Welcome to another wonderful wacky story of late 20th century American finance, replete with all the usual suspects: Internet valuations, accounting rules and the illusions created by reported earnings.
Our subject today is
, the self-billed world's largest market research firm.
The business is not rocket science: They collect data from retail stores, consumer panels and surveys, slice and dice it, and then sell it to consumer products firms to provide ideas on what's selling, how much and, maybe,
it's selling. Nor does it include
Nielsen Media Research
, which provides a similar function for television audience measurement.
If you remember a ways back, I wrote a
, which is in the midst of what should be a very large, U-shaped turnaround. (Update -- there's a new CEO, and the stock is up 35% since then. There's more to go, in my humble opinion.)
ACNielsen is the better half of that industry and we have held it in our small-cap portfolios since it was spun off from
Dun and Bradstreet
a few years ago. The premise was that two publicly traded companies in an information-based business with 95% market share between them would find it a no-brainer to be extremely profitable, which was a long way from the near-zero profitability they were experiencing at the time.
And things were working out quite well until about a month ago, when ACNielsen put out a press release which -- if it were an Internet company -- would have produced an instant double. ACNielsen bought 10% of
, one of the two biggies in Internet usage tracking, and set up an 80% owned joint venture which launched "the first global service for tracking audiences, advertising and user activity on the Internet." That means everything but the U.S., which was locked up by a Nielsen Media Research/NetRatings joint venture.
So in a
sort of world, what would you suspect the value of this move would be to ACNielsen?
How about, say, 30% of the value of their publicly traded competitor, Media Metrix , reflecting the non-U.S. value of that business, which would come to $270 million? Or,
Our discounted cashflow estimate of $190 million (or $3 per ACNielsen share), reflecting company estimates of $40 million in revenue in the third year with "better than 20% margins?" And don't forget to add in the value of the deal of the year -- that is, in paying only $12.5 million for a 10% stake in NetRatings, which is going public shortly.
The answer is: c) none of the above, because the market's vote was a negative $420 million, reflecting the recent drop in the stock from 28 to 21.
Where's the Justice?
The fundamental problem it seems, is that ACNielsen earns money: 95 cents a share last year, $1.25-ish this year, and what would have been $1.55-ish in 2000. Naturally, "ACNielsen eRatings.com" will eat some $50 million in operating income over the next two years that otherwise would have dropped to the ACNielsen bottom line, so, after tax benefits, that's 20 cents per share in 2000 earnings.
(This reinforces, incidentally, one of the
Internet investing rules: Internet companies and bricks-and-mortar businesses have serious problems mixing. The internal thought process of a "traditional" investor seems to overload at the thought of the losses incurred by an Internet company, while the Internet investor overloads at the thought of being saddled with anything that cannot conceivably grow at an infinite rate.)
The absurdity here is in regard to
(the American Institute of Certified Public Accountants) rule 98-5, which was adopted by much of corporate America in 1999.
It forces companies to "expense" a lot of start-up costs that formerly could be amortized. It is difficult to say categorically that this is a good or bad change, but what this means for ACNielsen is that the $50 million to be invested in eRatings now hits the income statement from the get-go, hurting reported earnings. The deal is also constructed such that AC eats 100% of the upfront losses (it will also get 100% of the income until certain hurdles are cleared), which magnifies the effect on reported earnings in the short run.
To see how ridiculous things are setting up here, take a look at the table below, which presents a simplified version of the ACNielsen conundrum. The numbers are a little exaggerated, but they help point out the difference between amortizing the start-up costs of the first two years (the first example), and taking the entire hit up front (second example.)
Why shouldn't investors be absolutely ambivalent as to how the company is forced to account for the investment in eRatings? There is zero difference in the intrinsic value of a company making this kind of investment, regardless of the accounting treatment. This, incidentally, is one of the many things that can be obscured by simply comparing two companies on the basis of earnings per share.
Now, there may be an issue as to whether investing $50 million in eRatings is a hare-brained scheme, but I think that is not the case given the fundamental performance of ACNielsen since going public. The company boasts longtime, worldwide leadership, and a business plan that is a natural e-extension of its core business. There is a simmering issue of a fat lawsuit filed by Information Resources against Nielsen, but there was nothing newsworthy to tank the stock in the past month.
In other words, I'm stumped.
If the "market" is perfectly capable of giving
a market value of umpteen billions by discounting future and potentially illusory profits back to the present, why isn't doing the same for a company -- with real earnings -- that takes the logical step of recognizing the change in the business landscape and intelligently repositions itself to take advantage of it?
Is there truly a case to be made that all the accumulated business experience of any industry leader over the age of 40 is nearly worthless in the face of 400 Gen-Xers and an IPO?
Picking up the refrain from a few weeks
ago, are investors so clueless that we need tracking stocks so that Internet spending and ventures can be carefully parsed out so as not to disturb the illusion that these ventures cost money and have potentially huge execution risks attached?
It certainly seems that way.
Jeffrey Bronchick is chief investment officer at Reed Conner & Birdwell, a Los Angeles-based money management firm with $1.2 billion of assets under management for institutions and taxable individuals. Bronchick also manages the RCB Small Cap Value Fund. At time of publication, RCB was long Information Resources and ACNielsen, although holdings can change at any time. Under no circumstances does the information in this column represent a recommendation to buy or sell stocks. Bronchick appreciates your feedback at