Monday, July 7, 2014

UNTD - United Online On Track For A Turnaround or Slow Burning Death?

  • United Online Was Known For Using Spammy Techniques To Generate Revenue
  • Appears the new(er) CEO wants to clean up some of these practices
  • Will his strategy work out in the long run?

United Online (UNTD) is a company I have been following for a long time. Most average consumers will know UNTD by the Net Zero brand - which had a well known marketing campaign during the dawn of the consumer internet age where they offered "free" internet. Believe it or not, people still use dial-up internet, especially in the more rural parts of the country. Those days are numbered, but the company has bolted on other internet properties to form a company with 2 separate divisions.

Content & Media

For the sake of this article, I'm not going to discuss the internet business in much detail. The company has made a push into high-speed internet, and have partnered with 4G spectrum providers to grow that area of the business. UNTD will continue to use the dial-up/4G internet free-cash flow to fund some of the operations. They are in a fiercely competitive market where UNTD is simply an affiliate of the spectrum provider. Virgin Mobile is a competitor of UNTD, but is essentially employing the same business model. UNTD does not own any of the spectrum, they are simply using the Net Zero brand to market 4G internet service.
I wrote back in January: "Classmates is to social media as BlackBerry is to smart phones. That actually might be a compliment." Honestly, not much has changed, and while we see huge valuations being placed on tech companies - UNTD is an example of one that is being ignored, in part, because the web properties they own are considered.

Another troubling fact for Classmates is that it's business model leads to customer service issues & complaints. Classmates has a revenue model that is closer to an online dating website than a social media site. Members are allowed to browse the site for free, but in order to send messages, see who's viewing your profile ... ect - you need to pay as low as $30/year. It's a difficult proposition, considering you're likely to find the same friend on Facebook or LinkedIN, where you can try to reach them for free. Not surprisingly, some customers do end up paying, but it seems at an ever decreasing rate.

Based on the previous conference call with investors, my opinion of Classmates has not changed. On a recent conference call with investors - the only positive thing the CEO could say about classmates was the mobile traffic 'growth.' What is likely happening is desktop traffic is trending down at an equally negative rate to off-set any mobile traffic growth. The website will experience sequential declines in paid memberships as time goes on. An entire generation is growing up with free social media accounts and are unlikely to be willing to pay for it later in life. At some point the company will have to make a strategic decision with Classmates, as they've recently done with MyPoints, which might give investors hope UNTD can one day resuscitate this brand. Until then, it's business as usual at Classmates and less & less people are willing to pay each quarter for the right to use it.

Here is where the investment story gets interesting for UNTD. Not that MyPoints can all of a sudden become a revenue generating juggernaut in the customer loyalty space - but the CEO is actually taking a risk by changing the business model at MyPoints.

On the last investor conference call, UNTD CEO describes his strategy for MyPoints going forward.

(Bold emphasis added by me)
...the revenue we’re going to be taking out is primarily in two areas. The first area is very low margin gift cards. Now, that’s something where we get gift cards and we resell it to our user and everybody is happy but it’s low margin and it takes effort, it takes time, and it takes [mind] share so I don’t want to do that too much moving forward. The second area we’re taking out a lot of revenue is in our email advertising products. We have so many engaged users who we email very often. We email them every time we get good deals or promotions that we sell to advertisers.
Now, we can send out more emails, and even more, and even more, and sell them to advertisers and revenue will go up but at what point does it cross? At what point do we say, “This is not completely good for the user.” And, at what point does it, excuse my language, piss a user off that they don’t want to remain a member anymore because we are starting to SPAM them. Well, I want to respect our users more. The decisions we’ve taken on is we want to get back to what a good user experience is, respect our users and that’s another big chunk of revenue we are turning down.
(Q1 2014 Conference Call)
While the company took a $15m write down based on the CEO's decision above, this is a great move by the company. #1 it will create better company/employee moral. Employees don't like spamming other people and generally ripping them off, so a company more aligned with it's customers will attract and retain employees who are of high character. #2 the company is finally recognizing that respecting your user is a more sustainable business model and no one likes getting bombarded by spammy e-mail messages.

Bigger Announcement Coming?

During the last investor call, the CEO seemed to insinuate that he will discuss a broader overall strategy for MyPoints on the Q2 conference call. I believe this will be the first of many changes the CEO will eventually make to the Content  Media segment at UNTD. In the short run, I believe the company will loose revenue and traffic - but if he can put an effective plan in place, the revenue MyPoints generates should be more sustainable over time.

My theory is after the CEO went around to visit employees of the company, he learned that the company was making most of it's revenue spamming inboxes and re-billing subscriptions in a somewhat un-transparent fashion. The fact he specifically identified Gift Cards as being a low margin/high labor product they could stop selling leads me to believe he has a grip on the finer details of the company. Instead of continuing to compete in a low margin business, he's focusing on more profitable ventures. While his decision to eliminate certain areas of the MyPoints business hurts revenue in the short term, he clearly has a plan on where he wants to position the website in the future. I can imagine CEO Francis Lobo went to the board of directors after meeting with employees with a large list of changes to both Classmates and MyPoints. The Board more than likely said something like - let's restructure MyPoints first, then tackle Classmates once you prove yourself.

The fact CEO Francis Lobo is going out on a limb should also be a promising sign to investors in the long run. This is a first time CEO who could have easily sat back and milked the Classmates & MyPoints brands in spammy ways while drawing a paycheck. Instead, he's taking a risk by re-positioning MyPoints - and my guess he will be given the keys to do the same thing to the Classmates brand once (if) he proves himself.

Investor Outlook

Okay, so I've been long this company, then short - now I'm just watching. Given the CEO seems to have a plan & is being allowed to implement major changes to these aging websites, I probably won't jump on the bandwagon & buy shares just yet. Here's why: I believe UNTD will feel more financial pain before they turn things around. At the corporate level re-positions, pivoting, re-branding a website is more like steering a ship than driving a Tesla, however UNTD does have the advantage of an existing user database. It's likely the year over year growth will continue to decline in the coming quarters, which might lead to further deflation of the share price.

I will be watching Lobo's turnaround effort with MyPoints, as I believe he will be allowed to overhaul Classmates if he can prove himself. The stock is trading at around 11x forward earnings, which would be on the low end for a growing tech company. UNTD is far from a growing firm, in fact the websites are considering ancient in website years. However, this is one of those situations where a 1st time CEO could establish themselves. Lobo has already demonstrated he's willing to sacrifice profits for the good of the website's user. To some investors this may not seem like a good idea, but in the highly competitive website traffic world - what's good for the end user is good for the investor. Now that UNTD is focusing on the user experience again, they might be able to generate more profits from Classmates & MyPoints.

For now I'll be on the sidelines & watching. This company gets less coverage after spinning off FTD and canceling the dividend, so I expect much of what they will do will fly under the radar. If the turnaround efforts appear to be working, that might be the time to jump in and invest. Right now, I think UNTD will need to prove it can crawl before it runs.

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