Briefing.com DRIV article for tomorrow 3/4..good/bad ??
Digital River: Bridge Between Two Revolutions
Digital River is certainly one of the most intriguing Internet companies because
it has a foot in the previous revolution, PC software, and the current revolution,
the Internet. It is
logical, from a technology point-of-view, to sell software over the internet, as it
basically reduces the COGS (cost-of-goods-sold) to zero! However, with the
overall trend in software being driven to lower point prices, Digital River is
headed straight into a business whose prices, long term, will be squeezed. Since
Digital River operates on a percentage, the question becomes whether they can
grow the breadth of their business before the price pressures depress their
revenue growth.
An example of this is yesterday's announcement that Digital River will provide
download capabilities for Block Financial's TaxCut product. Although this
product must be purchased every year (a good thing), we've seen it in stores for
as little as $9.95. If the online price gets driven this low, Digital River may get
less than $2 per transaction.
Digital River is obviously clearly aware of this inherent problem in their
business model. In their presentation at the Robertson Stephens conference last
week, Digital River made a strong point of emphasizing that selling software is
not the only component of their long term business strategy. A key component of
the future will be creating new vertical applications, outside of the software
industry, that will generate new per-transaction fees, and leverage the existing
technical infrastructure. No details were given, but CEO Joel Ronning hinted
that news would be forthcoming in the next few months.
Working in Digital River's favor however is the growing trend towards
downloading software over the internet. Unfortunately, we strongly believe this
will also force prices lower, much lower, in the future, for all software that fits
Digital River's model. The long term future for point products is free software,
or software by subscription, neither of which help Digital River.
But, with a market capitalization of $721 million, Digital River is richly priced
at a Price/Sales ratio of 25. But if you count only Digital River's commission as
revenue, which we feel is more accurate, the Price/Sales ratio is an absurd 225,
putting it off the scale for comparison with any other Internet company. And
with details of the strategic future unknown, this makes Digital River even
riskier.
In summary, Digital River represents what we think of as "walking on lilypads."
By this we mean that Digital River can use its existing business model,
software, which is facing a future of
squeezed margins, to branch out into new areas. However, it must successfully
accomplish this transition before the current model weakens. The question is
rather it can make the transition, before weakness in the existing models hurts
them. It is incredible that a company growing this fast has to think about this
now, but that only demonstrates how quickly the Internet is changing things.
Nevertheless, Briefing.com feels Digital River will be an important company to
watch, whether you are invested in it or not. With one company, you watch the
maturation of the PC
software revolution, and the emergence of the next revolution.
|
