2005-02-17
Growth, Misinformation, and Valuation: ADBL part 2
In the wake of a 35% drop of Audible.com's stock price, I started visiting web sites for analyses. For the most part, I'm amazed at the amount of misinformation out there. But let's start with the analyst revisions, because they give a glimpse at how some parts of Wall St think.
For those not intimate with the Audible.com story, here's a synopsis. Audible is the premiere (and pretty much only) digital audiobook company. They have exclusive distribution through Apple iTunes, a partnership with Amazon, and deep relationships with hundreds of publishers and digital audio player manufacturers. With the worshipping of all things iPod, Wall Street has been particularly interested in Audible since more iPods on the street means more opportunity to put audiobooks on each of those iPods. A number of analysts, after years of neglect when the stock was extraordinarily cheap and -- at one time -- trading below cash value, have begun covering Audible.
On Tuesday, Audible management revealed a number of initiatives to put the company in hypergrowth, emphasizing expansion to capitalize on the tipping point we see for MP3, broadband, and digital content. The numbers in the conference call were good, the growth in subscribers more impressive than expected, but the stock was thrown out because management had the audacity to sacrifice short-term earnings for long-term profits and additional barriers against any competitor who might later come.
Most of the analysts downgraded the stock for similar reasons. (Addendum: 4 of 8 analysts downgraded, so some have similar views to mine.) I liked the explanation of Steven Frankel of Adams Harkness & Hill: "While management's wisdom in making these investments may be proven in the form of breakout results in 2006, the near-term picture forces us to retreat to the sidelines." Frankel was less charitable in other parts of his report, writing "While revenue guidance is higher than the consensus, these investments wreck earnings and, in our opinion, the stock."
The analysts' valuation models for Audible centered on earnings and free cash flow. In many cases, that's a good idea, but Audible is a massive growth company with no real competitors in a market at its infancy. Audible is, in short, a speculative high-growth stock. There are other ways to value a company, like using revenue and growth rates, and one wonders why the analysts didn't switch models to a more appropriate one or project discounting models past build out, despite a reluctance in dumping their previous hard work. Instead, some analysts have dutifully plugged in the numbers, calculated drastically different target share prices, and pronounced the bad news. But did Audible's business prospects improve or worsen with the earnings report and conference call? If you look at the new subscribers in Q4 and the management guidelines for revenue and subscriber base in 2005 and 2006, it's pretty obvious that management is almost giddy with the business prospects. The difference, though, is between using valuation models based on earnings and valuation models that don't penalize a company for massive re-investment of earnings into growth.
Aside from this, there has been "analysis" on Audible in the press that makes you realize how correct pros like Kwatinetz are: you should only cover a limited number of stocks because of time constraints. Example one is James Cramer of theStreet.com, a trader who I've always found to be fun. He wrote two articles published right after the earnings report and conference call that may have reflected some opinions on Wall St but were also patently wrong.
In a column titled "Audible Deserves to be Soundly Sold Off", Cramer rests his argument on an increased cost of customer acquisition, from $45 in Q3 to $48 in Q4. He notes how odd it was that a mere 7% increase in these costs wiped out almost a third of the company's market capitalization, and then with relish, he adds the "real kicker. The math made sense." Cramer then argues that this increase is just a symptom of the underlying disease: "the cost of finding new customers on the Web is going higher." Actually, in Audible's specific case, no such conclusion can be made.
Long-time holders of Audible stock know that its customer acquisition cost is determined by the percentage of new customers that come in as AudibleListeners, subscribers who agree to one year at $14.95 to $21.95 per month. Usually, that percentage is lower than 70%. Back in Dec 2000, only 38% of their 16,000 new customers were subscribers. In Q3 2004, 78% of 40,566 new customers became subscribers, a record at that time. This last quarter, though, due to new strategies, an impressive 88% of a record 47,500 new customers became subscribers. (And I should note that recent new customer figures don't seem to include iTunes a la carte customers.) Even though each AudibleListener raises the recurring revenue base (traditionally 80% of content revenue), they cost more to acquire because they can claim a rebate. The slight increase in customer acquisition cost was because Audible did a better job selling subscriptions.
So with this little tidbit of information we can go back and see that the $3 uptick was not worth a third of Audible's market cap, nor was the uptick a symptom of increased costs to find customers. In the most recent quarter, the number of new subscribers grew dramatically. The number of new customers grew dramatically. The amount of revenue Audible gets from each subscriber has been measured at over $400 for their lifetime. This isn't hand waving, this is empirical data, and Cramer's math doesn't make sense.
Cramer also said that higher costs were due to general trends, such as the two biggest funnels - Yahoo! and Google - continually raising prices. And this, my friends, is the problem of analysts using broad sector knowledge to buttress specific complaints about a company they apparently don't know. For the last couple of years, Audible management has described their efforts to try direct and innovative marketing approaches, ones that yield higher response rates with lower expenses. They've established retail presence with partners like Best Buy, their promos are packaged by audio device manufacturers, and they've fostered affiliates in Amazonian fashion. The biggest funnels, in Audible's case, would likely be iTunes, where each audiobook has a "Presented by Audible.com" label, and Amazon, which brings up Audible links when searching their catalog. I do agree with Cramer on one subject, though, when he writes "believe it or not, it comes down to the homework."
Another hatchet job in the media has been a series of newsletters by Bambi Francisco on MarketWatch. A recent story was titled "Audible's profit becomes road kill." After a brief introduction, she writes "Now what to do at current prices?" and then gives a paragraph to Bill Martin of "Indie Research", nicely pointing out that Martin "had been skeptical on Audible ahead of Tuesday's report" although not mentioning this is the same Martin of FindProfit.com who shorted Audible in September at $17.49, well before its rise to $30. Martin points to the Audible marketing expense, which increased 56% from Q3 to Q4, and says it's a "clear sign that Audible could be starting to see higher churn, market saturation and new signs of competition, rather than that the company is simply 'investing in future growth.'"
It's an interesting take given traditional holiday season marketing and the array of contrary data given by management: flat 3% churn, record number of new subscribers, record number of new customers, record revenue, and all that without the impact of planned initiatives or the newly introduced $99 iPod shuffle. Fortunately, Martin doesn't conclude there's market saturation from those kind of growth numbers, instead he says there's a clear sign Audible management must be seeing something that we don't see. Unfortunately, there's no counter-point to his short-side argument at MarketWatch. Good for Bill Martin, bad for us longs in the short-term. And that's what makes investing so fun and profitable. (Side note: A mutual friend I respect says Martin is a good guy & investor.)
For an immediate reaction to the ADBL price drop, see my earlier article. (A nod to 'monkeybidnez' over at ADBL.org for stressing the tipping point phenomenon.)
For those not intimate with the Audible.com story, here's a synopsis. Audible is the premiere (and pretty much only) digital audiobook company. They have exclusive distribution through Apple iTunes, a partnership with Amazon, and deep relationships with hundreds of publishers and digital audio player manufacturers. With the worshipping of all things iPod, Wall Street has been particularly interested in Audible since more iPods on the street means more opportunity to put audiobooks on each of those iPods. A number of analysts, after years of neglect when the stock was extraordinarily cheap and -- at one time -- trading below cash value, have begun covering Audible.
On Tuesday, Audible management revealed a number of initiatives to put the company in hypergrowth, emphasizing expansion to capitalize on the tipping point we see for MP3, broadband, and digital content. The numbers in the conference call were good, the growth in subscribers more impressive than expected, but the stock was thrown out because management had the audacity to sacrifice short-term earnings for long-term profits and additional barriers against any competitor who might later come.
Most of the analysts downgraded the stock for similar reasons. (Addendum: 4 of 8 analysts downgraded, so some have similar views to mine.) I liked the explanation of Steven Frankel of Adams Harkness & Hill: "While management's wisdom in making these investments may be proven in the form of breakout results in 2006, the near-term picture forces us to retreat to the sidelines." Frankel was less charitable in other parts of his report, writing "While revenue guidance is higher than the consensus, these investments wreck earnings and, in our opinion, the stock."
The analysts' valuation models for Audible centered on earnings and free cash flow. In many cases, that's a good idea, but Audible is a massive growth company with no real competitors in a market at its infancy. Audible is, in short, a speculative high-growth stock. There are other ways to value a company, like using revenue and growth rates, and one wonders why the analysts didn't switch models to a more appropriate one or project discounting models past build out, despite a reluctance in dumping their previous hard work. Instead, some analysts have dutifully plugged in the numbers, calculated drastically different target share prices, and pronounced the bad news. But did Audible's business prospects improve or worsen with the earnings report and conference call? If you look at the new subscribers in Q4 and the management guidelines for revenue and subscriber base in 2005 and 2006, it's pretty obvious that management is almost giddy with the business prospects. The difference, though, is between using valuation models based on earnings and valuation models that don't penalize a company for massive re-investment of earnings into growth.
Aside from this, there has been "analysis" on Audible in the press that makes you realize how correct pros like Kwatinetz are: you should only cover a limited number of stocks because of time constraints. Example one is James Cramer of theStreet.com, a trader who I've always found to be fun. He wrote two articles published right after the earnings report and conference call that may have reflected some opinions on Wall St but were also patently wrong.
In a column titled "Audible Deserves to be Soundly Sold Off", Cramer rests his argument on an increased cost of customer acquisition, from $45 in Q3 to $48 in Q4. He notes how odd it was that a mere 7% increase in these costs wiped out almost a third of the company's market capitalization, and then with relish, he adds the "real kicker. The math made sense." Cramer then argues that this increase is just a symptom of the underlying disease: "the cost of finding new customers on the Web is going higher." Actually, in Audible's specific case, no such conclusion can be made.
Long-time holders of Audible stock know that its customer acquisition cost is determined by the percentage of new customers that come in as AudibleListeners, subscribers who agree to one year at $14.95 to $21.95 per month. Usually, that percentage is lower than 70%. Back in Dec 2000, only 38% of their 16,000 new customers were subscribers. In Q3 2004, 78% of 40,566 new customers became subscribers, a record at that time. This last quarter, though, due to new strategies, an impressive 88% of a record 47,500 new customers became subscribers. (And I should note that recent new customer figures don't seem to include iTunes a la carte customers.) Even though each AudibleListener raises the recurring revenue base (traditionally 80% of content revenue), they cost more to acquire because they can claim a rebate. The slight increase in customer acquisition cost was because Audible did a better job selling subscriptions.
So with this little tidbit of information we can go back and see that the $3 uptick was not worth a third of Audible's market cap, nor was the uptick a symptom of increased costs to find customers. In the most recent quarter, the number of new subscribers grew dramatically. The number of new customers grew dramatically. The amount of revenue Audible gets from each subscriber has been measured at over $400 for their lifetime. This isn't hand waving, this is empirical data, and Cramer's math doesn't make sense.
Cramer also said that higher costs were due to general trends, such as the two biggest funnels - Yahoo! and Google - continually raising prices. And this, my friends, is the problem of analysts using broad sector knowledge to buttress specific complaints about a company they apparently don't know. For the last couple of years, Audible management has described their efforts to try direct and innovative marketing approaches, ones that yield higher response rates with lower expenses. They've established retail presence with partners like Best Buy, their promos are packaged by audio device manufacturers, and they've fostered affiliates in Amazonian fashion. The biggest funnels, in Audible's case, would likely be iTunes, where each audiobook has a "Presented by Audible.com" label, and Amazon, which brings up Audible links when searching their catalog. I do agree with Cramer on one subject, though, when he writes "believe it or not, it comes down to the homework."
Another hatchet job in the media has been a series of newsletters by Bambi Francisco on MarketWatch. A recent story was titled "Audible's profit becomes road kill." After a brief introduction, she writes "Now what to do at current prices?" and then gives a paragraph to Bill Martin of "Indie Research", nicely pointing out that Martin "had been skeptical on Audible ahead of Tuesday's report" although not mentioning this is the same Martin of FindProfit.com who shorted Audible in September at $17.49, well before its rise to $30. Martin points to the Audible marketing expense, which increased 56% from Q3 to Q4, and says it's a "clear sign that Audible could be starting to see higher churn, market saturation and new signs of competition, rather than that the company is simply 'investing in future growth.'"
It's an interesting take given traditional holiday season marketing and the array of contrary data given by management: flat 3% churn, record number of new subscribers, record number of new customers, record revenue, and all that without the impact of planned initiatives or the newly introduced $99 iPod shuffle. Fortunately, Martin doesn't conclude there's market saturation from those kind of growth numbers, instead he says there's a clear sign Audible management must be seeing something that we don't see. Unfortunately, there's no counter-point to his short-side argument at MarketWatch. Good for Bill Martin, bad for us longs in the short-term. And that's what makes investing so fun and profitable. (Side note: A mutual friend I respect says Martin is a good guy & investor.)
For an immediate reaction to the ADBL price drop, see my earlier article. (A nod to 'monkeybidnez' over at ADBL.org for stressing the tipping point phenomenon.)
