Internet marketing specialist XLMedia (LSE: XLM) saw its share price fall by up to 30% in early trade on Monday morning, following a profit warning. The stock has now fallen by 44% from its December peak of 220p.
Management said that revenue for 2018 is now expected to be about $130m, compared to $137m last year. Adjusted earnings before interest, tax, depreciation and amortisation (EBITDA) are now expected to be “marginally lower” than last year’s figure of $47.1m.
Analysts’ forecasts I’ve seen suggest revenue was previously expected to rise to $144m, with after-tax profits to increase by about 10%. So this is a significant miss, although not a catastrophe.
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What’s gone wrong?
This company publishes a wide range of websites, most of which carry content and reviews related to online gaming. XLMedia makes money by using these websites to generate leads and new customers for online gaming operators, who then pay the firm a commission.
It’s a lucrative business and the firm generated an operating margin of almost 30% last year. However, regulatory risks are a concern in this sector.
In an effort to diversify, management has been buying up personal finance assets, such as credit card comparison sites. Although progress is said to be good, this shift isn’t happening quickly enough to counter regulatory headwinds in the gaming sector.
Regulatory headwinds
In today’s profit warning, XLMedia said that regulatory changes in Australia had led to the “closure” of this market at the end of last year. I can’t find any mention of this in previous results, so I’m not sure if this was flagged up previously.
Regulatory uncertainty in Europe is also said to be hampering performance. And the firm says there has been “some reduction in SEO [search engine optimisation] performance in a few specific territories”. What this means is that some of the firm’s websites are not ranking as highly in internet search results as they did previously, reducing visitor numbers.
Should you buy, hold or sell?
I’ve previously been a fan of this stock, thanks to its high profit margins, strong cash generation and five-year growth record.
But today’s statement warns that “regulatory changes have triggered a re-alignment in how operators and marketers can work”. This suggests to me that profitability could be lower in the future.
Today’s warning could be a short-term blip, but it could also be a turning point for the firm. After today’s drop, I estimate that the shares trade on about 12 times forecast earnings with a prospective yield of about 4%. That’s not cheap enough for me at the moment, so I’ll be avoiding this stock until the picture becomes clearer.
A traditional moneymaker?
XLMedia provides free content and makes money by generating leads for gaming operators. But my next firm has customers who are happy to pay to read the material it publishes.
This traditional business model is working well for the publisher of the Harry Potter series, Bloomsbury Publishing (LSE: BMY). The firm’s latest results showed that sales rose by 13% to £161.5m last year, while pre-tax profit was 10% higher, at £13.2m.
These results were ahead of expectations. And the company delighted the market by announcing that 2018/19 profits were also now expected to be “well ahead of previous expectations”.
What could go wrong?
Bloomsbury doesn’t just publish Harry Potter. The group also has a growing academic publishing and adult fiction business. But one thing that jumps out at me from last year’s results is that 86% of adjusted operating profit came from “Children’s Trade”, which I assume is dominated by Harry Potter sales.
The only other profitable part of the business was “special interest”, which includes non-fiction books in areas such as history, sport and wildlife.
Over-dependence on Harry Potter could be a risk in the future, but it seems safe enough at the moment.
Should you keep buying?
Bloomsbury’s share price has risen by 20% since its results were published in May. The shares now trade on 17 times forecast earnings for 2018/19, with a forward yield of 3.3%. That’s not obviously cheap, but if earnings growth can be maintained, the shares could soon grow into this valuation.
I’d continue holding and would buy more on any dips. This appears to be a good quality business that’s firing on all cylinders.
