Introduction
Incredimail (Nasdaq: MAIL, Market Cap.: $32 million) is a decent speculation at current prices or lower. My optimism for the shares, at least over a short-period of time, is driven by the fact that the shares remain over 60% below their highs, and yet three positive pieces of news were recently delivered that seemingly could boost the stock price.

Specifically, in the last few weeks: MAIL signed a direct agreement with Google, announced the re-pricing and forfeiture of various options, and perhaps, most importantly, SEC filings indicate the culmination of selling by the company’s largest outside shareholder. Notably, the downside risk in the stock seems minimal at current prices given that nearly 75% of the market cap is in cash (MAIL has no debt), and the valuation measures seem very low (i.e. Enterprise Value (EV) relative to TTM Sales of 0.5X, and EV/Free Cash-Flow Potential of a mere 5X).

Company Background
MAIL basically provides some gimmicky free email services that have attracted about 10 million users. The company makes money by selling some premium products (e.g. a spam filter product), and increasingly via advertising thru Google’s AdSense program (a mostly automated Pay-Per-Click (PPC) advertising program). My own personal opinion is that Google’s Adsense program is one of the greatest businesses going right now worldwide, and I’m always interested in investing in businesses that can generate significant revenue via the program. There is obviously a ton of competition for MAIL’s service, but the fact remains that the company has already attracted a huge amount of users allowing it to generate about $9 million in advertising revenue in 2007, nearly four times what it did the year before.

Financial Facts concerning MAIL are available at this link:

What Went Wrong at MAIL?
In early 2008, Google abruptly decided to stop its Adsense partnership with MAIL, leading to a collapse in MAIL’s stock price as Adsense is the company’s primary, and most profitable, revenue stream. Though Google soon reinstated MAIL back into the Adsense program, there was still concern over the initial Google ban and a fear that the company could lose Google Adsense over the long-term.

In addition, to the Google mishap, MAIL did have a fair amount of auction rate securities (nearly $5 million) on its balance sheet which it needed to write off in 2007. This write off effected reported earnings and, like many other tech companies with large cash positions, has cast some doubt as to the value of the company’s other cash holdings. For more on the cash situation, please see the “Risk” section below.

What Has Changed?
The Google mishap led to a management shakeup at MAIL, and the start of renewed negotiations with Google. In early July 2008, MAIL finally announced the signing of a Google Adsense direct agreement, which I think completely allays the fears over the future of the Google business and removes a large amount skepticism related to MAIL’s ongoing viability.

In addition, to the Google announcement I also noticed that one of the largest sharholders of the company, LongView Fund, who was sitting on a major loss in MAIL’s stock finally dumped all of their remaining shares at about $2.60. The culmination of selling by a large shareholder removes the selling pressure in MAIL’s stock, and should help the upside when and if good news is announced.

Finally, just the other day, MAIL announced another repricing of options for key employees that I thought was quite revealing. Namely, the company moved up the strike price from $3 to $3.75 and cancelled the options of the CEO.

Valuation

As for the valuation of MAIL, I think the repricing of options to $3.75 strongly reveals management’s view as to the downside value of the stock and the potential for a nice gain from those levels.

From a financial perspective, please see this link:
to the financial figures below for MAIL where I list certain key figures for the company.

My feeling is that a company that is growing revenues at a double digit rate, has gross margins of 90%, and almost no cap-ex, is extremely undervalued selling at 0.5X revenue and less than 3X EBITDA. Of course this valuation reflects lingering skepticism towards MAIL, its management team, and its business model.

On the upside, though, should MAIL demonstrate some renewed financial momentum and should investors regain trust in the business, it would appear that the stock could easily double, at which price the shares would be trading at about 2X revenue and a little over 10X TTM EBITDA, both reasonable values for this company. I would note that I use TTM EBITDA as the benchmark for the company’s EBITDA and FCF potential and hence upside valuation since the recent earnings report was somewhat disappointing due to some one-time write offs and a large uptick in R&D as the company is nearing the launch of some new products.

Risks

The major risks for MAIL are:

Cash Value: In looking at the most recent 20-F, it would appear that the company has entirely written off the auction rate securities and the vast majority of the remaining cash ($17 million or so), is invested in corporate debt securities which have an active market. However, I can not be completely sure as to the ultimate liquidity of these holdings and/or whether the company can readily convert these to cash. My assumption is that the Auction Rate security debacle has probably refocused CFO’s and that the remaining cash is liquid.

Ongoing Business: While the company can generate nice gross margins off the Adsense business, the issue is whether management will bring those dollars to the bottom line or whether they will waste the profits on new endeavors that will never pay off. The risk of this type of situation is not all that remote given the large uptick in R&D expenses in the most recent quarter, reflecting the upcoming release of new products as detailed in the company’s earnings release. Of course, if AdSense revenue continues to grow, these additional expenses will be negligible, but investors need to pay close attention to upcoming financial reports and sell on any indication that profits are being sucked out of the business, instead of flowing to the bottom line. It may take a few quarters to get a sense of the financial direction of the company.

Disclosure: I am currently long shares of MAIL and I may buy and sell shares at any time without telling you about these actions. I do not have any obligation to share with you any updated information about MAIL in the future.
All ideas, opinions, and/or forecasts, expressed or implied herein, are for informational purposes only and should not be construed as a recommendation to invest, trade, and/or speculate in the markets. Any investments, trades, and/or speculations made in light of the ideas, opinions, and/or forecasts, expressed or implied herein, are committed at your own risk, financial or otherwise.