“I regard golf as an expensive way of playing marbles.” ― G.K. Chesterton
Today, we look at an interesting small cap company we had never researched until recently. A full and updated investment analysis follows in the paragraphs below.
Headquartered in Santa Monica, California, Leaf Group Ltd. (LEAF) owns a portfolio of digital-first brands focused primarily on fitness & wellness and art & design. Its more notable brands include eHow, Livestrong.com, Hunker, Society6 and Saatchi Art, amongst others. The company was founded in 2006 as Demand Media and went public in 2011, raising net proceeds of $81.8 million at ~$85 per share (1-for-5 reverse split adjusted). Its stock was initially a highflyer, trading north of $120 a share a few months after its IPO. Beginning in late 2018, Leaf Group has been the focus of an activist investor group led by Osmium Capital with its stock trading around $5.50 a share, translating to a market cap of approximately $150 million.
The company has two reporting segments: Marketplaces and Media.
Marketplaces consists of the company’s art and design assets, which are platforms on which artists and designers can peddle their wares. Two of its offerings are Society6.com and Deny Designs (collectively, Society6 Group), which are primarily marketplaces where original artwork is provided made-to-order on a vast array of consumer products in the home décor category. At YE19, Society6 Group boasted ~380,000 active artists marketing 6.4 million unique designs on 70 consumer products. Society6 competes with the likes of Redbubble (OTCPK:RDBBF), Threadless, and Minted, as well as broader home décor and apparel companies such as Etsy (ETSY), Wayfair (W), Urban Outfitters (URBN), and Williams-Sonoma’s (WSM) West Elm.
Source: Company Presentation
The other major asset in Marketplaces is SaatchiArt.com, an online art gallery highlighting emerging artists. It is this business that current Leaf Group CEO Sean Moriarty ran when it was purchased in 2014. At YE19, Saatchi Art featured 1.4 million original paintings, drawings, sculptures, and photography from ~95,000 artists. It also hosts approximately one dozen in-person art fairs in the U.K., U.S., Australia, and Canada annually. Competitors include Artfinder, Artspace, Rise Art, eBay (EBAY), and Amazon (AMZN) Art.
Source: Company Presentation
Collectively, Marketplaces’ assets accounted for 1.26 million transactions and $114.8 million of gross transaction value (GTV) in 2019, representing declines of 12% and 2% (respectively) from 2018. This segment contributed $2.2 million of operating losses (before corporate overhead) on revenue of $89.6 million 2019, representing 58% of Leaf Group’s total top line and a 5% deterioration versus 2018.
Source: Company Presentation
Media is comprised of over 60 brands that focus on the home & design and fitness & wellness verticals, the most popular of which are Hunker, Well+Good, Livestrong.com, and eHow. Whereas the majority of the revenue generated by Marketplaces is from commission on sales of art and design work, Media derives most of its top line from advertising sales, a function of the 2.8 billion unique visits to its websites in 2019, flat relative to 2018. Revenue per 1,000 visits [RPV] increased 7% from $21.48 in 2018 to $22.95 in 2019. Overall, Media was responsible for operating profit of $24.7 million on revenue of $65.3 million in 2019, reflecting a 6% decrease and a 7% increase over the prior year, respectively. The increasing top line contribution was due to 133% uptick in traffic at Hunker and the February 2019 acquisition of Only In Your State, as well as the June 2018 purchase of Well+Good, which was partially offset by a 37% plunge in revenue from Livestrong.com. The drop in operating profit was a function of the additional overhead onboarded with the buyout of Well+Good.
Activist Shareholder Issues:
General administrative expenses also increased 11% in 2019, the majority of which was a function of a proxy battle and strategic review associated with activist shareholders – led by Osmium – who desire to have (in their minds) the underperforming and undervalued assets sold off, and if that can’t be effectuated by current management, the replacement of CEO Moriarty with someone who will sell the company. The battle began as a discussion in late 2018 with the first public letter issued by Osmium in March 2019. The company responded with the initiation of a strategic review of its business in April 2019 and concluded (in May 2020) that its current path (not selling) was the best for maximizing shareholder value. That announcement was met with the resignation of the company’s CFO and another missive from the activist shareholder group on June 29, 2020, which now represents over 40% of the shares outstanding, calling for the resignation of Moriarty. Four (out of nine) board members have resigned since April 2020. The letter cited that shares of LEAF were trading at an 85% discount to its digital media peer group and that a gradual disposition of individual assets would return ~$665 million – $205 million for Media assets and $460 million for Marketplaces’.
At that time, shares of LEAF were trading at $3.59, after hitting an intraday low of $1.03 during the COVID-19 panic selloff of mid-March. The stock has continued to rally owing to two dynamics.
3Q20 Preliminary Results and Outlook:
First and foremost, the business has turned around significantly at Leaf Group, as evidenced by its preliminary 3Q20 results, announced on October 5, 2020. The press release stated that 3Q20 revenues had sprouted more than 50% from the prior-year period result of $40.0 million, representing its strongest year-over-year growth since going public. This news comes on the back of 42% Y-o-Y top-line growth in 2Q20 as people sheltering inside are spending more money online. Sparking this resurgence is Society6 Group, which realized a 115% spike in 3Q20 GTV on the back of a 128% rise in Y-o-Y revenue in 2Q20. Also contributing was Saatchi Art online, which realized a 70% increase in 3Q20 GTV – more than offsetting the loss of business from the cancellation or postponement of its in-person shows – netting to a 30% GTV gain for Saatchi Art Group. Media revenue declined 13% Y-o-Y, which was an improvement on the 26% pandemic-induced drop witnessed in 2Q20.
Management reiterated its 2022 organic (i.e., no acquisitions) revenue and Adj. EBITDA guidance of $250 million and $20 million (respectively), which suddenly seemed conservative. Also included in that forecast was 15% long-term revenue growth.
Actual Third-Quarter Results:
On October 29th, the company posted actual third-quarter results that were as good or better than previous guidance. Net income came in at $3.7 million. This was an increase of $8.2 million over the year-ago period. It should be noted that $5.5 million of that was for a one-time gain. Revenues increased 58% from the same period a year ago to $63.3 million.
Sales growth for the company’s different media properties broke down like this.
- Society6 Group revenue increased 127% year over year from $19.2 million to $43.6 million.
- Saatchi Art Group revenue increased 13% year over year from $4.1 million to $4.7 million.
- Media Group revenue decreased 10% year over year from $16.7 million to $15.0 million.
Source: Company Presentation
Balance Sheet & Analyst Commentary:
The company had cash and cash equivalents of $33 million at the end of the third quarter. It also had $11.4 million in debt outstanding which included $7.1 million from the Paycheck Protection Program and $4.0 million drawn on its revolving credit facility. It should be noted that the company has ~$351 million of state and federal net operating loss carryforwards. Backing at net cash, the shares sell at approximately 50% of annual revenues using the third-quarter run rate.
The only sell-side firm to proffer commentary on Leaf in 2020 is Canaccord Genuity, which reiterated a buy in August with a $7 price target which it reiterated again the day after third-quarter earnings were posted.
Curiously, Osmium purchased 500,000 shares of Leaf Group on the same day of its preliminary 3Q20 announcement. The transaction must have occurred off-board (i.e., away from the NYSE) as the price ($5.13) was below the daily range and the size of the purchase eclipsed the entire volume on the NYSE for October 5, 2020. Whether this is a move to control – through its and other activist group members’ positions – over 50% of the shares outstanding to force Moriarty out or a nod to two excellent quarters is unknown.
Although it is very likely the former, all the publicity surrounding Leaf Group has drawn enough attention to it for investors to realize that the sum of its parts is much greater than where the whole had been trading. This focus on the sum-of-the-parts valuation is the second reason why Leaf has rallied from just over a buck a share to over $5 since mid-March. It doesn’t matter which point of view – excellent operational performance or cheap embedded value – an investor takes. The good news is that Leaf Group is in a virtuous (yet tumultuous) upward spiral, with plenty of upside remaining versus the activist group’s sum-of-the-parts valuation, as it currently trades at a huge discount to the $665 million valuation suggested in the June 29, 2020 letter.
We posted our original analysis on LEAF exclusively to Busted IPO Forum members in Mid-October. At the time, the shares were trading at approximately $6.50 a share. We recommended it for a small ‘watch item’ position then. We also stated it would merit a full position if the shares fell back down to the $5 level, but we were not going to chase the stock’s huge rally at the time. The company subsequently posted robust third-quarter results late in October and the shares fell back down to the $5 level as some profit-taking took hold. We then ‘promoted’ the holding into our model portfolio last week and are now posting this updated ‘investment thesis’ on this ‘off the radar’ name.
“Golf is a game whose aim is to hit a very small ball into an ever smaller hole, with weapons singularly ill-designed for the purpose” ― Winston S. Churchill
Bret Jensen is the Founder of and authors articles for the Biotech Forum, Busted IPO Forum, and Insiders Forum
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Disclosure: I am/we are long LEAF. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.