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Thursday, September 18, 2008

From the Mailbag: Kaboose

Kaboose (KAB) is an online advertiser and marketer geared towards families and children. Some of the websites they run include bounty.com, babyzone.com, amazingmoms.com, funschool.com, zeeks.com and bubbleshare.com. Kaboose generates revenues through online commerce and advertising. The company has been growing revenues primarily by making strategic acquisitions of websites geared towards their target market segment.

First, lets review some of the Kaboose value indicators. The stock has a market cap of $101.5M based on the current market price of $0.73/sh. The relatively small market cap suggests that analyst coverage is likely low and could lead to pricing inefficiencies with the stock, as we've discussed here. The company is not yet profitable, however, with an equity value of $180M the price to book ratio is 0.53. Depending on the quality of the assets, the low P/B value could indicate value.

As a value investor, I heed the warnings of Graham, Dreman and Athanassakos (and others) and do not attempt to forecast a company's earnings. Rather, I assess earnings strength by looking at the track record of what a company has already accomplished and make a judgment if the results are repeatable or not (look out for value traps!). Kaboose is not at a stage where they can show consistent positive free cash flow, and for this reason I personally would never buy a company like Kaboose until they have demonstrated the capacity to do so. For that reason, let's review the quality of Kaboose's assets to see if value can be found there.

Total assets for Kaboose total $249M. Reviewing the assets, I found that goodwill and intangibles are on the books at $107.5M and $103.5M respectively. Goodwill is the excess value paid over the fair value of the assets acquired. Presumably, Kaboose is paying more than fair value for the acquired assets because they believe those assets will generate adequate returns in the future to justify the price paid. However, since Kaboose has yet to demonstrate profitable operations, I have deep reservations about recognizing goodwill at its book value. By the same line of reasoning, I have similar reservations about recognizing the full intangible value on the books.

Even though the price to book value looked promising for Kaboose, the tangible asset value of the company is rather small compared to the total assets. Since the goodwill and intangibles represent $210.5M of the total asset value of $249M, if those "softer" assets are impaired significantly, an investor may be investing in a company with a very high price to book ratio. The extremes then for price to book would be the 0.53 if you accept goodwill and intangibles at book value ranging up to 2.6 if you write them off completely. I don't know what the real value of goodwill and intangibles should be but without a reliable gauge on earnings strength I would tend towards being more conservative rather than optimistic in my judgment.

To summarize, since Kaboose has not yet demonstrated the ability to consistently generate positive free cash flows and that the asset value of the company is predominantly made up of goodwill and intangibles (84.5% of the total assets), I would consider putting money into the company's stock at this time speculative in nature without adequate protection of capital. Of course, people that decide to speculate under such circumstances and subsequently do well may be left with an exciting sense of precognitive abilities that are bound to disappoint in the future.