Shadowstock is a another very interesting niche blog that covers “Deep Value Micro Cap Investing” and I’ve been following it for awhile. Once of his more recent ideas as a possible Ben Graham net/net is Looksmart (Nasdaq:LOOK), the “second tier” Pay-Per-Click search engine.

“Second tier PPC network” is basically a euphemism meaning that this is one of the less successful pay-per-click ad networks that competes for the scraps around the edges of the 800lb gorilla known as GOOGLE. They have not been cashflow positive since 2006, but as ShadowStock observes, they have a lot of cash, net-operating-losses to carry forward, and a new CEO with some plans to turn the company around.

One commenter on shadowstock pointed out that LOOK is not a  “net/net” in the strict Ben Graham sense of the term, but that it is still relatively cheap at these levels.

A Ben Graham “net/net” was basically a company trading at 2/3’s or less of it’s net current assets: current assets minus total liabilities, which for LOOK would mean it would have to be trading down around .78.

The thing we need to keep in mind about a net/net approach was that it’s not really a “stock pickers” approach. It’s a numbers game approach. Ben Graham basically would go out and buy a lot of different net/net’s. Some of which would go to zero, but enough of them would appreciate that he made decent returns. But he basically diversified across many net/nets.

While Graham was Warren Buffet’s mentor, Buffet didn’t stick to the net/net scattergun approach. He honed his approach to a stock-picking methodology that became the core of “value investing”.

Why does it make a difference? Because here we are concerned with analyzing both public and non-public web assets from a value investing perspective on a case by case basis.

You could buy LOOK as a net/net if you were buying a bunch of other net/net’s and then the odds, according to Graham, would be in your favor. But if you were going from a Buffet approach, perhaps best summed up as “you have to be happy buying something and positing that it doesn’t trade again for 10 years”, you need to look at it differently.

From the other comments on the Shadowstock comments, people are looking at this as a turnaround play with perhaps the involvement of an activist investor. There is also some speculation that Apple will inevitably enter the search space, and if they do, acquiring LOOK will be a natural way to kickstart it.

These are plausible predictions. But they are just that predictions. Everybody has to shape their own investment methodology and I’ve made the assumption that I cannot predict the future a cornerstone of mine. What that means is I have to like a business, in it’s current form, right now and it has to be trading at some kind of discount to my valuation process to get me interested. From there, the closest I will get to predicting anything is thinking about sustainability. I don’t want to rely on growth to make my investment compelling, I want growth to be gravy.

So for me, buying LOOK hoping for an activist turnaround or an acquisition by Apple is the same as future price speculation. The business doesn’t attract me right now. I’m not a huge fan of the pay-per-click space in general. It seems to be driven largely by click arbitrage of one form or another and to me that isn’t a long term sustainable model because you’re always running a footrace with Google and traffic quality metrics. As a personal aside, I made a telling discovery when years ago, shortly after I bought my company from my partners, I shutdown all of our PPC advertising campaigns and revenues didn’t decline. Granted that’s specific to my business and anecdotal but it reinforced my opinion that PPC tends to be the fuel that floats marginal business models (*duck*). Just my opinion.

Compared to something like Tucows, where we’re just as cheap or even cheaper, making money and sitting on some off balance sheet assets that exceed the total market cap of the company, I would never divert funds to LOOK that I could instead put into Tucows.

Disclosure: Tucows: Long, Looksmart: No position