process undertaken in Q3, the company has reduced its workforce by 25%, eliminated open positions that were no longer deemed strategic and subleased the 4th floor of the company's headquarter facilities in a move that will save the company approximately $1.2 million per year going forward. The bottom line impact of these initiatives will be felt in an approximately 15% reduction in overall operating expenses going forward, which management indicated should put them in the range of breakeven operating results even without achieving any growth to the top line.
The company also mentioned that their sales efforts are finally starting to bear fruit, with several closed deals that will have a meaningful (six figure) impact on the top line and that the deal with Wikia is moving forward on schedule. Such commentary leads us to believe that the company should see some top line growth over the next couple of quarters which, when combined with the cost cutting measures mentioned above, might lead the company's core operations back into the black sooner than many have expected.
While it is apparent that much effort has been expended to align the company's resources to achieve profitability in the near future, we feel that its very unlikely that the company will remain independent for very long. Management was very clear on the Q3 conference call that they are focused on achieving the highest value possible for LOOK shareholders and they suggested that the company's core business is for sale. As traffic aggregators and content owners snatch up one ad network after another, we feel that the assets and distribution partners in play with LOOK will make the sale of the company's core business very competitive and you need not look very far for evidence of the value currently being placed on ad networks. Just today, TWX/AOL announced the purchase of ad network Quigo, with many sources suggesting that the price was upwards of $340 million.
While Quigo was obviously one of the biggest prizes still remaining among independent ad networks, it is hard to imagine that this sale will not have very positive implications for LOOK shareholders, as we see deal after deal raise the bar for valuations of assets like those owned by LOOK. Between the prices paid for the ad networks that have been acquired (mostly in the $250 million + range) and the valuations used for recent VC funding of ad network properties, its not inconceivable that a profitable LOOK could command a price approaching $100 million for its core ops. Even taking a more conservative bent and assigning a valuation in the $65 - $70 million range for LOOK's core ops, would add another $2.85 - $3 per share to the value of LOOK, effectively doubling the cash value discussed above.
Who would be interested in LOOK's business? There are a number of potential suitors that come to mind, the foremost being some type of deal that emerges as we saw with Quigo/AOL. Remember that it was only a couple of months ago that Quigo inked a broad deal with TWX/AOL to provide contextual ads across the AOL network of websites and today we find them together at the altar. LOOK provides the technology backbone for IAC's Ask.com sponsored search listings and it is likely that they would have significant interest in owning the LOOK technology and assets.
One could certainly surmise that IAC's (Nasdaq: IACI) recent move to split the business into five segments was partially for the purpose of allowing each division to be valued based on its own prospects, with hopes that Ask.com could achieve a valuation that would allow it to be a viable currency for acquiring assets, technology and companies that will allow it to better compete with the Googles (Nasdaq: GOOG) and Yahoos of the world. As that process plays out, it would seem that LOOK would be an excellent prospect for acquisition by the independent IAC.
IAC is not the only company that might place a significant value on LOOK's core ops. Any of the existing larger networks that has achieved greater monetization of their traffic might find LOOK compelling. With LOOK's average revenue per click of only 12 cents, there are many networks that could do the simple math and determine that they could finance a purchase of LOOK based on simply taking LOOK's 360 million or so paid clicks per year and applying their own higher revenue per click. Or perhaps LOOK's Aussie origins might attract the attention of Mr. Murdoch, who might decide to buy his own ad network to further monetize MySpace and the rest of his rapidly expanding web empire?
Regardless of who ultimately emerges to purchase LOOK, one thing is certain. Investors who have bought shares of LOOK at current prices will be handsomely rewarded when everyone else realizes the true value of this company, which will likely turn out to be more than double its current price.
Disclosure: Author has a long position in LOOK