I'm a believer in growth stocks. As an analyst for our Motley Fool Rule Breakers service, I think you should be a believer, too. But some growth stories are inevitably better than others, hence this regular series. My goal? Out the Fakers, elevate the Breakers, and examine the growth stories stuck in between.
Next up: Digital River
|CAPS stars (5 max)||**|
|Bullish pitches||45 out 49|
|Highest-rated peers||Spark Networks, Photochannel Networks, Chordiant Software|
Data current as of March 27.
Conceptually, there's a lot to like about Digital River. The company's tools and services are the backbone of online storefronts for many of the Web's largest e-tailers, including Adobe Systems
The bad news? Those numbers are done substantially from earlier years, mostly because of the loss of Symantec
Revenue dipped $40.6 million last year, or a little more than one-third of the value of the Symantec contract. Worth celebrating, right? Not exactly. According to Digital River's financial filings, the agreement ended on June 30. The company still enjoyed half a year's worth of payments from its top client. Not so this year.
Bullish investors counter that e-commerce is one of the best businesses to be in right now. They're right. According to Commerce Department data, U.S. e-commerce sales rose 14.8% to $165.4 billion last year. That's a serious wave for Digital River to surf.
Don't expect the bears to care. Shares of Digital River sold off mightily in January, after the company issued predictably lean fourth-quarter results and a surprisingly scant outlook for 2011. The stock is up slightly year to date, but not enough to outperform the S&P 500 index.
The elements of growth
|Normalized net income growth||(75.0%)||(28.4%)||(16.3%)|
|Shares outstanding (millions)||39||38.7||37|
Source: Capital IQ, a division of Standard & Poor's.
A little more than a year ago, CEO Joel Ronning pledged to replace Symantec's revenue contribution. Judging from this table, I'd say he still has a way to go.
- Growth investors like me love straight-line accelerating revenue growth leading to accelerating profit growth. Not surprisingly we have neither here. Call it the downside of betting big on a client with a big wallet, as Symantec was.
- Pricing power is also something we like to see. Or, in lieu of that, excellent cost management leading to higher margins. Thankfully, losing Symantec hasn't cost Digital River much in the way of pricing power. That's a positive sign. Extreme discounting almost always does more harm than good.
- We also like businesses that collect quickly. Revenue isn't growing, so there isn't much in the way of good news here. But Ronning and his team did manage to keep a lid on receivables growth, which again suggests that the company is pursuing responsible growth rather than booking deals it can't collect on.
- Finally, Digital River is experiencing only modest dilution. A history of stock buybacks also suggests that management is sensitive to the need to return value to shareholders. Both are good signs.
Competitor and peer checkup
Normalized Net Income Growth (3 Years)
Source: Capital IQ, a division of Standard & Poor's. Data current as of March 27.
No doubt because of the Symantec snafu, Digital River is by far the worst performer in this table. But that also might not mean much. More important is Ronning's commitment to get growth back on track. A lighter-than-expected outlook for 2011 could mean he's having trouble making good.
But it could also mean he and his team would rather remain conservative. After all, they've been burned once before. And it wouldn't be out of character. Digital River maintains more than $374 million in cash and investments on its balance sheet after accounting for debt. That's quite a stash for a company worth $1.4 billion in market cap.
I'm siding with Fool co-founder David Gardner on this one. He singled out Digital River in the December issue of Motley Fool Rule Breakers as a long-term growth story worth buying. After having reviewed management's performance in the wake of Symantec's devastating defection, I think he's right.
Do you agree? Disagree? Let us know what you think about Digital River's products, strategy, and valuation using the comments box below. You can also ask me to evaluate a favorite growth story by sending me an email, or replying to me on Twitter.
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