InfoSpace, Inc. (NASDAQ: INSP) has been a frequently cited poster child of the dot.bomb era and has been prominently and frequently mentioned in connection with the Merrill Lynch analyst controversy. Its market capitalization has paid the price, decreasing from an unrealistic peak of more than $30B at the height of the dot.com boom to its current $133M. To avoid NASDAQ delisting, InfoSpace recently announced a 10 to 1 reverse stock split which resulted in a substantial reduction in its already diminished market capitalization. However, unlike the many other dot.coms that never had a “real” business, InfoSpace has 2 sustainable business units generating in excess of $100M of annual revenue on a near break-even basis and has cash and investments available for sale totaling more than $270M with no debt. The market is valuing INSP at an enterprise value net of cash and investments of approximately negative $140M. As described below, the value of InfoSpace’s business is worth considerably more.
InfoSpace has three business units, (1) Wireline and Broadband, (2) Merchant Services and (3) Wireless. The Wireline/Broadband and Merchant Services Business Units generate 78% of InfoSpace’s revenue and have promising futures. The Wireless Business Unit’s customer base is comprised the struggling debt laden wireless carriers and is facing a difficult time in the short-term.
The Wireline/Broadband Business Unit provides private label syndicated services, such as Web search, directory services (including yellow pages, white pages, maps and directions), and a comprehensive platform of other content to destination Web sites, such as MSN, and to DSL (Digital Subscriber Line) and cable-modem Internet Service Providers. The Wireline/Broadband Business Unit generated more than $13M in revenue in Q2 2002 with a gross operating margin of approximately 40%. InfoSpace is continuing to invest in and grow this business as evidenced by its recent release of an updated Web meta-search capability and the signing of Cablevision as a new broadband customer.
The most exciting of InfoSpace’s business lines is its Merchant Services Business Unit. Merchant Services has several offerings including credit and debit card authorization services, online yellow pages directories, universal stored value solutions and turnkey ecommerce solutions for small and mid-size merchants. InfoSpace's channel for selling merchant services has grown to include more than 1,200 resellers. InfoSpace's payment solutions are of particular interest. InfoSpace processed more than $1.5 billion in payment authorization transactions in Q2 2002 (20 million transactions), up from the $1.3B (and 16 million transaction) reported in Q1. It is my understanding that there are two main components to credit and debit card processing – first the authorization and second the billing/payment processing. FirstData dominates the billing/payment processing (it shares the market with 7 other processors) whereas InfoSpace competes with VeriFone in the authorization sector. InfoSpace is one of the leaders in authorization for the rapidly growing Internet and wireless credit and debit card transactions and is paid a fee for each authorization transaction. InfoSpace is also handling ecommerce merchant services for American Express with respect to American Express’ cardholder redemption website. The Merchant Services Business Unit generated $12.6M in revenue in Q2 with gross margins of 75%. InfoSpace is spending resources to grow this business line by, among other things, developing a new payments architecture designed to deliver the next generation electronic payment capabilities, including eCheck, eDebit and stored value technologies, to merchant service providers and financial institutions. For example, in Q2 InfoSpace released stored value products where consumers utilize a Web interface to create and load value to branded credit cards, such as Visa and MasterCard that can be used at the point-of-sale in both the physical and virtual world. Consumers are able to utilize the Web to check balances and statement information, as well as add additional funds.
As stated above, the Wireless Business Unit is having a more difficult time in the current market. The Wireless Business Unit offers turnkey platforms to wireless carriers that enable the carriers to offer private label branded content, ecommerce capabilities, SMS messaging, corporate email access and application management capabilities for deployment wirelessly to their customers. This Business Unit generated $7.4M in revenue in Q2, but due to its R&D intensive nature and high operating costs totaling over $9M InfoSpace is currently losing money on this business line. Given the short-term revenue growth opportunities in the wireless sector, InfoSpace is looking at ways of cutting back its short-tem investment in this Business Unit.
In short InfoSpace has appeared to stabilize its business with an annual revenue rate in excess of $130M and has reduced its annual cash burn under the current mode of operation to $5M per quarter. If the anticipated reductions occur in its Wireless Business Units take place, the company could be at or near cash flow breakeven. In any event, given the prospects of both the Merchant Services and Wireline/Broadband Business Units, it seems that some positive value should be attached to those businesses rather than the current negative $140M value being assigned by the market.
Like any prospective investment, there are some cautionary issues to consider. First, InfoSpace’s CEO, Naveen Jain, is a classic energetic, hyperactive, overpromising, revenue chasing entrepreneur who has limited experience managing a company of this size. However, InfoSpace recently announced that Jain was stepping down as CEO and the company was mounting an executive search for a new CEO. Jain will remain on the board and active in the company which could be problematic. Second, there are numerous shareholder and other lawsuits against InfoSpace. Although the company has insurance that applies to most of these claims, the continued distraction and expense as well as the risk of large damage awards remains a real risk. Nonetheless, given the substantial cash/investment reserves and its decent business prospects, I believe that InfoSpace is substantially undervalued at its current market price.
The company has announced that it is conducting a search for a new CEO and 2 of its 3 business lines are showing profitable revenue growth.