The below post was a foray into the world of macroeconomics, a matter which I have no formal and little informal education in but I nonetheless feel perfectly qualified to give my opinion, just like everyone else. Now I would like to talk about issues in valuing United Online, a matter with which I have much more fluency.
I have recommended United Online (UNTD) here in the past, and I do still like their FTD online property, and I think their dialup business is capable of spinning off quite a bit of free cash flow before it ceases operations. (I am fairly indifferent to classmates.com). By traditional valuation metrics, the stock is still underpriced, but I have noticed that their free cash flows are declining quarter by quarter, presumably as the result of the loss of some after-sale marketing programs. I think the company will eventually find a new equilibrium, but on the other hand, I wouldn’t care to place a bet on what level of free cash flow that equilibrium will be.
Last quarter, they reported net income of $14 million, depreciation of $14 million, and capital expenditures of $10 million, producing free cash flows of $18 million. If we use this figure as the basis for their full year outlook and capitalize it at a rate of 10x, we get a market cap of $720 million, which is a good 50% above the current market cap. However, the quarter before last, free cash flow was $21 million, and the quarter before then $23 million, and the quarter before that, $26 million. Fortunately, as the result of their disappointing earnings announcement and not-optimistic outlook, the company’s market cap dropped by roughly $90 million, so it seems that the market is more or less instinctively walking the price down until the company regains cash flow stability, so hopefully those of us who are waiting for that moment will not see the apparent bargain price pulled away from us prematurely.
I should also point out that for whatever reason, the company includes stock-based compensation alongside depreciation and amortization. I agree that much like the other two, stock-based compensation is a non-cash expense, and if I were one of United Online’s creditors I would support that designation. However, stock-based compensation still dilutes the equity holders, and since United Online is probably undervalued I dislike seeing so much stock being given away all the more. Stock-based compensation ran them $40m last year, $36m the year before, $19m the year before that, and nearly $15m year to date. I will say that such compensation has allowed the firm to pay down its debts (almost $30 million more last quarter alone), and although interest expense is highly manageable at approximately 1/4th free cash flow to the firm, I do like to see debt being paid down in this environment.
The bottom line in terms of recommendations is that United Online is apparently underpriced on a free cash flow yield basis, but until they can get their declining free cash flows under control, I would probably not consider investing in them without a much larger discount. In terms of book value, they’re not particularly impressive either. I believe that such an occasion, as indicated by a quarter or two of flat or increasing free cash flows, is not long in coming, and I hope that the market will not walk the price away from us bargain hunters in the meantime.