March 11, 2012 - 11:43pm EST by
2012 2013
Price: 13.58 EPS $0.00 $0.00
Shares Out. (in M): 56 P/E 0.0x 0.0x
Market Cap (in $M): 760 P/FCF 10.0x 9.0x
Net Debt (in $M): 100 EBIT 0 0
TEV (in $M): 860 TEV/EBIT 0.0x 0.0x

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  • Software
  • Highly Cash Generative
  • Deleveraging
  • IT Security


Investment thesis – LONG

AVG is a recently-broken IPO with immediate catalysts.  Although the company has been a cash generating machine with projected 2012 revenue growth of 15%, its stock currently trades at 10x TTM FCFF and 9x NTM FCFF.  AVG has traded below its $16/share IPO price because investors are concerned about (1) subscriber growth, (2) operating margin, and (3) its relationship with Google.  However, I believe the market is under-appreciating a large active user base which AVG has found ways to monetize effectively.  I believe AVG should be valued closer to $18-20/share at 11-12x 2012 EV/FCFF (35-50% upside) given its growth rate vs. peer Symantec.  There are a couple of catalysts that should help drive AVG’s share price over the next few weeks.  First, the underwriters (GS, MS, JPM, Cowen and JMP) will be issuing initiation reports this coming Tuesday (March 13).  Given that the current stock price is 15% below its IPO price of $16 and AVG just raised 2012 numbers above those of the syndicate, I’d expect mostly (if not all) positive ratings.  Second, management is starting to meet with potential investors after reporting its first post-IPO quarter.  With only 14% of total shares floated, any positive exposure should boost the stock price.


Company background

AVG’s predecessor was founded in 1991 as a computer IT security company.  In 2000, AVG introduced a free version of its anti-virus (AV) software to consumers, thus paving the way for its successful freemium model of today.  Since 2006, AVG has made numerous bolt-on acquisitions in security software to augment its premium product offerings.  Today the company has over 108m active users and 15m paying subscribers.  AVG’s free AV software is one of the most downloaded software in CNET’s download.com website with over 400m downloads.  It’s also the second most popular software in recent weekly chart with over 1m downloads per week.  AVG went public on February 2, 2012 with the initial offering of 8m shares (4m primary) at $16/share.  The main stock holders include TA Associates, PEF, Grisoft and Intel Capital.


Business model

AVG’s success has been largely based on the freemium business model: give away its base product for free and monetize the user base by up-selling premium versions and with other means.  AVG uses the Internet to widely distribute its free AV software and build a large installed base at low acquisition costs.  AVG’s free AV software is a fully functioning version, extending beyond the 30-day trial offered by traditional vendors such as Symantec and McAfee.  It’s also important to note that AVG’s free AV software is highly rated by reputable reviewers such as CNET and is comparable to the paid versions from Symantec and McAfee.  Because the product is high quality and free, AVG’s freemium model has become a disruptive force to traditional consumer security leaders such as Symantec. 


AVG monetizes its large and growing user base through two ways: subscription and platform-derived revenues.  For subscription revenue, AVG sells annual software licenses to its free AV users who upgrade for additional premium products such as firewall, anti-spam, ID theft, PC optimization, online backup, mobile devices.  For platform-derived revenue, Google pays AVG for online search traffic that AVG sends via its safe-search toolbars that active users downloaded.


Subscriber growth

AVG’s active user and paying subscriber count have stalled in the past couple of years.  This is perhaps the biggest concern among potential investors.  However, I believe the market has not given credit to AVG’s most valuable asset: a large, albeit slow-growing, base of 108m active users that stay engaged with AVG via ongoing AV protection (free or paid).  In turn, AVG has continued to find ways to better monetize this installed base and increase ARPU.  First the company has made bolt-on acquisitions in security software to augment its premium product offerings.  Second, Google-related revenue has continued to grow at a rapid rate.  In the just reported Q4 results, AVG saw its subscription and platform-derived revenues grow at 16% and 24% annualized rate, respectively (annualizing sequential quarterly growth).  For 2012, total revenues are expected to grow at 15%+.


Operating margin

AVG’s operating margin has declined the past two years.  GAAP operating margin declined from 33% in 2009 to 25% in 2011.  There are two contributing factors: (1) costs of going public; (2) acquisitions.  The recent acquisitions are adding material operating expenses but providing little in immediate revenue recognized due to a subscription-based model.  AVG believes that it will gain back operating leverage as it up-sells the premium offerings from these acquisitions.  AVG should see some margin expansion in 2012.  Longer-term, the target operating margin should trend back to the mid 30s.  Importantly, AVG continues to generate substantial free cash flow with $90m in 2011 and projected $100m+ in 2012.


Google contract

Google contributed about 37% of AVG’s revenue via platform-derived advertising revenue.  AVG’s current arrangement with Google expires on September 30, 2012.  There has been some concern about whether Google would continue its relationship with AVG.  I believe the more relevant question is why Google would NOT want to continue.  InteractiveCorp/IAC’s relationship with Google would indicate such deal would be renewed on favorable terms.  Google currently contributes 47% of IAC’s total revenue via search advertising on IAC’s sites and toolbars.  IAC faced similar investor concerns whenever Google’s contract expiration date approached, but IAC was able to renew each time: first thru 2012, now thru 2016.  In fact, IAC’s Google-related revenue has grown substantially since the prior renewals.


Positive sellside initiation coverage

Increased exposure to investment community

Upsell additional premium products

Further monetization of traffic

Deleverage the balance sheet

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