“One of the Hidden Internet Pioneers of 2011”

By Travis Johnson, Stock Gumshoe, January 18, 2011

Last week I started taking a look at a Nancy Zambell teaser for her Buried Treasure Under $10 newsletter, and I’ve had quite a few folks chime in that they’d like to hear about her second stock as well … so here goes:

Zambell’s pitch is that she finds unknown, undervalued stocks at low prices that will move quickly — last week it was a data security company that she said was getting ready to double, and this week we’re in a different part of the online business: local advertising. Here’s how her spiel begins:

“Bull Beater #2:
“Record-breaking performance thanks to search technology everyone wants

“Talk about high expectations! You go online to search for a restaurant, for instance, and we now expect more than just a phone number and address. We now expect maps and directions from your front door, and menus and reviews.

“I know… there are a lot of local search engines putting along out there, but only a few of them have the power to expand their reach to the next tier continuously. This takes technology that’s, shall we say, pretty nifty.

“Specialized World-Wide-Web search engines are required for local searches to give us, say, Mexican restaurants within five miles of where you might be at the time… home, on the road, visiting friends… wherever.”

So this is probably sounding like something familiar — we’ve been talked to about the huge potential of local search and mobile search for years now, and the dream (or nightmare) of having your cell phone tell you when there’s a sale at the pizza place on the next block is now pretty much a reality. So this is some kind of business along those lines, it sounds like.

She throws out the big name of the month, too, in saying that the fact that Groupon rejected Google’s $6 billion bid means that the money to be made in this area is huge (Groupon aggregates local coupon deals, to oversimplify, and they have several direct competitors as well, none of the big social coupon/social shopping sites are public yet).

We get a few details about this stock:

“The company was just ranked #1 in ‘directory search for highest traffic’ by Compete.com and Deloitte’s 2010 Fast 500 ranks the company as well….

“… though the company provides information on about 14 million businesses….

“The company’s local syndication network boasts 100,000 web sites that are powered by its patented technology….

“The entire local-search industry is on fire, growing sales at a 21.47% rate. But Bull Beater #2 is whipping its peers to a pulp, growing sales by 62.57%.

“Wall Street, ever mindful of Google’s $6 billion bid for Groupon, is just now starting to take notice of this hidden pioneer. The time to buy is today!

“My report tells you to buy below $6.70 — because this one’s galloping to $12 at least. And it won’t take long to get there, either.”

So … hoo dat?

Toss it all into the mighty, mighty Thinkolator, which we thankfully remembered to cover with a tarp before the latest blizzard, and we learn that this stock must be …

Local.com (LOCM)

This isn’t a slam-dunk match, I should warn you — Local.com has recently been growing at more like a 48% clip, and there’s a lot of squishiness in those numbers each quarter for this company (they’re so small that amortization and warrant revaluation swing the earnings number pretty dramatically), but they did put together one quarter, the second quarter, that was roughly 60% growth. It wasn’t exactly 62.57%, though, so that makes me somewhat uncertain.

Everything else is an exact match — this is the major local search company that’s publicly traded and is not a former yellow pages publisher. Those yellow pages publishers are also local online advertising companies these days, that would be SuperMedia (SPMD) and Dex One (DEXO), (renamed from Idearc and R. H. Donnelley, respectively, to shake the taint of bankruptcy, from which both emerged last year).

And “major” is all relative, of course — Local.com is tiny, with a market cap of less than $100 million. And the share price was right around $6.70 a few weeks ago, but they pre-announced that their fourth quarter numbers were going to stink, coming in about 10% below expectations for revenue and probably continuing to suffer because of Bing … so now the share price is down considerably, right around $4.50.

The Bing problem, by the way, is that they were making more from syndicating Yahoo ads than they are with Microsoft Bing ads, now that the two have effectively merged their search and advertising networks.

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When you look at the three local search companies, SuperMedia and Dex One are substantially larger and more focused on the “boots on the ground” sales work, signing up individual local businesses for online advertising programs and websites much as those same salespeople signed them up for splashy yellow pages ads a decade ago (and both still rely heavily on the print yellow pages directories). Local.com, in fact, does a fair amount of partnering and syndication with those two firms, as well as with Bing and with thousands of local websites (their PR material does claim the 14 million, maybe up to 17 million now, local businesses advertised, and the network of 100,000 sites that they advertise through — including about 20,000 that they own directly).

Their most lucrative business, as you might expect, is when they can get people to come to their own sites — their flagship, local.com, or one of the other thousands of locally branded sites that they own. They can sell ads direct for those sites and keep all the money, while for the rest they partner with publishers and ad network providers, much like this site and many others partner with Google to let them display relevant ads on the site for a cut of the revenue.

And the one thing that really stands out in Local.com’s favor? Compared to DEXO and SPMD, their balance sheet is a thing of beauty — which, unfortunately, is like saying that your friendly neighborhood Gumshoe is a dashing prince … when compared to a toad. LOCM doesn’t carry any debt to speak of, though they did just do a capital raise, so they don’t have the historic weight of massive debt that brought down the yellow pages companies (back when the yellow pages firms were spun off from their telecom parents, people thought the revenue was so stable and “forever” that the parent companies were able to saddle them with incredible debt burdens that folks thought were manageable even with huge dividend payouts … until the revenue started declining and they both hit bankruptcy, and even after emerging from bankruptcy they carry a lot of debt).

So yes, it’s nice that LOCM doesn’t have any net debt. And that they had a good growth year in terms of revenue in 2010, at least for the first few quarters. It’s not as nice that the analysts cratered their estimates when LOCM announced the bad news about weaker numbers from Bing/Yahoo — as soon as that happened the shares lost about 30% of their value (they had run up from $4ish to $6.50 in just the last couple months, so the real optimism that was quashed was quite recent), and the analysts cut their earnings per share estimates for 2011 almost in half. And it didn’t help that they’ve sold another four million shares just in the past week, which doesn’t sound that much if you’re used to larger firms but diluted the current shareholders by something like 20%.

Still, the shares are pretty reasonably priced based on earnings — if you think the analysts are right, the stock trades for less than 10X next year’s profit. The question is whether or not they’ll grow, and reach a level of sustainable profitability or if 2010 was as good as it gets for Local.com.

I’m no expert on this business, but my concern when I think about local.com would be mostly competition, as you might imagine — Google and the other big advertising companies are certainly working on local search and local advertising and have hugely scalable networks, particularly for what is expected to be the core mobile market, and I have no idea whether Local.com’s technology or network provides any kind of competitive advantage.

Certainly it’s not unique to be able to search by map locations anymore, or to syndicate ads across networks of sites, though it may be that Local.com does it better than most or has some inherent advantage. This stuff changes quick, though, with app-mania and mobile search and advertising being hot areas of innovation that is often “localized.” there’s even an ex-Googler on the hunt to open up local search to more competitors — Gil Elbaz, who is credited with inventing AdSense (which Google acquired, and which is a huge portion of their revenue), started a company called Factual that’s making big data sets, including local data for stuff like restaurant addresses and geolocation, better and easily available to developers.

So I can’t say that I’m as pessimistic about Local.com as I am about the debt-ridden yellow pages companies — but that’s not saying much. If I’m missing the great story behind these shares, or you’ve got a better match for Zambell’s tease, let us know with a comment below. Local search should be big, logic tells us, but I have no idea whether that’s going to mean great things for Local.com (or, fingers crossed for them, a big buyout from one of the many cash-rich local or social internet firms).

And if you’ve subscribed to Zambell’s newsletter, we’d love to know what you think — click here to review Buried Treasure Under $10 for your fellow investors. Thanks!

Full disclosure: I own shares of Google. I do not own shares of any other stock mentioned above and will not trade in any mentioned stock for at least three days.



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