Investors can make good return of investment if they can spot the opportunity when growth stocks fall out of favor from growth-oriented investors and value investors step in to fill up the void. An example can be Apple (NASDAQ:AAPL), AAPL used to be the hottest stock before 2013. All a sudden when the iphone growth rate started to become not as strong as anticipated by growth investors, they start to dump AAPL and create great entry point for value focused investors. I believe that the same kind of opportunity now resides in YuMe (NYSE:YUME). With solid financial strength, bright prospect of digital media growth, and attractive valuation, the 100% upside potential investing in YUME is a rare investment opportunity investors cannot overlook.
Business overview
YUME provides digital video brand advertising solutions in the United States and internationally. It has a proprietary data sciences platform, which drives outstanding brand results. The key service of YUME is to go to TV brand advertisers and assist them in migrating audiences online. The data sciences platform is the solution to solve the TV brand advertisers' problems. YUME uses data and survey capabilities to build an audience segment that helps to reach the targeted audiences and effectively deliver the impacts the TV brand advertisers looking for.
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Source: Company Presentation
As shown above, there has been a solid growth of total advertisers from 242 in 2010 to 580 in 2013. Although the revenue per advertiser has been more constant around $255, the increase in the number of advertisers helps YUME to attain 42% CAGR in sales since 2010.
In addition, YUME developed Placement Quality Index "PQI." PQI leverages the data captured so as to conduct real-time scoring and grading video inventory. Because of PQI, YUME can intelligently buy and delivery video advertisements to the targeted audience.
More detail about the business of YUME can be found on the company website.
Why did YUME decline to today's level?
In the Q2 2014, YUME reported $40.4 million sales compared to the street consensus of $42 million. However, the decline in sales is due to the constrained advertising spending from a few large advertisers other than market share loss. Plus, YUME was able to increase its gross margin to 48.8% versus 45.6% in Q2 2013. With the share price of YUME close to 52 weeks low, I believe that most of the bad news have already been reflected in today's share price. This indeed helps to provide an attractive entry point for prospective investors in YUME.
Outlook is bright
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Source: Company Presentation
The brand advertisement has risen to $580 million with 33% CAGR, which shows that YUME has been in a rapidly growing brand advertisement industry. But for the sophisticated data scientist analysis, YUME has been capable of achieving 42% CAGR from 2010 to 2013 as shown in the chart above. This further illustrates that YUME is able to grow faster than the overall brand advertisement industry.
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Source: Company Presentation
YUME's main video advertising industry is expected to grow 30% CAGR to $15.1 billion in 2016. As we can see from the dramatic shift in consumer viewing patterns below, there have already been a declining trend in TV viewing but an upward trend in digital media consumption, such as tablets, smartphones, desktops, etc.
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Source: Company Presentation
YUME is riding this upward trend and providing a good solution for the TV advertisers. That's why YUME has achieved 42% CAGR in sales since 2010. In fact, this trend is widely expected to continue and will act as a tailwind for the future growth in YUME.
Financial strength
Out of $172 million market cap, YUME has $61 million in cash. This results in only $111 million enterprise value. From Price/Sales ratio, it is currently close to 1. However, if we take out the cash to assess the value of YUME, it drops to around 0.6x EV/Sales. With the high growth outlook given by the migration to the digital media, the financial strength of YUME should give the management team the flexibilities to pursue these opportunities.
Valuation
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Source: Company Presentation
For most high growth internet or mobile related stocks, their valuation is normally out of reach for value investors. Not to mention that YUME has solid financial strength illustrated by its high cash position. As shown below, I modeled a 33% industry sales growth combined with the 20% targeted adjusted EBITDA margins provided by the company presentation above:
| TTM Sales (in million) | 168 |
| 2015 Sales (in million) | 223.44 |
| Adjusted EBITDA (in million) | 44.688 |
| Targeted Enterprise Value valued at 6x EBITDA | 268.128 |
When I apply 6x EV/adjusted EBITDA to value YUME, I find that YUME has more than 100% upside potential to rise to $268 million enterprise value from the current $111 million. It is rare to find such asymmetric risk/reward profile with limited downside risk as the financial strength and business prospect of YUME is strong. Plus, the 100% upside valuation does not incorporate any highly optimistic assumptions. With the expectation that YUME will grow at the industry rate and trade at a reasonable 6x EV/EBITDA valuation, prospective YUME investors can reap 100% upside potential.
Insider ownership
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Source: Gurufocus.com
According to the insiders' buy and sell information above, we can see that there is much more buy than sell by insiders. Despite 44k sell, DAG Ventures Management III still owned a sizable stake of 3,173,923 shares in YUME. Overall, we can see that the insiders voted their confidence in YUME by gradually increasing their stakes in YUME.
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Source: Proxy Statement
Even though my valuation shows that YUME is severely undervalued, we should also check insiders ownership to see whether insiders share the same point of view as us. I found that some well-respected venture capital funds still hold onto their shares of YUME: Accel Partners (15.5%), Khosla Ventures (15.5%), DAG Ventures (9.8), Menlo Ventures (7.7%), and BV Capital (6%). All in all, executive officers and directors, together with venture capital funds, own a significant 48.2% of YUME. Again, the insiders' ownership speaks strongly for the rosy prospective of YUME.
Management team
Other than 3.1% ownership of YUME, Jayant Kadambi, the founder and the CEO of YUME, earns a strong reputation on the street about his credentials. One of the reasons is that Jayant Kadambi is an enterpreneur, who founded a Vonage-like service DSL router service company, Starnet, before founding YUME. Starnet was acquired by Netopia, and Jayant Kadambi stayed with Netopia for five years. Afterward, he co-founded YUME with Ayyappan Sankaran, the chief technology officer and executive VP of Enginnering of YUME. As a seasoned CEO with successful background in Starnet, well-regarded investors, including Accel Partners, BV Capital, DAG Ventures, Khosla Ventures, and Menlo Ventures, voted their confidence in him and YUME without selling their YUME shares. In general, a CEO, who has gone through different cycle in raising up a start-up company, earns much more respect and credit from investment world and prospective investors. Given the strong background of Jayant Kadambi as the CEO to run YUME, prospective investors in YUME should be assured that they are investing alongside with reputable Venture Capital funds and a well-regarded CEO, Jayant Kadambi.
Risks
First, YUME derived $61.9 million sales from the top 20 advertisers out of the $151.1 million total sales. The concentration risk among the top 20 advertisers is a concern for prospective YUME investors. However, YUME has already doubled the number of advertisers from 242 in 2010 to 580 in 2013. This will eventually help to alleviate the concentration risk through more revenues from new advertisers. Second, technology changes rapidly. All technology companies have to constantly update themselves through R&D and remain relevant in the technology world. This does pose an unique set of risk to shareholders. For YUME, although it is subject to the same technology risk as all other technology stocks, its financial strengths and the tailwind in the migration from TV to digital help YUME to be an attractive investment opportunity given its asymmetric risk/reward profile. Third, please read the risks section in the 10-K to further understand the risk investing in YUME.
The bottom line
The combination of the following makes YUME a strong investment opportunity: a solid financial strength with ample of cash on balance sheet, a well-regarded and seasoned CEO with the financial backing of reputable Venture Capital Funds, a promising outlook with the growth prospect derived from the migration from TV to digital, an irresistable 100% upside potential with reasonable assumptions. As I pointed out in the risk sections, technology stocks are risky in their business nature. Hence, I would like to recommend YUME to those investors who can tolerate the business risks inherited in YUME.
Disclosure: I am not a securities broker/dealer or an investment adviser. You are responsible for your own investment decisions. All information contained should be independently verified with the companies mentioned, and readers should always conduct their own research and due diligence and consider obtaining professional advice before making any investment decision.
