Berk Sure Has A Way

MCHX is overvalued. I will admit that they’ve made some smart financial moves and they own some profitable internet domain names. However, MCHX shares are probably worth maybe $7, not $20. I don’t know the folks at Marchex and I have nothing against them. But, I am definitely self-interested – I think MCHX will decline so I own MCHX puts at various prices.

I used to work at LookSmart and saw the challenges that tier two search syndication players (MCHX, MIVA, LOOKD, INCX, INSP) face first hand. MCHX has been able to delay a decline through smart acquisitions (paying 10-20x cash flow for domain names funded by selling stock at 50x), but most tier two search syndication business models are unprofitable, strategically challenged, and deteriorating. The key point is that while the other tier two players seem to be more appropriately valued, MCHX is way out of whack. It is important to note that owning end-user traffic combined with a winning tier one syndication business is beautiful, profitable, and often defensible. Google and Yahoo have built great businesses, but MCHX is not in the same league.

Over the course of a few weeks, I will outline my reasons why I think MCHX will decline. In my opinion, it is a combination of the 10 points below. I will try to blog about each of these in turn.

1. Low Organic Revenue Growth – 7% pro-forma revenue growth from Q1 to Q3 that has been masked by acquisitions

2. 50+ P/FCF ratio (on a run-rate basis) is absurdly high 

3. Enhance and GoClick (search syndication) are deteriorating low-margin businesses likely struggling with traffic quality problems and a lack of scale

4. Most tier two search stocks have stumbled (LOOKD, MIVA, INCX, INSP) and the majority of MCHX’s business is very similar to these players

5. MCHX is stretched too thin across too many products with no real synergy

6. TrafficLeader is a former SEM/SEO leader likely struggling with conflicts of interest

7. Direct Navigation is a slow growth business vulnerable to changes in behavior and technology

8. Wacky corporate structure has two tiers of stock and preferred shares. For a company with less than $100 million in revenue?

9. Marchex is pursuing low quality traffic through irrelevant traffic arbitrage.  More details here.
10. Bubble-era accounting does not take into acquisitions into account

I own puts on MCHX stock.

NOTE: I edited this post on 12/6/05 to link to my recent posts. I aslo swapped out reason 9 (MCHX paying too much for acquisitions) with the current 9 (MCHX pursuing sketchy traffic).