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MFI Stock Review: United Online (UNTD)

United Online (UNTD) is a sort of "mini-conglomerate" with three lines of business. The first, FTD, markets floral and gift products over the Internet and through a toll-free telephone number (1-800-SEND-FTD). Orders are then fulfilled by one of the company's large network of local florists. While FTD is a U.S. concern, the subsidiary also has a similar business in the U.K. and Ireland known as Interflora. FTD provided 60% of United Online's revenue and 35% of operating profit in 2010. It was acquired in 2008.

The second line is called Content and Media, namely Memory Lane (formerly and MyPoints ( Classmates is a 60 million strong social network organized mainly by academic institutions attended. While most members just list their information with a free account, a paid account is required to contact former acquaintances. The Memory Lane re-branding was finished in February to highlight some of the nostalgic content added (like yearbooks). MyPoints is a "pay to click" site where people get points towards rewards for taking surveys, responding to email offers, and so forth. This business segment delivers around 22% of total revenues and 27% of operating profits.

The third and final business is called Communications, mainly dial-up Internet service under the well-known NetZero and Juno brands. Most revenues here are from dial-up accounts, although some other auxiliary services like hosting, broadband, premium email, and such are provided. Communications comprises just 18% of sales but is the largest profit producer, at 38% of the total.

Classmates/Memory Lane and NetZero/Juno are businesses facing terminal decline. While both were once very popular, technology has doomed them. For Classmates, free social networking applications like Facebook make paying for reconnecting with old friends a questionable proposition at best. For NetZero, dial-up Internet is a relic that has been declining for the past decade. Neither business has any kind of growth potential, and in fact both will probably deliver steady declines going forward. In the most recent quarter, Memory Lane posted 4% lower revenues and 9% lower profits against 2010, with paying accounts falling 15%. NetZero/Juno was even worse - 23% drops in revenue and profit, with paying account volume declining 25%.

With FTD, United Online acquired a business with a decent competitive position and a fairly stable outlook. FTD is very well-known (the brand is over 97 years old), and along with Teleflora, FTD enjoys a virtual duopoly on nationwide florist networks. Flower and gift sales are discretionary, but even in tough times it is hard to see Valentine's and Mother's day without a glut of flower orders being delivered. Most recently, FTD has been performing well, posting a (pro-forma) 10% rise in sales and 16% rise in profits. FTD's existing network provides it with a fine, short-term competitive position that should easily withstand a year in an MFI portfolio. Longer-term, though, there are few moat factors because this is a business with no switching costs, barriers to entry, or unique assets. Smaller competitors like 1-800-Flowers (FLWS) and ProFlowers can and do take business from FTD through underpricing, and there is nothing stopping others from following that strategy.

United Online is a solidly profitable company that generates good cash flows. Probably the most attractive part of this stock is its juicy 6.4% dividend yield. The dividend looks relatively safe in the near term at just 41% of free cash flow. However, there are some concerns. First, operating margins are in a steady decline, falling from 18.6% in fiscal 2007 to just under 12% today. Considering its two most profitable businesses are also the fastest declining, this is a trend that is unlikely to reverse going forward.

Also, the balance sheet is not the cleanest. $106 million in cash offsets $259 million in debt. Operating earnings cover interest payments about 5 times over, just about the minimum coverage I like to see. To be fair, United has done well paying down the debt incurred to purchase FTD. I don't see it as a huge concern, but as a rule I don't like to see a lot of debt on a declining businesses' balance sheet.

The stock is appropriately cheap, with a Magic Formula earnings yield of 12.8%. Still, this is below the stock's 5-year average of about 14%. Modeling modest overall declines going forward, I value United Online generously at about $6.50 a share. Combined with the dividend, that's about 10% upside over a year holding period. Given this rather meager margin of safety and little growth prospects, United Online is a second-tier MFI stock. Magic Formula investors can probably do better elsewhere, or wait for a lower price.

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