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Saturday, July 18, 2009

Youbet.com: Free Cash Flow Yield and Fundamentals Provide Support

We've received questions on Youbet.com (UBET, $3.37) and whether we're now sellers after the big run from the bottom over the past six months, aided by the recent addition to the Russell 2000 index.

Answer: not yet, although we may begin to reduce our exposure if the free cash flow yield continues to compress toward 5%. The 2008 equity free cash flow yield is now 9.5%, just below our normal buy threshold of 10%. On a forward basis, the estimated 2009 FCF yield is 10.0% assuming $14 million of owner free cash flow.

As noted in a prior post, shares of small-cap Youbet.com have recovered from fire sale valuations of 2008 (20-30% free cash flow yields) created by company- and industry-specific issues that left the stock for dead. The stock is now back to life as institutional investors understand that overhangs are removed and that Youbet is a viable, well-positioned, cash generating business.

Moreover, while Equibase data shows 2009 industry wagering through June down 10.5%, we expect Youbet.com to grow top- and bottom-line this year. The growth is a result of renewed content relationships and increased wagering per customer, as well as the secular shift toward online betting from offline. Although Youbet's net income won't increase lockstep with revenue because of lower contribution margins from new content, growth in the current environment puts Youbet.com in a small group of companies growing through the recession.

We believe solid fundamentals and the company's difficult to replicate online wagering franchise – brand, customers, platform, marketing partners, and track relationships – can justify higher valuation multiples. If the company traded at 20 times 2009E free cash flow (5% yield), the implied price per share would be approximately $7.00 including year-end estimated net cash of $15 million. At 7%, the implied share price would be $5.00. Even if multiples do not expand further -- not a sure thing in this market -- earnings and cash flow growth can drive a higher share price over time. For a relative comparison, below we include our updated comp sheet for Youbet versus select gaming and niche franchise Internet companies (click table to enlarge).

Last week, Youbet management presented at an investor conference. The message was similar to a presentation in March except that CEO Goldberg did not mention anything about "strategic alternatives" for the United Tote segment. We note that lower industry wagering (on-track) presents some risk to our FCF forecast as the tote segment may remain a drag on Youbet's overall business. Below, we include several key slides from the management deck.
  • Asset light business model with comparison to Netflix (NFLX, $44.22), Blockbuster (BBI, $0.65), and Churchill Downs (CHDN, $34.72):
  • Financial progress in March quarter (small font - click to enlarge somewhat):
  • Growth initiatives:
With respect to the last slide, increased marketing efforts are evident in the horse racing section of Sportsline.com and Youbet also launched a beta version of a community Web site called WhoDoYouLike.com "powered by Twitter".

Happy investing,

Jeffrey Walkenhorst

Disclosure: long UBET.

© 2009 Jeffrey Walkenhorst
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  1. I recently came accross your blog and have been reading along. I thought I would leave my first comment. I dont know what to say except that I have enjoyed reading. Nice blog. I will keep visiting this blog very often.



  2. Hi Sara, thanks for making time to read and for your kind words.


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