Friday, March 12, 2010

Digital River (NASDAQ:DRIV): Checks Indicate McAfee Is Running Tests With DRIV; Raising Price Target to $34 - JMP Securities

JMP Securities is out with an interesting call on Digital River (NASDAQ:DRIV) saying their checks indicate McAfee is running tests with DRIV. Firm is raising their target to $34 (prev. $31) while reiterating Outperform rating.


JMP notes they came across several fully functional McAfee sites in various geographies, languages and currencies, which were being powered by Digital River. They could not verify this with management, but they believe that these are preliminary tests for now and no formal contract has been reached. While there are many variables that could impact McAfee’s potential contribution if the deal were to happen, firm's back-of-the-envelope calculation suggests a conservative 15% increase to their 2011 adjusted EBITDA estimate, if the entire consumer business – new sales and renewals – in all geographies is moved to Digital River. JMP is maintaining 2011 their adjusted EBITDA estimate of $97.9 million (consensus at $93.7 million) awaiting a potential deal. However, they are raising their price target from $31 to $34, as they believe this information removes two major overhangs for the stock – it highlights the value proposition of the platform as an old customer potentially comes back and exhibits that the software category is not fully penetrated as once thought.

As of now, it appears as if Digital River is only running tests for McAfee, but JMP believes that the implementation of a test indicates that conversations and negotiations, regarding the transition of McAfee back onto the Digital River platform, are well underway. They could not reach management for a comment prior to publishing this report. However, Figure 1 shows what they believe to be a reference to a Digital River landing page. Interestingly, the site seems to be live for a number of countries, as can be seen from the screenshot below.

How could this impact estimates?
The firm does not think that there is a contract between Digital River and McAfee as of yet. While the timing ofan announcement is unclear, they would mention that from discussion to contract to launch could take several months. Sans any new large client signings, Digital River will be undergoing a restructuring of its workforce as soon as Symantec fully transitions off its platform, which is scheduled for June 30th. Once Digital River undergoes its restructuring, it will not have the resources to expedite the launch of such a large client. Hence, they believe that Digital River will use the pending transition of Symantec to expedite the closing of the deal.

From a back-of-the-envelope perspective, JMP notes that in calendar 2009, McAfee’s consumer business generated $714 million in revenue. In the same period, Symantec generated $1.8 billion in consumer revenue, of which approximately 80% was online. Applying this 80% ratio to McAfee’s consumer business would imply eCommerce revenue of approximately $570 million that Digital River could help transact.

Net net, assuming a take rate of 10%, they believe that McAfee could easily generate $57 million in revenue and at Digital River’s current margins, it would imply incremental EBITDA of $15 million, which would raise their 2011 estimate by 15%.

Notablecalls: See the huge gap on DRIV's chart in October 2009? That happened when Symantec announced they would take online sales in-house.

McAfee isn't as big as Symantec but would still account as bagging an elephant. It would re-validate DRIV's platform. Kaspersky took its solution in-house several years back and returned to the Digital River platform in 2009. Who knows, maybe Symantec will do the same?

I think DRIV has a fair chance of trading up a full 1pt on this.

Kudos goes to Sameet Sinha & his team at JMP Securities for excellent research! Keep up the good work, guys!

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