Summary
- 65% gross margin tech revenue with no media risk make for a compelling business model.
- Increased sales and operating leverage reflected in rapidly expanding EBITDA margins.
- Fascinating backstory with major shareholder all but guarantees positive long-term outcome.
- Uniquely positioned with access to an unprecedented amount of the most valuable data.
- The only true full stack independent competitor to Google's Doubleclick ad management platform.
When it was announced that Alliance Data (NYSE:ADS) would buy Conversant (NASDAQ:CNVR), traders seemed confused. Frantically trying to figure out the closest competitor of the acquired company to bid up, somehow they arrived at Rocket Fuel (NASDAQ:FUEL). A burst of trading sent Rocket Fuel shares up as much as 20% on this news. The stock that should have moved up and can be more closely compared to Conversant is a little known but major player called Sizmek (NASDAQ:SZMK).
Similar to Conversant, which was previously known as ValueClick, Sizmek recently was the target of a re-branding following the sale of its TV advertising platform to Extreme Reach. Sizmek was spun off from Digital Generation and represented the desirable online ad tech assets minus all of the debt and legacy analog TV technology of the parent company. Combined, the new company is an open full stack ad management competitor to Google's (NASDAQ:GOOG) DoubleClick. It is by all accounts the second largest player in this space behind DoubleClick, albeit far behind in market share. But this unique runner-up and publisher independent position makes Sizmek a highly strategic asset.
Other than Conversant - which is off the market now having been acquired - there are only a few pure play public ad tech companies that can be considered true independent tech companies rather than media traders. These include Rubicon Project (NYSE:RUBI), TubeMogul (NASDAQ:TUBE), Sizmek and SaaS platform Marin Software (NYSE:MRIN). Out of these true tech companies, Sizmek is by far the cheapest. This table will illustrate the classic valuations based on enterprise value to sales and EBITDA. None of these companies have any debt except Marin which has a relatively insignificant amount. These statistics were calculated as of October 3 following the close of trading:
| Tech Company | EV/Sales TTM | EBITDA TTM |
| Rubicon Project | 2.93 | -$8.11M |
| TubeMogul | 3.68 | -$685k |
| Sizmek | 0.80 | $19.53M |
| Marin Software | 2.49 | -$27.02M |
So as you can see by this apples-to-apples comparison in the ad tech sector, Sizmek is valued extraordinarily cheap. Now there are a few reasons for this. For one, almost nobody has heard of Sizmek. Unless you are in the online advertising industry (like myself), the name will not ring a bell. Although it served 1.5 trillion advertisements last year, Sizmek has been trying hard to attract investment coverage to the company, going as far as putting on a 3 hour analyst presentation in May. I can't say that I've ever seen a company presentation this extensive and I suggest that everybody views the webcast as it is extremely informative. Despite this, only two analysts cover the stock. They are Darren Aftahi from Northland Capital and Jared Schramm from Roth Capital Partners. Only Aftahi has a rating on the stock and it is an "Outperform" and a $14 PT which is nearly double the current stock price.
Another reason that Sizmek is trading so cheap is because it is not very "sexy." Rubicon Project puts on incredibly inspiring presentations. Both the CEO and CFO are great speakers. They tell compelling stories and the vision that they sell of being the "NASDAQ of advertising" is catchy. In a space where investors have real difficulty distinguishing between the different companies, hype sells stock. Rubicon Project and TubeMogul are promoted well by management. From the road shows to presentations, these companies have an impressive "sizzle" and rapid top line growth, albeit off a small base. It is an easy story to sell to momentum focused investors. Although both of these high flying companies have negative EBITDA they are still awarded a higher valuation than Sizmek from a very risk-tolerant market. Marin Software on the other hand derives a lot of value from its SaaS model that seems to attract investors that might otherwise be flying blind.
Marin Software is losing the most money of this group, but it is a very well known brand. I use Marin Software myself to run ad campaigns and was a shareholder before I recently cashed my post-earnings gains and jumped in to Sizmek as it simply represents a much better investment opportunity at these valuations. It is worth noting that Sizmek is transforming to a SaaS model over the next 3 years but this has not been priced in to the stock price yet. With no conventional analyst coverage, investors really have to tune in to the 3 hour investor presentations to find out what is going on. That is if they can make it through the webcast without falling asleep.
At Sizmek's current valuation you would think that the business model is broken. However, I don't believe this to be the case. While the rate of sales growth is slower than some of the other companies in the space at a projected 12%-17% for FY2014, the gross margins are high at 65% and increasing. This revenue growth rate exceeds the 8% rate that Conversant is growing at YOY. Conversant of course is very similar to Sizmek in that it generates a significant amount of positive EBITDA, unlike its "grow at all cost" competitors that are losing money with no long-term profitability in sight. Sizmek's gross margins are in line with Rubicon Project, TubeMogul and Marin Software. They dwarf the sub-50% and 40% gross margins of the primarily media trading ad tech companies mentioned earlier in the article, which again leads to this apples-to-apples comparison with pure tech fee companies.
The real story here for Sizmek is its operating efficiency. It is not clear if Rubicon Project, TubeMogul or Marin Software will ever be sustainable or profitable business. Meanwhile, Sizmek demonstrated during Q2 an impressive 25% EBITDA growth on a modest 7% increase in sales. It also announced that it authorized by the board to buy back up to $15M in shares during Q4. At the current depressed prices that is about 7% of the outstanding shares, which is a meaningful amount. Sizmek's relative slow growth in the sector is due to its historical strength in rich media, a segment that is growing much slower than mobile or video but still dominates online advertising. Over 50% of Sizmek's business is rich media or display. Sizmek acquired Aerify Media in order to bolster its mobile business. It will be fully integrated in to the Sizmek MMX this quarter. Sizmek also introduced recently a Video Verification service that has been immediately accretive to high margin revenue growth.
The return to double digit growth can be attributed to strong traction in mobile and video. In Q2 mobile grew at 58% YOY and in-stream video at 101%. Sizmek's programmatic revenues increased 54%, mainly through its Peer39 offering, but also assisted by three other in-house programmatic offerings. While these programmatic revenues are undoubtedly building off a small base, they are approaching a double-digit multi-million dollar business this year. Two big Q2 client wins include Amazon's (NASDAQ:AMZN) A9 subsidiary and Yahoo (NASDAQ:YHOO).
One of the major reasons that I'm so bullish on Sizmek is because of Alex Meruelo. He is a very disruptive activist investor who cleaned up by buying DG shares in the open market on the cheap and pushing for a sale of the TV advertising unit. He succeeded with his efforts and now owns 13.2% of Sizmek shares and more or less controls the board. His ownership stake is increasing with the buyback and he is active and vocal although he has agreed to initiate a proxy war to take full control of the company until next quarter. As a result of Meruelo's activism, the Sizmek board is now extremely shareholder friendly. In my opinion, it is all but certain that Meruelo will be active during Q1 2015, particularly with the share price sitting at such depressed levels.
After stripping away the legacy TV business and the large debt, Sizmek is now a very strategic and highly desirable asset. It features a strong balance sheet with high EBITDA and is cash flow positive. The company is profitable unlike every other independent ad tech company out there, with the exception of the recently acquired Conversant. As a neutral middleman, Sizmek has unprecedented access to massive amounts of the most valuable data out there. That is, the campaign results of its competitors. Succeeding in ad tech is all about having access to big data and that is a result of scale. Sizmek is a big player with greater ad management market share than any other independent ad tech company. Its open stack platform provides it with a unique position in the market as customers do not necessarily need to use Sizmek's analytic products for instance. As opposed to DoubleClick, which is a closed system that requires its ad serving customers to use its full stack.
While point solution companies are a dime-a-dozen right now in ad tech, very few companies have complete end-to-end capabilities. In fact every other ad tech company that I mentioned in this article is simply a point solution. Sizmek is a full stack and the compilation of several acquisitions over the years that are worth (after write downs) $400M, or about double its current market capitalization. There is simply a lot of chicken on the bone here. Investors benefit because Sizmek simply does not tell a great story, despite being firmly rooted RTB innovator.
The CEO does not present very well and analysts genuinely seem disinterested in covering Sizmek. Otherwise it would be trading at a much higher multiple in line with its apples to apples ad tech peer group. A valuation of 2x EV/Sales, which is very conservative given its peer group comparisons, would value the stock at nearly $20. If it was to be valued in line with the recently acquired Conversant, which has slower sales growth than Sizmek but higher EBITDA, it would be awarded 4x EV/Sales and that would equal a near $40 stock price. Either way, at 0.8x EV/Sales Sizmek is grossly undervalued.
Bargain hunting hedge fund Roumell Asset Management, which owns Sizmek as a top holding in its portfolio, had this to say about the company in its Q2report to investors:
Moreover, operational metrics are steadily improving. To wit, management has boosted EBITDA margins from 5% in 2011 to 14% in 2013 and has a goal of reaching 30% in the medium term. Many of its peers have growth but no margin. SZMK's revenues are growing (profitably) at about 15% annually. We believe after the sale of its legacy TV ad distribution business and resulting emergence as a stand-alone online company, few investors understand the potential value of SZMK.
In summary, display accounts for roughly $30B of the $40B in online advertising spend. Sizmek is already a renowned leader in this market segment, particularly in social rich media through its Republic Project acquisition. Growth in display is only growing at roughly 5% annually. Sizmek is increasing its efforts in the faster growing, but comparatively nascent video and mobile segments which are growing at 25% and 30% respectively. New video and mobile initiatives along with a heavy focus on programmatic will likely drive increased profitable growth.
CEO Neil Nguyen and DG founder Scott Ginsburg own about 14% of the outstanding shares. While the CEO isn't the greatest showman, I believe that he has a profound understanding of the technology and a clear vision of what it will take to position the newly formed Sizmek as a clear winner in a sea of many unsustainable business models. With no debt, positive EBITDA, 65% margins, high quality tech fee revenue, plenty of cash and strong secular positive industry trends, Sizmek looks remarkably cheap at its current market valuation.
This price has been discounted by nearly 50% off its post spin-off highs only a few months ago in sympathy with a broader ad tech sell-off. I have been buying Sizmek stock for the past week and plan on continuing to take advantage of the market misunderstanding by accumulating shares on further weakness. My short-term target here is $14, which represents a very conservative EV/Sales of 1.5 that is still well below fair value in its apples to apples peer group. This is nearly a 100% return and I think we can see that by the end of the year with a slight change in sentiment towards this profitable ad tech company that nobody is talking about.
ByCharles Moscoe - Disclosure: The author is long SZMK.
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