DGIT's business model somehow reminds me of Office Space:
- "So you take specifications from the customers and bring them to the engineers. Well that just makes me ask why can't the customers do it themselves?"
- "I'll tell you why. That's because engineers are not good dealing with people".
Ok, I'm being a bit unfair, DGIT existence is somewhat justified.
Industry Background. There are a total of 11K radio and 5K TV stations in the U.S. that advertisers have to distribute their content to. Depending on whether the ad is local or national, the advertisers need to send it to a local station, or network center respectively. Traditionally delivery was done through dub and ship - a copy of the ad is made, and the duplicate (dub) is shipped to the station by mail. However increasingly networks started turning to digital delivery. DGIT owns satellites, transmitters and receivers that it uses to transmit the ads.
From 12% share of deliveries digital grew to currently account for ~58% of ad distribution. Management is projecting the penetration to increase to 80% by 2010, but recent penetration growth has been slow, as 2004 penetration was 54%.
Competitive position. DGIT is far away the industry leader in digital distribution, with almost 100% penetration of customer accounts. Company used to have ~50% share of the market, with Vyvx second at 28%, but after announcing Vyvx acquisition in Dec 2007, it is by far the biggest gorilla in the room.
There're a number of small dub and ship players that compete with DGIT but no one too threatening.
So if the technology didn't change I'd say the future for DGIT looks fairly bright, as they have a big competitive moat with 5000 units installed across the country. However, tech does evolve and there are risks to the model.
For example in company's 10-K DGIT states that "certain common and/or value-added telecommunications carriers and other companies, such as Pathfire, may develop and deploy high bandwidth network services targeted at the advertising and broadcast industries". For example AT&T could start delivering content which would be a huge hit for DGIT.
Another threat that is not really mentioned in the analyst reports: why can't a major studio like NBC just have it's own FTP server, where the advertisers would upload and studios download content. The process perhaps wouldn't be quite as fast as with DGIT, but if you spend weeks on creating an ad, why does another hour matter with delivery? Maybe networks don't want to bother cause they're not paying much for the service, but still.
To give company credit, to combat competitive entrants DGIT strives to provide additional services that would make customers more sticky: cataloging, closed captioning, archiving.
Financials.
Company revenue has actually declined from 2003 to 2005, after which DGIT went on a major shopping spree to revive growth. This fact, combined with historical digital penetration figures, makes me question the future growth figures. Management projects 10% growth next year, however going forward I doubt growth will exceed mid-single digits.
EBITDA margin projected to expand as Vyvx acquisition is integrated. I halfed the projected synergies from $8M to $4M, but even then, the margin right now is really high. The argument for the margin to keep expanding is a) high fixed cost base, so additional revenue should flow disproportionately to the bottom-line b) HD penetration, increasing the margins
Valuation. Valuing the company on basis of EBITDA and FCF multiples seems like a more appropriate methodology given earnings number are skewed by high D&A component. The analysts are talking about multiples of 12X EBITDA and 15FCF. I think a lower multiple is appropriate given slowing growth profile and volatility . On that you get to 2008 valuation of ~$600M . Assuming post-acquisition TEV of $367 (current market cap)+$170 = 537. That values equity at $430M or $24 per share. If you believe a higher multiple, value grows to ~$31 per share.
Bull thesis. 1) HD penetration. Currently HD is .5% of all ads. Management estimates that each 1% of penetration increases revenue by $5M, with a high % of that increase flowing straight to margin. 2) Election cycle. Huge ad spending already seen this year, and will only increase in the future to DGIT's benefit.
Bear thesis. 1) Poor history of organic growth rate 2) Fairly commoditized nature of the business 3) Recession putting will put pressure on a) ad spend in general reducing the number of ads transmitted b) pricing, including HD pricing which will eat into margin.
Outlook. I believe the company can be a decent performer in the 12-24 months time frame with potential for up to 50%+ return. Conversion to HD, high ad spend for 2008 Elections, integration of the acquisition, dominant position which should allow it to maintain (and hopefully push up) pricing are all factors that can propel the stock towards $30. However personally I am not a believer in the long-term success story and think company is fairly value based on long-term fundamentals, so if you want to buy and hold for five years - stay away.
It was hard, but I avoided playing any puns on the ticker's name.
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