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No Damming Digital River
Nothing irks value investors like an expensive stock that stays expensive and more or less delivers the performance investors want. E-commerce specialist Digital River (Nasdaq: DRIV) is a good example. The stock has rarely been cheap, but the company continues to separate itself from would-be rivals and seems to have a way of bouncing back from setbacks.
The Quarter That Was
Digital River announced that revenue fell 14% in the third quarter, due mostly to the loss of Symantec (Nasdaq:SYMC) as a customer. The company has done a great job of scrambling to replace that loss, though. Revenue excluding Symantec would have been up more than 20% over last year, due in part to the expansion of the company's relationship with other software companies like Microsoft (Nasdaq:MSFT) and Electronic Arts (Nasdaq:ERTS).
Profitability was a bit more problematic, however. The company made scant progress in trimming down expenses in sync with revenue, and Digital River saw total operating expenses fall only a bit more than $2 million. Consequently operating income fell precipitously, though the company's adjusted earnings were fine relative to Wall Street expectations.
The Road Ahead
The biggest ongoing fear for Digital River investors has to be the threat that other companies will follow the lead of Symantec and in-source their e-commerce needs. Of course, not all in-sourcing is created equal. Companies like Accenture (NYSE:ACN) and IBM (NYSE:IBM) can come in and develop custom approaches for companies, and there is the thought that SaaS vendors could also get into the game as well. On top of all that, there is straightforward competition from the likes of GSI Commerce (Nasdaq:GSIC) and the threat of Amazon (Nasdaq:AMZN) continuing to expand its e-commerce partnerships.
On the other hand, Digital River is the leader in its field and boasts customers ranging from Microsoft (Nasdaq:MSFT) to Adobe (Nasdaq:ADBE) and Logitech (Nasdaq:LOGI). For Microsoft (of all companies) to decide to contract with Digital River, instead of building their own system, has to be some kind of validation of Digital River's software and the conveniences of going with their approach.
The Bottom Line
Curiously, Digital River is issuing a $250 million convertible bond, with little explanation beyond funding a modest share repurchase and the boilerplate "business purposes". Then again, Digital River is a curious company - it generates pretty good free cash flow, but its returns on capital and assets are not excellent.
In terms of valuation, it all comes down to profitable growth. If Digital River can maintain double-digit revenue growth and rebuild its margins, the shares are slightly undervalued. Given this company's erratic history, though, investors might want to wait for another dip before buying shares in a big way. (For more, see The Characteristics Of A Successful Company.)
Use the Investopedia Stock Simulator to trade the stocks mentioned in this stock analysis, risk free!
The Quarter That Was
Digital River announced that revenue fell 14% in the third quarter, due mostly to the loss of Symantec (Nasdaq:SYMC) as a customer. The company has done a great job of scrambling to replace that loss, though. Revenue excluding Symantec would have been up more than 20% over last year, due in part to the expansion of the company's relationship with other software companies like Microsoft (Nasdaq:MSFT) and Electronic Arts (Nasdaq:ERTS).
Profitability was a bit more problematic, however. The company made scant progress in trimming down expenses in sync with revenue, and Digital River saw total operating expenses fall only a bit more than $2 million. Consequently operating income fell precipitously, though the company's adjusted earnings were fine relative to Wall Street expectations.
The biggest ongoing fear for Digital River investors has to be the threat that other companies will follow the lead of Symantec and in-source their e-commerce needs. Of course, not all in-sourcing is created equal. Companies like Accenture (NYSE:ACN) and IBM (NYSE:IBM) can come in and develop custom approaches for companies, and there is the thought that SaaS vendors could also get into the game as well. On top of all that, there is straightforward competition from the likes of GSI Commerce (Nasdaq:GSIC) and the threat of Amazon (Nasdaq:AMZN) continuing to expand its e-commerce partnerships.
On the other hand, Digital River is the leader in its field and boasts customers ranging from Microsoft (Nasdaq:MSFT) to Adobe (Nasdaq:ADBE) and Logitech (Nasdaq:LOGI). For Microsoft (of all companies) to decide to contract with Digital River, instead of building their own system, has to be some kind of validation of Digital River's software and the conveniences of going with their approach.
The Bottom Line
Curiously, Digital River is issuing a $250 million convertible bond, with little explanation beyond funding a modest share repurchase and the boilerplate "business purposes". Then again, Digital River is a curious company - it generates pretty good free cash flow, but its returns on capital and assets are not excellent.
In terms of valuation, it all comes down to profitable growth. If Digital River can maintain double-digit revenue growth and rebuild its margins, the shares are slightly undervalued. Given this company's erratic history, though, investors might want to wait for another dip before buying shares in a big way. (For more, see The Characteristics Of A Successful Company.)
Use the Investopedia Stock Simulator to trade the stocks mentioned in this stock analysis, risk free!
by
Stephen D. Simpson, CFA
Stephen D. Simpson, CFA, is a freelance financial writer, investor, and consultant. He has worked as an equity analyst for both sell-side and buy-side investment companies in both equities and fixed income. Stephen's consulting work has focused primarily upon the healthcare sector, while he has also written extensively for publication on topics pertaining to investments, security analysis, and healthcare. Simpson operates the Kratisto Investing blog, and can be reached there.
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