GSIC

[David Randolph]

1. Introduction

My curiosity on GSIC comes from owning a much smaller competitor. I would like to know the differences between the two business models and why does GSIC has such positive seasonality in the 4th quarter (from a fundamental, not technical, standpoint).

2. Business Description

GSI Commerce® (GSIC) is a leading provider of e-commerce solutions that enable retailers, branded manufacturers, entertainment companies and professional sports organizations to operate e-commerce businesses. We provide solutions for our partners through our integrated e-commerce platform, which is comprised of four components: technology, customer care, fulfillment and marketing services. We provide e-commerce solutions for approximately 85 partners.

3. Business Model Analysis

How does GSIC make money?



I'm particularly interested in these "service fee" revenues, because they have higher gross margins and the business model is more closer to the smaller company that I own.

GSIC's service fee revenue grew 36.1% in Q3 2007 versus Q3 2006 to $46 M. My company had service fee revenue of $18.4 M in Q3 2007, so, 40% of GSIC's. But my company's market cap is just 7.1% of GSIC's.

I understand why GSIC has strong positive seasonality in the 4th quarter: its costumers are mostly retailers which also have positive seasonality in Q4 and GSIC earns a tiny part of the revenue generated in the e-commerce platforms it operates for its costumers.

4. Valuation Model
4.1. Dilution Factor

GSIC has been a public company since 1994:



In terms of the historical share count, I see heavy dilution in 1999, 2000 and 2001, but not all that much since then.

However, in last July, GSIC made a 150 million private placement, through the issuance and sale of convertible notes convertible into 6,157,635 common shares. This represents 13.2% dilution. It increases the # of shares outstanding on a fully diluted basis and therefore acts as a negative factor into EPS.

I'll put the dilution factor in my valuation model at 7.5% a year.

4.2. Revenue CAGR

GSIC's revenue grew at a CAGR of 39% between 2001 and 2007. Analysts estimate revenue will grow 28.5% in 2008. I'll put 25% revenue CAGR for the 2008-2011 period in my valuation model.

4.3. Net Profit Margin

GSIC lost money in 1999, 2000, 2001, 2002 and 2003. In 2004 and 2005 it turned profitable, but just marginally. 2005 net profit margin was just 0.45%. In 2006 the company enjoyed a $43 M tax benefit ... without it net income would have been about $6 M and net profit margin would then be roughly 1%.

For 2007 analysts are expecting EPS of $0.8, which translates into about $37.6 M net income and roughly 5% net profit margin. As for 2008, analysts expectations are for a much lower EPS of $0.38 on $961 M revenues, which means about 2% net profit margin. I believe the change from 2007 to 2008 is mostly due to a change in the tax rate, but also because analysts have turned negative on consumer spending going forward. The company will go from enjoying a small tax benefit in 2007 to a tax rate on income of 35-40% in 2008.

I figure the net profit margin may grow 1 percentage point a year in 2009 and 2010 and I'll put 4% as my estimated net profit margin. Longer term I guess GSIC's business may get to a maximum net profit margin of 6-7%.

4.4. EPS Multiple Estimate

I figure a company like GSIC will trade at an earnings multiple of 20 over the long term.

4.5. Computing the Valuation Model



According to my estimates, GSIC will rise at an average of 6.9% a year between now and late 2010, so the stock doesn't look attractive, since I look for at least a 16% average annual return, which is double the long term general market average.

5. Conclusion

I've studied GSIC mainly because I wanted to understand the micro cap stock I've been holding better. GSIC trades at 21 times 2007 estimated EBITDA and my company trades at 5.5 times 2007 estimated EBITDA. I believe my micro cap has a lot more upside potential than GSIC.

But I still didn't get why GSIC has so much positive seasonality in Q4 and my company hasn't. I'll try to figure that out.

As for GSIC, I like the business, but valuation still isn't compelling. The stock has been dropping like a stone because Jefferies & Co. downgraded it. The expansion of profit margins is the key issue around GSIC's long term fundamental landscape.

[David Randolph]

GSIC has been bearish over the medium term, as expected by my initial analysis just above. I figure that the 50% rebound in March is more of a selling opportunity than a buying one.

Perhaps the stock will still make another push to touch the 50 days SMA, currently at $14.30. With the current information I believe a short sale around the 50 days SMA would be a low risk/high profit proposition.

I'll keep an eye on GSIC.