Hopes were high in investor-land going into Digital River's
A few words, first, for those not yet familiar with Digital River, which I myself discovered only when its PR firm pinged me looking for some coverage a few years ago. We're talking today about the leading company in the business of moving software downloads from sellers to buyers and collecting payments for doing so.
When you buy a copy of Microsoft's
Enough with the bio. Now for the report card. Digital River reported its Q4 numbers Thursday evening, and the stock promptly cratered, down 18% in a day, even though profits under GAAP were in line with management expectations: $0.46 per share for the quarter and $1.58 for the year. That's 28% and 13% growth, respectively.
So what's wrong with that?
Nothing, really. But that's not the point -- or at least not the point Wall Street was making. The analysts were apparently disappointed not with what Digital River said about last quarter, but rather with guidance for the year ahead: The company promised $1.58 per share on revenue of $395 million in 2008, whereas analysts wanted to hear "$2.19 per share on revenue of $406 million."
Exactly. Digital River warned that it would be making some $30 million in investments in its business this year and, in the process, temporarily depressing profits to enhance competitive advantage and produce even greater profits in the future. I'm sure that would have been OK, because investors are really good about delaying gratification. (In literary circles, we call this "sarcasm.")
But while spending on the future would explain depressed profits, it can't explain why Digital River would lower revenue expectations for this year. For that, CFO Tom Donnelly blamed, first, lower-than-expected revenues from the company's renegotiated relationship with dominant client Symantec, and second, a generally anemic overall economic outlook. Not what investors wanted to hear.
But here's something you need to hear. In the wake of the sell-off, Digital River is looking positively cheap (this coming from a pre-sell-off buyer, by the way). The company generated $127.7 million in free cash flow last year, up 26% from fiscal 2006, and much more than you might think it was generating based on its GAAP net income alone.
By my calculation, Digital River sells for less than 10 times its trailing free cash flow. Although earnings are expected to be flat this year, management expects the investments it's making this year to drive future revenue growth and margin improvement. That future growth, coupled with the currently depressed stock price, makes this stock a screaming buy.
Ply the rough waters of Digital River's history in:
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Fool contributor Rich Smith owns shares of Digital River. Or did he already mention that? No matter -- there's a conflict of interest in anything he writes about a stock he owns, and he wants to make sure you keep that in mind. Why? Because The Motley Fool has a disclosure policy.