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ReachLocal Hits Record Lows; Can It Recover?

|Includes: AABA, GOOG, MS, ReachLocal Inc. (RLOC)

ReachLocal, Inc. (NASDAQ: RLOC) is a Woodland Hills, California based marketing and advertising firm providing Internet and mobile marketing solutions like search engine marketing, web presence, online marketing analytics, display advertising and assisted chat services targeting small and medium businesses (SMBs).

The company was founded in 2004 and has served over 24,100 SMB customers. The company provides solutions through its own proprietary platform and direct sales force. About 66 percent of ReachLocal's revenue comes from North America, while the rest of the world contributes 34 percent to the total revenue.

ReachLocal released its Q1 2014 results on May 7, 2014 which saw EPS at $0.07 better than the Street estimate of $0.16. Revenue grew 2.5 percent to $124.7 million in Q1 2014. International revenue grew by 23 percent during the period. The number of active clients and active product units grew by 6 percent over Q1 2013.

North American revenue declined by 7 percent and the company is currently in the process of re-aligning its local sales force to address falling revenues. The guidance for 2014 is muted with expected revenue in the range $500-$525 million, adjusted EBITDA from $2-$5 million and the company is not expected to be profitable on net income basis.

ReachLocal has shown 26 percent CAGR growth in revenues from 2009 to 2013. The addition of active clients has also grown by 1000 clients each year. However, the revenue per active client has decreased from $ 5,431 in Q1 2013 to $5,202 in Q1 2014, which is a worrying trend affecting the gross margins to below 50 percent.

The company is debt free, but the operating cash flow has reduced to $30.7 million in 2013 from $46.6 million in 2012. The current quarter saw operating cash flow slide to negative territory due to $5.5 million worth of business closures in 2013. ReachLocal expects to expand to Mexico in 2014 and has planned a capital expenditure of close to $23 million for the year.

The online marketing industry is highly competitive with big players like Google (NASDAQ: GOOG), Yahoo! Inc. (NASDAQ: YHOO) and Microsoft (NASDAQ: MSFT). But ReachLocal targets only the SMB segment and also partners with Google, Yahoo and other large players to avoid competition.

The opportunity in the highly fragmented SMB online marketing segment is about $24 billion of which ReachLocal currently has only a single digit market share. Potential for revenue growth is visible, but only better operating margins in future will provide value to investors and improve the profitability of the company.

ReachLocal has appointed Ms. Sharon Rowlands, who has experience in driving growth and transformational change at Thomson and Penton Media, as CEO in April 2014 to drive it back to profitability.

ReachLocal is currently trading at $6.22 as of June 02, 2014, up 3.67 percent over the previous close. The 2013 EPS was $0.09 and the analysts estimate EPS to be $0.55 in 2014. The adjusted EPS (excluding loss from discontinued operations) was $0.11 in 2013. An EPS growth of 15 percent can be expected on an adjusted basis in 2014.

Without further losses from discontinued operations, the company can be expected to post positive EPS by 2015. The stock price has fallen from $12 to $10 post full year 2013 results and has fallen further to 52-week low of $5.87 post Q1 2014 results.

Considering the current cheap valuation and expecting better or at least similar performance to 2013, on adjusted EPS basis, in full year 2014, the stock price should improve to previous trading range of $9-$10.