Frank Voisin is the author of the popular value focused website Frankly Speaking, found at http://www.FrankVoisin.com.
Arbitron Inc (NYSE: ARB) is a market research company that has, since 1912, estimated the size and composition of radio (and later TV) audiences for broadcasters and advertisers. The company has no debt, pays a steady dividend, and traditionally has earned strong ROEs thanks to the company’s near 100% market share in terrestrial radio market research.
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What I like about ARB is the industry niche it occupies and the moat it has in this core niche. For decades the barriers to entry were quite high because customers were concerned primarily with the reliability of the data being purchased, and so it was difficult for upstarts (even those as part of larger organizations) to establish the credibility needed to gain market share. Looking back at ARB’s historical track record, we see this its market dominance in its relatively uninterrupted revenue growth (thanks largely to contracted annual price increases) and relatively strong gross margins.
In 2007, the company’s gross margins began declining, signalling a potential problem. To understand the problem, we have to understand how the company has traditionally collected its data. Prior to 2007, the company collected data from listeners solely in this manner:
Arbitron uses listener diaries to gather radio listening data from sample households in 297 U.S. local markets for which it currently provides radio ratings. … When participants (known as “diarykeepers”) agree to take part in a survey, they are mailed a small pocket-sized diary and asked to record their listening in the diary over the course of a seven-day period. Participants are asked to report in their diary the station(s) to which they are listening, when they are listening and where they are listening, such as home, car, work or other place. … Each diarykeeper receives a diary, instructions for filling it out and a small cash incentive.
This is a labour intensive process both for the company in terms of identifying and recruiting participants and for the participants themselves who have to fill out the diaries by hand. Over time, participant interest has declined and the company has had a more difficult time finding willing participants:
Response rates are one measure of our effectiveness in obtaining consent from persons to participate in our surveys and panels. Overall response rates for survey research, in general, have declined over the past several decades, and it has become increasingly difficult and more costly for us to obtain consent from persons to participate in our surveys and panels. We have been adversely impacted by these industry trends.
Recognizing the decades-long trend, the company began seeking a new method of tracking that is easier for participants and more accurate. In 2007 the company began deploying the “Portable People Meter” system, which is a next-generation method of tracking radio audiences:
The PPM device is a small mobile phone-sized device that is worn or carried by a survey participant throughout the day. It automatically detects inaudible codes that radio, broadcast television, cable television, Internet and satellite radio and satellite television providers embed in the audio portion of their programming, using encoders provided by Arbitron. These proprietary codes identify the media to which a participant is exposed throughout the day without the person having to engage in manual recording activities. At the end of each day, the PPM device is placed into a base station that recharges the device and sends the collected codes to Arbitron for tabulation.
The roll out of the PPM was expensive, and the company recorded this cost under “Cost of Revenues” since presumably their accountants would not let them capitalize these expenses. During the initial years of the roll out, the company was effectively doubling up its costs, running both PPM and the Diary service in parallel. Going through the company’s 10-Ks and looking at the disclosure on Cost of Revenues, we see that 2011 was the first year where the increase in the cost of running PPM was more than offset by the decrease in the cost of running the traditional diary program. This was also the first year since 2007 that Cost of Revenue as a percentage of Revenue declined:
|Year||Cost of Revenue|
As the transition from Diary to PPM continues, we should expect to see Gross Margins increase toward traditional revenues. I have been unable to find any commentary about whether PPM will ultimately be as profitable as Diary, but the trend is positive and 2010 appears to be a low point in gross profits.
While a return to historical gross margins an honourable goal, some worry that ARB’s business model is subject to disruption as advertisers turn to more targeted methods of reaching their customers (e.g. internet advertising) and consumer consumption of radio transfers to digital offerings (which are easier to track) like satellite radio. This is a real threat, as the company’s moat in its current niche is attractive only if its niche remains sizable. To get comfortable with an investment in ARB, one would want to know that it is getting ahead of the curve to avoid future revenue disruption.
Indeed it is! Last year, the company purchased Zokem Oy, a Finland based market research technology firm. According to TechCrunch:
Just 4 years after its founding, mobile research firm Zokem has been snatched up for $11.7 million up front, with a potential payout of an additional $12 million through 2014. Their buyer? Arbitron Inc. (ARB) …
Their main product is an SDK which developers can plug-in into their smartphone (iOS, BlackBerry, Android, and Windows Phone) application to gather up all sorts of anonymous data like usage patterns, signal strength, and creepier stuff like location. Zokem had raised around $2M in funding prior to the acquisition, all from European VCs …
This is a big move for the company, which is aggressively moving forward with commercializing Zokem’s technology:
COLUMBIA, Md., April 17, 2012 — Arbitron Inc. announced today the launch of a syndicated, mobile consumer research service in the United States. The Arbitron Mobile Trends Panels™ service is a new research offering that utilizes a proprietary, on-device software meter to provide marketers, content providers, app developers and wireless access suppliers with information on how mobile consumers use apps, surf the web, engage in social media, participate in e-commerce, are exposed to and act on advertising, and employ their device to communicate. …
The Arbitron Mobile Trends Panels service is designed to help marketers, app developers, content and wireless providers answer key questions about the mobile consumer:
- how popular is an app overall and by category;
- what the key differences in mobile use patterns are by operating system;
- how much time users spend with content, apps or activities such as messaging;
- how people act on mobile advertising;
- where consumers come from to find content;
- where they go when they leave; and
- what a day in the life of the mobile consumer looks like.
The initial launch includes an opt-in voluntary panel of about 6,000 smartphone and tablet users. The results will be used to market the technology to app developers and other clients in the future. While other software developers can create similar products, ARB possesses the same advantage that has allowed it to compete for a hundred years, a reputation for providing credible analysis and bringing value to its clients.
There is another benefit to this transition. ARB is currently beholden to a small number of customers, as 50% of its revenues come from just 10 corporations (with Clear Channel being the largest, at 19% of sales!). Be transitioning into a mobile market research company, ARB will diversify its revenue based and, over time, possess a less risky revenue stream.
Another thing I like about ARB is that in the past, when it has had a share repurchase program, it has used it aggressively. While this by itself isn’t very interesting, what is interesting is that in the company’s Q1 2012 conference call it announced the Board’s authorization for a new $100 million repurchase plan that expires in two years. Strangely, this was not included in the company’s press release.
With ARB, I see a company that is continuing its long tradition of getting in front of trends by transitioning to a diversified mobile market research company. Its reputation for credible research will serve it well and over the next five years we could see this business become a significant growth driver. In the meantime, the company will be aggressively repurchasing shares and we should see its gross margins revert toward stronger historical levels. All of this portends a healthy future.
For those interested, I also found this interview with Dan Moore of CJS Securities about why ARB is overlooked and undervalued:
What do you think of ARB?
Author Disclosure: None, but may initiate within the next 72 hours.