I am advocating Alloy, Inc.
(ALOY) as a long based on numerous catalysts this year (including upcoming
earnings), thereby raising visibility of the company (and its cheap valuation)
to both public market investors and ultimately to strategic buyers. ALOY trades at 3.4-4.1x 2008E EBITDA, based
on management’s range of guidance which was provided on December 5, 2007 (among
the catalysts is my expectation that guidance will be reiterated in the next
couple of weeks when earnings are announced).
This valuation doesn’t account for NOLs (over $35M as of July 2007). If one adjusts for NOLs, ALOY is trading for 2.9-3.5x
management’s EBITDA guidance. Based on
EBITDA guidance and $8M of anticipated capital spending, the implied FCF yield
at the current stock price is ~15-20%.
reasonable downside protection. If the company were to miss the low-end of
guidance ($20-24M EBITDA on $225-240M Revenue) by 25%, this implies a current
valuation of 5.4x EBITDA (unadjusted for NOLs) for a company strongly
positioned with marketers/advertisers seeking to penetrate the Gen Y community
through non-traditional approaches.
Based on the company
achieving the mid-point of guidance (which I try to validate in some detail
below) and trading at just 6x EBITDA, the company could soon trade to ~$12
(over 65% upside) as visibility from results improves that supports
management’s guidance. More importantly
though is greater upside that could materialize over the next two years, based
on successful execution of the Channel One strategy coupled with the on-line ad
network business growing (both described below). In the case that both of these businesses
grow as management envisions, it’s likely that EBITDA will be $35M in
2010. At just 6x, this implies a stock
price of $17 (over 135% upside).
However, if management does achieve $35M of EBITDA in 2010, the
valuation multiple is more likely to be above 6x (each multiple point, with no
change to current shares outstanding, is ~$2.50 of change to share price). The company has a strong balance sheet and
continues to buyback shares.
Summary Company Description
ALOY is almost exclusively
focused on marketing to the Gen-Y demographic (specifically 10-24 year old) and
is primarily engaged in the fastest growing sectors of marketing/advertising to
reach the Gen-Y demographic for its clients.
Alloy is a beneficiary of advertising/marketing growth/mix shift to
The company serves over half
the Fortune 500 and nearly every major advertising agency. ALOY’s clients have recently included
McDonald’s, Wal-Mart, Proctor & Gamble, Heineken, Unilever, Cadbury
Schweppes, Burger King, Burt’s Bees, Clinique, Ford, Paramount, Verizon
Wireless, AT&T, and Sprint.
ALOY’s businesses are
segmented across three reported segments:
Media, Promotion, and Placement.
The Media segment (~30% of 2007 revenue) provides the most potential
upside given fixed cost leverage, undermanaged assets (sellout of out-of-home
billboard inventory is less than 50%) and from its recent acquisitions
(including Channel One, which is described more thoroughly below).
- Display Media Boards
- Over 65,000 display media boards enable
out-of-home/billboard advertising across college/high school campuses (~60%
of total display boards) and bars/restaurants/fitness centers
- National in-store advertising and display
network (Frontline acquired in April 2007) comprising ~7,000
- Channel One Network (acquired April 2007)
- 12-minute program to over 8,500 middle/high
schools (includes two minutes of age appropriate commercial time
advertising); on a daily basis, Channel One reaches over 6M teens through
- Internet advertising (primarily via the
company’s on-line advertising network described more below in the forecast
- 17 million unique visitors within the company’s
online network in December, up from less than 10 million in the prior
quarter; according to their network, called TEEN.com, current uniques are
- Owned Alloy sites include: dELiAs.com, Sugarloot.com, Sconex.com,
- Database of over 20 million Gen-Y names
leveraged for direct marketing by the company and others (for a rental
- Specialty print (college and career guides)
- Entertainment (a “creative think tank” that
develops and produces original books, television series, and feature
- Largest packager of books for teen market; over
thirty new books per year (Gossip
Girl, The A-List, The Sisterhood of the Traveling Pants)
- Currently-televised Gossip Girl on CW Network
- Upcoming film sequel to The Sisterhood of the Traveling Pants)
The Promotion segment (~45% of 2007 revenue) conducts sampling, event
and field marketing, consumer research, and on-campus marketing (approximately
one-third of segment revenue and includes residence linen, care packages, and
diploma frames). On the recent earnings
call in December, management highlighted 83% of the revenue generated by Alloy
in 2007, from its main promotion business, is already pre-booked for 2008 two
months prior to the start of fiscal year 2008.
Moreover, the typical pattern for Alloy’s promotion business is that
another 50% is usually booked during the year; this is among the reasons
Alloy’s management team conveyed their guidance for 2008 with confidence.
The Placement segment (~25% of 2007 revenue) is strictly an agency
business (generating a margin of 11-12%) representing third party media
properties that cater to the Gen-Y community.
For example, if a client wants to advertise to reach the college
demographic and the client’s advertising campaign is being directed through
newspapers, that client will reach out to Alloy as the placement agency; this
is by far more efficient than a client like McDonald’s conducting a national
advertising campaign and contacting all the major universities on their
own. Alloy estimates its market share
for placing national advertising in college newspapers is 85%. The company also serves as a placement agent
in multicultural and military newspapers, and is also a buyer of radio/other
media on college/high school campuses for its clients.
Valuation / Financial / Forecast Summary
Based on guidance, ALOY is cheap. The valuation coupled with numerous catalysts
is both a source of downside and upside.
Therefore, the key question is whether guidance is reasonable. The company doesn’t frame their guidance
specifically by segment but I attempt to do so below in an effort to validate my
perspective that guidance appears reasonable.
In FY 2007 (i.e., CY 2006
since FY ended January 31, 2007), ALOY generated the following Revenue and EBIT
Promotion Media Placement Corporate Total
Revenue $96.0 $46.3 $53.8 NA $196.1
EBIT $11.1 $6.6 $5.6 ($10.7) $12.7
D&A $0.8 $1.8 $0.0 $0.8 $3.4
Stock-based $0.5 $1.0 $0.1 $1.1 $2.8
EBITDA $12.4 $9.4 $5.7 ($8.8) $18.9
% Margin 12.9% 20.3% 10.6% NA 9.6%
Because of two acquisitions
completed in 2007, including Channel One which creates a host of accounting
issues (described below) that clouds the transparency of recent CY 2007
results, and also because 2007 results have yet to be announced, I use CY 2006
as my baseline from which to describe how the company is likely to achieve 2008
guidance of $20-24M in EBITDA. The
summary of my estimates for 2008 is shown immediately below; the rationale for
these estimates is described in more detail below this summary.
Promotion Media Placement Corporate Total
Revenue $90.5 $89.4 $50.0 NA $229.9
EBITDA $11.8 $13.0 $5.0 ($9.8) $20.0
% Margin 13.0% 14.5% 10.0% NA 8.7%
As described above,
management highlighted in December that the visibility of bookings was strong
at 83%. The promotion business is
inherently lumpy but also inherently attractive as marketers / advertisers seek
non-traditional channels to penetrate targeted demographics. For the nine months ended October 31, 2007, although
promotion segment revenue was down 14% yoy, the company’s operating income was
down just 3.5% as management pruned some less profitable business
activity. For 2008, given the comments
regarding strong visibility, I assume ALOY’s promotion segment grows 7% yoy
from 2007 and a 13% EBITDA margin is generated (consistent with 2006). I assume the promotion segment will generate
$84.6M in revenue in 2007 (this is derived from the nine months ended October
31st adjusted to account for the seasonality of the business such
that the first nine months is roughly 80% of the annual segment revenue). Based on 7% yoy top-line growth and EBITDA
margin of 13%, the revenue and EBITDA for promotion segment is assumed as
$90.5M and $11.8M, respectively. During
the call in December, management said that the visibility of the pipeline
provided confidence that promotions would return to the level achieved in 2006
Since there were two
acquisitions made in this segment last year and since the internet part of
Alloy’s business is growing very quickly, I will address the “legacy” media
segments first. I view 2006 as a good
baseline for such in light of Alloy having virtually no internet business
then. In 2006, the media segment
generated $9.4M EBITDA on $46.3M of revenue.
I think this business has been flat at best but I am going to assume
revenue is down 5% to $44M and EBITDA declines by $1.2M (assumes 50%
contribution) such that the “legacy” media segment is $8.2M.
During April 2007, Alloy acquired
Frontline Marketing, a national in-store advertising and display network
comprising displays located in ~7,000 grocery/other stores. The company paid ~$6.0M for the business plus
agreed to pay a potential earn-out of up to $7.2M based on EBITDA performance
over the next three years. Although no
figures were disclosed, it is estimated that Frontline was generating $1.2M of
EBITDA. I assume EBITDA grows 5% and
EBITDA margin is 15% (i.e., $8.4M Revenue, $1.3M EBITDA).
Also during April 2007,
Alloy acquired the operating assets of Channel One Communications. The transaction was with PRIMEDIA by which
Alloy received $8.6M of working capital, of which $5.0M was cash, by assuming
certain liabilities of Channel One, with ~$8.6M value. Subsequent to the transaction
announcement/closing, the actual value of certain assumed contract obligations
and severance agreements was determined to be just $3.1M. Therefore, Alloy recently recognized an
extraordinary gain of $5.5M. Because of
the acquisition of Channel One, the media segment’s results are difficult to
analyze without isolating Channel One.
Channel One’s business model
is relatively simple. The business
debuted in 1989 as the first news program beamed directly into schools. In exchange for TV equipment for each school,
Channel One provided a 10-minute daily news program with two minutes of ads.
controversial, the advertisements are age appropriate and not the junk
food-type. School principals have the
authority to preview/block ads.
Advertisers include the Armed Forces, Gatorade, New Line Cinema, and
Alloy was prudent to
recognize its core competency did not include originating video content on a
daily basis but rather its strong relationships to thousands of marketers
seeking to reach the Gen Y community through non-traditional media. Therefore, shortly after the Channel One
acquisition, Alloy entered into an arrangement with NBC whereby NBC would
program the ten minutes in exchange for some inventory that NBC gets to sell.
Since ~$10M of capital was
spent last year (of the total company $14.6M in capx) to upgrade Channel One
technology to digital, Alloy’s Channel One now has two-way communication,
better compliance and participation.
Management reported in December that Nielsen ratings were up 15-20%, on
I am not asserting anything
by the following except it’s interesting for context to note that KKR’s
PRIMEDIA bought Channel One in 1994 for $300M.
My research evidences Lazard was interested in buying the business for
$750M in 2000. Channel One complements
Alloy strategically and Alloy’s arrangement with NBC reduces Alloy’s break-even
to ~$20M (i.e., Alloy needs to sell $20M of Channel One inventory). According to the CEO, the sales capacity for
Channel One is ~$70M and he envisions ultimately selling $30-35M but I am not
comfortable ascribing probability to that potential outcome in advance of
visible traction. I am confident,
however, asserting that Channel One is a valuable asset because of the captive
audience marketers seek to reach but is notably hard to do through traditional
During the call in December,
management said Channel One would contribute to profitability this year and was
already breakeven in the last quarter. I
assume that revenue in 2008 is $22M and EBITDA is $2M. I don’t think it’s a stretch for this
business to ultimately generate $10M of EBITDA by 2010 if the business plan is
The next critical incremental contributor to the media segment is the online ad
network called TEEN.com. If you didn’t
see the WSJ article on page B3 on February 25th, I encourage you to
review such for context. According to
the article, Glam Media is being valued at $500M by a variety of VCs. The article reinforces the secular growth
trend among online advertising networks.
Such networks sell ads that appear on an array of other Web sites and
sometimes their own sites. These
networks have gained traction recently as advertisers seek to reach groups
(e.g., teens) of consumers beyond the main portal properties. According to the WSJ article, Glam is
targeting $100M of revenue this year. As
a value investor, I am not quick to embrace that Glam is “worth” 5x revenue but
I share it for context because it highlights enormous potential upside at Alloy
from improved visibility of the growth expected from its on-line ad
network. Alloy’s network is now ~20
million in unique users compared to Glam at 25 million.
I don’t know the magnitude
of revenue being generated from Alloy’s internet businesses but there is much
traction in executing its strategy in this secular growth opportunity as
evidenced by the unique users among its owned and publisher sites having grown
by over 5x in less than a year. There is
increasing evidence of advertiser, publisher, and investor interest for on-line
ad networks. Alloy was strongly
positioned to launch their business because of the thousands of relationships
it has with marketers who know Alloy as a platform through which to target the
Without the internet
segment, I’ve described media in aggregate summing to an estimated $11.5M of
EBITDA in 2008 ($8.2M for “legacy”, $1.3M for Frontline, $2.0M for Channel
One). To achieve management’s guidance
of $20-24M of EBITDA this year, there is an implied (based on the other
segments described above and below) $1.5-5.5M required from Alloy’s internet
businesses (i.e., primarily the on-line ad network). I will use the reported Glam Media $100M of
revenue on 25 million uniques for context and assume that Alloy’s TEEN.com is
therefore likely to generate $15-30M of revenue at 10-20% margin on 20 million
uniques. I think I am being conservative
based on my research of other on-line ad network activity. I assume the low-end of the range in the
summary I shared above (i.e., $1.5M from Alloy’s internet business).
Although Alloy’s position in
this market is dominant, we can probably all agree that it’s a niche market in
decline given the increasing importance (and area of focus by Alloy) of
alternative / new media. For the nine
months ended October 31, 2007, the placement segment revenue was up 2.8% yoy
and operating income was up 3.6%.
Although EBITDA for placement was $5.0M through October 31st
and will likely finish the year at ~$5.8M, I assume EBITDA for placement in
2008 is lower, at $5M, on lower revenue (assume $50M) because of further
displacement of newspaper advertising.
As a small public company,
Alloy has a substantial fixed corporate cost structure as a percentage of
revenue. I believe (and I know some
major shareholders agree) the company’s corporate expenses are unreasonably
high. It is possible that major
shareholders agitate for change in such regard.
I also think that the ultimate upside will materialize from a strategic
takeout which will presumably ascribe some value to the elimination of corporate
redundancies, including public company costs which amount to $1-2M.
For 2008, I assume $9.8M of
corporate expense (in line with run-rate as of October 31st) when
adding back stock-based compensation and D&A.
Why does this attractive opportunity exist?
There are a variety of
reasons the opportunity exists and some require patience among investors to
monitor the improved visibility from execution and results. A key reason the stock is so cheap is simply
because it’s a micro-cap (i.e., there are many cheap micro-caps nowadays). Another reason is because there is no
meaningful research coverage to elevate the company’s profile with the investor
community. Another reason is because the
guidance seems like a leap of faith without spending time with some of the
details to understand the reasonableness (I hope I’ve assisted you in this
regard) and especially since last year’s numbers are clouded by the
acquisitions and the absence of the on-line ad network growth.
What might drive the stock (i.e., catalysts)?
- Channel One and the on-line advertising network
are among the key enablers to catapult the company’s presence with
marketers and the investment community (the latter being if EBITDA growth
materializes as envisioned)
- Upcoming earnings that highlights recurring
strength at Channel One and reinforcement of $20-24M EBITDA guidance
- Improved transparency of the contribution from
the on-line ad network (expect this to become increasingly important and
therefore a source of questions by existing investors and some answers by
- Potential activity by major shareholders if
results don’t materialize as guided / envisioned (corporate expense
structure would be among areas of likely focus)
- Ultimately a consolidation premium as increased
interest develops for non-traditional advertising and Alloy evidences its
strong position that can be further leveraged by larger strategic
- Continued buyback activity
1. Channel One and the on-line advertising network are among the key enablers to catapult the company’s presence with marketers and the investment community (the latter being if EBITDA growth materializes as envisioned)
2. Upcoming earnings that highlights recurring strength at Channel One and reinforcement of $20-24M EBITDA guidance
3. Improved transparency of the contribution from the on-line ad network (expect this to become increasingly important and therefore a source of questions by existing investors and some answers by management)
4. Potential activity by major shareholders if results don’t materialize as guided / envisioned (corporate expense structure would be among areas of likely focus)
5. Ultimately a consolidation premium as increased interest develops for non-traditional advertising and Alloy evidences its strong position that can be further leveraged by larger strategic
6. Continued buyback activity