Babylon Speaks the Tongue of the Markets

Oren Freund
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Oren Freund

After adding more than NIS 1 billion to its market capitalization since the start of 2012 to reach NIS 1.6 billion, Babylon is ready to move up in the ranks. Several days ago, the online language and Internet advertising company joined the MSCI Global Small Cap index and next week it is expected to join the Tel Aviv Stock Exchange's TA-100.

A 230% jump in the company's share price is quite impressive, but CEO Alon Carmeli says it's just the beginning. "As far as growth goes, Babylon is still in diapers. We are very optimistic about the future," he said in an interview with TheMarker.

Babylon's trading volume on the TASE seems to back up his words. From an average daily volume of NIS 1.5 million, turnover in the stock has reached more than NIS 25 million - more than the daily average for Cellcom, Partner and even Yitzhak Tshuva's Delek Group.

The reason is that Israeli and foreign institutions have taken notice of Babylon and its enviable rate of growth. Among the Israeli institutionals, Phoenix, Epsilon, Clal Finance and Clal Holdings have all increased their holdings in Babylon in the past month to the threshold where they have had to declare themselves major shareholders.

What's happened to Babylon in the past two years that has turned it into one of the most talked-about Internet companies in the world today?

The answer lies with two Israeli businessmen and an engineering student from Tel Aviv University who have made over the company from end to end.

Until five years ago, the company' sole source of revenue was online translation software sold over the company's website. Over the years, however, Babylon's product gradually lost its place in the market to free software, most notably Google Translate.

50 million visitors a day

Change started happening in 2007 when Noam Lanir acquired the company for $11 million from a group of investors that included Kardan Technologies, Formula Vision, Eliezer Fishman and the Bar-On family. That is when Carmeli, Lanir's brother-in-law, came to Babylon too.

Lanir brought with him a rich background in Internet marketing and metrics acquired from buying and developing online gambling companies in Britain over the previous decade. He and Carmeli adopted the business model of Israel's most successful Internet company, Conduit, in which a 7% stake changed hands in March in a deal valuing the company at $1.3 billion.

From now on, Babylon would shift its focus from selling online translation, becoming a company that sold advertising space and services over the Internet. Today, Babylon is ranked 38 among the world's most frequently visited websites, just below Bing, the Microsoft search engine, and ahead of others like the BBC and Apple. More than 50 million visit it every day and a million of them download the translation program.

In 2007, 98% of its sales revenues came from selling its translation software; in the first three months of 2012, 92% came from advertising and marketing services over the Internet and just 8% from software sales. And what a difference that made: The first quarter of this year saw Babylon's revenues reach NIS 113 million, yielding it a net profit of NIS 14.4 million - up 3.4 fold from the same period in 2011.

To really appreciate Babylon's business model you have to understand a few things about the world of Internet advertising. Every time you click on a link on a particular website, be it a banner or a Google ad, money changes hands. In contrast to content sites like Ynet or Walla, which use their online exposure to sell ads, Babylon focuses on search engines, principally Google's, which accounts for 82% of its revenue.

Google's search engine is integrated into Babylon's website, with the two companies each paying each other for services rendered. Babylon pays Google for searches conducted through its website. In return, Google's Adsense service places ads of customers whose businesses are related to Babylon translations, paying Babylon for each click on the ads. Babylon also works with Yahoo and several other search engines.

What Babylon gives Google, thanks to its translation function, is entry into markets Google would have trouble reaching, like Russia, China and Eastern Europe.

'No concrete plans to sell shares'

What separates Babylon from the rest? Carmeli answers in four words: "My deputy, Nadav Shemesh."

Until two years ago, Shemesh was a student at Tel Aviv University who worked part-time on Babylon's help desk. But Carmeli quickly identified his potential and appointed him deputy CEO for information systems. Shemesh developed a series of statistical tools that give the company unusually sophisticated analytical powers that, in turn, allow it to leverage its exposure into ad revenue. More recently, Shemesh has been promoted to vice-CEO.

"The real uniqueness of Babylon, beyond the huge numbers of people who visit our websites, is our statistical ability to analyze from every shekel that's invested how much we will earn in the future," explains Shemesh. "Babylon knows how to act faster than the competition and can pursue the most profitable areas."

Babylon's analytical tools make sure advertisers are reaching the right people. "When a 12-year-old girl does a search for a BMW on the Internet, I wouldn't offer to sell her a car," Shemesh explains.

Benny Dekel, senior analyst at the Union Bank, says Babylon has only achieved a tenth of its potential in the sales and marketing arena. He gives the stock a NIS 46 target price. It closed up 5.7% yesterday in the TASE, trading at NIS 33.81.

"The company is unique because it brings traffic in the best way I have ever seen," says Dekel. Nevertheless, he warns that the risk in holding the shares is high. "The main element of its revenues comes from its contract with Google, which expires on November 30, 2013. The chances of Google not renewing are virtually nil, but a scenario is certainly possible in which someone at Google would decide not to renew it. The results would be disastrous for Babylon."

Babylon's entry into the MSCI index will attract more investors, says Dekel, pointing to the higher market valuation of American companies like Inter-Active even though they have fewer visitors to their site.

Nevertheless, looking at Babylon's market value relative to its forecast earnings for 2012, the ratio is high. Its market cap as of yesterday was close to NIS 1.6 billion, while its forecast profit for the year is NIS 60 million - a price-to-earnings ratio of 38, much higher than that of similar Internet companies.

The reasons for that is in accounting. Whereas most companies register their investments in their balance sheet, Babylon's investment in advertising space on the Internet that will eventually generate revenues is listed as an advertising and marketing expense in the profit and loss statement.

Thus, for example, in standard accounting practices Babylon would have registered a profit of NIS 53 million, instead of the NIS 14.4 million that is actually reported. If Babylon booked profits like that, its price-to-earnings ratio would move down into the single digits like other Internet companies.

Why doesn't Babylon trade overseas? "Right now, we have no concrete plans to sell shares, but it is inevitable that it will happen," Carmeli answers.

"We have no need for cash at the moment and our shareholders aren't looking for an exit - on the contrary, they are buying more shares," he says. "The one factor that might make us think about an overseas share offering is the foreign currency issue. There are not a few foreign investors who want to minimize their exchange rate exposure."

Babylon shares informationCredit: Haaretz