Like any recently-launched IPO, Limelight's trading history has been anything but calm and easy-going. Simply due to the nature of the process, sentiment for IPOs seems to rapidly shift from euphorically positive to exceedingly negative. At the outset, investors and traders are extremely hyped on a company's products, management, and future. When the new issue finally hits the market, it tends to move up very quickly, especially if it's in a hot sector and riding an interesting secular trend. For example, look at the lululemon athletica inc. (NASDAQ: LULU) IPO. Although the stock was priced at $18 per share, it came public above $30 per share and has since traded even higher. This is an incredible company which I will feature in about a week, but for now all you need to understand is that Wall Street is tremendously optimistic about the company's 'lifestyle' branding power and store growth potential.
Similarly, investors were very excited about Limelight when it first came public. After watching Akamai Technologies, Inc. (NASDAQ: AKAM) fly on powerful momentum in the internet video space, the chance to buy a younger, smaller, faster growing internet video company excited investors beyond belief. When the stock came public, it finished its first day of trading $24 per share, good for a premium of more than 50% over the issue price.
But the good times don't always go on for new issues. Any news that can lead to skepticism for these preciously-priced story stocks can be simply devastating for the newly-issued stock. As Doug noted in his post, the sector is not doing as well as people had first expected -- price wars have plagued the company. As a result, bad news seemed to plague this quarter -- guidance was cut, pricing power is diminishing, etc.
To no surprise, Limelight's stock has been killed and is currently trading around it's 52 week low of $7.80 per share -- a far cry from its price of $24 on its first day of trading. After reporting a mediocre quarter and slashing guidance, investor optimism for the stock is now far outweighed by overall pessimism for this company.
But the value investor in me smells opportunity. As Warren Buffett once said, "Be fearful when others are greedy and greedy when others are fearful." Investors are clearly fearful of the company's future at the current time, but is it that bad?
While there are definitely pricing issues facing the company due to heavy competition from companies that provide similar services such as Akamai, it seems like the company has been able to offset forced cost cutting with volume increases. In fact, according to a Morgan Stanley research report, "growth in volume has been more than able to offset pricing decline historically experienced by the company."
Interestingly, cost cutting strategies from the company's competition don't seem to be working. For the quarter, Limelight reported a 149 customer increase -- a new record in increases, up from the previous record of +102 customers in the third quarter of last year. Succinctly put by the Morgan Stanley analysts, " with a significantly growing customer base, the company maintains potential for increased volume going forward over pricing declines expected." This implies that Limelight's competition won't be able to annihilate the company, as the current share price would force you to assume.
All of this basically means one thing: despite the increased competition for the company, Limelight has been able to maintain solid customer growth. As a result, volume growth should remain strong enough to offset any further price cuts -- a very good thing for the company.
Now, I'm not going to try and justify a valuation above the current stock price (although I've read many reports which suggest the stock is cheaper than peers such as Akamai on a forecasted EV/EBITDA or EV/Sales basis), I'm going to argue that the current sentiment in the stock is irrationally pessimistic.
As you can see from the chart to the right, the stock price has recently been beaten down, most recently due to the
weak earnings report. While I'm not going to argue that the company's quarter was a success, I think the market overreacted for a variety of reasons. First and foremost, many investors involved in this stock were momentum traders looking to ride the Akamai wave. Already down on their positions, this earnings report was spark to trigger closing their positions.
In addition, analysts were forced to cut their forecasts for the company (understandably), causing price target cuts and stock downgrades. For example, Goldman Sachs Group, Inc. (NYSE: GS) removed the stock from its buy list. All of this was enough to scare much of the 'smart' money out of the stock, especially those who had used much higher forecasts in their models to justify their ownership of the stock.
Wall Street seems to have now taken a sit-and-wait approach with the company. Goldman's analysts covering the stock have recommended "moving to sidelines" until "credibility and pricing dynamics can be reassessed." Due to constant performance pressures on Wall Street, Goldman was forced to 'move to the sidelines' despite acknowledging very convincing reasons to continue holding the stock: an overreaction following earnings (to which these analysts seemingly contributed to) and takeout potential.
This situation creates a perfect 'time arbitrage' opportunity, a term I described in this post. Basically, opportunity arises when Wall Street is forced to dump the stock until a more optimal ownership period, due to incredible performance pressures. Because fund performance is now analyzed on a monthly, weekly, and even daily basis, funds are forced to try and properly time the ownership of all their positions.
As a result of all of these factors, I believe that anyone who would've or could've sold the stock is out of their position for the time being. This screams opportunity -- once the internet video trade becomes hot again, these investors who were burned once before are going to eagerly re-enter this stock as it is again promoted as the 'cheaper, smaller' play on internet video growth.
Limelight is not the seemingly-perfect momentum story it once was, but at the current price of just one-third its 52-week high pessimism has reached extraordinary and irrational levels for the company. Yes, the most recent quarter was bad. And yes, competition in the sector is causing price cuts. But investors are overlooking the company's strong customer growth, solid gross margins (despite the price wars), and the take-out potential from a larger competitor or customer.
When pessimism greatly overpowers optimism the scent of opportunity begins to rise. The stock could easily bounce to $10 per share as the sellers are finally washed out of the stock and more value-conscious investors begin scooping up the stock. If the headlines shift for the internet video space, this stock could return to the $20-range as investors regain their optimism for the stock.
But the value investor in me smells opportunity. As Warren Buffett once said, "Be fearful when others are greedy and greedy when others are fearful." Investors are clearly fearful of the company's future at the current time, but is it that bad?
While there are definitely pricing issues facing the company due to heavy competition from companies that provide similar services such as Akamai, it seems like the company has been able to offset forced cost cutting with volume increases. In fact, according to a Morgan Stanley research report, "growth in volume has been more than able to offset pricing decline historically experienced by the company."
Interestingly, cost cutting strategies from the company's competition don't seem to be working. For the quarter, Limelight reported a 149 customer increase -- a new record in increases, up from the previous record of +102 customers in the third quarter of last year. Succinctly put by the Morgan Stanley analysts, " with a significantly growing customer base, the company maintains potential for increased volume going forward over pricing declines expected." This implies that Limelight's competition won't be able to annihilate the company, as the current share price would force you to assume.
All of this basically means one thing: despite the increased competition for the company, Limelight has been able to maintain solid customer growth. As a result, volume growth should remain strong enough to offset any further price cuts -- a very good thing for the company.
Now, I'm not going to try and justify a valuation above the current stock price (although I've read many reports which suggest the stock is cheaper than peers such as Akamai on a forecasted EV/EBITDA or EV/Sales basis), I'm going to argue that the current sentiment in the stock is irrationally pessimistic.
As you can see from the chart to the right, the stock price has recently been beaten down, most recently due to the
In addition, analysts were forced to cut their forecasts for the company (understandably), causing price target cuts and stock downgrades. For example, Goldman Sachs Group, Inc. (NYSE: GS) removed the stock from its buy list. All of this was enough to scare much of the 'smart' money out of the stock, especially those who had used much higher forecasts in their models to justify their ownership of the stock.
Wall Street seems to have now taken a sit-and-wait approach with the company. Goldman's analysts covering the stock have recommended "moving to sidelines" until "credibility and pricing dynamics can be reassessed." Due to constant performance pressures on Wall Street, Goldman was forced to 'move to the sidelines' despite acknowledging very convincing reasons to continue holding the stock: an overreaction following earnings (to which these analysts seemingly contributed to) and takeout potential.
This situation creates a perfect 'time arbitrage' opportunity, a term I described in this post. Basically, opportunity arises when Wall Street is forced to dump the stock until a more optimal ownership period, due to incredible performance pressures. Because fund performance is now analyzed on a monthly, weekly, and even daily basis, funds are forced to try and properly time the ownership of all their positions.
As a result of all of these factors, I believe that anyone who would've or could've sold the stock is out of their position for the time being. This screams opportunity -- once the internet video trade becomes hot again, these investors who were burned once before are going to eagerly re-enter this stock as it is again promoted as the 'cheaper, smaller' play on internet video growth.
Limelight is not the seemingly-perfect momentum story it once was, but at the current price of just one-third its 52-week high pessimism has reached extraordinary and irrational levels for the company. Yes, the most recent quarter was bad. And yes, competition in the sector is causing price cuts. But investors are overlooking the company's strong customer growth, solid gross margins (despite the price wars), and the take-out potential from a larger competitor or customer.
When pessimism greatly overpowers optimism the scent of opportunity begins to rise. The stock could easily bounce to $10 per share as the sellers are finally washed out of the stock and more value-conscious investors begin scooping up the stock. If the headlines shift for the internet video space, this stock could return to the $20-range as investors regain their optimism for the stock.
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