PERION NETWORK LTD PERI
January 02, 2013 - 3:18pm EST by
oliver1216
2013 2014
Price: 8.94 EPS $0.00 $0.00
Shares Out. (in M): 12 P/E 0.0x 0.0x
Market Cap (in $M): 106 P/FCF 0.0x 0.0x
Net Debt (in $M): 15 EBIT 0 0
TEV ($): 122 TEV/EBIT 0.0x 5.1x

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  • Internet
  • freemium model
  • Israel

Description

OVERVIEW

 

Based on management’s very preliminary guidance, in 2013 Perion (“PERI”) should grow organically at least 25% in 2013, and at least 80% in total (including a recently completed acquisition), yet it trades at only 5.1x 2013E ADJ. EBITDA and 6.3x PF LTM ADJ. EBITDA.  (We believe this 2013 EBITDA, which has not been widely publicized, is way too low, so it’s actually trading even cheaper).  Furthermore, the company has limited capex requirements (so free cash flow is very high) and we believe there are several near-term catalysts that should drive the stock price higher.

 

It is unusual to recommend on VIC a stock that doubled last year, but we believe this stock should appeal to value investors once they understand the dramatic changes that the new management team has implemented, including a great acquisition which closed just last month. 

 

 

BUSINESS DESCRIPTION

 

PERI has 3 “products”, although, as discussed below, the company generates most of its revenue by giving away its products for free in return for generating search revenues from people who download the products.   This freemium business model is similar to AVG Technologies’ and Babylon (an Israeli Comp):

 

            1) IncrediMail, an award winning e-mail product sold in over 100 countries in 10 different languages.

            2) 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.

            3) Sweetpack – a great acquisition that closed in December 2012 that offers instant messaging tools (thru a freemium model)

 

 

PERI generates revenue 2 ways:

1)      Search revenue – this is a vast majority of the business.  As part of its freemium model, virtually all of PERI’s products are free (although some consumers pay for more advanced, premium products discussed below).  In exchange for using the product for free, the consumer agrees to use PERI as the default search provider.  User then searches online as usual (powered by google) which generates search and advertising revenue for Peri thru a revenue sharing agreement with GOOG.

2)      Premium revenue – Customers pay for certain richer versions of PERI products.  This is a stickier and better business.  However, it is a smaller part of PERI’s business.  Sweetpack does not have any premium revenue.

 

 

 

See the latest PPT at http://www.perion.com/events-presentations   (look at Dec. 2012) or the 10k for more description of the business.

Note the 5.1x multiple above is really for TEV/ADJ EBITDA, not EBIT.
 

BACKGROUND

 

Since joining the company in the summer of 2010, Perion’s new CEO, Mr. Josef Mandelbaum, has transformed the once sleepy, single product, low growth, high dividend paying company into a more attractive, more diversified, high growth company that is well positioned to capitalize on favorable industry trends and acquisition opportunities.  This transformation, which required the company to discontinue its dividend to allocate cash to more accretive uses, has been accomplished through i) investing in the company’s (previously neglected)  infrastructure, which has led to strong organic growth and ii) two highly successful strategic acquisitions which have provided many benefits.

 

The latest acquisition, which was completed a month ago, was of Sweetpacks, an Israeli company that also utilizes a freemium model.  PERI paid ~ $39mm (net of cash) for a company that had LTM ADJ. EBITDA of $9 mm, will grow ~100% in 2012 and has minimal capex requirements.  This implies a 4.4x purchase price multiple.  Furthermore, the company expects to generate $2-3mm of cost saving from the acquisition, which would reduce the multiple to 3.4x.  While Sweetpack is unlikely to grow 100% again in 2013, it should continue to grow meaningfully.  Besides being a highly accretive acquisition, the deal also is great because it significantly improves PERI’s management team with the addition of Nadav Goshen, who had been running Sweetpack.  Goshen had been largely instrumental in Babylon’s (and Sweetpack’s) significant growth and brings to PERI Sweetpack’s strong back office technology and his experience.    

 

 

 

VALUATION

 

The following is pro forma an acquisition that closed last month.

 

Stock Price                                          $8.94

Shares???                                                     11.9

Equity Cap??                                          106.3

 

Cash???                                                       9.1

Debt/Earnout??                                           24.4

 

Enterprise Value?                                 121.7

 

 

 

 

EV/2013E ADJ. EBITDA ($24.0)                           5.1x

 

EV/LTM PF ADJ. EBITDA ($19.3)                       6.3x

 

 

On a back of the envelope free cash flow analysis we assume $24 mm of Adj. EBITDA, 25% cash tax rate on ADJ. EBITDA (a simplistic approach as we dont yet know what d&a will be), 5% interest on the ~ $10mm of debt and $1mm of maintence capex, we get $16.5mm of free cash flow in 2013, or 6.4x EQ/FCF

 

 

 

 

 

WHY 2013 “GUIDANCE” IS TOO LOW

 

(Note: In recent investor presentation, managment has provided ” rough” (my word not theirs) guidance).  LTM Sept. 2012 the combined company generated pro forma $81 (51+30) million of revenue and $19 (10+9) million of ADJ. EBITDA.  PERI has said that 2013 revenue should exceed $100 million and ADJ. EBITDA should exceed $24 million.  This implies LTM to 2013 revenue growth of  about 23%.  The EBITDA margin of  24%  is exactly the same as the PF LTM figure and assumes no operating leverage or cost savings (despite management’s assertion they will generate at least $1mm of cost savings in year one).  Thus we believe this 24% margin is conservative.

 

We also believe the revenue guidance is too low because (i) prior to the Sweetpack acquisition, PERI (standalone) was expected to grow ~ 30% in 2013 and Sweetpack’s business is growing faster than PERI’s; (ii)  Prior to acquiring Sweetpack, PERI standalone was projecting 2012 revenue of $55 million (which it recently stated it would exceed).  Anyone paying attention could tell that this figure was too low as it implied a down sequential Q4, even though management said q4 would be up sequentially.  (we believe management left guidance unchanged last quarter because they didnt want to guide up yet again after having recently done so).  PERI’s sequential, organic revenue growth was up 9% in Q2, up 32% in Q3 and management was very upbeat about q4 (it is rather complicated but in q3 management made a significant change to its technology (how it buys key words) which lead to a meanignful increase in revenue and which makes them very upbeat about the company’s future).  So if instead of using LTM PF we use $56.1 million of PERI standalone revenue (which again is too low as it assume no q4 sequential growth for PERI and that q4=q3)  and assume no growth in q4 for Sweetpack (another unrealistic assumption) that implies that to achieve $100 million of revenue in 2013, the combined company will need to grow only 16% from its 2012 revenue of $85 (55+30).  

 

Investors can make their own assumptions as to how fast Q4 will grow sequentially; Our point is that we believe the current guidance is too low, however, even if they only achieve the current guidance for 2013, we think the stock is still  undervalued.   

 

 

 

 

 

  OTHER CONSIDERATIONS

 

1)      Although the company is based in Israel, it does very little business in Israel or the middle east.  

2)      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.

3)      Non-cash D&A is higher than the (minimal) maintenance capex.  There will probably be an even greater difference between the two in 2013 when the company consolidates the Sweetpack acquisition, so PERI’s true free cash flow will be even higher than one might expect based on EBITDA.

4)      The company was founded by two relatives named Adler.  Neither are involved in the company anymore.  They have been sellers of stock which had been an overhang on the price.  We do not believe they are still sellers of stock.

5)      In addition to the free cash flow it is generating, PERI has a valuable intangible asset in its user 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.  

6)      One of the company’s biggest costs/investments is its customer acquisition costs (buying key words).  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. In Q3, the company’s updated technology enabled it to get a higher ROI on its customer acquisition costs (so management increased its expenditures), which has led to an increase in search revenue and profitability.

7)      One of the company’s biggest costs/investments is its customer acquisition costs (buying key words).  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. In Q3, the company’s updated technology enabled it to get a higher ROI on its customer acquisition costs (so management increased its expenditures), which has led to an increase in search revenue and profitability.

8)      While we do not think a takeover is imminent as management sees too many growth opportunities, we view PERI as an attractive takeout candidate down the road.

9)      Organic growth will come from increased customer acquisitions , new product introductions and new platform introductions.  Acquisitions can be an added source of growth.  Management is experienced and disciplined in its acquisition strategy, however it sees many orphaned companies that must sell (due to timing of the vc funds that are lead investors) and that could be easily integrated into PERI.  All acquisitions will be accretive from day 1.  

 

I do not hold a position of employment, directorship, or consultancy with the issuer.
I and/or others I advise hold a material investment in the issuer's securities.

Catalyst

CATALYSTS 

 

 

1)      End of tax selling - The stock was up 100%+ in 2012 and we believe that towards year end some investors sold to lock in gains before the increase in capital gains tax rate.

2)      Visibility and increase of guidance – Management has mentioned, in recent investor presentations, the 2013 “rough” guidance of ($24mm ADJ. EBITDA)  discussed above.   However, the company has not mentioned it in a formal press release, so many investors are not aware of this figure (which we believe is too low anyway).  Last year the company provided formal guidance in January and we would not be surprised if they did the same this year, especially since they will be presenting at the Needham conference mid-January.  The “formal” guidance could be higher than the $24mm of EBITDA.    

3)      IR – PERI will be presenting at the Needham conference in January.  Not only will this enable them to speak to potential new investors, but it will allow them to dispel some stories written in an Israeli newspaper which indicated that PERI (and Babylon) could be greatly harmed by the new rules GOOG is inserting in the new contracts.  We believe this article also contributed to recent weakness in the stock, and note that BBYL and PERI (both Israel companies) both sold off on the news, yet AVG (a US company) did not appear to sell off (even though AVG would be subject to the same changes).

4)      Babylon IPO – PERI’s closest comp, Babylon (ticker BBYL IT on Bloomberg) , is expected to do an offering in the USA in the near future.  The company currently trades in Israel at 9.5x LTM EBITDA. A registration statement has been filed with the SEC.  The roadshow will illustrate the attractiveness of the industry and, indirectly, highlight PERI’s relative undervaluation.

5)      GOOG renewal – PERI’s contract with Google , which accounts for a vast majority of  PERI’s revenue, expires at the end of this month.  While we see no reason why the contract wouldn’t be renewed (PERI’s new management has a great relationship with GOOG) , the renewal will eliminate one risk to the story.

6)      Strong reported growth-  we expect that in 2013 PERI will report very strong revenue and EBITDA growth in each quarter.  The strong growth will be both organic and acquisition related. EBITDA growth should be greater than revenue growth as the company leverages its fixed costs and generates cost savings from the recent acquisition.

 

 

 

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