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InfoSpace has room to grow
Despite a nearly 30% run, there's still a lot to like about this company and its stock.
February 2, 2005: 4:13 PM EST
By Eric Hellweg, CNN/Money contributing columnist

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BOSTON (CNN/Money) - For people considering an investment in InfoSpace, the question to ask is this: Better late or never?

For in many respects, this isn't an optimal time to be picking up a position in the company, with its stock price up almost 30 percent in a little more than a week on a strong fourth quarter. But another school of thought says that you ain't seen nothing yet -- there's still a lot of pop left in this one.

After speaking with half a dozen analysts who cover the company and researching the markets in which InfoSpace travels, I'm tentatively in the latter camp. Tentative mainly because this is a volatile stock with a jagged share-price fever chart.

After the recent gains, I can hear loud alarms screaming that the fundamentals indicate that this is not the time to get into the stock. But even with the recent run-up and those alarms, InfoSpace is still undervalued by many measures.

What's more, I'm a long-term bull on the two markets in which it operates: paid search and mobile data services. And I'm hardly the only one.

"InfoSpace is one of the companies we tell the story on quite aggressively," says Peter Spears of Delafield Hambrecht. That's analyst-speak for "We like this company a lot."

Core businesses

If you've heard of a company called Google, you know paid search is a hot market. And InfoSpace has created a strong position for itself there, serving as a partner for Google and Yahoo!.

It serves their search results and collects a bounty on the ad referrals. InfoSpace's partnerships with both companies run through 2006. It's a pretty sweet business, and InfoSpace's search division in the fourth quarter returned operating margins of 46 percent.

"Their yield is very high," says Scott Sutherland, vice president for equity research at Wedbush Morgan Securities. "They add a lot of value in a fragmented search market."

Analysts get even more excited talking about the growth potential in mobile data services. There, too, InfoSpace serves as an intermediary between content companies and carriers. (Remember when people thought the Internet would usher in a period of disintermediation? Pshaw!)

In short, InfoSpace negotiates usage rights and licenses from the record industry and irons out the back-end technology issues, giving mobile carriers a simple way to offer ringtones and other media services to customers. The operating margins aren't as strong as in search, but they still come in around 25 percent. Through its purchase of Moviso, InfoSpace is the leader in the ringtone market.

What's more, the company recently purchased two firms that give it a strong position in mobile games, a market that's expected to exceed that of ringtones this year and to generate $1.5 billion in revenue by 2008, according to IDC.

Valuation

That's the core business argument for InfoSpace. Let's examine the company from a pure valuation perspective. Its trailing price/earnings ratio is 34 -- kind of lofty, but down from 43 six months ago. Its forward P/E is 19.83, which is downright cheap for the Internet sector. InfoSpace, the analysts predict, will have strong enough growth to justify those numbers.

"We're looking at 59 percent EBITDA growth," Spears says. "With that kind of cash-flow growth perspective, there's a lot of upside potential here." EBITDA is earnings before interest, taxes, depreciation and amortization.

InfoSpace has no debt, and it possessed $283.6 million in total cash in the most recent quarter. The seven brokers who cover the stock, which is now at about $46, give a median target price of $65.

Of course, with a stock as volatile as InfoSpace's, there's considerable risk. The biggest concern I have is the margin squeeze the company is seeing on the mobile side. Last quarter its content-acquisition costs rose 33 percent, because the record labels demanded more money for ringtone licenses. I expect further pressure, but I doubt it will be as tight as last quarter.

"The margin pressure on music will be offset by the growth in games, where we don't expect the margin squeeze," Spears says.

Stewart Barry, an analyst for Think Equity, is even more sanguine in the face of margin erosion, but he brings up a good point: "Last quarter, the margin decline was offset by the overwhelming growth of the market. EBITDA is all that matters," he says. "In the end, they're outperforming as the cash hits the bottom line."

If you're not risk-averse and you're bullish on the long-term growth prospects for data on mobile phones, InfoSpace still has tremendous upside potential despite its recent gains.


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