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MFI Stock Review: ValueClick (VCLK)

ValueClick (VCLK) is one of the largest pure Internet advertising agencies. The company has 3 operating segments. The largest is the Media business (58% of sales, 52% of profits, 33% operating margin), which creates and provides tools to create Internet-only ad campaigns for its customers, and distributes the ads through search, e-mail, display ads, mobile, and a network of 18,500 web sites, reaching over 80% of all U.S. internet users, a reach second only to Yahoo! (YHOO).

The Affiliate Marketing business (23%; 38%,; 60%) is ValueClick's Commission Junction subsidiary. Affiliate marketing allows advertisers to offer their own ad creatives to a large network of website publishers, who serve the ads then receive a commission whenever a customer completes a targeted action, such as buying a product or signing up for a service. ValueClick similarly gets paid a percentage of commissions from the advertiser. Management believes that Commission Junction is the largest affiliate marketing network in the world.

The third unit is Owned and Operated Websites (19%; 9%; 18%). This consists of price comparison shopping sites and UK-based, online coupon finder, and my personal favorite, an online collection of financial terms and topics. All of these websites have the same business model, offering free-to-use content and tools and earning money by providing ad space for both ValueClick-sourced and third party (particularly Google) ad networks.

ValueClick has performed impressively over the past 3 years, growing revenue at 25%+ annual rates and earnings at over a 30% clip. Much of that growth has come from acquisitions, including the additions of Dotomi (retail display media) and Greystripe (a mobile ad network) to the Media division in 2011, and Investopedia to Owned & Operated Websites in 2010. ValueClick has a strong balance sheet, with $130 million in cash vs. $80 million in debt and a free cash flow run rate of about $140 million a year. This gives the firm ample firepower to continue delivering growth in this manner. There are almost limitless opportunities to add to the Owned & Operated division, and affiliate marketing is still a rather scattered industry, with various competing networks often focused on a particular topic or business vertical.

Organic growth has been driven in Affiliate Marketing, where Commission Junction has built a modest network effect through its large networks of both publishers and advertisers. Revenue growth has slowed somewhat here, from 12% in 2011 to 7% last year and down to 3% in the most recent quarter. However, I see it picking back up again with Google's decision to exit affiliate marketing services. Management is keenly focused on winning Google's legacy customers in the short-term, and CJ is the most logical place for those customers to go.

Finally, ValueClick has done a good job over the past several years controlling its expenses. A look at the operating margin ramp shows this clearly: 8.3% in 2008, 19.5%, 21.6%, 22.3%, and 23.7% in 2012. The trend continued in Q1, coming in at 25.3%. The firm's business model is fundamentally healthy and its operating leverage is clear. With a renewed focus on Affiliate Marketing, a 60% margin business, there is upside potential even to the latest figure.

The risks here are largely macro-economic. Advertising is an economically sensitive activity, and ValueClick suffered revenue declines in 2009 and 2010. The O&O business is reliant on Google for ad revenue, and that firm remains a competitor (the divestiture of Search123 notwithstanding). Growth has been mostly via acquisition, always a risky route, and ValueClick has taken substantial goodwill write-downs in the past.

ValueClick is a decent Magic FormulaŽ pick at present. My fair value estimation here is about $30, representing modest 13% upside. However, I would ideally like to see the stock drop into the low $20's before considering it for the Top Buys portfolio.

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