|Shares Out. (in M):||85||P/E||10.1x||12.7x|
|Market Cap (in $M):||634||P/FCF||4.6x||5.6x|
|Net Debt (in $M):||253||EBIT||152||113|
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I am recommending a long position in the common stock of United Online, ticker UNTD.
3 segments: FTD / Classmates / Communications / Consolidated
LTM Revenues in USD millions (% of consolidated): 538 (54%) / 238 (24%) / 223 (22%) / 997
LTM Adjusted OIBDA in USD millions (% of consolidated): 85 (34%) / 76 (30%) / 92 (36%) / 253
FTD: FTD is a network of florists in the USA and UK as well as a direct-shipping flower and gift marketer. 90% of product orders are generated through its website, FTD.com, where consumers can order flowers to be delivered either by a local florist within the FTD network (chose by FTD) or shipped directly from an out-sourced warehouse. FTD also provides various services to its florists such as website hosting, credit card processing, and order-taking services, and also charges a service fee to consumers. FTD generates revenues from product sales, florist services, and advertising. Segment LTM Revenues: Products $404mm, Services $128mm, Advertising $7mm (75/24/1% split). LTM Adjusted OIBDA $84.7mm (16% margin).
Classmates Media: comprised of social networking websites Classmates.com in the U.S., Stayfriends and Trombi in Europe, and loyalty marketing firm MyPoints. Classmates.com is a social networking website that has 60mm+ registered users including 17mm active members, and 4.8mm Gold Service members who pay $59 for a two-year subscription, $39 for one year, or $15 for three months. Classmates Online generates revenues from Gold Service subscription fees and advertising. MyPoints is a loyalty marketing company that generates revenues from advertising. Segment LTM Revenues: Services $153mm, Advertising $85mm (64/36% split). LTM Adjusted OIBDA $76.2mm (32% margin).
Communications: dialup internet service provided under the NetZero and Juno brands. 1.4mm customers pay $9.95 or $14.95/month for internet access, an email address, virus protection and other ancillary services. The Communications segment generates revenues from subscription fees and advertising. Segment LTM Revenues: Services $185mm, Advertising $38mm (83/17% split). LTM Adjusted OIBDA $91.6mm (41% margin).
CEO Mark Goldston is very promotional, but I believe he has created a lot of value in the way he has managed the business and de-emphasized dialup as those revenues shrink yet improved its OIBDA margins, a remarkable feat. He has made two value-creating acquisitions (Classmates and MyPoints); it remains to be seen if FTD will turn out to have created value for UNTD shareholders.
Major Acquisition history last 5 years:
11/17/04: Classmates Online, private company, $100mm cash, UNTD Stock Price = $11.04
4/10/06: MyPoints from United Airlines, $56mm cash, UNTD Stock Price = $12.89
8/26/08: FTD Group, publicly traded, $754 cash and stock, UNTD Stock Price = $10.93
The company gives quarterly guidance and has generally reached or exceeded the high end of the forecasted OIBDA range.
4Q08 guidance given on 11/5/08:
Revenues: 264-272mm vs. 256mm Actual
OIBDA: 59-63mm vs. 65mm Actual
1Q09 guidance given 2/19/09:
OIBDA: 53-58mm vs. 61.5mm Actual
2Q09 guidance given 5/5/09:
Revenues: 248-257mm vs. 261mm Actual
OIBDA: 60-65mm vs. 68.5mm Actual
3Q09 guidance given 8/5/09:
Revenues: 208-216mm vs. 216mm Actual
OIBDA: 53-58mm vs. 57.5mm Actual
4Q09 guidance given 11/4/09:
Communications 4Q09 and 2010 adjusted OIBDA margin: mid-to high 30s
Why is the stock mis-priced?
Although the company presented at 10 conferences in 2009 and 7 in 2008 and is covered by 6 analysts, I feel that there is still a misperception about the business mix at UNTD. Before I went to see them at a recent conference, I had forgotten about the FTD acquisition and still thought of them as primarily a dialup company. As most investors don't like to invest in declining businesses, I had never taken a serious look at them before. When I did, I saw that only 21% of revenues and 34% of adjusted OIBDA is derived from dialup, and the rest from businesses with decent growth prospects. Classmates LTM adjusted OIBDA growth YoY is +48% and FTD I estimate at -11%. As a whole, UNTD has had positive OIBDA growth each of the last 4 quarters, a feat not achieved by most domestic companies. L4Q organic adjusted OIBDA growth: +4% (includes FTD), +13%, +5%, +11%. While Classmates has competitive issues and FTD is heavily exposed to discretionary consumer spending, I don't believe either is a secularly declining business in the way that dialup is. Yet the stock trades as a whole as if the entire business were declining secularly (3.7x EV/2010e EBITDA, 22% LTM FCF Yield). As dialup continues to organically shrink as a percentage of the company, and as FTD stabilizes, I believe this perception issue will correct itself. Dialup's prominence will diminish further when UNTD makes its next acquisition. At some point investor will realize that it is a small, yet incredibly profitable and valuable piece of the overall business, and give the company a more appropriate multiple reflecting its true underlying growth prospects as a whole.
Beyond the misperception about the significance of dialup to the overall business, I believe that investors are overly focused on the post-transaction marketing issue, and the competition with Facebook issue, both of which I address in the Risks section at the end of this writeup.
Market dynamics and strategy
Below are some quotations from recent company presentations accompanied by some of my own descriptions of what has been occurring competitively over the past year in United's three businesses.
FTD: 11/5/08 call-a couple of competitors in the space continue to spend aggressively to acquire customers. 2/19/09 call: competitors engage in "ridiculous tactics" during the holiday season. FLWS offers free shipping and no service fees during the holidays. "That is basically just like giving flowers away. We are in business . . . to run a profitable business and if that means sacrificing some revenues that you wouldn't make a dime on, then we will do that."
FTD has generated mid-teens OIBDA margins versus negative EBITDA each of the last three quarters from its closest publicly traded peer, 1-800-FLOWERS.COM (FLWS). Despite the aggressive discounting FLWS has had worse revenue declines the L3Q compared to FTD, -20%, -8%, and -21% YoY for FLWS vs. -7%, -10%, and -14% for FTD on a constant currency basis.
Classmates Media: 11/5/08 call-look at the monthly active membership. If it is growing, it probably means the content is attractive (and they have a bigger pool from which to convert free members to paying members). They like subscription/advertising business model because subscriptions are less economically sensitive, recurring, and very profitable. 5/5/09 call-ARPU declines are due to lower ARPU in higher growth Europe, not to promotions or price cuts in U.S. International ARPU is about one-half or ARPU domestically. "Domestic ARPU is by and large pretty stable." 8/5/09 call-"It appears that key metrics that reflect the vitality of our domestic site and offerings remain strong, while our members' propensity to pay has weakened . . . . There seems to be an increasing overlap between our members and Facebook members . . . but it's important to remember that we offer a completely different feature set and site experience than other social networks, including Facebook." The average member age for Classmates if over 40 years old. "We routinely attract a few thousand new Classmate signups everyday from ad campaigns that we run on Facebook, and these users have a higher propensity to convert to paid subscribers than the users we get from other channels." International segment accounted for all of the net growth in pay accounts during 2Q09 (+58k). Lower ARPU partly due to discounted pricing plans offered from time to time in the U.S. 11/4/09 call-Classmates.com had a net decline in paid subs in 2Q09. "The social networking business increased revenues by approximately $4 million or an impressive 10% year-over-year [in 3Q09] while the MyPoints business declined roughly $4 million year-over-year." Churn decreased to an all-time low 3.8%. Fired 71 employees, or 17% of global Classmates workforce.
Communications: 2/19/09 call-churn lower than competitors. ELNK has been promoting a mid-$5/month for the first 3 months offer for years. 5/5/09 call-ELNK lost 160k dialup subs vs. UNTD loss of 72k access subs, so seem to be gaining market share in dialup. 5/27/09 presentation at Cowen conference: Dialup demographics-70% of subs are over age 35, 30-35% are over age 55. Income generally below $50k/year. 8/5/09 call-32% of all dialup users live in rural counties and 46% make less than $50k/year.
I have done a DCF of each of the three segments as well as a sum-of-the-parts based on publicly traded comparables. On the DCF I feel that the assumptions are conservative. On the SoTP, a couple of notes on the comparability of metrics: UNTD uses a measure of earnings called Adjusted OIBDA which adds back stock-based compensation (SBC). As UNTD's SBC is higher than that of the comps, the 2010e EBITDA could be haircut by about 9%, or from 242mm to 221mm, which would lower the SoTP value/share to $11.80 from $13.30. However, the GAAP P/E-based value/share is not affected by this haircut and remains at $14/share. On the other hand, certain other assumptions would increase the value/share. For instance, if AOL is substituted for ELNK as the dialup comp, value increases by $0.30-0.45 per share. And given that LTM EBITDA for FLWS is $28mm but FY10e and 11e (June) expectations are for $42mm and $49mm, respectively, if these expectations turn out to be too high the fair value could increase above $15/share. This is especially so given the conservative 2010e OIBDA number of $80.5mm used in the SoTP vs. FTD's LTM OIBDA of $84.7mm.
Another data point other than current comparable trading multiples is the cancelled IPO for Classmates Media in 2007. UNTD filed an S-1 in August 2007 and ended up pulling the deal in early December 2007 at the very end of a two week roadshow. The pricing range was $10-12 per share, and the book was coming together in the $7-8 range. There were going to be 60mm shares outstanding, so $10-12/share is $600-720mm or $7-8.50 per current UNTD share; $7-8/share is $420-480mm or $5-5.67 per current UNTD share. This compares to $2-3/UNTD share implied in the current stock price. You might respond by saying that the IPO was priced at the peak of the market, and at a time when Facebook had only 50mm registered users versus 350mm today, which hurts Classmates' growth prospects. I agree with those points and due to those factors Classmates is probably not worth $600-720mm today. But I would counter by pointing to actual results since the roadshow compared to expected results at that time: management was forecasting $35mm of adjusted OIBDA in 2007 and $47-53mm in 2008. Actual results were $35mm in 2007, $60mm in 2008, and now $76mm LTM through 9/30/09. So while future growth prospects are somewhat uncertain, the company has proven over the past 2 years that despite a deep recession and unexpectedly humongous growth in registered users by Facebook, Classmates has grown faster and more profitably than was expected.
Because I am unable to paste the excel tables here I will have to summarize the results:
FTD: fair value $6.90, range $2.50 to $12
CMC: fair value $3.50, range $1.50 to $7
Communications: fair value $2.30, range $1.20 to $3
Total fair value: $12.70, range $5.20 to $22
Using FLWS, ACOM, and ELNK as comps, fair value based on 2010e EBITDA is $13.42, using GAAP P/E $14.15.
1) Post-transaction revenues and profits disappear. This is a significant risk to the company's valuation, but it is already priced into the current price in my opinion. On November 18th, 2009 UNTD filed an 8-K in response to the Senate Committee on Commerce, Science, and Transportation staff report and hearing criticizing post-transaction marketing. The filing quantified the company's L9M post-transaction revenues at $20.2mm. As these are high margin revenues the loss of them would significantly decrease profitability. The day before UNTD's press release the stock was at $8.39. Two days later it was at $7.03 (-16%). The market's reaction anticipates the complete loss of these revenues and profits. In order to be conservative I have built in the entire loss of these revenues--and the loss of the associated operating profit assuming a 90% margin--into my 2010 forecasts. According to the company, however, they should still be able to generate some post-transaction revenues, even if the Senate banned the current methods or forced modifications to current practices. To be clear, UNTD is not a post-transaction marketer itself, but it partners with two of the three large companies in the space: Vertrue on Classmates and Webloyalty on FTD.com. I believe that UNTD issued a press release because Classmates.com was singled out amongst the eighty-eight companies that have partnered with the three named marketers that have made over $1 million through these partnerships, as the Senate release stated that Classmates.com has made more than any other company as a result of this partnership, more than $70mm. While this number might be accurate as a cumulative amount of revenue since the company's inception in 1995, it is misleading since the annual amount of revenue from Classmates Media is about $20mm. Classmates might have the most exposure to these post-transaction marketers, but there were other companies listed in the Senate Committee report as having been paid over $10mm, including (2-day reaction / change to current price since 11/17/09): FLWS (-4% / -4%), EXPE (-1% / +3%), OWW (-6% / +23%), PCLN (-1% / +7%), SFLY (-7% / +12%), and VPRT (-6% / +3%) vs. UNTD (-16% / -11%). I don't know the timing of the Senate Committee's next steps, but it seems to me that the most likely outcome is enforcement of new regulations at some point during 2010 which will make it clear that the post-transaction marketers' offers are not related to the transaction just completed. As a result the revenues that Classmates and FTD generate from these partnerships will likely be significantly reduced probably beginning in late 2010 or 2011, but not completely eliminated.
2) Federal government money to bring broadband to rural areas: 12/17/09 Biden announced the first $182mm of a $7.2B plan to bring HSI to rural areas, poor neighborhoods, and Native American Communities. Also there is a bill in congress that contemplates more funding for rural broadband. The FCC will make formal recommendations on February 17, 2010, when it is set to release its National Broadband Plan, a blueprint for improving broadband speed and access. It appears that two out of the three main options being considered could significantly increase investment in rural broadband and increase competition for UNTD's dialup business. Currently, according to the FCC there are 3-6mm households without access to broadband internet, as well as millions of others that have access but choose to use dialup, since there are about 10mm dialup subscribers in the U.S. Any investment that increases internet access choices for these customers is bad for UNTD. Increased government investment is a significant risk, but it is mitigated by the fact that I am not ascribing much of a terminal value to UNTD's business, and therefore if dialup disappears entirely in a few years, my fair value would only decrease by about $1/share.
3) Facebook conquers the world: with the recent slowdown in the growth rate of Classmates.com active subscribers and paying subscribers, there is the possibility that Facebook has grown so large that it prevents further growth in Classmates and other social networks. An even worse scenario is that paying members begin shrinking if Facebook gains enough scale to begin providing for free the services for which Classmates.com currently charges, such as high school reunion-themed services. Management has acknowledged that Facebook's growth is probably having an impact on Classmate's ability to attract new subscribers, but at the same time Classmates is advertising on Facebook and gaining significant subscribers who are more likely to become paying members than leads from other sites. Net paying subscriber growth fell precipitously in 2Q09, management reacted by discounting a bit in 3Q09, and growth picked up to about 60% of prior levels. Since the division is so profitable, they have a lot of room to experiment in order to maintain growth, if that is what they choose to do. If they instead decide to just try to maintain its size and profitability, they can of course forget about an IPO, but it will become another cash cow which can fund future acquisitions. A shrinking Classmates Media segment, however, would shave $1-2/share off my fair value.
4) FTD's falling revenues could be secular rather than cyclical if there was a flower-buying bubble fueled by excess credit. If this is the case, this would have the largest affect on fair value as FTD is the largest segment of UNTD. If FTD fails to stabilize my fair value could fall by up to $4/share. However, this is also the segment with the most upside, and since UNTD only closed the acquisition in late August 2008, we still haven't seen the effect of the changes the company has implemented in a healthier economy. I am optimistic that there is more upside to my FTD fair value than downside as the company has implemented a number of positive changes and has maybe two-thirds of its original ideas from its "idea vault" still to implement. Encouragingly, constant-currency revenue declines have decreased each of the last three quarters, from -14% in 1Q09, to -10% in 2Q09 to -7% in 3Q09. In addition, UNTD management has been able to significantly increase margins at Classmates, a growing business, but also at NetZero/Juno, a declining business. If it turns out that FTD revenues stabilize but they cannot profitably grow the top line, based on management's track record I am confident that they will generate OIBDA growth by increasing margins.
In order from most to least likely:
Accretive acquisition that further decreases exposure to declining dialup business-expect this in the next 9 months as the Chief Strategy Officer is actively working on this task.
FTD improves with economic stabilization and company-specific efforts from the "idea vault".
Classmates IPO-pulled 2 years ago, less likely now despite better than expected profitability unless higher growth resumes.
Dividend increase-less likely but certainly a possibility.
Advertising environment improves with economy.
Less important catalysts:
Classmates.com new site launch in 4Q09
FTD increased advertising coincident with 100-year anniversary in 2010
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