AI imaginima
Introduction
The year has started out well for unprofitable firms that found the going tough last year. Tax-loss selling ended, interest rates are yet to go up any more, and people presumably got bonuses they can throw into the market. The Nasdaq is up 11% to start the year. Any news from a company, even if it’s an announcement about layoffs, is being interpreted positively. The move up in some stocks has been stunning. None has been more impressive than that of BuzzFeed (NASDAQ:BZFD), up 5x this month!
Company background
BuzzFeed is a digital media company that has a portfolio of websites including Buzzfeed.com, Huffpost.com and Tasty.co. It also owns Complex Networks, which distributes youth-oriented programming to broadcasters and websites. The company was founded in 2006 and is headquartered in New York. Its founder, Jonah Peretti, is the current CEO.
BuzzFeed came public through a SPAC deal in December 2021, and the stock has had a rough ride since the deal was announced. It halved in 2021 and lost more than 80% of its value in 2022.
A few days ago, it announced that it would use AI from ChatGPT creator OpenAI to generate some content. ChatGPT has got some good press of late and is the latest technology buzzword. News of BuzzFeed using AI was enough to send the stock rocketing up, from 70c at the beginning of the year, to close to $4 over the course of a few weeks.
If you’re thinking of buying or selling the stock, I offer a fundamental value perspective on what the stock could be worth in the long term.
BuzzFeed financial overview
For the quarter ending September 30, 2022, the company generated $103.7 million in revenue, up 15% YoY. Operating income was a loss of $18 million (-17% operating margin). While the revenue growth seems impressive, it was juiced by the company’s acquisition of Complex Networks in the prior year period. From the company’s 10-Q, this contributed $13.6 million of revenue, without which the growth rate would have been zero. On the positive side, there was about $4 million of intangible amortization from the acquisition, which I usually add back when evaluating most firms. So the adjusted operating loss would have been $14 million, not nearly as bad as the reported number. The company calculates an EBITDA figure that I ignore, as I do not believe there is much value in it.
The company has 139 million shares and a market capitalization about $500 million. It has $150 million of debt and $$60 million of cash. It thus has an enterprise value of $600 million.
For the December quarter, the company guided to $129 to 134 million in revenue, which would represent a drop of 10% from the prior year period. GAAP profitability is nowhere on the horizon.
BZFD stock valuation and recommendation
It is hard to believe that using some AI to produce quizzes and the like will dramatically alter the company’s fortunes. I will optimistically assume that the company can cut about 20% of its costs and get to a 6% operating margin.
A 6% margin on $447 million of expected revenue this year would mean normalized annual operating profit of $27 million. Due to the company’s substantial net operating losses (accumulated deficit of $418 million), it is safe to say that the company will never pay taxes. Thus, the company would generate $27 million in after-tax operating income or $0.19 per share. I will apply a market multiple of 18x to arrive at a per share value of $3.4 for the business. Then I will add subtract the $0.7 per share of net debt on the balance sheet, for fair value for the shares of $2.7. Thus, I believe there is 30% downside from the current share price of $3.9.
This scenario assumes that the company can rapidly get to profitability. If it cannot, it will have trouble servicing its debt and the stock could go back to the distressed state it was in.
I recommend that investors sell any existing positions in BZFD stock before employees sell their stock or the company does an equity issuance. Although the short interest is low here, it is hard to recommend shorting a low priced stock, and I usually like to have more fundamental downside. However, intrepid investors looking to hedge a long portfolio may give it a try! With the high volatility in the stock, selling calls on it is an attractive proposition. For example, the February calls at a $6 strike price (expiring in three weeks on Feb 17) can fetch you $0.50 per share. Of course, you need to be prepared to short the stock or roll the options forward if they are going to expire in the money. Otherwise, you can pocket the premium. I expect some of the January froth in the market to start coming off in February after the Federal Reserve further increases interest rates at their meeting on Feb 1.
External ratings
Seeking Alpha’s quantitative system warns that BZFD is at high risk of performing badly. It assigns it a composite rating of 1.1, equating to a strong sell, with a D+ for valuation and D for profitability, offset by a B- for growth. Wall Street analysts are more positive on the company with a rating of 3.3, equating to a hold.
Risks are high
With a low market cap, the risks are high here on the long and short sides. I would recommend having a small position that would allow you to sustain large percentage losses. Although I do not expect moves that mimic the prior meme stock frenzy, capital flows into and out of the stock can make it very volatile.
The fundamental risk here is that the company could turn around its revenue growth, or improve its margins to a level above what I have assumed. I don’t think this is likely, but it is possible.
Conclusion
I recommend making use of BZFD’s current volatility , impressive YTD move and fundamental downside to sell calls on the stock or outright short it. The company may be tempted to issue stock to capitalize on this price move, and shore up its liquidity.
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