Berk Sure Has A Way

Putting my mouth where my money is.

MCHX Cash Flow Tells a Story…

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50x cash flow… that’s Google-esque! Few companies are valued greater than 50x cash flow. Those lucky enough generally grow revenue and earnings in the 50%+ range per year for multiple years and boast businesses with very wide moats. MCHX is not one of those businesses.

The math. MCHX has 38.3 million fully diluted common shares outstanding trading at about $22 a share as of today’s close. It has about $55 mil in cash on hand and a liability in the form of convertible preferred shares of about $50 mil. Therefore, MCHX’s enterprise value is about $840 million. MCHX generated $8.6 million in free cash flow so far this year, $2.9 of it in Q3. Trailing 12 month’s cash flow is $9.6 million, implying a ratio of 87. If you annualize the Q3 cash flow to $11.5 million it gives MCHX an EV/FCF ratio of 73. Even if you annualize their peak cash flow quarter of Q2 2005, you still get an EV/FCF ratio of 50. 50! 73? 87!?! Wow.

Growth? As I outlined in my previous post, MCHX’s revenue growth is largely illusory as it has been coming mainly from acquisitions – primarily domain names. Similarly, organic cash flow growth seems to be stuck in neutral or reverse given that MCHX is acquiring new domains with cash flow every quarter this year. Cash flow should be growing at a much greater rate than what they’ve reported:

Mchx_cash_flow_1

MCHX fans will say that the direct navigation business is nearly all profit – domains are truly cash flow machines. However, at $7.7 million in direct nav revenue in Q3, if you assume anything above a 40% cash flow margin, the direct nav business provided greater than 100% of MCHX’s cash flow in Q3 2005. This means that cash flow from MCHX’s other businesses must be deteriorating. MCHX only boosted cash flow by $700k over 2004’s Q3 results. Given what they paid for the domains, you would have expected MCHX’s cash flow to be at least $3 – $5 million higher than last year. If you assume the Direct Navigation business gets a 58.5% cash flow margins (90% margin with a 35% tax rate), an interesting tidbit arises. If you compare the first three quarters of 2004 to 2005 for MCHX’s other businesses (excluding direct navigation), reported revenue rose from $28.7 to $48.6 million, while cash flow dropped from positive $1.7 million to negative $1.1 mil. You know you have deteriorating fundamentals when you grow revenue by $20 million but cash flow drops by close to $3 million.

What about next year? Next year’s analyst projections are actually pretty rosy – “earnings” up 47%. But…digging beneath the surface, this makes some sense since their domains businesses were acquired this year making year over year comparisons favorable and “earnings” as tracked by MCHX’s analysts exclude amortization. That means MCHX’s gets to spend shareholder money without it impacting “earnings”. No wonder MCHX keeps buying companies – what a deal!

Wide Moat? MCHX is not the leader in any of its businesses. I will admit the direct navigation business makes good money (for now), but it relies heavily on user error to generate traffic. It strains credibility to think that MCHX will be able to maintain the same level of monetization while making these domains true destinations. As for the rest of MCHX businesses, they are each strategically weak and lack scale (more on that later).

What’s the story? I said that businesses trading at more than 50x cash flow are growing rapidly and have a wide moat. I forgot one case… when a stock is wildly overvalued. That is the story with MCHX’s valuation. Given its risks, MCHX should probably be trading at a EV/FCF of less than 20, implying it should decline 60-75% from $22 before it is back in line with reality.

I own puts on MCHX stock at various prices.

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Written by Kevin Berk

November 22, 2005 at 11:11 PM

Posted in Picks and Pans

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