One Really Interesting Short Idea

By Matthew DiLallo - June 14, 2012 | Tickers: HDGE, CTCT, FB, GRPN | 0 Comments

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With the markets in a tug-of-war thanks to Europe over whether they rise to the occasion or we fall into the abyss, I’m on the lookout for ways to profit on any further slide down. Because of the politics involved, bets made on the short side should be based on a company's deteriorating fundamentals. This opportunities can become even more pronounced when the company is being aggressive with their accounting in order to hide those weakening fundamentals. On-demand email marketing provider Constant Contact (NASDAQ: CTCT) is one such company who’s fall might have just begun.

I was very interested in looking into the bear case after seeing a segment on CNBC the other day featuring the co-manager of the AdvisorShares Active Bear EFT (NYSEMKT: HDGE). While their fund would be an easy answer for a portfolio hedge, what caught my attention was the fund’s direct short of Constant Contact. Fund Co-Manager Brad Lamensdorf pointed out that Constant Contact’s sales growth is being manipulated by passing out $50 American Express Gift Cards and not expensing them properly. Brad said this is an accounting issue that will come back to bite them eventually. When it does, shares could be on an express trip to a much lower market cap.

What interests me is that Constant Contact is a company I know very well as we use it for email marketing at my office. All of us on staff that use the program have a love, hate relationship with it. We love it because it works; we are able to send out our weekly email updates and well as sales specials to our customers and are able to directly drive revenue via these emails. I get excellent reports as to who read the email and who responded. We hate it because of the technical glitches in designing emails as well as the blacklisting of some of their servers. At times our customers will call in and say they are having problems receiving the emails and there is just nothing we can do about it because I never receive a useful response from customer service. All that being said, it’s probably the foundation to our internal marketing at the moment.

Shares though are already down a lot the past few months since the company missed first quarter earnings and provided below consensus earnings estimates for the second quarter. What’s important going forward is to see them continue to add customers and particularly increase average revenue per customer. They are attempting to do this by adding new products to take advantage of the social media and local deals enthusiasm. Both new platforms have the potential to drive revenue going forward if their customers find them to be valuable add-ons.  Of course the hard part will be turning these new products into revenue.  Their Social Campaigns platform is designed to help a small business turn Facebook (NASDAQ: FB) fans into paying customers.  This is of course the key issue many small businesses are having as they turn to social media as a viable advertising platform, so it will be interesting to see if this actually gains any traction.  Their other new platform, Save Local, is taking a page out of Groupon’s (NASDAQ: GRPN) playbook and pocketbook as the fees charged to businesses are just a fraction of what Groupon is charging. It remains to be seen if either platform can generate any meaningful revenue as in both cases they are trying to gain entry into industries that are fairly congested with much deeper pocketed and technologically advanced competitors. 

To add more to the bearish argument, tucked into the announcement of their acquisition of privately held SinglePlatform for over $65 million was a fairly significant guidance reduction.  While the acquisition will only add a million dollars to revenue for the rest of the year, it’s adding another million dollars of acquisition related expenses.  What’s further concerning was the complete washout of adjusted EBITDA as they slashed the range from $45.8 million to $46.9 million all the way down to between $35.4 million and $36.7 million.  It’s too early to tell if this had anything to do with the American Express accounting issues that Brad Lamensdorf was pointing to or if this is the result of some deeper struggles at the company.  With this new revelation hitting shares by another 15%, the risk-reward on the short isn’t as enticing as it was just a few short days ago.

While I think this is a very interesting short idea, the key point to the bear thesis is tough for the average investor to grasp. Unless you are a forensic accountant like those over at the Active Bear, it’s really hard to see what they are seeing in the numbers to make this a high conviction short. I will say from experience following the work they do that I’ve seen them be correct all too often to simply pass this off and the recent hits to the stock are prime examples of their expertise.  Going further, as a customer of Constant Contact, they are the third provider we’ve used in the past four years so the industry as a whole really lacks a competitive advantage to combat customer churn.  Unless their new initiatives really gain traction, there will be a constant churn of customers who decide to connect with something that can do the same thing better and cheaper.  While I can’t with enough conviction suggest shorting at these levels, I certainly would not be a buyer until meaningful revenue is generated from their new initiatives. 

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