Wednesday, July 19, 2006

Calls of Note Part 4

- Bear Stearns is defending Digitas (NASDAQ:DTAS) following weak Q2 results and guidance issued last night:

Firm notes the three small client losses were due to consolidations to ad holding companies and to aQuantive. Importantly Digitas management reiterated that their major client relationship are very strong and no business at top ten clients have moved to competitors or are in review. In fact management went as far as to say that their relationship with American Express is the strongest it has ever been.

The real disappointment was the expected pullback in spending by GM and Delta where issues at those companies are leading to a 14% decline in their spending in 2006 at Digitas, versus expectations for flat growth at the beginning of the year.

Client concentration has always been an issue with this stock as volatility in spending levels at the larger clients can have huge ramifications on earnings. The good news is that this client concentration is declining, with the top ten relationships down another 4 points in Q2 versus Q1, to 65%. American Express is steady at about 25% of revenues with good growth in the quarter, GM is down to 16% of revenues (from 20% in Q1) and Delta is still about 3%. While these relationships appear strong, challenges in the auto and airline industries seem to be impacting the spending levels at both GM and Delta to a much greater degree than anticipated.

Bear Stearns notes that in their history of covering this stock dating back to its IPO, they have seen instances where a top client has pulled back meaningfully only to see Digitas a few quarters later rebound to its robust growth levels as newer client relationships ramp up. Firm upgraded DTAS stock two weeks ago when they determined that concerns over the American Express relationship possibly being in review were unfounded. Notes they were aware of some volatility in smaller client relationships, so the lose of the three small clients is not a big surprise.

While earnings growth will be muted in the next several quarters, they believe Digitas' competitive position in a robust macro backdrop, along with its healthy cash balance and the possibility of a sale of the company, should make any stock weakness at the open a good buying opportunity.

Maintains Outperform rating but takes tgt to $13 from $15.

Notablecalls: I think DTAS will prove to be a nice bounce play around the open. Piper is downgrading the shares to Mkt Perform from Outperform and they are way late to the party. Suspect this will create the selling pressure needed for the stock to bounce.

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