DOLAN MEDIA CO DM
May 17, 2010 - 10:24am EST by
skca74
2010 2011
Price: 13.15 EPS $1.03 $1.15
Shares Out. (in M): 30 P/E 12.8x 11.5x
Market Cap (in $M): 397 P/FCF 6.8x 6.7x
Net Debt (in $M): 146 EBIT 55 67
TEV ($): 544 TEV/EBIT 10.0x 8.0x

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Description

Investment Thesis:

DM is a busted IPO trading at 5.3x 2011 EBITDA vs. historical range of 8-10x (trading range at the time of the IPO in 2007) despite showing significant growth in revenues and margins during the last several years.  The overhang on the stock exists because the Street believes foreclosures have peaked and that the majority of DM's revenue will be declining in the coming years. We believe this business is not dead yet and there is likely another wave of home foreclosures in the back half of 2010 and beyond, as many variable interest rate mortgages adjust.  Additionally, DM has "growth" revenue streams (revenue streams that do well in a booming economy as well) that should see improvement as we make our way out of the recession.  This includes classified and circulations revenues.  A recent acq of DiscoverReady should provide "any" economy type revenue, as this is a service invaluable to the legal profession.  Q1, 10 revenues in this group exceeded expectations, up to 9.7m from 4.9m the prior year (before DM owned the business).  With the stock at 6.2x 2011 FCF with minimal capex requirements and still strong growth prospects, the company should trade at a minimum of 10x 2011 FCF of about $65MM, which equates to $20-$21/share or 50-60% upside from here.

 Business Description

Founded in 1992 and based in Minneapolis, MN, The Dolan Company ("DM"), formerly Dolan Media Company, is essentially a roll-up of professional services and business information services to legal, financial, and real estate sectors in the United States.

 Professional Services Division

DM's Professional Services division consists of two further subdivisions - mortgage default processing through NDex and litigation services through Counsel Press and DiscoverReady.   DM's mortgage default processing primarily services California, Florida, Georgia, Indiana, Michigan, Minnesota, and Texas. It assists law firms and other customers in processing foreclosure, bankruptcy, eviction, and litigation and other mortgage default related case files in connection with residential mortgage defaults; offers real estate title services; and provides loan modification and loss mitigation support on mortgage default files. DM also offers litigation support services, such as procedural and technical advice services to law firms and attorneys in organizing, preparing, and filing appellate briefs, records, and appendices in paper and electronic formats through Counsel Press. As a way to counteract the cyclical nature of its mortgage default processing business, DM acquired an 85% interest in DiscoverReady in November 2009.  DiscoverReady provides discovery management and document review services. 

 The Business Information Division

The Business Information division provides various information products consisting of print and online business journals; court and commercial newspapers; and other electronic media offerings. As of December 31, 2009, it published 64 publications comprising 11 paid daily print publications, 23 paid non-daily print publications, and 12 non-paid non-daily print publications, as well as 18 publications that are provided through online or email. This segment also provides business information services through its 39 event and other non-publication Web sites, and email notification systems.

 

Investment Highlights

Mortgage Default Processing Business Not Dead Yet

  • Continued Growth and Revenue from Foreclosures.   Management believes that there remains substantial foreclose backlog that could take them through 2018. Delinquency rates for mortgage loans on 1-4 unit residential properties fell to 9.47% by the end of Q4'09, up 159 bps y/y and does not include loans already in foreclosure process. Additionally despite recent headlines that foreclosures have peaked, it is more likely that foreclosures have just stalled/delayed by recent federal and state intervention.  Many states have enacted limits on the amount of foreclosures files DM can do in a given period. Michigan, an important state for the company, has added steps to the foreclosure process. On a federal level, many servicers are voluntarily reducing flow of files due to political pressures. The backlog of homes underwater and likely to foreclose continues to be large but the timeline maybe be extended.  According to Lender Processing Services, Inc. ("LPS"), a mortgage data research firm, "...there are millions more potential foreclosures ahead. Nearly 7.4 million borrowers, or 12 percent of all households with a mortgage, had missed at least one month of payments or were in foreclosure as of March [2010].  LPS also stated on their earnings conference call that revenue for their default revenue streams should see a steep increase, indicating another year of heavy foreclosure activity as lenders begin clearing out seriously delinquent loans.  Management has stated that they have a backlog of seriously delinquent loans - about 1.5 yrs of inventory not yet processed. Through 2011, growth is expected to be in the high single digits and continue at a slower rate until normalized levels around  - 2018-2019. RealtyTrac, Inc., stated  in April of 2010 that in Q1, "...more homes were taken over by banks and scheduled for a foreclosure sale than in any quarter going back to at least January 2005.  Foreclosure filings were reported on 367,056 properties in March, an increase of nearly 19 percent from the previous month, an increase of nearly 8 percent from March 2009 and the highest monthly total since RealtyTrac began issuing its report in January 2005.

 

  • Growing Share of Fragmented Market.   DM is also growing its share of the mortgage default processing business through acquisitions. Most recently in October 2009, it acquired the mortgage default processing and related services business of Florida-based Albertelli allowing it to provide mortgage default processing services through NDeX in Florida.

Barriers to Entry.   

  • Long Term Exclusive Contracts With Law Firms Customers.   DM has long term (25 year with opportunities to extend) relationships with eight major law firms through which is does its mortgage default processing business. One of the larger clients - Trott & Trott - has 2/3 of the market share in Michigan and ¾  share in Texas.  Those exclusive and proprietary relationships make it difficult for another competitor to enter into the space.  
  • Proprietary Technology.   Another barrier to entry is DM's two proprietary case management software systems  for  its mortgage default processing business.  This software system is used to store, manage and report on the large amount of data associated with each foreclosure, bankruptcy, eviction or litigation case file. The system follows state specific rules so it's very customizable and scalable.  It is also very difficult to replicate.

 

Growth Engine via DiscoverReady (acquired for $32MM cash)

DM is focusing on increasing its revenue from non-recession legal activities. This has been cemented by the acquisition of DiscoverReady in November of 2009 which will help the legal industry electronically manage the discovery process - currently a hugely time-consuming and expensive process. This segment should see substantial growth in the near future, as law firms focus on improving their efficiency and manage costs.  Growth is accelerating in this business segment with the current Q12010 revenue runrate of $40MM (which was a 100% increase from Q12009.)

 Valuation.

DM is cheap on most metrics (trading at less than 6.0x EV/EBITDA, down from a peak of 8-10x) with considerable upside from the current price of $13/share. Looking out a few years, the company will generate about $120MM in free cash flow over the next 2 years.  Even if foreclosures slow down significantly by 2012, the company will be trading at around 4x FCF taking the cash into account.  At this price, there is a significant margin of safety and if we are right about the foreclosure wave still continuing over the next few years, there is upside to the low $20s.

In Thousands

 

 

 

 

 

 

FYE

2007A

2008A

2009A

2010E

2011E

2012E

Revenue

$151,989

$189,946

$262,917

$309,882

$336,915

$342,938

Revenue Growth Rate

36.1%

25.0%

38.4%

17.9%

8.7%

1.8%

 

 

 

 

 

 

 

GM%

66.0%

64.2%

63.5%

63.1%

63.4%

63.8%

OM%

21.2%

18.0%

21.1%

21.5%

21.7%

21.9%

 

 

 

 

 

 

 

EBITDA

$43,573

$51,787

$81,916

$94,230

$102,519

$104,479

Capex

       (7,281)

       (6,601)

       (3,050)

       (4,500)

       (4,500)

       (4,500)

Cash Interest

        5,238

        7,340

        6,834

        7,136

        7,200

        7,200

Cash Taxes

        6,941

      10,607

      13,658

      22,953

      25,407

      26,148

FCF-E

$24,113

$27,239

$58,374

$59,641

$65,412

$66,632

 

 

 

 

 

 

 

EV/Sales

3.6x

2.9x

2.1x

1.8x

1.6x

1.6x

EV/EBITDA

12.5x

10.5x

6.6x

5.8x

5.3x

5.2x

EBIT/EV

5.9%

6.3%

10.2%

12.3%

13.4%

13.8%

MV/FCF

16.5x

14.6x

6.8x

6.8x

6.2x

6.1x

 

Market's View

DM trades at a discount to its historical valuation and the market due to the Street's belief that home foreclosures have peaked and will soon drop precipitously, eliminating 50% of DM's revenue stream.   Any news that the economy is improving erroneously sends the shares south.  The mortgage default processing business will continue to have runway long past 2010. Management believes it can continue through 2018 before normalizing. In the meantime, DM is focused on building its cyclical business revenues through acquisitions such as DiscoverReady.  Additionally, DM was originally classified as a publishing company. When grouped in an industry that is facing secular headwinds (new technology making many forms of publishing obsolete) and economic pressure, DM had little chance to break out of the pack and garner credit for its successes. Recently the firm was reclassified to a research and consulting firm, which should help boost its multiple vs. its old peer group and should put it on the radar of large investors as they do their investment screens.

 

Risks:

-Legislation to delay or reduce foreclosures by renegotiating mortgages

-Incorrect market belief that foreclosures have peaked and will drop precipitously post 2010

-Inability to fully integrate and grow DiscoverReady business    

Catalyst

Continued and slow decline in number of foreclosures
Continued growth in DiscoverReady trends
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