Early Advisor subscribers may recall that Edgar Online (EDGR) was the inaugural recommendation in our Swing for the Fences portfolio. At the start of 2005, we entered a buy recommendation when the price was $1.35. The stock has since appreciated +326% with much of that increase seen the last few months. (Advisor sold the stock from the portfolio on 9/30/05, but not because our optimistic view changed, as Cory Janssen explained in the subscriber-only update. Instead, Investopedia had purchased EDGAR Online's i-Metrix product and so the company was dropped from the portfolio due to a strict policy on avoiding even the appearance of conflicts of interest).
For some Wall Street professionals and the cable television talking heads, there is one thing you can bank on: after a stock leaps, somebody will step up to recommend it without checking the new valuation. Some of these gurus apparently screen for ideas based on stock price momentum. So if a stock doubles quickly, like EDGAR Online has since the beginning of the year, it bounces freshly onto their radar and becomes interesting.
It would be funny if it weren't such a money-losing strategy. The trick -- does it need to be said? -- is to find these companies before they leap but you can't do that if you obsess on the thin market layer of frenetic trading and price movements. You need to dig deep into business analysis and try to discern trends that impact products, markets, and channels.
EDGAR Online is an acceptable but highly speculative purchase at recent price levels, but -- please -- nobody can justify the stock on traditional valuation multiples. One recent analysis relied on EDGAR Online's enterprise-to-sales multiple (enterprise value equals market equity plus long-term debt).
As EDGR has no long-term debt, their enterprise multiple is about the same as their price-to-sales ratio). Finding this multiple too high, the author added an estimate for 2006 sales and compared EDGAR Online's stratospheric forward multiple (almost 8x sales) to its peers' current multiple of 5x. Even the 5x is too high, if you want to make the right comparison. I guess if you sift through enough metrics and compare apples to oranges, you can find something remotely plausible.
But for last three years that I've covered EDGR, you have not been able to justify the company based on multiples. It's still the case now, only more so. For three years running now, the value of the stock has been a function of an ongoing subscription-based business plus an embedded option for their sizable bet on XBRL. The value of the embedded option is now larger than the ongoing piece. EDGAR Online is still the only aggregator of XBRL-tagged SEC filing data. Their market opportunity is still huge, but I would say the embedded option is more fairly valued today.
When Advisor initiated coverage at $1.35, we could only find a place for the stock in the Swing portfolio because, according to our calculations, its ongoing (intrinsic) equity value was about $0.90 per share. What then justified a recommendation? We saw the real option (or embedded option) value in their strategy to deploy an XBRL-based service ahead of all of their competitors. The company had spent over two years in a brave bet-the-company strategy to be the first-to-market financial aggregator of tagged filing data in the XBRL format. In the intervening years, mainstream perception of XBRL drifted from skeptical, to affirmative, to endorsing.
This perceived progress was buoyed of course by SEC Chairman Cox's public endorsements, but it was -- and still remains -- only a matter of time before demand settles the matter. XBRL adoption is inevitable like water flows downstream. The cost and efficiency advantages of XBRL-based reporting (on the corporate filer side) and analysis (on the advisory side) are so compelling that the big hurdle is currently awareness. Most potential users aren't quite sure "what XBRL means for me."
And even many XBRL disciples are not fully aware of EDGAR Online's achievement. The reason, I think, is that you've got to use it (or demo it) to see why it's so powerful. I attended XBRL-US at Adobe Systems (ADBE) in January; I still run into industry participants who are a bit incredulous that EDGAR Online has already tagged virtually all publicly traded companies, including a five year history, because they assume the slow pace vis-à-vis mandatory XBRL filings defines the state of the industry.
But make no mistake, we are still early in the XBRL adoption cycle -- XBRL has not reached its tipping point. Contrary to a recent article, the market opportunity has almost nothing to do with individual investors and do-it-yourselfers -- don't count on that market anytime soon.
The current market opportunities include:
• Corporate filers: EDGAR Online has a formidable beachhead in the RR Donnelley relationship but also formidable competitors
• Financial services (e.g., investment managers, funds): a huge untapped opportunity in an inevitable market where EDGR has a big head start but not quite the organizational scale to exploit. In other words, they need distribution help/partners. Do not be surprised to see acquisition overtures
• Advisory services; e.g., accountants, professional services, etc.
• International markets: EDGAR Online will be deploying a "global prototype" for Chinese and Japanese data, among several other international jurisdictions
I love this company and its products. They have great people, too. But with annualized sales of $14.7 million and a market cap now having breached $100 million, they are still a micro (or really small) cap with no profits, trading at almost 8x price-to-sales. Continued organic growth ought to be brisk: for top-line growth, high single digit quarter-over-quarter growth ought to produce annualized growth in the mid 20% range. But it's hard to figure. The R.R. Donnelly (RHD) agreement could push this into the 30% range. That's great but, alas, that growth expectation is now already incorporated into the stock.
Therefore, just like our original thesis, further returns depend on unannounced exploitation(s) of the embedded XBRL option; e.g., a meaningful distribution agreement, several large high-profile accounts (preferably in financial services rather than corporate), more traction in international jurisdictions, or an acquisition offer. Personally, I think every last one of these will happen, so I still like the stock. But my original point is that it can't be justified on a value-based discipline. It's for the high-octane portfolio that can afford a 50% drop (because if you remove the embedded option, that's where you end up, plus or minus).
Is it too late to play the XBRL idea? Are the any lessons for the here and now? No and yes! Truth be told, it was not hard to see that EDGR would reach some level of significance because XBRL is eXtensive Markup Language (XML) -- an ugly-looking markup language that will pervade everything. XML enables machine-to-machine sharing of structured data. Not only is XML native to the next version of Microsoft Office, but it incarnates as Really Simply Syndication (RSS) feeds, it fuels the (appropriately) hyped emergence of so-called web services and it will manifest in dozens of industry-specific applications.
The idea behind the EDGAR Online selection was simple: they were (and are) the lead contender to exploit XML in the vertical industry that happens to be financial reporting. To play a similar but not identical theme we only need to look in other industry verticals for the companies uniquely well-positioned to exploit the inexorable shift to XML-based data interchanges. Wherever information is important but brokered laboriously, XML will play a role in disintermediation and the replacement of labor-repetitive tasks with automated machine-to-machine interchange.