RetailMeNot (SALE) stock has crashed by more than 50% over the last six months. Google's new search algorithm is having a negative impact on the page rank for the online coupon provider, and this is hurting RetailMeNot's business. However, the company has a solid business model, and it is still delivering sound financial performance under challenging conditions. Should you buy the dip in RetailMeNot stock, or is the worst yet to come for shareholders?
The problem
RetailMeNot investors have been faced with considerable uncertainty lately. The company relies heavily on search for its traffic, and Google is the undisputed market leader in that business. Google regularly updates its search algorithms to improve the quality of results, and the Panda 4.0 update rolled out in May had a negative impact on RetailMeNot's page rank and traffic coming from organic search.
RetailMeNot has successfully adapted to previous changes in search algorithms, and CEO Cotter Cunningham said in the company's latest earnings conference call that performance was partially recovering: "We did see our organic search rankings affected beginning midquarter, and while we've seen a partial recovery over the past two months in overall organic search rankings, we're not back to the growth levels we were seeing in the first quarter."
Organic search represents 64% of total traffic for RetailMeNot, and management estimates the new search algorithm will reduce full-year 2014 sales by 5%, while revenue for the second half of the year is expected to be 8% below the midpoint of the company´s previous guidance.
Making things worse, organic traffic tends to have higher conversion rates and a stronger monetization than other traffic sources for RetailMeNot, so the company is not only seeing slower revenue growth, but this is also affecting margins in a negative way.
In this context, the company delivered lower than expected sales and earnings for the second quarter, and management also reduced its guidance for the rest of the year, which generated considerable negativity among RetailMeNot investors, as suggested by the stock's price performance in recent months.
The opportunity
While it's never nice to see a company reducing guidance, it's important to keep in mind that management still expects solid sales and profit margins, both for the coming quarter and the full-year 2014.
For the quarter ending on Sept. 30, RetailMeNot projected net revenue in the range of $53 million to $57 million, implying an annual growth rate of 16% at the midpoint. Adjusted EBITDA is forecast to be between $14 million and $16 million; this would mean an adjusted EBITDA margin of 27% at the midpoint of the range.
For full-year 2014, the company expects revenue between $262 million and $270 million, a 27% year-over-year increase at the midpoint. This is actually the same guidance range RetailMeNot provided at the beginning of the year, before raising guidance due to strong performance in the first quarter and then dropping it again later. Adjusted EBITDA margin is expected to be roughly 34% of sales during the year.
These numbers don´t look that dismal at all. Besides, management said in the latest earnings conference call that strong growth in other traffic sources such as mail, social media, and direct navigation is mitigating the negative impact from slower growth in organic search.
What doesn't kill you makes you stronger, and RetailMeNot could emerge from its problems stronger than ever by reducing its dependence on organic search and building a more direct relationship with customers.
From a long-term perspective, the company has an interesting business model. While competitor Groupon (GRPN -4.94%) is more focused on providing huge discounts from small merchants and local companies, RetailMeNot is successfully attracting big retailers and coveted brands, a key differentiating factor for the company.
RetailMeNot also beats Groupon by a wide margin when it comes to cash flow generation. The company produced $36.5 million in operating cash flow during the first half of 2014, while Groupon delivered negative operating cash flow of $43.5 million over that same period. This represents a considerable advantage for RetailMeNot when it comes to financial flexibility to invest in areas such as marketing, technology, and acquisitions.
The takeaway
RetailMeNot's dependence on Google and its organic search traffic is an important risk to keep in mind, so investors might want to watch the financial performance over the coming quarters in order to evaluate the company´s ability to deliver sound results under the new scenario. However, the market usually exaggerates its short-term reaction to negative news, and this seems to be the case with RetailMeNot recently.
The company is still delivering healthy financial performance, and the business model remains quite solid. All in all, there is a good probability that the recent collapse in RetailMeNot stock will turn out to be a buying opportunity for contrarian investors.