(BTAB part 2 continued)
The company finished the quarter with 2,848 customers (up 11% Q/Q),
compared to our estimate of 2,705 customers. Software publishers totaled
1,677 (up 13% Q/Q) versus our estimate of 1,520 publishers, while the
number of on-line retailers equaled 1,171 (up 7% Q/Q) slightly below our
estimate of 1,185 on-line retailers. We feel that the Company has largely
attained its goal of gaining a dominant share of ISVs and retailers, and is
likely reaching the lay of diminishing returns as many new ISVs are much
smaller. We note that the Company plans to focus its efforts on attracting
higher quality software publishers and on-line retailers to its software
DTN, rather than the quantity of customers, throughout 1999. We feel that
on-line auction company, uBid, represents a good example of this strategy.
CUSTOMER ANNOUNCEMENTS EXPECTED IN NEW FEE-BASED E-COMMERCE BUSINESS
Digital River's new transaction fee-based e-commerce service, officially
dubbed CommerceBridge, leverages its existing CNS technology to provide an
outsourced e-commerce marketing and data communications solution for non-
software companies. We estimate that the Company will charge roughly $1 per
transaction, most of which should flow to the bottom line. In our view,
this business will become a clear positive driver of gross margins. We
feel that this business not only truly leverages, but also highlights, the
industrial strength nature of the Company's core technology platform.
We anticipate that Digital River will announce several key customer wins
within its CommerceBridge business shortly. On its conference call, the
Company announced the types of vendors using its service, including a beer
company, a PC company, as well as a nuts and bolts vendors. Although
revenue contributions from the business likely will be minimal in the near-
term, we note that this business could potentially scale to become a
significant revenue opportunity in time. Digital River should benefit
(particularly at the gross margin line) from a higher-margin (80-90%)
revenue stream longer-term. Any contributions will likely represent upside
potential to our revenue and gross profit assumptions over the course of
the year.
ESTABLISHING THE DTN MODEL IN THE DOWNLOADABLE MUSIC ARENA
Digital River yesterday morning (4/22) announced that it forged its first
music download partnership with WWOZ-FM radio. Similar to its core ESD
service, the Company plans to sell and deliver music content in the MP3
format through WWOZ's Web site (www.wwoz.com). It plans to establish a DTN
in the downloadable music arena, and will act as the back-end outsourcing
solution for music listeners to buy and download music over the Internet.
We note that the revenue model for this lower-priced, high-volume business
has not been finalized, given the early stage nature of the opportunity.
We feel that downloadable music could represent upside potential to our
revenue forecast long term, as the MP3 music download market appears to be
gaining strong consumer momentum. We anticipate that the market for
downloadable music will likely grow significantly, and will represent a
multi-billion dollar revenue opportunity in 3-5 years. Moreover, we believe
that Digital River will be able to scale this business with marginal
incremental costs as it leverages its core technology platform (including
its proprietary i-stream download manager). Similar to its core ESD
business, Digital River is expected to add more retailers (radio stations,
retailers, etc.) and content publishers (labels, artists, etc.) in future
quarters to ramp this business.
ACQUISITIONS ESTABLISH DIGITAL TRADE NETWORK WITHIN SHAREWARE SEGMENT
The Company also recently acquired several privately-held companies focused
on the shareware software segment for $14.2 million in cash and stock. We
anticipate Digital River to incur non-cash goodwill amortization expenses
of $1.2 million each quarter over the next 3 years associated with the
deals.
We feel that the acquisitions of Maagnum Internet Group and Public Software
Library will provide multiple benefits to the Company in coming years.
These benefits include:
--Entry into the shareware segment of the ESD market
--Build up a critical mass of smaller publishers and software SKUs
--Gain access to a self-service technology platform (similar to Yahoo!'s
Viaweb offering)
--Generate incremental revenues
We believe that Digital River could establish yet another digital trade
network encompassing shareware and software from smaller publishers, while
enjoying the benefits of the network effect by distributing through its
existing on-line retail partners as well as end users.
RISKS
The management of hypergrowth may become increasingly difficult as the
Company extends its network to include larger-scale retailers. We believe
that Digital River's solid management team and its combined extensive
industry experience in Internet technology and computer software mitigate
this risk.
As with all acquisitions, risks associated with integration, relocation of
employees, and maintaining customers may pose difficulties for the Company
in the near term. We believe that the Company's incentive plans (already
in place) and solid internal execution capabilities minimize this risk.
Digital River's most immediate threat comes from on-line software retailers
that could have access to capital resources and would choose to build their
own ESD platform. We believe that over time on-line software retailers will
recognize their opportunity to leverage the Company's database of over
130,000+ SKUs and will ultimately view Digital River as a "neutral"
provider of a cost-effective outsourcing solution.
VALUATION AND RATING
We believe that Digital River represents a core holding for investors
seeking exposure to the Internet and the rapidly growing electronic
commerce market (both b2b and b2c). We believe that the Company's business
model is based on a long-term 8-11% operating margin, but could be
considerably higher if its new business initiatives gain momentum. We
believe that the Company's superior business-to-business e-commerce service
model will command both a premium long-term operating margin and should
command a premium revenue multiple. We maintain our 12-month price target
of $65 which is based on a 14x multiple of our 2000 revenue forecast of
$87.0 mm. We reiterate our "Strong Buy" (1) investment rating on these
shares. |
