Audible (NASDAQ:ADBL) is a dot-com business that survived the bursting of the Internet bubble. Perhaps that's because, like another survivor, Amazon (NASDAQ:AMZN), Audible sells real products: downloadable audiobooks, radio programs, newspapers, and magazines that can be played from your PC, burned to a CD, or played on virtually every MP3 player out there. The key to Audible's success in selling such wares is digital-rights-management technology, which not only protects the copyright of the content but also tracks users, registered devices, and purchased content.

The vast majority of Audible's revenue -- about 97% -- comes from downloadable audio. Content is sold on a per-item or subscription basis. It provides all of Apple's (NASDAQ:AAPL) popular iTunes spoken-word content via an agreement that lasts through 2007, and it has partnered with Amazon and XM Satellite Radio (NASDAQ:XMSR), thereby turning would-be competitors into collaborators. (The company also has licensing agreements with many publishers, including major investor Random House.)

Over the past year, Audible has grown its infrastructure significantly. It launched a U.K. site and added to its German and French sites, and it's beta-testing a service called Audible Air, which provides wireless downloads to smartphones -- though, at the moment, only to Palm's (NASDAQ:PALM) Treo. The company also launched Audible Wordcast -- allowing podcast producers to track unique downloads -- and revamped its website and membership plans to now allowing book-credit rollovers.

Because of unexpectedly high marketing and operating expenses -- primarily related to the late launch of the reworked website -- in the most recent quarter, Audible no longer expects to be earnings-positive for 2005. Therefore, P/E is not a good metric to use for this company. (The company only became earnings-positive in 2004.)

Let's use discounted cash flow (DCF) instead. Over the past four quarters (from a trailing-12-month (TTM) perspective), Audible's free cash flow was $9.4 million. However, 2005 was hardly typical for capital expenditures because of the company's rapid expansion of services. From 2002 through 2004, the company averaged $230,000, instead of the TTM amount of $2.2 million -- about nine times as much. If one uses half of the TTM capital expenditure instead -- a balance between TTM and the historical average -- free cash flow would have been $10.6 million.

Thomson First Call's low estimate for growth over the next five years is 20%, while the median estimate is 30%. (For conservative-estimate purposes, I don't use the high rate.) Using those rates for free cash flow, halving them for the following five years, and using a terminal rate of 3%, while applying a discount rate of 12%, gives us a range of $11 to $20 for Audible's stock. That's quite a range, which proves that growth rates play a huge role in a DCF. Note that the company went from FCF-negative to FCF-positive over the past three years, a move that implies a strong growth rate for the next few years. At the lower but still healthy rate, the stock seems close to being fairly valued at current levels.


Growth rates (%)**














*Trailing 12 months, in thousands.
**5 years/next 5 years/terminal rate.

As you can see, a crucial component of your investment decision would be whether Audible can reach 30% earnings growth over the next five years.

Audible is indeed acting like a real business by expanding its infrastructure instead of providing dot-com-like promises. Last summer, analysts seemed to recognize this, but with the recent disappointment from the earnings forecast, the price was punished again. As Rick Munarriz wrote, Audible needs to get expenses back under control. Now that the updated site has launched, it might do just that.

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Fool contributor Jim Mueller doesn't own a MP3 player yet, but he does own shares in Audible. The Motley Fool is investors writing for investors.