It's important to maintain a watch list of stock ideas. Many of
your investment ideas can be intriguing, but not quite tempting
enough to merit your hard-earned dollars just yet. I like to check
in on all of these investment ideas almost daily, waiting to see if
the stock falls down to a level that I can't resist, or if the
company has announced new initiatives or quarterly results that
make the stock a true bargain.
But a stock's downward move may be the result of bad news that has
dimmed the investment picture. The question is whether the downward
move is justified, or if it has sharply overshot the mark, well
below where shares should trade.
That scenario is playing out with
DG FastChannel (Nasdaq: DGIT)
, which has run into some short-term growing pains after a long
stretch of solid growth.
Growth stalls out for now
Following the dot-com boom, DG FastChannel was a perennially
frustrating story. The company's advanced media placement services,
tailor made for the digital era, never saw the demand that
investors had expected. In hindsight, the company arrived before
the market opportunity did. By the middle of the last decade, the
advertising market suddenly embraced the use of very advanced media
buying. Digital platforms for the delivery of ads, syndicated
programming, multimedia advertising and web-based content were
finally in vogue, and DG FastChannel's technology found a home with
dozens of ad agencies and broadcasters. The company's satellite and
web-based network now delivers programs and ads to more than 25,000
companies in the entertainment and marketing fields.
Sales rose more than +30% in 2006, 2007 and 2008 and a
still-impressive +20% in 2009 -- which was hardly a banner year for
the entire media industry. Until recently, many investors assumed
growth would be robust again throughout 2010 and into 2011. In
early August, the company posted impressive quarterly results,
highlighted by strong demand for high-definition (
) advertising delivery services.
But shares began to lose steam as investors grew concerned that any
economic slowdown would lead advertisers to throttle back spending.
On the DG FastChannel's early August conference call, management
noted that it may need to reposition some of its offerings to
maintain customer interest. The company had previously simply sold
its technology to customers and let them conduct media buying
plans, but thought it could capture more business by entering into
the market with its own ad and content exchange where buyers and
sellers can meet. Any time a company makes such a major change, it
virtually invites sales disruption as customers figure out whether
or not they want to participate.
When pressed about growth prospects for the rest of the year,
management seemed unusually reserved compared to previous bullish
body language in previous quarterly conference calls. "Management
was stuck with the word 'good' for much of the call, which we do
not believe was enough to get investors excited about the rest of
the year," noted analysts at Dougherty & Co. That certainly
spooked some investors, and the stock began a steady decline from
$38 in early August to recent $24.
That selling now looks quite prescient. Management now concedes
that the slowing
is starting to bite and a decision to alter its sales approach is
also keeping some clients on the sidelines. As a result, sales will
grow only modestly in the current quarter compared to a year ago,
and sales growth is likely to be negative on a full-year basis. DG
FastChannel's shares, which had already been in freefall, lost
another -38% on Monday to around $16 and are now about -60% below
levels seen a month ago.
To be sure, it will take some time for DG FastChannel to get sales
growing at a fast pace. First, the economy needs to rebound to help
drive higher media buying levels. Second, the company will need to
prove that its new sales approach wins favor with its massive
customer base. If not, it may need to reverse course on those new
Investors are now bracing for a period of stagnant growth, but it's
important to remember that this is a remarkably profitable
business. Even with its downbeat sales forecast, DG FastChannel
will still likely generate more than $100 million in
this year, which translates into EBITDA margins exceeding 40%. Few
companies can say that.
of customers means it's not likely that a rival can come in and
steal the company's thunder. Management has invested nearly $200
million in the company's technology, and that platform now accounts
for nearly half of the company's just-reduced
. DG FastChannel now controls roughly two-thirds of the market, and
it would be very costly for customers to switch to a rival.
Action to Take -->
In any situation like this, it's important to measure the upside
and the downside. The downside here is that shares stay stuck in
the teens as investors come to expect slow growth in the years
ahead. That looks overly bearish, but even if that were to be the
case, shares have likely found a floor at current levels due to the
company's deep technology platform and impressive customer base.
On the upside, even if sales growth rebounds to just the +10% to
+15% range in 2011, EBITDA would likely grow even faster as
incremental new revenue falls quickly to the
. In that scenario, shares would quickly move back into the mid
$20s and perhaps exceed the $30 mark -- double their current
levels. A stock with limited downside and +100% upside always
-- David Sterman
David Sterman started his career in equity research at Smith
Barney, culminating in a position as Senior Analyst covering
European banks. David has also served as Director of Research at
Individual Investor and a Managing Editor at TheStreet.com. Read
Disclosure: Neither David Sterman nor StreetAuthority, LLC hold
positions in any securities mentioned in this article.