Short-Term Woes Create a Compelling Value for this Industry Leader
It's important to maintain a watch list of stock ideas. Many of your investment ideas can be intriguing, but not quite tempting enough to merit your hard-earned dollars just yet. I like to check in on all of these investment ideas almost daily, waiting to see if the stock falls down to a level that I can't resist, or if the company has announced new initiatives or quarterly results that make the stock a true bargain.
But a stock's downward move may be the result of bad news that has dimmed the investment picture. The question is whether the downward move is justified, or if it has sharply overshot the mark, well below where shares should trade.
That scenario is playing out with DG FastChannel (Nasdaq: DGIT), which has run into some short-term growing pains after a long stretch of solid growth.
Growth stalls out for now
Following the dot-com boom, DG FastChannel was a perennially frustrating story. The company's advanced media placement services, tailor made for the digital era, never saw the demand that investors had expected. In hindsight, the company arrived before the market opportunity did. By the middle of the last decade, the advertising market suddenly embraced the use of very advanced media buying. Digital platforms for the delivery of ads, syndicated programming, multimedia advertising and web-based content were finally in vogue, and DG FastChannel's technology found a home with dozens of ad agencies and broadcasters. The company's satellite and web-based network now delivers programs and ads to more than 25,000 companies in the entertainment and marketing fields.
Sales rose more than +30% in 2006, 2007 and 2008 and a still-impressive +20% in 2009 -- which was hardly a banner year for the entire media industry. Until recently, many investors assumed growth would be robust again throughout 2010 and into 2011. In early August, the company posted impressive quarterly results, highlighted by strong demand for high-definition (HD) advertising delivery services.
But shares began to lose steam as investors grew concerned that any economic slowdown would lead advertisers to throttle back spending. On the DG FastChannel's early August conference call, management noted that it may need to reposition some of its offerings to maintain customer interest. The company had previously simply sold its technology to customers and let them conduct media buying plans, but thought it could capture more business by entering into the market with its own ad and content exchange where buyers and sellers can meet. Any time a company makes such a major change, it virtually invites sales disruption as customers figure out whether or not they want to participate.
When pressed about growth prospects for the rest of the year, management seemed unusually reserved compared to previous bullish body language in previous quarterly conference calls. "Management was stuck with the word 'good' for much of the call, which we do not believe was enough to get investors excited about the rest of the year," noted analysts at Dougherty & Co. That certainly spooked some investors, and the stock began a steady decline from $38 in early August to recent $24.
That selling now looks quite prescient. Management now concedes that the slowing economy is starting to bite and a decision to alter its sales approach is also keeping some clients on the sidelines. As a result, sales will grow only modestly in the current quarter compared to a year ago, and sales growth is likely to be negative on a full-year basis. DG FastChannel's shares, which had already been in freefall, lost another -38% on Monday to around $16 and are now about -60% below levels seen a month ago.
To be sure, it will take some time for DG FastChannel to get sales growing at a fast pace. First, the economy needs to rebound to help drive higher media buying levels. Second, the company will need to prove that its new sales approach wins favor with its massive customer base. If not, it may need to reverse course on those new initiatives.
Investors are now bracing for a period of stagnant growth, but it's important to remember that this is a remarkably profitable business. Even with its downbeat sales forecast, DG FastChannel will still likely generate more than $100 million in EBITDA this year, which translates into EBITDA margins exceeding 40%. Few companies can say that.
DG FastChannel's critical mass of customers means it's not likely that a rival can come in and steal the company's thunder. Management has invested nearly $200 million in the company's technology, and that platform now accounts for nearly half of the company's just-reduced market value. DG FastChannel now controls roughly two-thirds of the market, and it would be very costly for customers to switch to a rival.
Action to Take --> In any situation like this, it's important to measure the upside and the downside. The downside here is that shares stay stuck in the teens as investors come to expect slow growth in the years ahead. That looks overly bearish, but even if that were to be the case, shares have likely found a floor at current levels due to the company's deep technology platform and impressive customer base.
On the upside, even if sales growth rebounds to just the +10% to +15% range in 2011, EBITDA would likely grow even faster as incremental new revenue falls quickly to the bottom line. In that scenario, shares would quickly move back into the mid $20s and perhaps exceed the $30 mark -- double their current levels. A stock with limited downside and +100% upside always appeals.
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StreetAuthority LLC does not hold positions in any securities mentioned in this article.