Will Other Ad Slingers Destroy ReachLocal?

More than anything else, managers determine returns. They set strategy, hire key team members, oversee operations, and cash paychecks. Every move they make either enhances or destroys shareholder capital.

It pays to know who these men and women are, how they're paid, whether they, too, are owners, and how they perform versus competitors in certain key metrics. In this regular column, I'll examine all that and more with the goal of enhancing our understanding of some of the top stocks in Fooldom.

Next up: ReachLocal (Nasdaq: RLOC  ) . Is the executive team of this provider of localized advertising services doing all it can to earn you outsized returns?

Foolish facts

Metric

ReachLocal

CAPS stars (5 max) ***
Total ratings 74
Percent bulls 94.6%
Percent bears 5.4%
Bullish pitches 10 out of 10
Highest rated peers China Mass Media, Omnicom Group, Interpublic Group

Data current as of April 2.

ReachLocal is too new for Fools to have formed a definitive opinion. They want to like its buzzword-compliant name and business model -- local advertisers! increased reach! -- but they're fearful the company lacks any advantage in a digital ad market dominated by Google (Nasdaq: GOOG  ) and Yahoo! (Nasdaq: YHOO  ) .

Recent forecasts have also fed bearish fears. Shares of ReachLocal fell as much as 17% on Feb. 16 after management called for less first-quarter revenue than analysts were expecting. To be fair, the miss was minor: $83 million to $85 million versus the $86 million the Street had been calling for.

Skittish investors nevertheless fled ReachLocal for display ad peer ValueClick (Nasdaq: VCLK  ) , whose shares popped more than 16% on the same day. Management's upbeat guidance fed the rally. But it was short-lived. Both stocks have taken a turn for the worse since mid-February, badly underperforming the S&P 500.

Yet the freefall says little about the overall health of digital advertising in general -- and localized advertising in particular. Researcher BIA/Kelsey says the market for localized digital ads is on track to grow 14.4% a year to $42.5 billion by 2015.

Interestingly, ReachLocal has already been growing much faster than that. Revenue is up more than 43% over the past year, to $291.7 million, or a fraction of the $21.7 billion in overall market revenue BIA/Kelsey tracked during 2010.

At Motley Fool Rule Breakers, we expect ReachLocal's technology and existing customer relationships to drive increases in its share of the local online ad market. The company's platform connects to every major ad network and, via an exchange, brings in big sites that also sell ad space. Historical data helps to optimize campaigns, while proprietary technology tracks leads from the first click or call.

Management overview

Executive

Years

Cash Compensation

Shares Owned*

Zorik Gordon, co-founder, CEO, president 8 $889,095 1,617,520
Nathan Hanks, co-founder, chief distribution officer 8 $1,186,242 223,722
Michael Kline, co-Founder, chief operating officer 8 $628,208 417,171
Ross Landsbaum, chief financial officer 3 $429,926 0

Source: Capital IQ, a division of Standard & Poor's. Data current as of April 2. Gordon's stake includes 1,617,520 shares owned by the Gordon family trust. Hanks' shares held by Digital Media Distribution, where he is the managing director. Ownership data for Kline and Landsbaum calculated by Capital IQ.

It's a compelling vision, right? As All-Star CAPS blogger latimerburned points out in this post, there's a large contingent of small businesses that want to reach consumers where they're browsing. Doing so only makes sense; I haven't picked up a Yellow Pages book in years.

Incentives are where the story gets tricky. ReachLocal has been public for less than a year. While the table below shows a healthy chunk of the business still owned by the insiders, that 14% includes a 4.25% stake controlled by investor Elisha Gilboa of Las Vegas-area investment holding company AVTZIM. ReachLocal says in its S-1 that Gilboa is a former director of the company.

Among the executive insiders, only CEO Zorik Gordon owns a good chunk of the business, and virtually his entire stake is squirreled away in a trust. That's not necessarily bad; it's just that I expected to see lower salaries and higher direct holdings among the company's co-founders.

Management analysis versus competitors

Company

Insider Ownership

Gross Margin

Return on Capital

Return on Equity

Constant Contact (Nasdaq: CTCT  ) 3.05% 70.8% 1.4% 2.5%
ReachLocal 14.05% 45.5% (12.4%) (18.0%)
ValueClick 3.57% 72.9% 13.2% 18.3%
Yahoo! 9.37% 58.5% 4.1% 9.8%

Source: Capital IQ, a division of Standard & Poor's. Data current as of April 2.

Finally, it's in a comparison with peers where the ReachLocal story begins to break down. Though revenue is growing and cash is flowing -- and has been since 2007 -- management hasn't demonstrated expertise at deploying resources. Returns on capital aren't just negative; they're worse than they were a year ago. Not good.

For investors, this creates a dilemma. Buy shares of ReachLocal on the promise of capitalizing on the opportunity local online advertising presents, or wait to see if this would-be disrupter becomes the disrupted. With the rise of Groupon, that's a distinct possibility.

Do you agree? Disagree? Let us know what you think about ReachLocal's products, strategy, and valuation using the comments box below. You can also recommend other stocks for me to evaluate by sending me an email or replying to me on Twitter.

The Motley Fool recently introduced a free My Watchlist feature that allows users to stay ahead of the curve and receive up-to-date news on companies like ReachLocal, or any of its competitors. To get up-to-date ReachLocal news and analysis, add the company to your watchlist today:

Google and ReachLocal are Motley Fool Rule Breakers recommendations. Google is also a Motley Fool Inside Value pick. Yahoo! is a Motley Fool Global Gains recommendation. ValueClick is a Motley Fool Big Short selection. Try any of our Foolish newsletter services free for 30 days.

Fool contributor Tim Beyers is a member of the Rule Breakers stock-picking team. He owned shares of Google and Interpublic Group at the time of publication. Check out Tim's portfolio holdings and Foolish writings, or connect with him on Twitter as @milehighfool. You can also get his insights delivered directly to your RSS reader. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool owns shares of Google and Yahoo!. The Fool is also on Twitter as @TheMotleyFool and its disclosure policy is managing just fine, thanks.


Read/Post Comments (5) | Recommend This Article (4)

Comments from our Foolish Readers

Help us keep this a respectfully Foolish area! This is a place for our readers to discuss, debate, and learn more about the Foolish investing topic you read about above. Help us keep it clean and safe. If you believe a comment is abusive or otherwise violates our Fool's Rules, please report it via the Report this Comment Report this Comment icon found on every comment.

  • Report this Comment On April 05, 2011, at 12:53 PM, MamaRaisedNoFool wrote:

    ReachLocal might be a good short-term play because of the buzz surrounding this space, but their long-term viability is questionable.

    Consider the company's products and services:

    . ReachLocal's search product, on which they built the company and launched an IPO, has never been profitable because the margins are too tiny to support the cost of selling it. This will always be the case, and SEM/display ad management is only getting cheaper and easier to do as Google and other search engines simplify it and as more small consultancies enter the space.

    . ReachCast is a too complicated and is priced out of the comfort level of most small businesses. It's hard enough to pitch and sell the much simpler search product.

    The only real recognition ReachCast has received is the Mashable award, which was earned through an organized effort by ReachLocal employees to vote for themselves.

    . The DealOn acquisition seemed like a hail-mary, and the Facebook deal may prove that out. The Facebook deal is shaping up to be a similar low-margin situation as ReachLocal has been in with their SEM management service. Once again, high revenues that look great at first glance, but ultimately another source of red ink because the cost of selling it eats up the margins and more.

    Add to this other problems that have become familiar:

    . ReachLocal's abysmal customer retention rate, made worse by the lack of urgency on the part of management to address this problem.

    . An abysmal employee retention rate, having the effect of educating employees and sending them out to compete, not to mention brain-drain and re-training costs.

    . Serious structural operations inefficiencies.

    . The entrance of countless small consultancies into this space, offering similar services more affordably

    . The apparent lack of faith of the company's own executive management, which I think is what this article is hinting at.

    The founders of the company have done an outstanding job of creating and executing a vision that produces huge revenues quickly. It just seems that they never got around to figuring out how to make money.

  • Report this Comment On April 27, 2011, at 12:41 AM, TechCrunch wrote:

    MamaRaisednoFool wasn't completely honest with their evaluation of ReachLocal products. As a small business owner I've been working with Reach for sometime and have welcomed their work in after using many horrible local services in the Chicago area. Here is the scoop...

    SEM- Their pay-per-click campaigns give us owners a chance to compete in a space that is dominated by huge businesses. Cost per clicks are through the roof competing against large corporations. Having an option without a huge mark up and a reach for all major search engines will prove to be profitable if more medium sized businesses jumped on board. Small business... i.e. 1-shop locations, small blue collared operations aren't profitable. Agreed. but their real niche, 12-15million dollar revenue businesses will help the company become profitable if they help combat the floor of PPC campaigns from giant companies.

    ReachCast- was selected by Mashable to be considered an option for voting. There isn't nearly enough folks at the company to carry the vote just on their power. ReachCast is an excellent product and at the price that is charged, it adds up to be less annually than what the service provides; a full-time social marketing consultant.

    The display package bar-none is the most affordable of all. It can cost almost double to run display campaigns at stand alone providers like our Chicago Tribune efforts did prior...

    Affordable representation is huge. RL will have success moving forward as long as the feet-on-the-street efforts are powered by good Sales people. To hire those folks, the existing good ones need to continue to develop business with profitable medium sized businesses

    Momma should have raised an objective person

  • Report this Comment On July 13, 2011, at 2:02 AM, FlySpy wrote:

    MamaRaisedNoFool is 100% spot on...

    Faltering retention rates for staff and customers within the organisation will be their down fall.

    The small consultancies invading this space are quicker to act, more dynamic, and highly service driven because they are getting paid well to look after a small group of clients while ReachLocal and their staff are being paid poorly to look after a lot of clients.

    Unfortunately, the end game of this equation is that you have a big business which can't properly respond to customer and staff needs. There will always be room for big players like ReachLocal but their expensive feet on the ground sales force will inhibit profitability for a long time to come.

    Personally, as a small business owner. I would prefer to deal with a small company where i am more than just a number and that I know can respond to the fast changing online market place more nimbly and with customized solutions.

    Cheers,

    The Fly !

  • Report this Comment On July 14, 2011, at 5:09 PM, lwells101 wrote:

    The Mashable award was absolutely driven by votes from ReachLocal employees. It was ridiculous watching the daily votes for Social Media Service, Mashable posted the email addresses of all the voters each day and the vast majority ended in @reachlocal.com.

    It looks like that information is no longer on the site, but even if you don't believe me, this part of Mashable's official rules should make you think twice about how legitimate the award is:

    "You may nominate yourself and we encourage everyone to nominate themselves and spread the word (see our Promote page)."

    See http://mashable.com/awards/pages/rules

  • Report this Comment On July 14, 2011, at 5:35 PM, lwells101 wrote:

    I meant this part:

    "You may vote for yourself and we encourage everyone to vote for themselves and spread the word (see our Promote page)."

    Because you can vote for yourself once per day and because ReachLocal has so many salespeople, it was an easy award for them to win.

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