The Salad Oil Scandal of 1963 was a crucial event in the career of Warren Buffett. In the aftermath of massive fraud, Buffett concentrated a large part of his portfolio in the stock of American Express (the victim of the scam) after its market value had dropped by more than half. For Buffett, the scandal presented a rare opportunity to invest in a highly profitable business at a depressed valuation.
XL Media Feels the Heat
XL Media (XLM) is a small public company that trades on the AIM in London. Over the last two years or so, the company has been experiencing a salad oil scandal of its own. The situation is far from being identical with that of American Express, back in the days. XL Media, for instance, is not the victim of a fraud.
What is reminiscent of the situation of American Express, is that XL Media is suffering from a GoodCo/BadCo situation, in which the BadCo has caused significant value destruction. The big question, as in the case of American Express, is if the GoodCo will weather the storm and continue to thrive.
The Go-Go Years
XL Media went public in 2014 on the Alternative Investment Market (AIM) in London. The company raised $69.5 million (£41.8 million) in the IPO and at 49 pence per share, commanded a market capitalization of $154.5 million (£92.9 million).
One of the stated objectives of XL Media was to “consolidate a fragmented marketplace“. The company highlighted acquisitions specifically as part of their core strategy. The company stated that the directors “have identified a pipeline of potential acquisition opportunities. The Group is currently at advanced stages of due diligence with several potential acquisition leads“.
XL Media entered the public markets as both a fast-growing and a highly profitable company. After becoming public, XL Media just kept going:
| Year | Revenues | Profit | PBT Margin |
| 2012 | $26.1m | $13.5m | 52% |
| 2013 | $34.5m | $11.7m | 34% |
| 2014 | $50.7m | $13.2m | 26% |
| 2015 | $89.2m | $24.3m | 27% |
| 2016 | $103.6m | $31.0m | 30% |
| 2017 | $137.6m | $39.3m | 29% |
The company grew, both organically and through acquisitions. Before-tax profit margins were north of 30% and the company paid out a regular dividend. XL Media grew revenues from $26 million in 2012 to $137 million in 2017. Net profit after tax in 2017 was $31.9 million, considerably higher than what the company’s revenues in 2012.
A Question of Capital Allocation
In January 2018, XL Media announced that the company would issue 16 million new shares in a private placing at 198 pence per share, raising gross proceeds of approximately £31.7 million for the company. When the placing closed, CEO Ory Weihs commented that the fundraising will “enable us to fully capitalise on acquisition opportunities we have identified in key verticals.” Between February and July that year, the company announced 3 new acquisitions.
Then things took a turn for the worse. In October, XL Media issued a press release. In it, the Company noted recent share price movements and stated that it “knows of no operational or corporate reason for the movement”. At the time the press release, the stock price had fallen to a new historic low of 87 pence per share.
A Question of Core Competence
2018 ended in mixed results for XL Media. Although revenues dropped to $117.9 million (2017: $137.6 million), EBITDA remained strong at $43.9 million (2017: $47.1 million). In its Business Summary in the 2018 Annual Report, CEO Ory Weihs explained: “In the first half of 2018 our business faced a number of unexpected headwinds, namely the impact of gambling regulation uncertainty in specific territories and SEO performance issues impacted by spamming and other attacks.”
The SEO performance issues on the publishing side of the business were cause for great alarm. Search Engine Optimization is a core competence of the publishing business model and its performance will hit the company’s revenue generation directly. This likely explains the “unexpected price movements” in 2018.
In the Annual Report, Weihs also commented on the Media Business Segment of XL Media. “Media revenues decreased 29% to $47.1 million (2017: $66.4 million). We assessed our media activities and, as announced on 26 February 2019, decided to reduce further media activities, thereby increasing the overall quality of earnings over time.”
XL Media had invested heavily on media assets during the preceding years. Now, not only was it uncertain if the Media Segment would earn satisfactory returns on capital, but there was serious doubt if XL Media would get a return of capital from the Media Segment.
Naturally, this posed serious questions regarding the capital allocation capabilities of the company’s leadership. For a company whose whole business model is centred around growth through M&A, this is a big big problem.
The Crisis Continues
The year 2019 was a year of reckoning for XL Media. The company recorded an $81 million impairment, writing down all remaining goodwill as well as about half of the value of the website and domain portfolio. The write-down cast a sober light on the feasibility of the company’s prior M&A activities. The sale of Webpals Mobile was particularly revealing. The transaction indicates that Webpals Mobile was essentially given away, the only payment consisting of $1.8 million of intra-company debt to facilitate the transaction.
The year also marked the end of Ory Weihs’ tenure as CEO of XL Media. In August it was announced that whilst Weihs would continue as a director, he would be replaced as CEO by Stuart Simms, a veteran CEO of Rakuten Marketing. Interestingly, after being relieved of his position, Ory Weihs continued to buy shares of XL Media stock in the open market.
The Google Demotion
On 18 January 2020, XL Media became aware that a number of its casino sites had been manually demoted by Google, impacting their online ranking and therefore significantly reducing their ability to generate revenues. 105 sites were demoted, thereof 23 premium, high revenue-generating sites.
Sims provided an update on the situation in his letter to shareholders in the 2019 Annual Report: “As announced in February 2020, management expects a monthly reduction in Group revenues of between $1 million and $2 million (assuming only a minor fall in its repeat revenues) as a result of the Google demotions.”
In addition, management anticipates that any lengthy period of demotion could impact the rankings once restored, and that it may take a period of time to re-establish. However, based on industry experience, we do expect re-ranked sites eventually to outperform any historical results.”
If you are not familiar with Google demotion, you should understand that Google only resorts to manual actions if sites are not compliant with its webmaster quality guidelines (most manual actions address attempts to manipulate Google’s search index). This is a pretty elementary mistake from a pure-play online publishing company.
Media Business Post-Mortem
XL Media built its Media Business Segment through a series of acquisitions. The businesses within the Media consisted of social media and mobile gaming marketing companies. After going public, the Company made three high profile investments for a total amount close to $34 million:
- ExciteAd Digital Marketing Ltd, a leading social and mobile gaming marketing company, was acquired in 2014 for a consideration of up to US$19 million in cash and shares.
- The Company acquired 54% of Marmar Media in 2015 for $7.38 million in cash. The remainder of Marmar was acquired in 2017 for$2.4 million.
- The Company acquired ClicksMob in 2017 for $5.1 million in cash.
In the 2018 Annual Report, the company had announced a 29% drop in revues from Media Segment. The company also announced that: “We assessed our media activities and, as announced on 26 February 2019, decided to reduce further media activities, thereby increasing the overall quality of earnings over time. The reduction of Media activities post period end resulted in a write off of the activities’ intangible assets, totalling $9.9 million.”
In the 2019 Annual Report, note 17 to the financial statements goes by the title Operating Segments (page 147). It tells us the following: “In 2019 the main part of the Group’s Media activities was classified a discontinued activity and sold. Other Media activities which provided complementary activities to the Publishing activities were integrated into the Publishing segment activities. Subsequent to this integration the Group has one operating segment – Publishing”
With this information, we can go back to the cash flow statement and see exactly how much the disposal of the media segment delivered to the company:
What we find is that in 2018 and 2019, the total proceeds from the disposals of discontinued operations is $1.5 million. Maybe, you might be thinking, XL Media reclassified some unsold media assets as assets held for sale on its balance sheet. You would be wrong, there is nothing there. What the company did record, was an aggregate writedown of $30 million in goodwill during 2018 and 2019.
The Turnaround Commences
Even though 2019 was a disaster year for XL Media, there are still some positives that we can take from the Annual Report. If we back out the $81 million impairment and restructuring costs of $1.3 million, the Company did deliver an operating profit of $26 million.
After the impairments in 2018 and 2019, XL Media now has a book value of about $60 million, mainly consisting of $27 million in cash and a portfolio of websites and domains valued at $40 million. The Company currently has a market capitalization of about $60 million (GPB 45 million), hence it trades at a price-to-book multiple of around 1.
If we assume that $20 million of the cash is not required for working capital purposes, we get an implied Enterprise Value of $40 million. With Operating Income adjusted for impairments of $26 million, the publishing business is generating a return of 65% Net Operating Assets.
You can also switch the denominator and say that XL Media’s EV/EBIT multiple is currently around 1.5. But this is a backwards-looking metric. In August, the company gave its shareholders an update on the results for the first half of 2020.
According to the press release, the company is expected the follwowing:
- Revenue of approximately $27.5 million
- EBITDA of approximately $3.5 million.
- Balance sheet remains strong, with cash balances at the end of June of approximately $27.9 million
Although the drop in revenues is significant, the fall in EBITDA is even more drastic. Much of this is due to one-off restructuring costs. Nonetheless, if XL Media finishes 2020 with $7 million in EBITDA, it will constitute a close to 90% drop from the adjusted EBITDA in 2019. Based on this, XL Media is trading at a 2020 EV/EBITDA multiple of about 5.7.
Taking a Closer Look at Publishing
Circling back to the analogy of American Express and the Salad Oil Scandal, the big question is whether XL Media can return back to normal. Just as AMEX exited field warehousing, XL Media has gotten rid of its Media Business. What remains is the legacy Publishing Business Segment.
For the Publishing Business, the question that still remains is how it is coping with its SEO difficulties and the Google Demotion. SEO difficulties can easily be a death sentence for online publishing and eCommerce companies. At the same time, they can also present opportunities if the patients survive. I have previously covered the case of Overstock and the investment opportunity presented by a big SEO hit.
XL Media is pretty secretive about the betting and gambling part of their business. The company does not disclose any sort of overview of the premium websites that the company operates in the Casino and Gambling categories. This is unfortunate, as 84% of the company’s revenues in 2019, came from Gambling.
The revenues that XL Media generates is concentrated around a few Premium Websites. In fact, the Company has stated that 50% of revenues are generated by 20 websites out of a portfolio of over 2,000 domains. Since most of the Gambling sites are licenced and regulated, the sites target specific niches (poker, bingo, betting, etc) and specific countries.
XL Media’s revenues are highly concentrated in Scandinavia and the UK. Although we don’t have full knowledge of the website portfolio, we do know a number of these websites, which allows us to take a closer look and see if they have been making progress.
Casino.se
As said earlier, we know that a big part of XL Media’s revenues come from Scandinavia, Sweden in particular. We also know that most of the Swedish revenues are gambling-related. As far as I can tell, the strongest publishing asset of XL Media in the Swedish market is Casino.se.
It is apparent that Casino.se is of the sites that got demoted by Google in January:
Casino.se has now lost all of its first-page keyword rankings. Furthermore, there seem to have been no improvements to the situation since the demotion in January:
It remains to be seen if Casino.se can be salvaged.
Freebets.com
Freebets.com is a premium site for XL Media which operates under a British license. Although it does not seem that Freebets.com has been the subject of a manual action by Google, it does look like the site took a hit in keyword rankings late in 2019 and around the turn of the year:
By the looks of it, Freebets.com has managed to turn things around and get back to its previous ranking.
Pokerupdate.com
Almost the exact pattern is visible when we look at the keyword rankings of Pokerupdate.com, also a website that operates under a U.K.-based license:
The same trend reversal is noticeable at pokerupdate.com.
Whichbingo.co.uk
A third example, shows a similar trend as Freebets.com and Pokerupdate.com, although not as drastic. Whichbingo.co.uk keyword rankings are trending downwards from August and until January 2020, where it starts to pick up again.
It is a possibility that for Freebets, Pokerupdate and Whichbingo, this is normal seasonality in website traffic. On the other hand, these sites are targeting different casino verticals and shouldn’t necessarily have the same seasonality.
Nonetheless, it is pretty obvious that Casino.se is one of the sites that was a subject to a manual action by Google.
Conclusion
Over the last year, XL Media has revamped its leadership team, disposed of an unprofitable business unit and reduced its effort on its core business. Problems still prevail with the Google demotion, but the company is addressing this and will dispose of lower value websites and domains and focus on higher quality assets.
XL Media’s core publishing business is asset-light and highly cash generative under normal circumstances. At the current market price, XL Media is poised for significant re-rating in the markets if they managed to turn around the business.
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