I like free things as much as the next guy. But there are some things you couldn't even pay me to take. A low stock price can sometimes hide the underlying company's balance sheet, such that a massive debt load goes unnoticed. Many were shocked when Sidney Harmon acquired Newsweek from The Washington Post Co. (NYSE: WPO ) for just $1. But they neglected the fact that Harmon also paid $10 million of Newsweek's debt.
On the other hand, some companies have no debt and piles of cash, leaving the business essentially free despite a high market cap. This is why it is important to also look at a company's enterprise value, which takes into account all assets and liabilities.
A balance sheet to die for
InfoSpace (Nasdaq: INSP ) falls into the latter category. It mostly specializes in search aggregation, allowing users to run a search on its flagship site Dogpile.com, which pulls together results from the big three -- Google (Nasdaq: GOOG ) , Yahoo! (Nasdaq: YHOO ) , and Microsoft's (Nasdaq: MSFT ) Bing -- as well as several others, such as IAC's (Nasdaq: IACI ) Ask.com.
The company has a market cap of $317 million, no long-term debt, and only about $25 million in net short-term liabilities. That leaves the company with $254 million in cash and cash equivalents. Add in the value of its other assets -- mostly goodwill and physical property -- and the total enterprise value comes down to about $6 million, about 2% of the company's market cap.
It is dangerous to accept this value blindly, however. The enterprise value is essentially what it would cost, net of everything, to acquire the business. If you bought InfoSpace, paid all its debts and sold all its assets, you'd be down $6 million. But, after selling all its property and the acquisitions that created the goodwill, you'd be hard-pressed to recoup your $6 million (or get full value for the company's carried goodwill).
In this case, it makes more sense to ignore any assets other than cash. InfoSpace runs a high-margin business, and has little need for vast amounts of working capital. It is safe to focus on a pure cash minus debt measure instead of other assets and current liabilities, for a more conservative enterprise value of $63 million, or $1.73 per share.
More than walking-around money
But what does InfoSpace plan on doing with all that cash? The most recent 10-K is vague. The company plans to use the cash for the usual things -- funding operations, developing new technologies, and paying for marketing -- but the report also notes that management plans to acquire other businesses that may or may not be related to its core business, and that it may issue a special dividend or use the cash to buy back stock. In other words, they might use the cash for just about anything.
There is precedent for a dividend. In 2007, InfoSpace paid out two special dividends totaling $507.5 million, nearly half its cash position at the time and representing an average yield of 40.8%. While this might sound like quite the pay day for investors, the stock dropped in value by about the same amount (thanks to the company reducing its cash hoard) and has struggled in the following years.
Bright skies ahead?
Paying out half the company's cash is rarely a vote of confidence in the future, otherwise the cash would be used to invest and grow. But the company has grown, with revenues rising by more than 20% annually since the payout, while free cash flow has been strong. In the recently ended 2010 fiscal year, InfoSpace reported free cash flow of $42 million, giving the company an enterprise value-to-free cash flow ratio of just 1.5 (using our conservative EV calculation).
The company also had so much cash even after its dividends that it continued investing in acquisitions. In May 2010, InfoSpace acquired certain assets from online retailer Mercantila for $16 million. This acquisition allowed InfoSpace to diversify away from its core search aggregation business, where Google and Yahoo! accounted for 95% of total revenue in 2009.
In 2010, Mercantila drew $33 million in revenue, representing a 25% pre-tax return on the investment after cost of sales, and helping dilute Google and Yahoo!'s share of total revenues down to 80%. Mercantila should see an even higher share of revenues in 2011, as this will be its first full year of operations.
With that kind of a return, it looks like InfoSpace is just waiting for the fat pitches by holding so much cash. The core business is performing admirably, so even if the cash is just paid out as a dividend, there isn't much reason to think it signals poor prospects. If nothing else, the strength of the business and the low enterprise value make InfoSpace an attractive takeover candidate.
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