“The Cheapest Stock You’re Going to See”
Featuring Jeff Meyers
Published on: August 6th, 2019 • Duration: 20 minutesJeff Meyers of Cobia Capital is one of the few investors looking at small-cap tech stocks from the value perspective. In this interview with Justine Underhill, Meyers makes his Real Vision debut with a look at a European performance marketing company that appears to be trading at shockingly low valuations. He breaks down the bull case for XLMedia, discusses potential catalysts for price action, and examines a unique short-term arbitrage opportunity in the form of a tender offer. Filmed on August 5, 2019.
JUSTINE UNDERHILL: Welcome to Real Vision's Trade Ideas. Today, we're sitting down with Jeff Meyers of Cobia Capital. It is great to have you here.
JEFF MEYERS: Thank you.
JUSTINE UNDERHILL: So, this is your first time on Real Vision's Trade Ideas. And we actually found out about you through SumZero, which is a buy side idea generation platform. And you were ranked number one on that site for the ideas that you had posted there. Could you give us a little bit of your background, what you do and your work with SumZero?
JEFF MEYERS: So, I start my own fund in '08 or late '07, I guess. I got seed from my former employer at Siegler Callory, $10 million seed. And launched January '08, obviously a great time to launch a hedge fund. You don't have volatility that year. But the truth is it ended up being a good time to start because at the end of the year, the bargains were ridiculous. There's things trading for cash, below cash. So, we just scooped up lots of companies at the end of the year, beginning with '09 and then '09 to the big rally. And we took advantage of that, had a great year in '09. And since then, I've been managing the fund.
JUSTINE UNDERHILL: And you're mostly looking at stocks that other analysts aren't looking at. So, you don't have huge mutual funds or large funds that are investing in these stocks?
JEFF MEYERS: Exactly. The small cap area is because of size and liquidity, the big mutual funds can invest there. And we also have something a little special, I guess, because we are as I indicated earlier, we're still a value-oriented strategy. So, a lot of guys in technology are not value guys, they're growth guys, momentum guys, et cetera. So, we're looking at different names than they're looking at or we're looking at names earlier than they're looking at them. So, we get a lot of interesting opportunities where we have very few other competitors, I guess, looking at them.
JUSTINE UNDERHILL: So, how do you come up with your ideas?
JEFF MEYERS: So, there's a lot of screening involved, because we're value-oriented, we would probably get 70% of our names through screening, and we have about 65 different screens that we use to parse the universe and try to figure out what's inexpensive, and then we dig into those names, so just the main way.
JUSTINE UNDERHILL: All right, so what trade are you looking at today?
JEFF MEYERS: So, we're looking at a company called XLMedia, ticker's XLM.LN, street in London, probably a cheaper stock you're going to see in a long, long, long time. Stock trades at three times EBITDA. So, basically, enterprise value to EBITDA is about three times. So, the way I think about that is, if you bought the whole company with that valuation, you get paid back in three years. So, it's very inexpensive. EBITDA multiples usually range six to 15 or so.
So, the reason is that they've had tough time the last couple years, that I guess explain the business. So, it's called an affiliate marketer. So, what they do is they get customers or clients, I guess, from the internet, and they pass them along to your site. So, we think it's a very transferable skill. They started in the online gambling universe. So, they get customers for Unibet, ADD, Betfair, guys like that.
JUSTINE UNDERHILL: Do they own their own websites? Or do they own part of the gambling websites? How does that work?
JEFF MEYERS: So, they have two ways really of getting these game customers. One is they have their own websites. So, they have about 2600 different websites they developed over time. And somebody will come and if you're interested in sport betting in the UK, so they go to one of their sports betting sites, there's a lot of information about different teams and odds and things like that. But then in addition, there are little, say, ads on the site for your $10 discount at Betfair, $10 discount at Unibet. So, if somebody clicks on that and they go to, let's say the Unibet site, any revenue that they generate on Unibet, XLM gets half.
So, it's a good arrangement and recurring revenue over time as long as the customer stays on on Unibet. People, I think, perceive it as somewhat of a shady business, it's gambling- what they do is they try to stay in the regulated markets so like the UK, for example, there's like a tax on online betting, so the government's getting money. They're incentivized not to shut things down.
JUSTINE UNDERHILL: So, they're not completely operating in a gray area?
JEFF MEYERS: Correct. I say, probably 70% of the markets are already regulated, and the other 30% are moving towards regulation. So now, there are like, for example, in the UK of last year, the regulators have cracked down a little bit on having kids, under 18 get into gambling, and so they've cracked down on the types of advertising there can be, and that's affecting XLM. Their big customers have gotten a little more conservative until the regulation pans out, and they can see, get better view of what the regulation is going to be. We feel that behind at this point, so that was really over the last few years, and there is some more like Sweden is regulating now. So, the tax there is going to hurt some of the guys for a little while.
So, that's one way they get their business is the websites, 2600 websites, people go to them, they eventually go to their customers and that's how they generate revenue. The other way was through media campaigns. So, they would have advertisements on other people's websites. So, that was a pretty fast growing revenue stream for them, but not very profitable one. So, what's happened over the last few years, they've really pulled back the media side of the business.
So, that's hurt revenue like revenue's down 18% last year on that. But EBITDA was only down 2%, because most of the EBITDA is being generated by the publishing business. And the publishing business has grown mid-single digits the last two years, so it's still growing. So, we think that there's a lot of opportunity ahead of them. Now, there is US basically said at least on our federal level, sports betting is okay. So now, each state has to come in and basically allow sports betting, and so that process is ongoing now. And over time, this can become a bigger and bigger market for them. And there's so- I don't even remember the number, it's some $20 billion amount of illegal sports betting in the US. So, as that gets regulated and those big customers, casinos want help gathering clients, and they'll bring guys like XLM.
JUSTINE UNDERHILL: So, that could be a big opportunity for them going forward. So then, is this the biggest aspect of their business, you have the sports betting, you have the gambling aspects, you have the publishing aspect? Are there other areas that they're involved in?
JEFF MEYERS: Yeah, so they basically diversify a lot since they went public. When they went public, they were really a Swedish gambling company. Now, they've diversified into other geographies, at least certainly within Europe, and now, looking at the US and Latin America as well. And they've also diversified their base of business. So now, they're 30% consumer finance and it's in the US and Canada, and sites where they talk about- you go to the site and it tells you about different credit cards, which ones have the best points, which ones are good for younger users, and then they have links on those sites to the credit card companies, and they get a revenue share from the credit card companies.
So, that's a growing part of their business. And as I said at the beginning, everybody wants customers, online customers, and they can gather them because of their expertise in doing this. And we've worked with them on trying to discern like how tough it is to start one of these sites that they have, and it's very hard to get ranked on Google, which is the key aspect of it. You have to have a lot of good content on there, you have to have a lot of good traffic on there. You have to have a lot of good links on there. It takes three to four years to develop sites. So, for example, in the US, they're not generating a lot of revenue now because the sites are still information. But that's something that is not easy to copy.
JUSTINE UNDERHILL: Now, over the past few years, there was a pretty big run up in the stock, I think it was trading at 200 pence. And then it recently sold off down to 40 pence, I believe. Can you talk about that, as well as where you see the stock going?
JEFF MEYERS: Sure. So, basically, the run was they're growing 25% plus, combination of publishing, which is growing pretty fast. And the media business which is also growing pretty fast. And profitability was growing as well. And they did that for four or five years. So, when I first started, nobody knew about the name. And in this one week, I came in, because we saw this thing growing, we liked the business model, but nobody cared about it. So, we got involved, it went from, as you see, it went from 40 to 200 pence, and, unfortunately, we can't get out of that budget to other paths, because the valuation was still pretty reasonable.
And then they ran into a couple issues with the media business, so they pulled that back. And then the regulation in the UK hurt them. So, that hurt the publishing side of the business. So, they have basically two profit warnings and that took the stock down from 200 to 40. So, we had some at 40, 42 that level. The stock can stay down there for a while, they had a trading update, which was they said trading is in line, and the stock started to move upwards slowly. Then they had more recently, a trading update, and also a tender offer that they announced when the stock was like at 70, basically.
So, the trading update was, again things are in line for the year, tender offer was they're going to tender for 10% of the stock at 80 pence. So, the stock basically went from 70 to 80, actually went above 80 for a little bit like 82. And then most recently, I guess, they announced a succession of the CEO. So, the former CEO was the founder of the company, he'd been on for 10 years. So, he basically wanted to step back. And they found the guy- he was more big picture oriented. And they found a guy who was more detail-oriented, very good background. And so, he's now taking over, but the stock took a hit on that. So now, it's trading at 72. So, it's actually interesting arbitrage opportunity, you could buy here, you could buy 300,000 shares at 72 and tender them and get 80 for them.
JUSTINE UNDERHILL: When is the tender offer going up?
JEFF MEYERS: You have to tender by the 9th.
JUSTINE UNDERHILL: Of October or September?
JEFF MEYERS: Of August.
JUSTINE UNDERHILL: Oh, very soon, okay.
JEFF MEYERS: It's very near term.
JUSTINE UNDERHILL: Oh, okay. But nice little opportunity there. So, with the tender offer, why would the company buy back shares at 80 pence on August 9th, rather than simply buying them back now at a lower price?
JEFF MEYERS: So, they had been buying back stock previously. But they just- liquidity wise, it just weren't getting enough shares in the market. So, they decided to do it all in one big fell swoop. I think they also think that AD is still pretty inexpensive relative to the value of the company. And also, the last reason is there could be sellers in the name, they just want to get them out already. So, I think those reasons are-
JUSTINE UNDERHILL: So then bigger picture, where do you see the stock going?
JEFF MEYERS: So, we see it going at least 120. So I said, I guess, at the beginning that enterprise EBITDA is trading at three times now, probably six times is reasonable. And they have like $40 million in cash. It doesn't actually double the stock price. But it gets you a significant amount higher than where it is today.
JUSTINE UNDERHILL: And over what time horizon do you see it reaching 120?
JEFF MEYERS: Over the next year.
JUSTINE UNDERHILL: And do you have a stop loss on this trade? Or is there a point at which something would happen and you would back out?
JEFF MEYERS: So, we don't have formal stop losses. As a value fund, we're probably more likely to add to something on a pullback depending on a few things, depending on if the thesis still makes sense. And the second thing is if there's a catalyst, we don't generally add unless there's an upcoming earnings announcements or something we think is going to be able to move the stock.
JUSTINE UNDERHILL: Do you see a catalyst now? So, I know you've been invested in this company for over a year, for how long?
JEFF MEYERS: Three years. Four years.
JUSTINE UNDERHILL: Three years, okay. So, is there a catalyst that you would see bringing it from 70 to 120?
JEFF MEYERS: Yeah, increasing penetration of the US market in sports betting and increasing penetration of Latin America. Brazil and Argentina are now starting to- there's online gambling presence there. That's totally new market for them.
JUSTINE UNDERHILL: What would you say is the biggest potential risk to this trade? Is it simply the sports betting aspect and waiting for regulations to come on?
JEFF MEYERS: Yeah. It is bad regulation in one of the bigger markets, if the regulators come in and say, shut things down, or impose some huge tax, that's something that could hurt them.
JUSTINE UNDERHILL: Given that we've seen a recent selloff in the stock, could you give us a perspective from the other side? What is the bear case for the stock right now?
JEFF MEYERS: Well, I think people look at it and say, oh, this is affiliated with online gambling, and that's like a vice and nothing good's going to happen to them. That's the prevalent thought of people who don't know it that well. People who know it better would say the risk is in regulation, like how do these companies regulate in a normal way, in a traditional way that other companies are regulated? Or do they come in with some ridiculous tax, which is really going to shut things down or to ban it?
The problem with markets where it's not regulated, it's the black market. People gamble on sites they're not paying any taxes on, it's totally unregulated. And you have kids gambling and addicted people gambling, and so that's why countries regulate, so they do have some control over what's going on. And if they regulate it in a logical way, they're going to get tax dollars out of it, and they'll be able to control experience for people. And that's the general experience of countries that have regulated, but there's always a chance that the country will do something crazy, and that'll block guys like XLM from the market.
And that's why they diversified. They are like, one country, one business model franchise, and now, they're in the consumer finance aspect of things and they're in a bunch of companies in Europe, and they're getting into the US and they're getting to Latin America, so it's more and more diversified and should be more attractive to investors.
JUSTINE UNDERHILL: All right, can you break down your trade in 30 seconds?
JEFF MEYERS: XLM is extremely cheap. The publishing part of the business has been growing 5% here in the last few years, when the media section of business has broken down, but since it wasn't that profitable, EBITDA has stayed pretty much the same. And we expect publishing to start growing again pretty nicely next year, EBITDA should start growing next year. And once there's stability, the stock's going to go up.
JUSTINE UNDERHILL: And we see it going up to 120?
JEFF MEYERS: At least, yeah.
JUSTINE UNDERHILL: Great. Jeff, thank you so much for breaking this all down for us.
JEFF MEYERS: Thank you.
JUSTINE UNDERHILL: So, Jeff is bullish on XLMedia, ticker symbol XLM.LN. He believes the stock is incredibly cheap and sees changing regulation in the US and Latin America as an opportunity for earnings growth. He believes the stock could trade as high as 120 pence over the next 12 months.
Just remember, this is a trade idea and not investment advice. You should do your own research, consider your risk tolerance and invest accordingly. For Real Vision, I'm Justine Underhill.