Marchex (MCHX) is an interesting company because it is well positioned in a nascent industry, which showed solid growth over the past few years. Marchex could experience explosive usage adoption as click to call spreads with the growth of smartphones. In addition, MCHX has a non capital intensive business model, which generates cash. Let's have a more precise look at the Marchex business and B class of common stock.
Business Description and Current Status
Marchex delivers call- and click-based advertising products, analytical tools, and solutions to large advertisers and local businesses. The company operates with distribution partners and owns its own proprietary network of web sites. According to the most recent 10-Q filed November 2, 2011, 3rd-quarter 2011 revenue increased 64% year over year to $39.9 million from $24.2 million in the same period during 2010. Nine-month revenue in 2011 increased 55% to $107 million from $69.6 million in 2010. Operating profit for the three and nine month periods in 2011 increased to $2.5 million and $7 million from losses in 2010 of $.5 million and $4.7 million last year.
All of the operating profit gains came from the sale of assets of $7 million over the nine months in 2011 and $2.5 million in the most recent quarter. The bottom line is operations are currently breakeven without asset sales to create profitability. Nine and three month net income for 2011 is .05 cents .03 cents per diluted B share.
Looking at the composition of revenue between distribution partners and Marchex's own network, in the most recent quarter distribution partners make up 34,820/39.862 or 87% of total revenue. The partner network percentage increased from 74% in 2010 (17,999/24,194). In the nine-month period, the percentages were 91881/107703=85% in 2011, up from 49,894/69,590=71.69% in 2010. In both periods, proprietary network revenue declined. For the nine-month period in 2011, revenue dropped by 20% and 19% in the most recent quarter. Clearly, the company relies on its distribution partners for the vast majority of its revenue and growth, a trend that became more apparent as 2011 evolved and will most likely continue in the future.
From a competitive standpoint, Marchex competes with larger search companies like Google (GOOG) and Yahoo (YHOO). According to a Comscore Media Metrix December 2010 Search Report, Google and Yahoo account for 67% and 16% of all online searches in the U.S. Marchexrelies much more heavily on distribution partners for placement of call and click based advertising than these larger companies.
A positive development in the most recent quarter was an announced agreement with CityGrid Media (formerly Citysearch) of IAC Interactive (IAC), another very large network of users and advertisers.
Growth Initiatives
Historically, Marchex has used acquisitions as a way to help accelerate its growth. On April 7, 2011, the company acquired 100% of Jingle Networks, a mobile, voice, search, and advertising solutions provider. MCHX paid $59 million, which consists of $16.5 million in cash, $7.6 million in stock, and future payments of almost $35 million. The future consideration are divided into $17.6 million owed one year from the closing of the transaction and $18 million due 18 months after the purchase. As of the date of the addition, Jingle Networks had $11.4 million of revenue and $3.6 million of losses during the prior nine-month period ended 9/30/2011.
Revenue in the United States accounted for 95% of total revenue in the most recent quarter. Canada provided the remaining 5% of total revenue. Marchex is currently expanding operations in the U.K. and Ireland.
Valuation
With almost 36 million fully diluted B shares outstanding, with the current stock price of $5.10, the current market capitalization is $183.6 million. In the most recent nine months, operating cash flow totaled $13.1 million. If we divide this by three and come up with a yearly figure for operating cash flow, we get 13.1/3=4.36*4= 17.5 for yearly OCF. The valuation would come out to 183.6/17.5= 10.49 x OCF.
If we use EV/EBITDA as our valuation basis, in the most recent earnings report, MCHX announced full year 2011 adjusted EBITDA would come in at close to $23 million. Total net cash on the balance sheet is $35 million so the calculations would be 183.6-35=145/23=6.46x EBITDA. However, MCHX owes $35 million for the balance of the Jingle purchase, so if we say the company uses its cash for the rest of the Jingle buy, the calculation looks like 183.6/23= 7.98 x EBITDA.
Other Considerations
Marchex has $85 million of Goodwill on the balance sheet, with $50 million coming from the Jingle Networks acquisition. 2012 will be a year to test if the buy accelerates revenue, operating profit, cash flow, and net income growth. If not, at the end of 2012, the $50 million of goodwill will need to be examined for impairment and a possible write down.
In addition, as of 9/30/2011, Marchex had a deferred tax asset of $46 million on the balance sheet, which it expects to realize. If it cannot use these assets, the company would have to adjust net income or shareholder equity in the period the determination is made.
Of more importance is the issue of two classes of stock the company uses. There are 9.85 million Class A shares and almost 24 million Class B shares. The four founders of Marchex control 100% of all A shares, which have 25 votes per share. The class B shares have one vote per share. As a result, the founders control 91% of the combined voting power of all shares outstanding. Minority shareholders are completely dependent on these four individuals to make good strategic and operational decisions for the future benefit and growth of the company.
The company does pay a small dividend, which is not supported by current operating income. The dividend has been paid from selling existing assets, typically domain names.
Decision Time
Marchex has a business model that uses acquisitions to fuel growth in an industry experiencing increased adoption. It is dependent on growing its distribution network with large partners, which it has done a good job with. If an investor believes click to call and click-based advertising in the mobile space will continue to experience accelerating adoption rates over the next 5-10 years, Marchex represents and interesting possibility.
Disclosure: I am long MCHX.
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