ADBL Audible (MM)

Red Oak Partners, LLC, a shareholder of Audible.com stock (ticker ADBL), has disclosed today that it sent a letter to the Chairman of Audible.com as well as the Chairman of Amazon.com (ticker AMZN) criticizing the proposed acquisition of Audible at $11.50./share as representing an unfair price. David Sandberg, the portfolio manager of the Red Oak Fund, LP, stated, �We analyzed this offer in great detail and believe the board ignored important factors in recommending the deal. The basis of our opinion is described in our letter.� The letter Red Oak Partners, LLC sent reads as follows: March 6th, 2008 � � Mr. Donald Katz Audible Inc. 1 Washington Park Newark, NJ 07102 Dear Mr. Katz, We are writing to express our criticism of Audible.com�s acceptance of Amazon.com�s $11.50/share offer, an offer which we believe to be inadequate and below fair value.�Red Oak Partners owns 364,400 shares of Audible (approximately 1.4% of Audible) and - as noted below - we do not intend to accept this price. This letter is being submitted now because Audible took (what we believe to be) an unacceptably long period of time to report its Q4 2007 results. We�are especially concerned because�Audible released its earnings just one week before the expiration of the�Amazon tender offer.�In our opinion this does not give holders adequate time to consider those earnings and evaluate the offer properly. Our concerns are highlighted below: 1. We contend that Audible�s board relied on analysis�about price premiums provided by Allen & Company (as noted in Audible�s Schedule 14D-9 dated 2/11/08, page 18, bullet 1) that was flawed,�because the December 6th, 2007 filing of Form S-3 (which registered nearly 6 million shares of Audible stock for resale in the public markets by Audible�s largest shareholder, APAX managers, Inc.) created a clear �overhang� of stock, pushing Audible stock down more than 20% over the ensuing two weeks. We submit that rather than analyzing the price premium over the closing price of Audible stock the day before the $11.50/share Amazon offer was announced, Allen & Company should have evaluated price premiums vs. Audible�s stock price before the S3 filing. In our opinion, Audible�s strong Q4 2007 would have pushed its stock price higher � not lower � than pre-S3 filing levels. 2. Audible states in its 14D9 (dated 2/11/08, page 5) that �From March 2007 through the end of July 2007, Allen�& Company approached 12 potential acquirers� and that �Allen�& Company informed these potential acquirers that an offer of $12.50 per share to purchase all the outstanding shares of Company Common Stock would likely represent an acceptable offer price.� We request that Audible make Allen & Company�s analysis public so that shareholders may compare the analysis performed in March 2007 vs. Allen & Company�s more recent analysis which has resulted in a lower price ($11.50/share vs. $12.50/share) than originally sought, despite a year in which Audible grew its revenues by 34% and added $0.50/share in cash to its balance sheet. Audible should require Amazon to extend its offer until that analysis is available and considered. 3. According to the 2/11/08 14D-9, Allen & Co�s more recent financial analysis included numbers through December 7th, 2007. We question why Allen�& Co. was not given estimates of the quarterly results, and why the directors did not wait until those results were available. 4. On page 18 of Audible�s 2/11/08 14D-9, it is stated that�Allen & Company utilized �(1)�comparable company premiums analysis; (2)�discounted cash flow analysis (� DCF �); (3)�comparable precedent transactions analysis and (4)�comparable company multiples analysis� to reach their $11.50/share price. We submit the following regarding each of these: � � � � � � � 1. Audible is the only public digital audiobook company and as such we contend that there are no direct comparables. We request that Allen & Company provide comparable companies which a) have recurring business models; b) have stable, growing end-user bases focused on the consumer media side; c) have no significant direct competitors; d) have grown revenues consistently (nine straight years for Audible), and have generated positive operating and free cash flow (four straight years for Audible). 2. The 2/11/08 Schedule 14D-9 states that "Allen & Company determined that the Offer Price of $11.50 fell below the range of calculated DCF equity values of $15.38 to $21.99 per share of Company Common Stock based on Audible management estimates." We question why the board accepted an offer 25-47% below the value calculated by its own advisor and using estimates coming directly from its own management team. We believe that the Board's decision to sell the company at such a large discount to its own estimates should be thoroughly questioned and possibly reflects a material breach of fiduciary responsibility. 3. We do not believe that the "comparable precedent transactions" listed by Allen & Company are of comparable companies. Our analysis shows that none of these businesses have material amounts of recurring revenues (as Audible does) nor do they resemble Audible in any other meaningful way other than being "dot-coms." We contend that the "dot-com" moniker is not in and of itself sufficient to qualify a company as a "comparable" and that - today - almost all businesses interact in some manner via the internet. As such, comparisons of ticket resellers (Stubhub.com) or online comparison shopping sites (Shopping.com) are not relevant. Instead, Audible.com should be compared to similar companies. If there are no similar companies with similar end markets, growth drivers, and business models (recurring revenue, operating leverage), then "comparable precedent transaction" analysis should not be viewed as relevant and should not be incorporated into any analysis relied upon by Audible's board. Additionally, Allen & Company compared trailing twelve month and forward twelve month EBITDA multiples vs. Audible's "comparable companies." We believe this is also flawed analysis as Audible has only recently become EBITDA positive and expects its EBITDA growth rate to be significant. Comparing Audible with larger and more established companies which have lower projected EBITDA growth rates is not an apples-to-apples analysis. Lastly, because of the magnitude of deferred revenue which comes in as cash but is not yet booked as revenue (nor included in standard EBITDA calculations), we believe that an adjustment should be made to EBITDA to include deferred and that this inclusion would have a material impact on all comparative analysis, in Audible's favor. 4. We believe that Allen & Company's usage of "comparable" companies (per page 19 of the 2/11/08 14D-9) is flawed. We do not believe that any of the companies mentioned - Netflix, Blue Nile, RealNetworks, 1-800-Flowers.com, drugstore.com, or overstock.com - are comparable. In fact, we are confused as to how sites which sell diamonds, flowers, drugs, and excess inventory correlate to a site which offers a digital audiobook download subscription service - they are entirely different markets and businesses. We believe that this analysis should not have been relied upon by Audible's board. 5. We question Allen & Company�s $2.62 million fee. According to the 14D9, �over the past several years, Audible and Amazon have from time to time engaged in discussions concerning Amazon�s potential acquisition of, investment in or commercial relationship with Audible.� Thus, discussions between the two companies �pre-existed� Audible retaining Allen & Company as its financial advisor. Permitting fees to be paid for relationships which pre-existed a service provider is not in the best interests of shareholders and we believe is�inappropriate. Further, according to the Schedule 14D-9A filed on 3/3/08, Allen & Company is to �be paid a fee equal to 1.2% of the price per share paid by any acquirer times the number of shares acquired minus the net cash, cash equivalents and short-term investments on Audible�s books.� We see no reference to additional retainer amounts and as such believe that Allen & Company will earn substantially less in fees if a deal is not completed. As such, there is an incentive for Allen & Company to get a deal done �at any cost,� creating a potential conflict of interest which calls into question all of their analysis and recommendations to Audible�s board. 6. I submit that the $10 million break-up fee plus up to $3.5 million in expenses is a breach of fiduciary responsibility and not in the best interests of shareholders, as it provides incentive not to shop the deal elsewhere. To reject this deal in favor of another potentially higher deal would cost Audible shareholders approximately $0.54/share in break-up fees and expenses. 7. In our opinion,�Audible.com�s biggest risk lies in the expiration of its contract with Apple�s Itunes in 2010. We have accounted for this risk in our modeling and � through its increased deferred revenues stemming from continued growth in Audible.com�s subscription site � we project a materially higher value than the $11.50/share offer made by Amazon. Our estimates are in-line with the DCF value calculated by Allen & Company using estimates provided by Audible�s management (again, page 18 of Schedule 14d-9 filed on 2/11/08). Further, we believe it would�be difficult for Apple to entirely walk away from its deal with Audible as it would require significant cost to create the systems, publisher relationships, and content creation and management required to provide a similar audiobook offering (for 2007, Audible reported over $48 million in �cost of content and services revenue: royalties and other content charges� and an additional $18 million in �Technology and Development� spending). We believe Apple would want a best of breed product and further believe that this would best be achieved by a continued partnership with the market leader - Audible.com (with nearly 15,000 Audiobooks and over 127,000 hours of audio content). Further, we believe Audible�s digital audiobook end market is highly stable as audiobooks are consistently used by commuters, those with sight impairment, those who frequent the gym/fitness train, and for a wide variety of other reasons. With a continued increase in consumer penetration and distribution of devices which play Audible�s digital audiobooks (currently over 570 devices are �AudibleReady�) and expected growth in smart mobile devices, we believe a continued increase in the availability and usage of Audible�s products to end markets can be expected. We believe commensurate revenue and profitability growth will continue. 8. In what is becoming a �war� over end consumers, we believe that Audible is a small yet important piece�in�a comprehensive consumer product offering, and therefore strategic value should be priced into any acquisition. We do not believe any such value was priced into this deal. 9. According to the 14D9, Allen & Company began its search for an acquirer In March 2007. Audible�s cash balance as of its most recent 12/31/06 reporting date was approximately $2.60/share. Additionally, Audible had approximately $120 million in usable net operating losses (NOLs) to offset future tax payments �NOLS which are now relevant as Audible has become earnings positive. Conservatively valuing these NOLs at twenty cents on the dollar, we value these NOLs at approximately $0.95/share. Coupled with the cash on the balance sheet, we believe that in March 2007 there was roughly $3.55/share in non-enterprise value, which further implies that at the March 2007 $12.50/share target or �list� price, Allen & Company was valuing Audible�s �enterprise� at approximately $8.95/share. Since then, Audible grew its reported and deferred revenues each by 34% while generating over $0.50/share in additional free cash. In now recommending an $11.50/share acquisition price, Allen & Company is implying that since March 2007, Audible�s enterprise value has declined nearly 20% to approximately $7.35/share ($11.50 offer price less current $3.20/share in cash less $0.95 in our estimated value of the NOLs). Contrary to this, we believe Audible�s enterprise is more valuable today and that any accepted offer should reflect this. We again request that Audible make Allen & Company�s financial analysis public to investors to explain this apparent inconsistency and�explain why the company�s board concluded�that this sale (at this price) was in the best interests of all shareholders. 10. We believe that the operating cash flows - net of any changes in the assets and liabilities but inclusive of deferred revenue � should be analyzed when assessing the value of Audible�s business. Upon review of Audible�s recently announced Q4 2007, we believe that approximately $9.3 million of these cash flows were �good� and repeatable. Less $0.9 million interest income and $1.2 million in capital expenditures, we reach �adjusted free cash flow� of approximately $7.1 million. Although deferred revenue has increased for at least eleven straight quarters, we offset a Q4 seasonal effect by removing � of the Q4 sequential deferred revenue increase. Lastly, we remove approximately $1.5 million of taxes, which gets us to $0.82/share in after-tax adjusted free cash flow/year. By recommending the sale of Audible at $11.50/share (and therefore valuing the enterprise at $7.10/share), Allen & Company is suggesting that Audible�s enterprise is worth less than 9x adjusted free cash flow. Again, this assumes Audible does not further grow its business, and disregards Audible�s significant growth in revenues, adjusted EBITDA, and cash flow. Again, we believe the board's action in accepting this offer is a material breach in fiduciary responsibility. We oppose this offer and do not intend to tender. Further, we would consider exercising our right to dissent from the merger should the offer go forward and would consider participating in the stockholder litigation which has been filed � including asking the judge to have the plaintiffs justify the�price of the currently proposed settlement. We await your response. � � David Sandberg Portfolio Manager Red Oak Partners, LLC