Marchex Attempts Overhaul of Web Site Ad Business
By Nicole Ridgway
March 7, 2007
WHEN IT COMES to collecting domain names, Marchex (MCHX1) is a pack rat. The company, which provides online advertising and marketing services, has spent millions of dollars to accumulate more than 200,000 web sites, which are populated primarily with links from advertisers. Now Marchex is hoping to make bigger profits off its investments by turning these sites into content-filled virtual destinations rather than spare digital billboards.
The strategy to make its sites more than just a platform for advertisers has been in the works for years now. If the thousands of pieces of Marchex's plan fall into place, then investors should see some upside to the company's shares, which have fallen 42% from a 52-week high of $23.24 hit last April. The stock recently traded at $13.55 a share. But investors should be warned that this plan won't be an overnight success for the Seattle-based company.
Founded in 2003, Marchex makes more than a third of its money by selling ad space on its network of "direct navigation" and zip-code-based web sites. The rest comes from the company's performance-based advertising and online search services, as well as partner relationships with search engines and online retailers. It's Marchex's direct-navigation sites, which typically hold generic domain names like videocamera.com, that hold the most promise in the company's makeover.
Here's how direct navigation works. Say an online shopper is looking for a new digital video camera. Whether via a search-engine hit or by intuitively typing in the web address, he ends up at videocamera.com2. There he'll find links to online stores like Target (TGT3) and Circuit City (CC4), where video cameras are sold. Of course, the retailers pay Marchex every time a web surfer clicks an ad.
These sites, Marchex hopes, will become the company's future cash cow. Independent marketing research firm eMarketer expects online ad spending to grow 19% this year to $19.5 billion. Marchex is also tapping into the local advertising markets with its thousands of zip code domain names like 90210.com, which showcases local restaurants, hotels and realtors in and around Beverly Hills. Local advertising is expected to comprise $2 billion of that $19.5 billion total, according to eMarketer.
Getting a bigger piece of that ad spending would be great news for Marchex and its investors, who have endured slowing profit growth at the company for the last few quarters now. Marchex management attributed declines in its latest quarter to lower spending among its ad services clients and softness among its third-party distribution partners such as online search site Yahoo (YHOO5) and shopping site Gifts.com.
In its latest fourth quarter, Marchex's revenue grew by a mere 9% year over year to $32.6 million. For the full year, revenue grew 35% to $127.8 million, up from $95 million in 2005. The company says this year investors can expect revenue to come in somewhere between $144 million and $150 million, with revenue growth rates at 8% to 10% during the current first quarter and accelerating to 20% to 25% in the fourth quarter of this year.
"At this stage we feel most of these noted challenges from the back half of 2006 are predominantly behind us and that we have laid a strong foundation from which to see growth rates accelerate as we move through each of the quarters in 2007," said CEO Russell Horowitz in the company's Feb. 22 earnings release.
A Sticky Situation
One way that the company hopes to turn its fortunes around is by getting the roughly 31 million unique visitors who come to its sites each month to stay on its pages longer, thereby giving advertisers a better chance of a hit. Marchex plans to accomplish this by offering relevant content along with the advertisements on its site.
Last May, Marchex paid $13 million in stock and cash to acquire Open List, a company that specializes in Internet search technology that seeks out and aggregates free editorial content, product reviews and other community-based material on the web. Using 90210.com6 as an example, Open List's technology scanned the web for restaurant reviews, maps and things to do while in Beverly Hills. By June, Marchex hopes to use Open List to populate 100,000 of its sites with such information.
Less predictable but worth noting is the possibility that Marchex could also benefit from the launch of Yahoo's Panama advertising platform, which is designed to help advertisers more effectively tie ads to online searches. Launched in early February, Panama uses an algorithmic ranking system that orders search ads by both the quality of the hit and the amount of money paid for a keyword. Marchex, which sends traffic to search engines and e-tailers, gets a cut from Yahoo. According to ThinkEquity analyst Stewart Barry, Marchex gets about 20% to 30% of its revenue from Yahoo. So if Yahoo can improve the quality of hits that advertisers get on their sites, the hope is that Marchex will benefit as well.
It'll take some time before Marchex sees any real payoff from these initiatives, though; at least six months, says Malindi Davies, an analyst at Susquehanna Financial Group. While the company says it expects improvements to be notched gradually throughout 2007, Davies believes it won't be until 2008 when Marchex's business will start showing signs of real growth from these initiatives.
However, not all is rosy and bright heading toward 2008. There are some red flags and what-ifs facing Marchex that investors should be aware of. Davies is concerned that the amount of money the company is spending on marketing in order to fend off growing competition in the space will continue to offset any benefits from Panama or Open List.
Investors will also want to keep an eye on executive pay at the company. On Oct. 2, Chief Executive Russell Horowitz received 800,000 shares of restricted stock, which vest over the course of six years. Horowitz may only pull in a meager $50,000 annual salary, but the company also disclosed that the bonus pool was up to $1 million for the top execs at the company. "With the way that the stock performed last year, they should not have paid themselves that kind of money," says Kaufman Brothers analyst Sameet Sinha. However, as Sinha explains, most of those payments were in stock, meaning that the execs' interests should be more closely aligned with the performance of the company.
Sinha notes that right now the company's stock is "very, very cheap" and probably trading close to a bottom. However, the analyst remains on the sidelines with a Hold rating. Though he says Marchex's shares trade at a level significantly lower than industry competitors, aQuantive (AQNT7) and ValueClick (VCLK8), he believes there are "headwinds that are against the stock right now, which potentially will keep the stock price down for some time." (Kaufman makes a market in Marchex's stock.)
Even Jordan Rohan, an analyst at RBC Capital Markets who has been bearish on Marchex's stock, notes that there's little downside at current levels. He calculates that the company's asset value alone would put the stock somewhere north of $12 a share. Yet Jordan, who recently upgraded his rating on Marchex's shares to Sector Perform from Underperform, wants to see real proof of a turnaround at the company before growing any more bullish.
ThinkEquity's Barry is more optimistic. He thinks investors should get in while the getting is good. Barry has a Buy rating and a $24 price target on Marchex's shares. "We continue to believe that [Marchex] is a [second half of 2007] story as growth should re-accelerate and the company should complete integrating Open List with most of its 200,000 web sites by the end of the year," Barry wrote in a Feb. 23 research report. (ThinkEquity makes a market in both Yahoo and Marchex's stock.)
Yes, perhaps the stock will remain in the doldrums for the next quarter or two until Marchex's plans start to take more recognizable shape, but if this stock goes too much lower — say below $13 a share — then it might just be a bargain that long-term investors will have a hard time ignoring. |
