Haven’t looked at a Motley Fool pitch in a while, so this one floated to the top of the pile today… the folks at Stock Advisor Canada (C$99 first year, renews at C$199) are pitching a way to profit from the “death of Twitter.”

Which is timely, since Twitter just “died” yesterday, to be reborn as Elon Musk’s vision of an “everything app” called X. Sometimes you build a brand and create a whole new way of communicating, and an eccentric billionaire just comes along and decides to replace it with his personal vision. I have no idea how that will work out, and the stock being teased by the Motley Fool Canada is not really any kind of direct play on the “death of Twitter”… but let’s dig in and look at the details.

What the Foolies were mostly focused on as their “attention getter” at the top was the brief headline splash that was generated by the potential “cage match” that was joked about between Meta’s Mark Zuckerberg and and Twitter’s Elon Musk a few weeks back…. here’s a bit from the ad:

“The fighting words are distracting the public from the real battle, however — a brawl for control of a $200+ billion social media advertising industry.

“Meta recently released their own Twitter-like platform, Threads, but while the tech billionaires battle on the public stage… their own kingdoms have been faltering.

“Meta’s ad revenue, the company’s financial backbone, slipped by 4% in Q4 of 2022.

“And Twitter? Its U.S. advertising revenue nosedived 59% within just five weeks in April to May, as reported by The New York Times.

“But there’s a secret we’re bursting to share with you — and it’s that you don’t need to pick a side in this Billionaire Brawl.

“Because there’s a third company emerging on the scene that we think could offer far greater returns to growth-hungry investors.”

Ok, so what’s that “third company?” Some clues…

“See, this small Canadian company is leveraging its massive audience to go after advertising dollars from a totally different angle.

“The results? While Meta and Twitter have seen advertising declines in the last year, this dark horse contender actually saw YoY revenue growth of 22% in 2022. More importantly, it’s wildly profitable!

“Even though this Canadian underdog’s market cap is over 10,000 times SMALLER than Meta, it already has over 113.6 million monthly active users (MAUs), putting it in the top 20 platforms by MAU in all of North America…

“…yet I can almost guarantee you’ve never heard this company’s name before.”

Well, it’s true that I had never heard of this one before… this time the Fool is touting another “hot” 2021 stock that has fallen on hard times, their “Canadian underdog” is VerticalScope Holdings (FORA.TO), which does not, strangely enough, seem to have a OTC ticker for US trading. Haven’t run across that for a Canadian stock in a long time.

VerticalScope is a bit of a throwback, they’re a rollup of “communities” and forums and review sites in niche web “verticals” where there’s generally some meaningful advertiser demand — here’s how they describe themselves:

“VerticalScope is a technology company that has built and operates a cloud-based digital community platform serving more than 100 million MAU and 55 million registered community members across over 1,200 online communities. Our digital community platform consists of and enables hyper-focused apps, forums, marketplaces, editorial, and e-commerce rating and brand review websites. Our platform operates at the intersection of community, content and commerce. We believe in the power of enthusiasts to inform and inspire. Our members are passionate about sharing their interests with like-minded individuals and those whose identities are similarly shaped by the things they love. We focus on hyper-specific subjects that engender strong affinity from online communities of enthusiasts, super fans, experts, pros, hobbyists and armchair analysts.

“Our mission is to enable people with common interests to connect, explore their passions and share knowledge about the things they love. We maintain separate brands for each of our communities. We believe that setting aside dedicated spaces for the exploration of unique interests creates a culture of ownership and belonging. Our strategic focus has been to invest in highly engaging topics, brands and activities that generate significant intensity of interest and commercial activity. While in aggregate our communities cover a wide range of interests, individually, they focus on narrow interests and foster both depth and breadth….”

This is indeed a tiny company, and it hasn’t been growing recently, but they did say, last quarter, that they are confident that the first quarter of this year was the “trough” for their results, so management, at least, believes things are looking up.

And yes, if you’re checking to see where those clues are matched, they did have 113.6 million monthly active users as of the fourth quarter of 2022, which would be enough to slot them into the top 20 “social media” companies in the US (they’re far below the leaders like Facebook, Twitter and TikTok, but have a similar user base to Nextdoor or Discord, and at the time they were close to having half as many users as Snapchat)… though that number fell by about 11% in the “trough” first quarter (to 100.4 MAU), probably thanks to weak search traffic for pretty much everybody. Their financials fell similarly to their active user base, they said their direct ad revenue was down only 11% year over year, which was actually pretty impressive given the weakness elsewhere in the business, but their total revenue fell by 36%, so presumably that’s mostly because of more radically falling revenue from e-commerce sales (through affiliate partners), Google ads, and other indirect ad revenue.

They are doing some intelligent things at VerticalScope, it appears — they accelerated their debt repayment last quarter, and they cut their operating costs with some substantial layoffs, like a lot of larger tech companies, though the revenue fell faster than their cost-cutting cutting, and they’re still losing money. Net loss was about $4.5 million this quarter, substantially better than the $11.9 million a year ago but still challenging… that comes in as a loss of 21 cents per share (56 cents a year ago)… they do have fairly high depreciation and amortization costs, since they’ve done a lot of acquisitions, so they do have positive EBITDA and free cash flow, which is why they were able to repay a little bit of their debt early last quarter (~$3 million, which is almost 5% of their total long-term debt) — though the cash balance continued to shrink, largely because of payments for “contingent considerations,” which is presumably payments they’re making to past owners of businesses they’ve acquired (that was a payment of $15 million — and it was not a surprise, that had been a liability on the balance sheet last year and it has now been paid, I think that was mostly from their acquisition of FOMOPOP in 2021). As of March 31, they were down to about $8.5 million in cash.

We’ll find out in a couple weeks whether that first quarter was really the “trough” for the business — from my perspective, they’re probably right about that, at least in the interim, just judging by the general recovery of ad-driven internet companies over the last few months… though that doesn’t necessarily mean the growth will be dramatic from here, just that they’re likely to have bottomed out. For the moment, at least.

Here’s their optimistic commentary from the last quarterly update:

“Our most engaged users continue to be very active across Fora. We are excited about the forthcoming launch of our Fora mobile app which will provide an even more engaging platform for our communities. We expect the app to be rolled-out platform-wide over the remainder of Q2 and into the beginning of Q3. We have also recently launched video advertising across Fora which will provide our customers with a more engaging and impactful opportunity to reach our 100 million MAU in contextually relevant and product-focused communities. Video along with our other monetization initiatives will support an improved revenue outlook in Q2 and beyond.”

Makes sense, in my spot checks of a few of their properties they’ve surge got plenty of ads, including some pretty intrusive video ads, and advertisers do pay well for those.

I can see why they’re focused on debt — they have $4 million in debt due this year, which is manageable, but they also have $65 million in long-term debt, and the interest expense has started to climb, which is of growing importance for a company whose annual revenue is below $100 million a year. Their debt is mostly in credit facilities with banks that both amortize to some degree (which means they have to pay back 5%+ of the principal each year, in addition to the interest) and have a floating interest rate (mostly LIBOR plus 3% or so — which today would mean roughly an 8% interest rate for FORA). That means amortization is in part a real cash cost, not just the amortization of past capital expenses, and the total debt service seems likely to rise to something like $8-9 million/year (they also have a lot of amortization and depreciation charges that are non-cash, since they write off the cost of websites and content they acquire pretty quickly).

The good news is that they’ve been generating about $20 million in cash flow from operations out of that ~$100 million in revenue (the reason they’re losing money is mostly because of large non-cash depreciation & amortization charges, about $50 million/yr), the bad news is that they also can’t really grow without acquisitions and investment in their properties (which means they need to reinvest in the business, not “keep” the depreciation or amortization “cash”), they’ve never really generated an actual profit under GAAP rules, their revenue is now back down to about where it was when they went public (a little over two years ago), and it’s pretty fair to say that investors are underwhelmed… they were willing to pay 8X sales for what they thought was a growing digital property with good ad revenue in mid-2021, and now they’re willing to pay 1X sales for a business that, as of last quarter, is shrinking. It wouldn’t be surprising if the “fair” valuation is somewhere in between those numbers, but it’s tough to judge where that should be.

So far, it’s looking like they paid premium prices for a lot of communities and forums during a time when online advertising prices were soaring and their sites were very active… and they’re suffering a bit as prices and traffic fall. Their press releases indicate that they’ve “deployed over $100 million of capital” on the 29 acquisitions they’ve made since June of 2021, and that has so far made no impact on their cash from operations — which is pretty shocking. They had $27 million in cash from operations in the quarter that ended in June, 2021, and $26 million last quarter.

Maybe that $100 million in investment will eventually pay off, if the properties they acquired are sticky and generate solid profit for at least 5-10 years, and that could mean they’re getting to “undervalued” now, but that thought requires some optimism, and a fair amount of faith that management can maintain the value of these websites and forums and grow their cash flow. They haven’t actually done those things yet, at least not to the extent that their work shows up in the income statement.

Put another way, they had about 91 million monthly active users before they went public, in mid-2020, and grew that to 94.8 million as of June of 2021… and the $100 million they’ve spent on acquiring 29 more businesses in the almost two years since then helped grow the monthly active user base to 113 million for most of last year, but it’s down to just 100 million now. As an investor, I’d be a little worried both about the stickiness of those users they’ve acquired, and about how much they paid to acquire these businesses when they were at peak user numbers.

Maybe things will bounce back meaningfully, their latest acquisitions will post strong revenue growth, and the new mobile version of their forum software will increase their revenue as both advertising and e-commerce appear to be bouncing back… we’ll see.

They’ve acquired some (relatively) larger sites over the years, including The Streamable when they bought FOMOPOP back in 2021, but most of their website properties are “old school” niche web forums that they’ve either built or acquired, and their forums all seem to use the same underlying code look about the same, from ArcheryTalk.com to GMFullSize.com to TennisForum.com to PoodleForum.com, and they all offer premium memberships and sell banner and video ads, so there’s nothing magic about it — either they keep and grow their user base and they feed them more (and more expensive) ads, taking advantage of extreme niche audiences to charge premium rates to advertisers, or they shrink, (probably slowly, given their reasonably large user base).

Because they rely almost exclusively on user-generated content, not unlike social media platforms, the cost of maintaining these forums should be fairly low, and there should be a network effect within their niches (if you’re obsessed with poodles, you will probably drift to poodleforum.com on your own, since that’s the most active place where they’re discussed… and people who want to sell to poodle owners specifically will also make the effort to advertiser there). I don’t know how many of their 1,200 communities are genuinely tiny, or how many are shrinking vs. growing, all I really know is that they’ve spent two years as a public company in a very acquisitive/growth mode, pushing to build their base, and they don’t have a lot to show for that spending yet.

There might also be more of an existential threat, as AI grows in use. The evolution of web search might end up being a challenge for VerticalScope, particularly if Google search goes from its current “click to look for answers on the page” to “AI-generated answers in the search results” — that’s likely to be bad for niche websites, because it’s expensive to grow these communities if you can’t do so organically (organic search is “free,” but if Google doesn’t send you people and you have to pay $1 just to get someone to click through to visit your forum, and only one in 100 visitors becomes a repeat visitor or a premium member and only two out of 100 click on an ad once they get to your site, the finances of these businesses can look much worse, very quickly). I guess it remains to be seen how artificial intelligence and bot-generated junk content eats into their organic “incoming” search and community building, but they do at least have a shared technology platform, which means they’ve got some hope of becoming more efficient, and they have a fairly large number of current users to monetize through premium upgrades or personalized ads… even if an 11% drop in MAUs in one quarter does sound pretty worrisome.

And that’s about all I can come up with to share with you about VerticalScope — in many ways, it seems like a business that was built in the early 2000s and has kept growing by doing the same thing that worked for a lot of web entrepreneurs 15-20 years ago, building niche communities for both enthusiasts and advertisers. Maybe that survives and thrives as a collection of niche “social network” businesses, but I can’t say that I’m all that impressed by how it has done during its first two years as a public company… the biggest caution flag for me is probably that they’ve spent $100 million on acquisitions in the past two years, most of that in 2021 as they used their IPO cash to buy businesses, but still haven’t grown their user base or cash flow in a dramatic way over the past four or five years.

The valuation has dropped dramatically, with the share price now down about 80% since the IPO, and at some point any cash-flowing business is worth buying, but it would take some optimism to forecast meaningful growth in their revenue or earnings from this point. I don’t have enough insight into the business to have that optimism right now… but perhaps you do, and it’s your money so you get to make the call. Do let us know what you think with a comment below.

Disclosure: Of the companies mentioned above, I own shares of Google parent Alphabet. I will not trade in any covered stock for at least three days after publication, per Stock Gumshoe’s trading rules.