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Published: August 30, 2010
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.
-- David Sterman
Staff Writer
StreetAuthority |
