My preference as an investor is to buy a great business at a good price rather than a good to mediocre business at a great price. Great businesses are generally lower-risk investments because of their superior competitive advantages and managerial strength.
That was the reasoning behind my recent purchase of Johnson & Johnson (NYSE: JNJ) at 17.6 times free cash flow, with a dividend yield of 1.9%. The only problem is I can't always find enough of these great businesses at good prices to fill up my portfolio. Therefore I, like practically all value investors, find it necessary to venture into good or even mediocre businesses available at great prices. When analyzed correctly and purchased at the right price, these subprime businesses can provide fantastic returns.
Today, I consider one of the less heroic but attractively priced businesses: advertising services firm ValueClick (Nasdaq: VCLK). It's not the best business under the sun, but it has lots of cash, almost no debt, no cash burn, and a stock that sells for less than its net cash per share. To be precise, ValueClick has $276.6 million in cash and equivalents, $2.4 million in short- and long-term debt, and 92.5 million shares outstanding (this is the actual final number as of June 30, not a weighted average figure). When you subtract debt from cash and divide it by the sharecount, that equals $2.96 per share. The current stock price, by way of comparison, is in the range of $2.40 to $2.50, or an approximate 17% discount to net cash per share. It's a bona fide opportunity to buy cash for 83 cents on the dollar.
In the most recent quarter, announced last week, ValueClick reported break-even results on a pro forma basis. Most noteworthy, the company generated positive free cash flow of $0.9 million on sales of $14.1 million. In addition, the board increased the stock buy-back by $30 million, and management indicated on the earnings conference call that it was interested in taking full advantage of that authorization at the stock's current level. Management sees this as a good deal, and so do I.
I've written about and owned ValueClick in the past. Partly through skill but mostly through luck, I said goodbye to my ValueClick shares in May and June at an average price of $2.85. I sold for the simple reason that I'd found better opportunities for my money. But now with the stock down to a steep discount to cash, I'm interested again.
To review, ValueClick owns a number of media and technology businesses that serve direct marketers and advertisers, primarily in the online arena. Looking at results over the past few years, it hasn't been a pretty picture. The company had annual revenue in 2000 of $64 million on 32 million shares outstanding. Now, here we are two years later, and the company is on its way to about the same level of revenue -- $64 million to $67 million is expected -- but with a share base almost three times higher. The additional shares are the result of numerous acquisitions over the past few years.
A highly acquisitive company with low revenue growth -- you may be thinking, "Yikes, no wonder the stock is at a discount to cash!" But that's the whole point. Most investors long ago ran far away from ValueClick. At the current price of around $2.45, the business could continue to stagnate, and yet as long as the company doesn't lose money, the stock has upside potential of 20%, based on its cash alone. This is a proposition precisely opposite that of richly valued stocks, which frequently require everything to go right for you to make a few lousy percent. In contrast, if almost anything goes right for ValueClick, the upside is very good; and as long as nothing goes terribly wrong, the downside is very limited. In my investing playbook, that's an attractive risk/reward profile.
For the record, I usually shy away from highly acquisitive companies, but ValueClick's acquisitions have been at very reasonable prices -- prices made available by the distressed online advertising environment of the past two years. These acquisitions have served to reduce ValueClick's competition, while also diversifying the company's revenue streams.
The combined company is now far more than just the original cost-per-clicks online advertising network. The many acquisitions have created a much more diversified but also more complicated company, and so I was happy to recently have the opportunity to discuss the business with John Ardis, ValueClick's vice president of corporate strategy. I asked him to give me a rundown of the company's competitive landscape across its many divisions. Here's what he told me:
In our media division, I would consider our main competitors to now be Yahoo!, AOL, MSN, and traditional media, the latter of which is still getting a disproportionate share of media dollars, as compared to the media consumers interact with most. In fact, I'd say that, overall, traditional marketing channels are the biggest competitor to all digital marketing, but we're seeing signs that that is changing. When you take out traditional media, it comes down to the portals versus us.
Our position is that consumers typically use the portals to find and get to their favorite sites -- and that those favorite sites are often part of our network. So, not only are advertisers reaching the same target audience, but they're also reaching them more cost-effectively and in a content environment where they spend most of their time. Moreover, we have established strategic partnerships with many major websites, so our advertisers don't have to choose between them. We can focus on placing their message wherever it makes most sense -- portals, well-branded verticals, or highly targeted niche sites. Our media group can now reach 9 out of 10 Internet users in the U.S., so we can address any objective that an advertiser has.
In the technology arena, DoubleClick is the 800-pound gorilla and our chief competitor, but we believe that they're also vulnerable around the edges, as the market keeps telling us that they're looking for alternatives. With DoubleClick and us (our Mediaplex division) being the only really sizable and financially stable players out there who offer both ad serving and email delivery, we're in good shape to gain market share, and have succeeded with recent wins with companies like General Motors, SBC Communications, Lexus, Progressive Insurance, etc. On a related note, our recent acquisition of Be Free promises to bring some cross-enhancements to both companies' technology offerings, thereby separating us further from DoubleClick.
In our affiliate marketing group, which is predominantly represented by Be Free, the competitors are also getting fewer and more financially unstable. There are a couple of companies that we run into, like LinkShare, Commission Junction, and Performics, but we're very confident in putting our successes up against any of them, mainly because of who our clients are and the scale of what we've been able to achieve for them. In other words, rather than trying to be all things to all people in this unit, we focus predominantly on the major clients, where we know we can have a major impact on their business. That, coupled with the financial strength of our combined company behind this division, portends very well for the future of this group.
Finally, our agency management software business, Adware, has potential for growth as well. The space is currently majority-owned by a company called Donovan, but, like in the DoubleClick situation above, we find that the gorilla often becomes a target as the market gets jaded and looks for other options, a la Avis ("We're No. 2, so we try harder").
My take here is that ValueClick has assembled a decent set of complementary marketing businesses. The real wildcard is the economy. As long as the economy suffers, ValueClick's marketing services won't be in high demand. The word from management on the Aug. 6 conference call was that the company has yet to see a significant sign of an economic recovery. That's somewhat of a concern.
At the same time, I see two indications that ValueClick's business isn't in danger of crumbling. One is the stock buyback itself. I don't think the company would let go of its precious cash unless it thought the business was on a good track. Second, in the footnotes of the Q2 earnings release, the company broke out the revenue that would've been reported if all of the company's acquisitions to date had been completed as of Jan. 1, 2001. This information is useful because it provides an apples-to-apples comparison of this year's revenue versus last year's. What we see is that Q1 pro forma revenue declined by 19.7%, whereas Q2 pro forma revenue declined by only 12.5%. Yes, revenue is still declining, but by much less. That's an encouraging sign considering that by all accounts, the economy got worse in Q2, not better -- and yet ValueClick's revenues declined by a smaller amount.
Management's guidance for the remainder of the year calls for Q3 revenue of $18.0 million to $18.5 million, and Q4 revenue is expected around $19.0 million to $19.5 million. Management also anticipates another cash-flow positive quarter in Q3, and positive operating income by Q4. These would be excellent results, and would surely result in a higher stock price. From a standpoint of conservatism, this guidance demonstrates that the company isn't in danger of burning actual cash. As long as the company maintains its cash balance, buying dollars for 83 cents remains a sound proposition.
I currently don't have funds at the ready, but I'd entertain buying the stock anywhere below $2.45. If the stock holds below that price, don't be surprised if you see the stock show up once again in my portfolio.
By the way, a great discussion on ValueClick is underway on the Green Gene Stocks board.
Matt Richey is a senior investment analyst for The Motley Fool. At the time of publication, he was long Johnson & Johnson. Matt's personal portfolio is available for view in his profile. The Motley Fool is investors writing for investors.
