Michael Mauboussin: Here’s what active managers can do
The debate over active versus passive management continues as trends show the ongoing shift from active into passive funds. Q2 2020 hedge fund letters, conferences and more At the Morningstar Investment Conference, Michael Mauboussin of Counterpoint Global argued that the rise of index funds has made it more difficult to be an active manager. Drawing Read More
Trading at only 3.7x 2012E EBITDA and 5.8x 2012E Net Income, Perion Network Ltd (NASDAQ:PERI) (“PERI” or the “Company”) is a misunderstood, underfollowed company whose stock has declined in large part due to steps intentionally taken by a new CEO when he arrived in the summer of 2010. These steps created some short term pain but have successfully positioned the company for long-term, profitable growth. The company is now beginning to benefit from these initiatives and we believe there are some short and medium term catalysts that will drive this stock higher. We think this stock is attractive to both value investors (considering its low valuation) and growth investors (revenue projected to grow ~30% this year).
As discussed, below the EBITDA figures listed in many databases (YHOO, Bloomberg) are incorrect/deceiving and make the stock appear to be trading at a MUCH higher multiple than it really is.
Perion Network Ltd (NASDAQ:PERI) is a digital media company that provides products and services catering to second wave adopters (typically people over 40 years old) who have relatively high levels of disposable income and want computer applications that assist them in effectively utilizing their time and that are simple, safe and useful.
PERI’s two primary products are
||IncrediMail, an award winning e-mail product sold in over 100 countries in 10 different languages; and|
||Smilebox, an Internet photo sharing service that allows consumers to use photos and videos to construct unique creations, including: greeting cards, invitations, slideshows, scrapbooks and photo albums.|
PERI generates revenue primarily by:
||generating searches and sharing in the revenues with the provider of the search engine (Google); and|
||selling premium software products;|
See the latest PPT at http://www.perion.com/wp-content/uploads/2012/06/June-2012-Investor-presentation.pdf or the 10k for more description of the business.
Josef Mandelbaum, a veteran consumer internet executive, became CEO of PERI after a successful career at American Greetings. After joining PERI, he began a process of transforming the company from a single product firm with an insufficient infrastructure into a more attractive, more diversified company with a stronger infrastructure and a healthy balance sheet that can accommodate significant growth.
Some of the more significant changes Mandelbaum has made include:
1) Diversifying product offering with the August 2011 acquisition of Smilebox, a rapidly growing company. Previously, PERI had been solely reliant on Incredimail, whose business had been flat/declining. To date, this acquisition has been more successful than management had originally anticipated. PERI has been able to extract value from Smilebox by both increasing its revenue and reducing its cost structure.
2) Improving and diversifying the revenue stream. Incredimail generates most of its revenue from search while Smilebox generates most of its revenue from product sales (which we consider to be a better business). The table below illustrates how the revenue mix has changed by comparing q1 of 2011 (prior to Smilebox) versus q1 2012 (which includes Smilebox).
Q1 2011 Q1 2012
Search 78% 49%
Product 14% 44%
Other 8% 7%
Total 100% 100%
3) Invested in infrastructure to support future growth. Previous management had treated the company more like a cash cow and paid out large dividends and did not invest enough in the company’s infrastructure to prepare it for organic and external growth. One of the biggest “investments” Mandelbaum has initiated is the increased spending on customer acquisition. Unfortunately, like many similar marketing related efforts, this expense creates an immediate p/l hit when the cost is incurred but, if successful, generates meaningful longer term benefits in subsequent quarters. Importantly, this customer acquisition cost can be easily and quickly reduced or modified if it is not being generating a sufficient ROI.
4) Replaced (and upgraded) a significant number of employees and brought in several highly qualified Board members. We encourage you to look at the bios of this impressive board.
5) Changed the capital allocation philosophy and discontinued the large dividend. Mandelbaum believed that over the long term, more shareholder value could be created by investing in and growing the business as opposed to simply returning “all” profits to shareholders.
Stock Price $4.79
Equity Cap 47.4
Enterprise Value 40.8
EV/2012E Revenue ($50.0) 0.8x
EV/2012E EBITDA ($11.0) 3.7x
Eq Cap/2012E Net Income ($8.0) 5.8x
EV/LTM EBITDA ($8.6) 4.8x – but this does not have full year of smilebox
Note: The above is not pro forma a $10mm bank loan the company took out after the end of the quarter, but the debt doesn’t change any of the multiples.
WHY HAS STOCK TRADED DOWN
1) The decision to discontinue the previously high dividend resulted in many yield investors abandoning the stock.
2) When the company announced the Smilebox acquisition, management was too conservative in “selling” the deal to the investment community. While the acquisition is now exceeding expectations, some impatient investors sold their stock.
3) The Smilebox acquisition was initially dilutive as it was a unprofitable under its former ownership. The dilution and uncertainty regarding the ability to make Smilebox profitable scared off some investors. Note: Management has successfully turned around Smilebox by reducing costs and increasing revenue. Smilebox’s profit has increased from an EBITDA loss of $1.5 million in 2011 to a projected gain of $2.0 million in 2012E. In addition, management has stated that its future acquisitions will be of companies that are already profitable and whose profitability can be easily further enhanced under PERI’s ownership.
4) Deceiving information on databases make this stock appear more expensive than it really is because:
- Recent reported results include some non-cash and non-recurring items which PERI excludes in calculating its Adjusted EBITDA. Unfortunately, many databases have not excluded all these items from their calculations, so PERI appears to have a much higher valuation than it really does. For example, YHOO shows LTM EBITDA of $4.9 million but PERI’s Adjusted EBITDA is really $8.6 million or 75% higher.
- PERI acquired Smilebox last August, so LTM figures do not reflect a full year’s contribution from that deal (although the enterprise value does).
1) In addition to the free cash flow its generating, PERI has a valuable intangible asset in its user base (13.3 million installed base). Management can extract meaningful value from this user base by making additional acquisitions and cross selling the acquired company’s products to PERI’s existing user base.
2) Although the company is based in Israel, it does very little business in Israel or the middle east.
3) Management is excellent (particularly for a company this small). Although they are based in Israel, both the CEO and CFO are bilingual and eager to speak with investors.
4) Net cash represents approximately 15% of the equity market cap.
5) We believe PERI is a logical buyout candidate considering its attractive user base, high free cash flow, low valuation, and the meaningful synergies a buyer could extract. While we don’t believe any deal is imminent, overtime, as the company either grows or fails to create shareholder value, we believe the chances of a buyout occurring increase dramatically.
1) Strong earnings announcement when they report on August 8. We believe the earnings will provide investors confidence that the full year guidance is achievable.
2) Possible beat of analyst’s estimates which are currently below the company’s guidance.
3) Increased/Improved IR – Management has recently hired a new IR firm (Hayden IR), is revamping its PPT to make it more effective in telling the story and will be doing additional IR throughout the year.
4) “Cleaner” EBITDA – Overtime, there will be fewer non-recurring items in reported results and which will make the company screen better on various databases.
5) Acquisition – Management is looking for an acquisition that will give it additional scale and scope and that will enable it to further lever its existing customer base and other soft assets. Management is conservative and disciplined so we do not expect them to do a foolish deal. Furthermore, given their healthy balance sheet, they shouldn’t need to use much equity to finance a deal.
Disclosure: The author of this article has or may initiate a position in the security at any time.