By Scott Kessler
Based in part on our belief that the online advertising market has likely bottomed -- and is poised for a healthy rebound in 2002 -- Standard & Poor's is bullish on the prospects for DoubleClick (DCLK ). We recently upgraded the volatile shares of this leading provider of Internet advertising solutions to 5 STARS (buy), S&P's highest investment ranking.
Things look brighter all around for the Internet advertising market. According to New York-based online research firm eMarketer, Internet advertising spending is seen rising to $7.6 billion in 2001, up from $7.0 billion in 2000. This number is projected to surge to $23 billion in 2005, which would represent a compounded annual growth rate of 32% over the next four years.
What will drive the growth in online advertising? Increases in Internet users and usage, greater broadband deployments and subscribers, and more compelling advertising formats. Over the next few years, spending on digital marketing will likely grow to become larger than each of the advertising markets for magazines, cable television and newspapers.
DoubleClick gets its revenues from three primary business segments: TechSolutions, Media and Data. The TechSolutions (or Technology) business (52% of third quarter 2001 revenues) offers software and services to provide marketers and publishers with interactive marketing solutions. The centerpiece of the TechSolutions segment is the company's industry-leading DART technology, which allows customers to use pre-selected criteria to deliver advertisements in a targeted fashion. DART also accounts for advertisement performance and inventories. The company also offers AdServer software, for use by those companies interested in assuming more of an active role in customizing and operating their digital advertising processes.
The Media segment (24%) offers advertising and marketing solutions to publishers (content providers) and advertisers. DoubleClick aggregates the advertising inventories of hundreds of websites into networks using criteria such as geography, size, traffic and content. It enables advertisers to target users based on a variety of characteristics. The company's two networks compliment one another for optimal results: the Brand Network and the Audience Network.
The company's Data unit (26%) provides information products and marketing research services to the direct marketing industry. DoubleClick's database of consumer purchasing behavior includes over 3.5 billion transactions from more than 90 million U.S. households. The company uses this proprietary information and statistical modeling to provide direct marketers with information and analysis designed to increase response rates and profits using a variety of channels.
In addition to its well-established businesses, DoubleClick has also focused on product and service offerings in two emerging businesses areas: e-mail marketing and research. The company's e-mail list services offer marketers a wide variety of lists to reach their target audiences. DoubleClick has also recently bolstered its e-mail serving technology, called DARTmail, with the acquisitions of privately-held Flo Networks and Message Media over the past year. The purchase of @plan enabled DoubleClick to create Diameter, a new online research company that offers objective research tools to enable marketers to better understand online behavior, and plan and evaluate campaigns and strategies.
The slump in the online advertising market that took hold in mid-2002 has enabled DoubleClick to strengthen itself through the purchases of third-party companies and business units. As the entire industry has struggled amid the dot-com crash and global economic woes, the company has been able to enhance several of its businesses by buying assets on the cheap.
During this challenging period, DoubleClick has also refocused itself. The company has reduced its workforce, taken action to divest underperforming businesses, improved efficiencies, and cut operating expenditures. S&P expects DoubleClick to emerge from the downturn in Internet advertising spending with greater market share, pricing power and operational leverage.
In November 2001, the company announced that it was going to sell its European media business to formidable competitor AdLINK for a stake in this market-leading firm. Although this transaction will likely reduce reported revenue, it is seen generating significant savings on costs, and positive contributions to margins. In December 2001, DoubleClick made a similar move by exiting the advertising effectiveness business.
We believe that there is a good chance that the company's domestic media operations might be the next business to be sold. If DoubleClick were to announce such a deal, margins and per-share earnings would likely be impacted favorably.
ON THE UPSIDE.
Despite our expectation that the company will lose money this year, we believe DoubleClick offers significant value for risk-tolerant investors. As of the end of the third quarter of 2001, the company held cash, cash equivalents and investments worth $778.5 million, equating to $5.80 per share. On a conservative net basis (excluding all debt), these assets were valued at $530.7 million, or $3.95 per share. S&P expects this cash reserve to be minimally impacted by losses over the next two quarters, and continue to fund strategic acquisitions, finance stock and debt repurchases, and serve as a competitive advantage.
Over the past year, DoubleClick has been able to win and keep business partially due to its healthy balance sheet. One factor that has swayed purchasers of Internet advertising solutions to buy from DoubleClick instead of its competitors is the perception that the company will continue to be a viable entity many years into the future (unlike other online advertising solutions companies). Investors mulling the choice of which leading Internet company to put their money into often came to similar conclusions.
Standard & Poor's discounted cash flow analysis work indicates that the intrinsic value of the shares is around $15, which is also our updated six-to-12 month price target for the stock. This translates to appreciation from current levels of approximately 25%. Further increases are possible based upon favorable developments as to the sale of the U.S. media business, increases in revenue and earnings expectations predicated by an earlier and more pronounced rebound in the online advertising market, and more positive investor sentiment.
In sum, we like DoubleClick because it is an established and entrenched leader in a high-growth market, is improving its focus and operational efficiency, and offers significant value to risk-tolerant investors.
Kessler is a technology analyst for Standard & Poor's