The third and final business is called Communications, mainly dial-up Internet service via the well-known NetZero and Juno services. 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 over 20% of sales.
Before purchasing FTD, United Online was a company in "run-off" mode, milking its two legacy businesses and paying off cash flow to shareholders for as long as it lasted. Clearly, Classmates and NetZero/Juno are businesses facing terminal declines. While both were once very popular, technology has doomed them. For Classmates, free social networking applications like Facebook make paying for Classmates 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. NetZero, for example, delivered 17% lower sales in the most recent quarter.
But now, with FTD, United Online has acquired a business with a decent competitive position and a fairly stable outlook. FTD is very well-known (it's over 95 year old brand), and with Teleflora, FTD holds 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. FTD's existing network provide 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. Small competitors like 1-800-Flowers (FLWS) and ProFlowers can and do take business from FTD through underpricing (flowers are a notoriously marked up product), and there is nothing stopping others from following that strategy.
The FTD purchase had some adverse effects on United Online, too. The dividend had to be cut in half, although the current yield is still very impressive at nearly 6%. Dividend investors may be intrigued, although given the nature of 45% of sales and the current 35% payout of free cash flow, it is unlikely to be sustained for more than a few years. FTD also carried a fair amount of debt, and the balance sheet is not all that impressive with about $117 million in cash dwarfed by over $380 million in debt. Interest coverage ratio is barely above 5, which is the absolute minimum MagicDiligence looks for. The FTD purchase also increased outstanding shares by over 20%, diluting any income gains delivered by the new business. Free cash generation is strong, though, with historical free cash margins in the high teens, and post-FTD FCF margins around 12-13%.
United Online also has an attractive valuation - a 15% earnings yield, and a 16% earnings yield against guidance for 2009 are reasonable prices to pay. Investors are already pricing in the likely declines of NetZero and Classmates, and the dividend isn't going anywhere near-term. In the best case, United Online might deliver a 10% valuation appreciation along with a 6% dividend yield over a year holding period... not bad but certainly not Top Buy worthy. While I'm putting a positive outlook on UNTD, this is a second-tier MFI stock at best and Magic Formula investors can probably do better elsewhere.
[b]Quick Look{/b]
Date: Sep 2, 2009
Growth: D
Competitive Moat: D
Management: B
Financial Health: C-
Opinion: Good dividend, cheap price, but mediocre businesses. Marginal buy.
Steve owns no position in any stocks discussed in this article.
Steve Alexander
[www.magicdiligence.com]
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