The Affiliate Marketing business (23%; 38%,; 60%) is ValueClick's Commission Junction subsidiary. Affiliate marketing allows advertisers to offer their own ad creatives to a large network of website publishers, who serve the ads then receive a commission whenever a customer completes a targeted action, such as buying a product or signing up for a service. ValueClick similarly gets paid a percentage of commissions from the advertiser. Management believes that Commission Junction is the largest affiliate marketing network in the world.
The third unit is Owned and Operated Websites (19%; 9%; 18%). This consists of price comparison shopping sites Smarter.com and UK-based PriceRunner.com, online coupon finder CouponMountain.com, and my personal favorite Investopedia.com, an online collection of financial terms and topics. All of these websites have the same business model, offering free-to-use content and tools and earning money by providing ad space for both ValueClick-sourced and third party (particularly Google) ad networks.
ValueClick has performed impressively over the past 3 years, growing revenue at 25%+ annual rates and earnings at over a 30% clip. Much of that growth has come from acquisitions, including the additions ofDotomi (retail display media) and Greystripe (a mobile ad network) to the Media division in 2011, andInvestopedia to Owned & Operated Websites in 2010. ValueClick has a strong balance sheet, with $130 million in cash vs. $80 million in debt and a free cash flow run rate of about $140 million a year. This gives the firm ample firepower to continue delivering growth in this manner. There are almost limitless opportunities to add to the Owned & Operated division, and affiliate marketing is still a rather scattered industry, with various competing networks often focused on a particular topic or business vertical.
Organic growth has been driven in Affiliate Marketing, where Commission Junction has built a modest network effect through its large networks of both publishers and advertisers. Revenue growth has slowed somewhat here, from 12% in 2011 to 7% last year and down to 3% in the most recent quarter. However, I see it picking back up again with Google's decision to exit affiliate marketing services. Management is keenly focused on winning Google's legacy customers in the short-term, and CJ is the most logical place for those customers to go.
Finally, ValueClick has done a good job over the past several years controlling its expenses. A look at the operating margin ramp shows this clearly: 8.3% in 2008, 19.5%, 21.6%, 22.3%, and 23.7% in 2012. The trend continued in Q1, coming in at 25.3%. The firm's business model is fundamentally healthy and itsoperating leverage is clear. With a renewed focus on Affiliate Marketing, a 60% margin business, there is upside potential even to the latest figure.
The risks here are largely macro-economic. Advertising is an economically sensitive activity, and ValueClick suffered revenue declines in 2009 and 2010. The O&O business is reliant on Google for ad revenue, and that firm remains a competitor (the divestiture of Search123 notwithstanding). Growth has been mostly via acquisition, always a risky route, and ValueClick has taken substantial goodwill write-downs in the past.
ValueClick is a decent Magic Formula® pick at present. My fair value estimation here is about $30, representing modest 13% upside. However, I would ideally like to see the stock drop into the low $20's before considering it for the Top Buys portfolio.