IACI and EPS Outlook

IACI Revnue inline as revnue is impacted the advertising market depression.

• IACI reported EPS Yesterday of $0.18 per share versus the $0.20 first call estimate and my expectation was $0.18 owing to the weak media advertising market. Clearly the recession continues to take its toll on corporate results and the lives of investors and workers.
• IACI posted 4Q:08 revenue of roughly $351 million which was significantly lower than the Wall Street Estimate of $373 million and my estimate of $365 million. Clearly the Internet sector of the advertising market is starting to feel impact of the recession. While traditional media such as TV Radio and Newspapers have been challenged by the economy since December of 2007 (the beginning of this recession); interactive media such as the Internet and video games have been in part immune to the Eco-virus created by the collapse of the housing industry in the US.

IACI results still support our long term investment thesis.

• We continue to recommend IACI share to Investors as we think the restructured IACI is positioned to benefit from an improved Advertising market in 2H:09 and an increase in market share as Yahoo (NASD: Hold) is challenged by its own reorganization and its bricks and mortar competitors such as the newspapers and business directories are irrelevant in the digital media universe.

• However we think given the challenges presented by the economy and IACI's ability to cut costs that the 4Q:08 are acceptable given the economic environment and taking into account that IACI is completing its corporate and business unit restructuring. CapitalIQ also thinks that IACI's recent redesign of its ASK.com website may have also contributed to the revenue miss. When Internet companies redesign websites legacy linkages to are often broken thus sights experience a decline in traffic and revenue.

• We like the optionality of the ASK.com website. ASK.com generated operating income of $10 million in 4Q:08 and EBITDA of rougly $18million. While we expect Ask.com's revenue to improve with a recovery in the economy; we think the opportunity exists for ASK.com to pick up market share from Google GOOG and YHOO. Despite good name brand recognition, ASK.Com is a small player and we think ASK has room to grow in the search market. According to Net Application (an industry trade website) ASK is currently ranked the 5th ranked search engine with just 1% of industry market share as compared to 81% for GOOG and 10% for YHOO. We think recent improvements to Ask's search algorithm's combined with new alliances with NASCAR and Symantec should attract new users. We think a significant EPS upside would result with just a 50bp improvement in ASK's market share and perhaps more if Ad agencies are serious about supporting viable alternatives to GOOG in the paid search market.

We think IACI's Service Master and City Search franchises will also benefit in an improved economy.

• While the current economic down turn seems like it will last forever we think an eventual recovery in the global economy fueled by lower energy prices and aggressive fiscal policy will likely improve conditions for consumers. However given our long-term investment thesis -that deleveraging will have a profound impact on corporations and their ability to growth- we think the relative health of balance sheets is a major factor in determining the ability of a corporation to capitalize on growth opportunities.
• IACI's competition for ad dollars in a recovery are newspapers and business directory publishers, both businesses are challenged by the current ad depression and poor financial decisions resulting in excess printing capacity as well as a high degree of financial leverage. Capital IQ thinks that deleveraging in the local advertising means that most newspapers and business directory publishers will need to re-organize or liquidate. Therfore the opportunity for Serivce master (an ad site dedicated to matching consumers with contractors) and City Search (a local search portal) will be able to capture the roughly $5 to $10 million in local advertising dollars that will transition from physical media forms like business directors to digital ad platforms that provide a value proposition (inour view) to consumers and advertisers.

We like IACI's strong balance sheet

• At the end of 4Q;08 IACI had roughly $1.9 billion in cash and marketable securities on its balance sheet and a net cash position of roughly $1.8 billion or over $10 per share in cash. We think IACI will use is ample cash reserves to buy Internet businesses at attractive valuations and growth its top and bottom line. While the company has also told investors that it may buy back stock we think many profitable Internet business can be purchased at steep discounts to their intrinsic value.

We think IACI shares are worth $25 - $30 in an economic recovery.

• We see limited down side and we think IACI shares are worth $22 to $24 per share in an economic recovery. We expect IACI to earn $0.60 to $0.70 per share (on a continuing basis net of interest) and derive our target range be applying a 20x multiple to our EPS estimates to derive a $12 to $14 per share enterprise valuation for IACI core business which we then ad to IACI's ample cash position.