2 Smart Ways to Play Online Advertising

Bill is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.

What is the first thing that comes to mind when I mention these names: Facebook (FB), Google+ and Twitter? Social media, of course. Lets face it, social media is all around us, and it is becoming a larger part of our lives every day. The rise of social media has changed the economics of the Internet forever. But how can investors capitalize on this? Should they invest in particular advertising stocks? Should they diversify their social media portfolio by buying companies which buy traffic and experiment with finding clients from social media sources? These are the questions I will answer in this article. 

Web Economics Version 1.0

Two pillars of the Internet economy are advertisement revenues and lead generation. Website traffic can be monetized either by selling viewer attention (advertisements) or by connecting them with vendors they might be interested in (these referrals are called “leads”). Google (NASDAQ: GOOG) is dominant in pay-per-click (PPC) advertising and directing traffic on the Internet. Microsoft’s Bing Ads business allows users to get their ads onto the Yahoo! Bing Network. Microsoft and Yahoo! are smaller but substantial players in this space. Microsoft currently holds approximately 20% of the pay-per-click market share. Google currently holds 66.8% of the market share , while Yahoo! holds 13.4%

In contrast, lead generation is more fragmented between many competitors such as Quinstreet (NASDAQ: QNST) and private companies like Vendisys. Companies like these operate as vertical marketing companies that generate leads for vendors. Vendisys describes its referral product as “Meeting-Ready Sales Leads” and “Powerful Actionable Leads.” Purchasing live leads can effectively outsource cold-calling, advertising, and appointment setting.  Online real estate search is a form of lead generation in which sites like Zillow (NASDAQ: Z) and Trulia (TRLA) can provide real estate agents and mortgage brokers with information about interested prospective clients. Each client referral constitutes a lead. Online travel search portals like Priceline (NASDAQ: PCLN) and Expedia (NASDAQ: EXPE) are similar in that they effectively direct traffic from search to online forms. Unlike the web search advertising market which is dominated by Google, the lead generation business does not seem to be a winner-take-most market. Instead, there are different lead generation websites for different product categories and there are multiple competitors which coexist inside each category.

Leads can be thought of as value-added products. A viewer can click on a banner and fill out a form, a process which converts an impression to a click to a lead. Leads can also be generated by mining data scraped from the Internet, social media, or proprietary data.

Web Economics Version 2.0

Social media and the rise of web 2.0 is a mega trend that is growing the U.S. economy.  In The next wave of digital growth is here, Todd Harrison wrote that web portal usage is down 24%, while social has grown 52%. These changes demonstrate how the economy of the net is fundamentally changing. New developments in the “hypernet” threaten to undercut television and web search. Though these changes and threats are substantial, investors should wait for web 2.0 ventures to demonstrate reliable earnings and trade at attractive valuations before riding “the next wave.”

This shift from search-dominated in traffic to multiple traffic sources including social media has the potential to turn the tables on negotiations between lead generation companies and search advertising companies.

In the Web 1.0 world, Google had the bargaining power. Companies who hoped to find new customers or convert leads from search traffic had to consider Google. It was the 800 pound gorilla in the room. If the marketing department was initiated it would investigate Yahoo, Ask Jeeves, or Bing as secondary sources of traffic.

Increasingly lead generating companies have more choices. For example, Facebook (FB) can produce traffic. This trend will continue and there will be more competition among traffic sources, to the benefit of traffic converters.

With this in mind, we can consider which lead generation and other traffic conversion companies are attractively priced.

<table> <tbody> <tr> <td> <p><strong>Ticker</strong></p> </td> <td> <p><strong>Company</strong></p> </td> <td> <p><strong>P/E</strong></p> </td> <td> <p><strong>P/S</strong></p> </td> <td> <p><strong>P/B</strong></p> </td> <td> <p><strong>P/FCF</strong></p> </td> </tr> <tr> <td> <p>EXPE</p> </td> <td> <p>Expedia</p> </td> <td> <p>22.45</p> </td> <td> <p>2.1</p> </td> <td> <p>3.45</p> </td> <td> <p>8.86</p> </td> </tr> <tr> <td> <p>PCLN</p> </td> <td> <p>Priceline.com</p> </td> <td> <p>26.28</p> </td> <td> <p>6.54</p> </td> <td> <p>10.74</p> </td> <td> <p>22.47</p> </td> </tr> <tr> <td> <p>QNST</p> </td> <td> <p>QuinStreet</p> </td> <td> <p>30.96</p> </td> <td> <p>0.96</p> </td> <td> <p>1.07</p> </td> <td> <p>8.3</p> </td> </tr> <tr> <td> <p>TRLA</p> </td> <td> <p>Trulia</p> </td> <td> <p> </p> </td> <td> <p>11.51</p> </td> <td> <p> </p> </td> <td> <p> </p> </td> </tr> <tr> <td> <p>Z</p> </td> <td> <p>Zillow</p> </td> <td> <p>343.82</p> </td> <td> <p>12.37</p> </td> <td> <p>9.8</p> </td> <td> <p>98.41</p> </td> </tr> </tbody> </table>

QuinStreet and Expedia are trading lower price-to-sale and price-to-free cash flow multiples than their peers. QuinStreet in particular is particularly attractive since its internally-developed intangible assets like brands, patents, and trademarks are not captured on the balance sheet. Thus, the price-to-book ratio of roughly 1 for this stock demonstrates that you can buy these assets essentially for free after buying the firm’s accounting net assets at book value.

Investors should consider small investments in QuinStreet or Expedia as ways to play a shake-up in web or “hypernet” marketing.

BillEdson11 has no positions in the stocks mentioned above. The Motley Fool owns shares of Google, Priceline.com, and Zillow. Motley Fool newsletter services recommend Google, Priceline.com, and Zillow. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.If you have questions about this post or the Fool’s blog network, click here for information.

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