There is one clear risk when looking at companies that may be
"in play." Even when companies are in the
cross-hairs, a huge amount of patience is still required: a company
may be actively holding discussions to sell itself, but any actual
agreement can take months to
That's a lesson clearly forgotten by momentum investors that
Digital Generation (Nasdaq:
this spring in hopes of making a quick buck. Media reports
circulated in late May that the company had just rejected a
. Traders quickly sensed that other offers could soon emerge, so
the stock started to move higher. Today, with no signs of a buyout
in hand, these same investors are now shifting out of this stock in
search of quick gains elsewhere. For the rest of us, the resulting
sell-off gives a fresh chance to wade in, as this stock appears
quite inexpensive -- even if a buyout doesn't happen in the
A valuableasset with falling margins
Digital Generation, formerly known as DG Fast Channel, was, not
long ago, one of the hottest growth stocks in the media landscape.
The company saw its sales rise at least 30% every year since 2006
(with the exception of 2009 when sales "only" grew 16%). Year after
year, the company signed up more TV stations for its syndicated
advertising insertion platform.
It's a remarkably profitable business. Thanks to minimal capital
spending needs, DGIT generated $165 million in cumulative
free cash flow
from 2009 through 2011on $748 million in revenue. That works out to
be 22% free cash flow margins for that time frame, which is
Yet management, which had pulled off a series of savvy
acquisitions, finally blundered when DG announced plans to spend
$481 million in the summer of 2011 to acquire Internet-focused
ad-serving firm MediaMind. Management thought this huge acquisition
would reap major synergies as the line between TV and Internet
advertising began to blur.
You can see how much the deal has hurt the
by comparing the first-quarter results. The MediaMind acquisition
boosted sales by roughly 50%, but a much higher level of
suddenly made the company look bloated.
The Internet business, as it turns out, isn't nearly as
profitable as TV, and it dragged down companywide gross margins by
nearly 50%. Adding insult, the increased debt taken on to pay for
the MediaMind acquisition really hurt net profits. Of the company's
$10 million in quarterly
in the most recent quarter, $8 million had to be paid out in
interest expense. Pretty quickly, it was easy to see why this
stock, which traded at $35 at the start of 2011, dropped to just $8
by May 2012.
The rumor mill churns
By late May, media reports started to circulate that DGIT would
stop fighting angry investors and put the company up for sale.
reported that the company had retained
Goldman Sachs (NYSE:
as an advisor, and noted that at least four private-equity firms
had requested to see the company's books.
Two weeks later,
reported that Digital Generation had turned down an offer to buy
the company for more than $20 a share. That offer allegedly came
from a rival, Extreme Reach, but DGIT's board apparently decided
between the two firms might create anti-trust concerns.
Rumors turned into fact on June 7 when Russell Glass, the
founder of RDG Capital, admitted he was in talks to buy the
company. RDG had previously announced a 4.9% stake in the company,
just below the threshold that would have forced RDG to file all
future purchases and sales with the S.E.C. Glass noted that he
believed DGIT's anti-trust concerns were overblown, and a deal with
Extreme Reach was worth pursuing.
By the middle of June,
were approaching $13 as investors grew to anticipate another
possible offer in the previously-cited $20 range. But no new deal
was announced. Shares held firm until last week, but have since
fallen 18% in the past six trading sessions. The momentum that
poured into this stock a month ago is gone, and investors are now
rushing for the exits as a buyout announcement has failed to
appear. However, the rush to sell is likely to prove to be
Risks to Consider:
DGIT topped first-quarter forecasts only after sharply lowering
the bar just weeks before. Had the company not taken that step, it
would have badly trailed estimates for the fourth straight quarter,
so investors should be braced for another tough quarterly
Action to Take -->
It's increasingly clear that DGIT is up for sale. Outside of
Extreme Reach, other potential buyers may be looking to pay
somewhat less than the above-cited $20-a-share price. But by simply
retaining Goldman Sachs as an advisor, and then holding talks with
various interested parties, the cat is out of the bag. Pulling the
company from buyout discussions is likely not anoption at this
point, as it would send shares to fresh lows, where they'd stay
until management can fix the
If those margin problems begin to resolve, then it could still
help to move shares upwards, but that would be a six-18 month
process -- unlike the more sudden pop that a buyout would bring.
One way or another, there is still value to be unlocked in this
-- David Sterman
David Sterman does not personally hold positions in any
securities mentioned in this article. StreetAuthority LLC does not
hold positions in any securities mentioned in this article.
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