Will Congress' SOPA Kill Internet-Based Companies?

As you may have heard, the United States Congress has kicked the war against online piracy into high gear, currently debating the Stop Online Piracy Act. SOPA has been causing waves of commotion in Congress obviously, but internet users across the globe have strong feelings for the potential statute's implications. For many critics, SOPA would give the United States unprecedented power in terms of control over the global information superhighway.

The Stop Online Piracy Act essentially states that the United States' jurisdictional power lies within the confines of the domain name registrars, not the actual owners of the website. So, if a Russian citizen hosted a file sharing website via a domain name registry like Demand Media DMD, the website would be considered to be American under SOPA's recommendation. Considering that the internet is the most vast information database that exists, the statute would give the United States total regulatory control over millions of websites, native and foreign. Apart from the geopolitical infringement that this potential law would cause, are there any publicly traded companies that could be affected?

InfoSpace INSP is a small-cap internet solution provider that specializes in information aggregation across multiple platforms. As the owner of search engines like Dogpile.com, WebCrawler.com, and MetaCrawler.com, InfoSpace may or may not lose business if SOPA is enacted in the United States. Search engines of all types are popular for regular information, but are also commonly used by individual consumers to find unique file sharing outlets. For example, instead of going to a large website that is well-known to host bit torrent files, users can use search engines to find blogs and other independently owned websites to find a direct download.

Is there a chance for InfoSpace to be significantly affected by a law like SOPA? While the company will not be affected by the United States in a legal manner, it may lose some search engine users due to diminished activity in the overall search engine space. If SOPA does have a detrimental impact on search engine providers like InfoSpace, investors should understand its historical performance to forecast what may happen in the future.

InfoSpace's revenues have been fairly volatile over the last five years. For example, revenues were about $372 million in 2006, about $141 million in 2007, and about $247 million in 2010. The sudden drop in revenues in the 2007 and 2008 time periods could be attributed to greater economic woes brought on by the retail housing crisis. Despite volatile revenues, the company has been able to cope by decreasing operating expenses. For example, InfoSpace has significantly cut research and development expenses since 2006. While R&D is important for growth, the company has been able to increase revenues since R&D expenses were cut down. Moreover, expenses related to restructuring as well as mergers and acquisitions have not been present in the last couple years, which has saved the company several million dollars. Due to income taxes and interest payments, net income has been fairly volatile in the last five years. However, in the last three years, net income and EPS have been steadily increasing.

For technology companies, especially those specializing in internet solutions, cash flow is of paramount concern. When things go wrong in technology companies, cash is bled very quickly, potentially killing companies in a matter of days and weeks. Over the last few years, cash flow from operations has been increasing due to positive changes in working capital. For example, the company has started to move towards stock-based compensation, which has freed up physical cash for it in the last few years. Moreover, it has been able to decrease receivables and take the money owed to it in a timely manner. Likewise, cash flows from investing activities has been increasing over the last few years. Despite spending a couple hundred million annually on investment securities, which may be used to hedge against adverse economic developments, sales of old investments have resulted in positive cash inflows for InfoSpace. Lastly, the company has not exercised its power to issue debt or equity. After all, it has been cash flow positive over the last couple years, so there was no pressing need to do so. However, it is notable that InfoSpace stopped paying a dividend after 2008.

Ultimately, cash has been increasing significantly over the last few years. Along with increasing current assets but a decreasing property, plant, and equipment base, Total assets have been increasing over the last few years. Lastly, certain accrued liabilities have been increasing, but minimally compared to asset growth. As a result, retained earnings have been increasing at a fairly rapid rate, which is a direct measure of the value added to InfoSpace's shareholders.

In terms of financial metrics, InfoSpace appears to be trading at lower multiples than its direct competitors. For example, its price/earnings, price/book value, and price/sales ratios are all lower than the average competitor's ratios. On the flip side, its return on equity is significantly lower than competitors's returns; the ROE is approximately 5.4% while the industry average is about 15.2%. In terms of growth metrics, InfoSpace has attractive revenue growth and operating margins over the trailing twelve months. Lastly, its debt/equity ration is virtually 0.

Te Stop Online Piracy Act has the potential to change the internet landscape forever. Along with this prospect, various internet-based companies like InfoSpace could be adversely affected. Investors should understand InfoSpace and keep track of the Congress debates regarding SOPA. After understanding InfoSpace's product offerings, its management's thoughts on SOPA, and how the technology sector will react to such legislation, investors can make an informed decision about InfoSpace's stock.

InfoSpace is currently trading at about $8.85, up over 6% for the year.

ACTION ITEMS:

Bullish View:
Traders who believe that InfoSpace is an appropriate long investment might want to consider the following trades:

• Unlike many other small internet-based companies, InfoSpace product suite is diversified across mobile services, search engine services, and data aggregation services.

• The company has been able to increased its distribution channels over the last few years as well strategic partnerships.

• The company operates at almost no debt, which is almost unseen in the technology sector.

Bearish:
Traders who believe that InfoSpace is more suited for a short play may consider an alternate position:

• The company's growth has been extremely volatile over the last five years; affecting aspects like revenues, cash flows, and balance sheet growth.

• InfoSpace's market share in its search engine division is nowhere near as large as that of Google GOOG or other similar competitors.

• InfoSpace stopped paying out a dividend a few years ago, which may indicate weakness in the ability to preserve stability and sustenance.

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