|Shares Out. (in M):||49||P/E||0||0|
|Market Cap (in $M):||1,060||P/FCF||0||0|
|Net Debt (in $M):||658||EBIT||0||0|
Sign up for free guest access to view investment idea with a 45 days delay.
WEB is a company in transition, but farther along than the market is giving it credit for. WEB runs a high-quality business from the perspective of subscription-based web services, carrying excellent cash flow, visibility, and low capital intensity. WEB has been in transition as of late, going from a focus on domain names and site building tools - where others have quickly taken a bigger lead (GDDY, WIX) - to a greater focus on value-added online services for SMBs, spanning web presence and digital marketing. While the early stages of the transition have been rough - from being chewed up and spit out in the domain/site-building biz in 2014 - to an optically rocky start with their Yodle acquisition in late 2015.
Nevertheless, WEB turned the corner in early 2017 and both the market and the sell-side haven’t taken notice or acknowledged it. With y/y rev growth returning in 4Q17 and significant runway to drive up margins materially, I view WEB as possessing >50% upside from here, based on substantial FCF growth and (hopefully) an improvement on its dirt-cheap multiple (9x FCF), particularly given the gap relative to peers (EIGI, GDDY) sitting in the mid/high teens.
Finally, there is further upside to the story than what is just presented here, with an LBO possible (likely?) at some point in the next few years, as well as no buybacks or reduction in interest expense considered in my estimates, despite the high likelihood of both.
Web.com (WEB) provides domain name registration, website building, and digital marketing services, largely to SMBs. Though WEB offers a broad variety of services, it’s probably best to think about the company’s offerings in the following buckets:
The weakest area here is DIY, which has been in steep decline. Generally speaking, WEB views its business through the lens of valued-added services (VAS) and non-VAS, which is now roughly 60/40 split VAS/non-VAS. The VAS business are the key focus and more-or-less comprise the digital marketing products and DIFM.
WEB’s business is fully subscription-based, mostly on monthly payment terms, which means a few things: 1) great cash generation profile - negative CCC - which allows for more leverage at better rates than most (regularly levered >3x net; gets great debt terms anyway); WEB’s peers are set up similarly; 2) excellent visibility; 3) gradual shifts in the business, given ratable recognition of new subs, so very rarely, if ever, is there a sudden spike or drop in results in a given quarter, which leads to...4) both sequential and y/y comparisons are important and valid; seasonality doesn’t really exist to a meaningful degree, so consistent sequential growth or declines in any meaningful metric can (and should) be read into.
Background / Recent History / Where the Opportunity Comes From
Back in 2014, WEB had hit it’s all-time share price high >$35 before the wheels started to come off. WEB’s business back then was primarily domains and DIY tools, which comprised >70% of rev. The domain market became largely penetrated and the DIY space became commoditized, creating a need for scale in domains and a race to the bottom (from a price POV) in DIY. With the market turning against them, WEB had a series of earnings misses and/or guide-downs, compounded by sell-siders turning against the name, sending shares into the teens.
In response, WEB management decided to focus on non-commoditized services and started re-apportioning out investment dollars toward higher-ROI opportunities, hence the focus on VAS. In order to scale the VAS side of the business, WEB bought a private company (who had previously filed for IPO, but never went) called Yodle in Feb 2016. The acq of Yodle supercharged WEB’s VAS game, pushing it to >50% of rev.
Thus, the strategy became to keep milking the low-churn high-FCF domain business by running what they have and selectively investing (e.g., in Latin America), but otherwise moving investment dollars out of the area. Put another way, don’t spend money on trying to replace the 1% churn - the ROI is too low and the market is too competitive. Same deal on the DIY business, though DIY is far less stable. Rather, investment dollars would be targeted at the VAS category, where there is less big-fish competition and higher-ARPU / higher-ROI opportunity. While the churn in VAS is significantly higher than domains, the ARPU and growth more than offset that factor.
The problem was that the Yodle acq got off to a less than awesome start. Long story short, WEB and Yodle had some overlapping products and technologies, so WEB mgmt paused investments in the products that would be discontinued or meaningfully altered (primarily the lead-generation and related digital marketing services) until the go-forward product portfolio was ready for prime time (why put money into something that’s going to be canned). The result was several quarters of poor financials and metrics following the Yodle acq.
This was all telegraphed by mgmt (i.e. that spending would be pulled back for a few qtrs, subs would decline and churn would rise), with mgmt being fairly consistent in its messaging that the product portfolio would be figured out by end of 2016, 1Q17 thus being the trough, and continued improvement through 2017 and beyond. Nevertheless, the market wasn’t forgiving, though somewhat understandably so - from a 30,000 ft view, it looked like a company that was the odd man out in the domain business made an acq to jumpstart an alternative strategy but fumbled the snap.
The key is that - true to mgmt’s word - the tide has turned. As predicted, the business troughed in 1Q17, with most metrics (all save subs/churn) improving since Q1. In terms of subs and churn, those numbers will stabilize but won’t turn positive for a while given the mix shift toward higher churn services and the lack of investment in retaining churned customers from non-VAS products. Yet, WEB is basically still at the same level that it was after they reported 1Q17 earnings. Sell-siders are running out of excuses to keep shares neutral-rated and Q4 earnings (being reported tonight) will see rev return to y/y growth.
Thesis / Investment Positives
Variant Perception / Bear Case
My methodology of choice is P/FCF - WEB stopped reporting a non-GAAP EPS number because its basically FCF anyway and FCF is the most important metric. Plus as a sub-based business, its the most optimal to use anyway (though I think FCF/share is always most important, generally speaking).
I have ~$3.40 in 2018 and $3.67 in 2019 (see calc below).
Note - taxes are a bit tricky; right now WEB is enjoying NOLs that limit cash taxes to single-digit millions. NOLs start to roll-off following 2018, but mgmt expects the remaining NOL balance to reduce taxes by $70M annually through 2021. Plus, given new tax legislation, I just throw another $5M of taxes on to 2019 from 2018, but that’s really just a random round number; it could very likely be $5-10M total.
Using 10x FCF seems fairly conservative, though GDDY and WIX trade in the teens. Using 10x, that gets to a mid-$30s target, or >50% upside from here. If the multiple were to materially expand and enter GDDY territory, upside could be into the $40s and $50s, making this a double-plus. All that said, I don’t want to rely too much on multiple expansion.
Thinking of it another way, I am getting to nearly 30% FCF growth y/y and at <9x FCF, WEB should get at least a little bit of multiple lift with strong performance / execution.
Primarily earnings - the primary aspects of the thesis are that rev turns positive on y/y basis and accelerates, while margins improve materially and sub metrics stabilize and improve
Sell-side upgrades - 9 guys cover the name, of which 4 are neutral (Barcap, JPM, Citi, and DB) and none of them have good excuses why. I expect them to start upgrading the stock over the course of 2018, which will help boost shares
|show sort by|
Are you sure you want to close this position WEB.COM GROUP INC?
By closing position, I’m notifying VIC Members that at today’s market price, I no longer am recommending this position.
Are you sure you want to Flag this idea WEB.COM GROUP INC for removal?
Flagging an idea indicates that the idea does not meet the standards of the club and you believe it should be removed from the site. Once a threshold has been reached the idea will be removed.
You currently do not have message posting privilages, there are 1 way you can get the privilage.
Apply for or reactivate your full membership
You can apply for full membership by submitting an investment idea of your own. Or if you are in reactivation status, you need to reactivate your full membership.
What is wrong with message, "".