While big names such as Buffett and Klarman draw the spotlight of media attention in the value world, there are a good number of lesser-known individuals with track records that rival these “celebrity” investors. One such individual is Dr. Phillip Frost. The big difference between Buffett and Frost, however, is Buffett defines value as a cut-price asset; Frost seeks out fledgling industries that he believes have large growth potential. The fledgling nature of these industries results in a general market undervaluation of their constituent companies, the undervaluation in which Frost’s value lies.
An Example
As an example, consider IVAX Pharmaceuticals. In September 1984, Ronald Reagan signed into law the Drug Price Competition and Patent Term Restoration Act, or Hatch-Waxman Act. The act encouraged pharmaceutical companies to develop and produce generic drugs, and established the modern system for government generic drug regulation. The huge generic drug industry of modern times was born of this bill. Shortly after the bill’s introduction, during 1987, Frost merged three small, struggling pharmaceutical companies into an already existing publicly traded company, IVACO Industries. He renamed IVACO IVAX, and turned the company’s focus to generic drug manufacture.
He recognized the potential value in international markets for cheaper, generic drugs and subsequently expanded IVAX’s operations to Latin America and Eastern Europe. It was 10 to 15 years before any of the major U.S. pharmaceutical companies identified this value, during which time Frost grew IVAX into one of the world’s leading generic pharmaceuticals companies.Â
Since then, Frost has diversified from pharmaceuticals. While the majority of his day to day operations involve Opko Pharmaceuticals (OPK), another drug manufacturer formed from the merger of three smaller companies, his investment portfolio includes a Chinese billboard company, a sports nutrition company and a Nevada gold mining company. In addition, it also includes a company that operates in the potentially undervalued industry this piece intends to highlight. The industry is social media sponsorship. The company: IZEA Inc. (IZEA).
What Is Social Media Sponsorship?
To answer this question, it is first important to define native advertising. Native advertising is a type of online advertising analysts champion as the successor to the traditional display advertisements that run alongside, and along the top of, web pages. The advertisements adopt the look and feel of the site on which they are placed, making them appear as normal content. An example of a native advertisement is a sponsored post appearing in the Facebook (FB) news feed. Reports suggest that native advertisements are between 2 to 10 times more effective than banner advertisements, lending credence to their billing as the next big promotional format.
Social media sponsorship is a type of native advertising that involves influencers, or promoters, publishing content through their own social media channels that mentions a particular good or service. Effectively, it is the online equivalent of Tiger Woods appearing in a Gillette commercial.Ă‚
What Part Does IZEA Play?
IZEA acts as a sort of sponsorship agency, bringing the advertisers and the content publishers together. Whereas traditional media agencies would marry the two parties and arrange a campaign, IZEA operates platforms through which the two parties can meet. The parties then arrange and implement the campaign using the platforms, through which IZEA provides both advertiser and publisher with detailed analytics as to its reach and effectiveness. The company generates its revenues from a transaction fee, taken each time a publisher releases promotional content. To date, A-list actors, reality television stars and top athletes have all reportedly used IZEA’s platforms, in conjunction with top brands such as Microsoft, Audi, LG and Kraft Foods.
Where Is the Value?
The value in IZEA, and a likely driver in the investment thesis of Frost, is the relative youth of social media sponsorship and, in turn, the concept’s growth potential. In April last year, research organization BIA/Kelsey predicted that native advertisement spending on U.S. social media platforms alone would rise to $4.57 billion in 2017, from $1.63 billion in 2012.
Furthermore, the organization expects native spending will grow at a faster rate than display spending in every year during the forecast period. Social media sponsorship is one of the fastest growing types of native social media advertising, with the amount of marketers using social sponsorship rising 5% from 2012 to 61% in 2013. As the industry grows, so will the capitalization of its leading constituent companies, of which IZEA is one.
The Financials
IZEAs financials illustrate this pattern. In the three since 2010, the company has grown its revenues from $3.82M to $4.95M, a close to 30% increase. During the first three quarters of 2013, IZEA grew its revenues from $1.38M to $1.56M, a 13% increase. Gross profit during this period grew to $1.06M from $809,000, another 30% increase.
Furthermore, IZEA recently reported fourth quarter 2013 bookings of $1.93M, a 140% increase over the same quarter in 2012. Bookings represent the dollar value of the pre booked campaigns that IZEA expects to collect during a 90-day period.
What Are the Risks?
Even with the backing of an investor who is world renowned for his small-cap prowess, IZEA is a high-risk stock.
With a market capitalization of just over $7 million, it is highly likely that any growth that comes as a result of value realization will be preceded by high volatility. In the short-term, in other words, IZEA stock could lose as much value as it might gain.
Further risk lies in the company’s balance sheet. IZEA is yet to generate any retainable earnings and at last count, held total cash and equivalents of $1.66 million. The company will likely require further funding before it becomes profitable, which will dilute the holdings of any early stage investors.
In addition, dilutive risk does not just come from further funding. At last count, the company reported 6.9 million options outstanding with a weighted average exercise price of $0.54. As these options are exercised, the value per share of an investor’s holding will fall, meaning IZEA stock will need to rise a considerable amount past the average strike price in order to mitigate the dilution.
The Value Proposition, Summed up
If IZEA can maintain its current growth rate it could become one of the leading companies in an industry that analysts expect to be the “next big thing” in online advertising. Frost looks to have recognized this and has taken a position that exposes him to this potential. While development stage companies such as IZEA can be risky, this does not mean value cannot be found. If a billionaire investor thinks they might have uncovered some, be it industry or company specific, it might be worth paying attention.
