If you missed my last live broadcast, be sure to check it out here (I discussed MRIN in greater depth at the 28 minute mark)… and as always, be sure to read my disclosures/disclosures below. Cheers!
Marin Software (MRIN) has taken flight on news that it has entered into a three-year revenue sharing agreement with Google.
According to MRIN, the agreement is meant to fund further development of its enterprise tech platform and software products. This will be fueled by revenue payments from Google based on revenue generated from Marin’s tech platform in connection with its clients’ spending on search ads. As a result, MRIN has upped its Q4 guidance by $3 million on the top and bottom lines. Guidance now calls for $14.6M-$15.1M in sales and an adjusted operating loss of $2.4M-$2.9M.
Unbeknownst to most investors, MRIN’s operating loss belies the company’s cash flow. During its most recent earnings call, management said:
“In terms of the balance sheet, we saw a cash decline of $2.5 million, which was better than our cash burn during Q2. As discussed last quarter, we have taken and continue to take meaningful steps to reduce our overall operating expense structure, including headcount reductions, lease restructurings and many other cost saving initiatives. These actions in conjunction with our management of working capital have served to improve our cash burn when comparing Q2 with Q3. We will continue to focus on cash management during Q4 and expect to narrow our cash burn during the quarter.”
In other words, with pre-Google cash burn pulling back toward $2 million per quarter, Google’s $3 million should flip MRIN from being a cash burning machine into a cash generator. $2 million of burn + $3 million of Google = $1 million of cash generation per quarter = $4 million per year = $0.66 of cash generation per share.
Based on the press release, SEC filings, and my discussion with management, that’s how I interpret the situation. As a result, I think MRIN’s cash balance should bottom out at $10-13 million (about $2 per share).
So, give the $0.66 of cash flow any multiple you choose, then add the $2 of cash, and there’s your current valuation.
Keep in mind, that’s a per-tax number. Thanks to MRIN’s NOL balance, they won’t be paying any notable taxes for a long time. Regardless, if you want to value the company on a fully-taxed basis, you can use something closer to $0.50 per share.
If you so, you should not only add back the net cash ($2 per share), but also add something to account for the value of MRIN’s NOLs. As of December 31, 2017, the Company had federal and state net operating loss carryforwards of approximately $110,087 and $91,585, respectively.
All said, the company values its tax assets at just over $40 million (close to $7 per share), but currently have that written down to zero on the balance sheet (because there’s been no imminent reason to believe they’d be able to utilize them… until now). I have a problem with the $40 million number, because I don’t see how they can accrue “$110,087 and $91,585, respectively” worth of tax liabilities to offset their tax assets in a timely fashion.
That being said, without a firm idea of where revenue is going over the next 10 years, valuing the NOLs is a tricky proposition. Running some numbers (some of which I provide below), I think something closer to $15-20 million is a more reasonable aspiration. But that’s still about $3 per share in hidden value to be added to the $2 in cash, plus whatever value we decide to place on the $0.66 of pre-tax / untaxed cash flow.
It certainly implies that its 2017 high of $19.18 is not an unreasonable price to target (though I’ll stop short of calling that my target). You have to decide for yourself. I’m just providing a framework here.
So what about the future valuation?
The timing of the Google deal is prescient. MRIN is set to ramp its next-generation system, which promises to return the company to top-line growth. Read its latest transcript for info on that.
Once revenue growth returns, MRIN will likely offer strong operating leverage from a fairly reliable / profitable / recurring revenue stream.
This will finally give investors a reason to start valuing the company based on traditional metrics. Looking at revenue multiples as an example, 1x MRIN’s Q4 guidance + net cash equates to $12 per share. If we assume that guidance to be their baseline average run rate for 2019, 2x revenue equals $22 per share. 3x = $32, 4x = $42, etc.
Looking forward to 2020, the key question is, “what kind of growth can MRIN deliver?”
That’s anyone’s guess, but we do know that they did $75 million in 2017. Getting back there (ex-Google) would represent 50% non-Google growth. If we give them a couple years to get back to those levels, MRIN might do something like $70 million in 2020 and $87 million in 2021… but who knows?
Regardless of that, I do know (based on their operating structure), that roughly 40% of each incremental dollar of revenue should flow straight to the bottom line. Thus, if the scenario above can come to fruition, it should enable total untaxed cash flow potential of roughly $7.5 million ($1.25 per share) and $14 million ($2.33 per share), respectively (all else being equal).
Suddenly, we can start to see how the value of those NOLs could get unlocked quickly… and where the stock could end up in the years ahead.
Assuming a 10x multiple on that 2021 cash flow (on a fully-taxed basis), then add the net cash (which will be higher at that point), plus the value of the NOLs, one could come up with an 18-month price target of somewhere around $36.
Again, I’m not here to make valuation calls or implications. All of this is simply walking through some scenarios / numbers. I am literally typing all of this as I think through it in my head. I go through this exercise with all of my investment opportunities.
Typing it all up gives me notes to fall back on. It also gives you facts and calculation frameworks with which to work. From there, it’s up to you to decide where everything should shake out.
What’s interesting about this exercise is that MRIN was close to $20 last year, nearly $25 in 2016, over $50 in 2015, about $88 in 2014 and close to $140 (its all-time high) in 2013. Those who know how to run the math can see why (and use that same math to determine whether it can reach those levels again).
As you can see from the valuation frameworks above, it’s not unreasonable to think that MRIN can recoup a good chunk of its past value. That being said, it’s hard to calculate a scenario under which the 2013/2014 levels get justified anytime soon.
Of course, I doubt anyone will complain if MRIN merely gets halfway to the levels I’ve calculated in the scenarios above… and that’s one of the key reasons why I was still buying shares at $7+ per share on Thursday. It’s easy to see (under any number of valuation methods) why higher prices could ensue as 1) the story gets out and 2) the math gets calculated.
In short, subject to my disclosures / disclaimers, I think the stock still offers appealing risk/reward from these levels. Due to its extremely low effective float (just 2 million shares), I didn’t want to wait for a pullback — it could reach fair-value equilibrium quickly if investors are competing for those remaining available shares. In turn, that will likely make the stock quite volatile, so be careful.
In any case, I have a nice-sized position and left room to buy more if it pulls back. However, I’m not going to hold my breath. MRIN’s entire effective float has turned over close to 20 times this week (yes… 20!), so a lot of people have an average cost in excess of $5. Plus, MRIN isn’t part of an index, so it doesn’t get directly effected as the market drops. As we’ve seen with TPCS, non-ETF stocks with a good fundamental story have suddenly become an effective money-making strategy.
The Bottom Line – The Google win deal validates why I’ve kept MRIN on my interest list. At its recent low, the company was selling for less than one year’s worth of R&D. However, investors were more focused on the company’s declining revenue and persistent, albeit moderating, cash burn.
In recent weeks, I started quietly buying, treating it like a VC investment. I planned on revealing this at an appropriate moment, but the Google news beat me to the punch. The good news is that I see many more opportunities like this starting to emerge. If the market continues lower, even more will emerge. However, the biggest profits will go to those who know how to find them. Unfortunately for most people, the chart didn’t tell you that this was coming…
…but the MATH and RESEARCH said that something was likely (though not guaranteed) to happen sooner or later.
That’s the advantage that fundamental analysis and risk/reward have over charts (especially in an ugly tape like this). This is why I maintain some of the positions I have, opting to use hedges and options to protect myself against short-term losses. In the end, value always finds its way home. Those who know how to calculate value can count on that, even if we don’t know WHEN it will happen. This is why patience is so important.
It’s been frustrating to see MRIN faltering these past couple of years, but the math reached a level that made it a “cheap development-stage company” in my eyes. Google just validated that. Unfortunately, the stock quickly reacted to the news (which is why holding some and dollar-cost averaging works with these kinds of investments). Thanks to that, I’m now (finally) up a bit on my overall position.
With the market seemingly in free fall, I see this as one of many such situations we will find in the months ahead. Almost every stock has been taken down. Ultimately, I STILL see many overvalued stocks… but now I also see some real bargains.
It’s about time.
This is what the stock market was like before quantitative easing. Now that the Fed is reversing course, I’m looking forward to seeing some aspects of the old market come back. Before 2010, fundamentally-driven analysts could kill the market with ease. During the financial crash, my clients and I were buying beaten down software stocks with substantial M&A value. About 30% of them got bought out. Most of the others took off once the market started to recover.
Since then, it’s been easy for any person or machine to make good money… until recently, that is.
Now, the winners are those who know how to value companies, employ hedges, and identify good shorts. I couldn’t be happier.
Time to dust off my list of cheap companies with heavy R&D investment again… stay tuned!
Appendix: 8-K Text
On December 17, 2018, Marin Software Incorporated (the “ Company ”) entered into a Revenue Share Agreement (the “ Agreement”) with Google LLC (“ Google ” and together with the Company generally, the “ Parties ”) for the Company to develop its enterprise tech platform and software products. The Agreement is effective as of October 1, 2018 (the “ Effective Date ”).
The Company will receive revenue payments from Google based on (a) revenue generated on the Company’s tech platform in connection with the Company’s clients’ spend on Search Ads (as defined in the Agreement) appearing on Google Search only, during a relevant calendar quarter (“ Eligible Google Search Revenue ”), and (b) revenue generated on Company’s tech platform in connection with its clients’ spend on Search Ads appearing on the Eligible Search Engines (as defined in the Agreement), excluding Google Search, during the relevant Contract Year (as defined below) (“ Eligible Non-Google Search Revenue ”). In the case of Eligible Google Search Revenue, following Alphabet Inc.’s public confirmation of its earnings for each calendar quarter, Google will provide the Company with the Eligible Google Search Revenue for the applicable calendar quarter and at the end of the calendar year and make a revenue payment to the Company. In the case of Eligible Non-Google Search Revenue, at the end of each annual anniversary of the Effective Date (a “ Contract Year ”), the Company will submit a report containing its Eligible Non-Google Search Revenue to an independent third-party auditor appointed by (the “Auditor ”), whereby such Auditor will report its findings to Google on the accuracy of the reported revenue. If the Auditor determines that the Company accurately reported its Eligible Non-Google Search Revenue, Google will make a revenue share payment to the Company. If the Auditor determines that the Company inaccurately reported its Eligible Non-Google Search Revenue, then Google will have no obligation to make any revenue payment until the Auditor determines such amount to be accurately reported.
Each revenue share payment will consist of a baseline revenue payment and an incremental revenue payment, the baseline revenue payment is a fixed percentage against all applicable Eligible Google Search Revenue and Eligible Non-Google Search Revenue, subject to a minimum baseline for such revenue amount. At the end of each Contract Year, if all aggregate Eligible Google Search Revenue and Eligible Non-Google Search Revenue for all calendar quarters during such Contract Year exceeds the aggregate minimum baseline for such revenues during the same Contract Year, then the Company will be entitled to an incremental true-up payment equal to a higher fixed percentage against the actual Eligible Google Search Revenue and Eligible Non-Google Search Revenue in excess of the aggregate minimum baseline for such revenues.
The Company will reinvest a fixed percentage of the baseline revenue payments received during the term of the Agreement to drive tech platform innovation. The Company will also reinvest a fixed percentage of its incremental revenue payments received during the term of the Agreement, where such fixed percentage escalates each Contract Year, up to 100% in the third Contract Year. Such reinvestments will be made exclusively for the growth, development, innovation and expansion of the Company’s enterprise tech business. Additionally, the Company has agreed to invest a specified amount of its own funds each Contract Year to further its enterprise business. Such investments will be subject to the review and assessment by the Auditor.
The Agreement contains customary confidentiality provisions, and representations and warranties of each of the Parties.
The Agreement terminates on September 30, 2021; provided, however , that at least three months prior to the expiration, the Parties will consider extending or renewing the Agreement. Google may terminate the Agreement under certain circumstances, including the Company’s material uncured breach of the Agreement, the Company’s breach of the confidentiality and publicity provisions of the Agreement, the Company’s breach of its representations and warranties, the Company is unable to pay its debts as they fall due, or the Company’s Quarterly Adjusted EBITDA (as defined in the Agreement) is a negative number in the three months ending September 30, 2020. The Company may terminate the Agreement at any time for any reason by giving at least seven days’ notice in writing. In the event that either Party experiences a Change of Control (as defined in the Agreement) then the other Party may immediately terminate the Agreement at any time for a period of 30 days following the Party’s receipt of notice of such Change of Control.
Happy Holidays & Best Wishes For A Prosperous 2019,
If you missed my last live broadcast, be sure to check it out here. Cheers!
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Disclosures / Disclaimers: I am long MRIN and TPCS. However, this is not a solicitation to buy, sell, or otherwise transact any stock or its derivatives. Nor should it be construed as an endorsement of any particular investment or opinion of the stock’s current or future price. To be clear, I do not encourage or recommend for anyone to follow my lead on this or any other stocks, since I may enter, exit, or reverse a position at any time without notice, regardless of the facts or perceived implications of this article.
I am not a financial advisor. Nor am I providing any recommendations, price targets, or opinions about valuation regarding the companies discussed herein. Any disclosures regarding my holdings are true as of the time this article is written, but subject change without notice. I frequently trade my positions, often on an intraday basis. Thus, it is possible that I might be buying and/or selling the securities mentioned herein and/or its derivative at any time, regardless of (and possibly contrary to) the content of this article.
I undertake no responsibility to update my disclosures and they may therefore be inaccurate thereafter. Likewise, any opinions are as of the date of publication, and are subject to change without notice and may not be updated. I believe that the sources of information I use are accurate but there can be no assurance that they are. All investments carry the risk of loss and the securities mentioned herein may entail a high level of risk. Investors considering an investment should perform their own research and consult with a qualified investment professional.
I wrote this article myself, and it expresses my own opinions. I am receiving no compensation for it, nor do I have a business relationship with any company whose stock is mentioned in this article. The information in this article is for informational purposes only and should not be regarded as investment advice or as a recommendation regarding any particular security or course of action.
The primary purpose of this blog/forum is to attract new contacts with professional industry expertise to share research and receive feedback (confirmation / refutation) regarding my investment theses.