I am making a bold prediction: Marketing is going digital.

Not surprised? Of course, businesses and consumers finding each other online is hardly a revelation. But half of America’s 28 million small businesses do not yet have a website, and for them, successfully winning customers online seems to require a computer science degree.

Enter Web.com, a one-stop shop for small-business Internet needs. And it’s cheap thanks to an audacious acquisition and muddled financial statements, despite being a major growth opportunity.

Mom and Pop Go Digital

Web.com (NSDQ: WEB) offers dozens of services, from domains to custom websites to ad campaigns to email blasts. As a result, new customers come in at all stages of the Web development process. In the journey to become Web-capable, a small business inexorably comes across one of Web.com’s services.

Once a small business becomes a customer of just one service, the magic of Web.com’s cross-selling ecosystem kicks in. A business that buys a domain will also need a website. A customer running ads will need tools to convert leads. Mass-email clients will need ways to fulfill orders online. Because Web.com offers all these services and each one integrates easily with others, the company’s 3.3 million customers are pulled further into Web.com’s web. They also tend to stick around: Retention rates run around 87%.

Moving On Up

A shift is underway in Web.com’s business. The company has longe catered to customers at different stages of Web proficiency by breaking services into DIY (do it yourself), DIWM (do it with me) and DIFM (do it for me) categories. Now the company is de-emphasizing lower-value DIY services, such as selling domains and basic DIY website-building tools, in favor of high-value, white-glove services, such as managing complex ad campaigns, optimizing conversion funnels and tailoring services to specialized audiences, including real estate agents and franchisees. This shift makes sense because the low-value end of the business has become increasingly competitive the past few years.

Web.com also is ahead of its competitors in that no player has created a rival one-stop shop, but several have carved out niches. They include Squarespace and WordPress (DIY websites), GoDaddy (domains) and Mailchimp (mass email). Some are startups with deep-pocketed backers and have poured money into ads, driving up the cost to acquire a new customer.

Web.com has the development talent to build tools just as good as these niche players. It also has the marketing budget to wage an advertising war.

Thankfully, Web.com has done neither. In fact, management did the opposite: They walked away. That’s because Web.com has something every low-value competitor can only dream about—the ability to serve small businesses that want to hand over nearly total control of their online operations and are willing to pay 20% to 30% more than the DIY versions for Web.com to do it all for them.

These small businesses are the minority of Web.com’s customer base but represent half of revenue. Competition here is low because few rivals have the breadth of offerings Web.com has.

These customers also tend to grow faster (thanks mostly to Web.com’s help) and buy more services.

Misunderstanding = Opportunity

The shift to high-end services is slowing  growth in the sheer number of customers.

This change is a natural outcome of the company’s strategy. Low-value customers are high in number but low in profitability. High-value customers are fewer but high in profitability. The strategy is good business, but it doesn’t reduce the shock factor that new customers fell by half in 2015 versus 2014. That headline had investors running scared.

Meanwhile, the goal of landing more higher-value customers leaped forward earlier this year when Web.com acquired Yodle, a local digital marketing specialist.

As an investor, I am deeply skeptical of acquisitions. Empirically, most fail. There are four reasons, though, that I love this move:

Yodle plugs perfectly into Web.com’s strategy. Yodle customers pay an average of $300 per month, compared to $14 at Web.com. The acquisition boosts Web.com’s revenue 40% while adding only 1.5% to its customer count.

As a niche player, Yodle lacked opportunities to cross-sell to customers. Throwing 53,000 new target customers into Web.com’s cross-selling machine will produce further growth.

Web.com now has Yodle’s 700-person inside sales team, which will be deployed to sell all Web.com high-value services, continuing the company’s push into lucrative niches.

Web.com has a fantastic track record of acquiring and integrating businesses like Yodle. In fact, acquisitions are how Web.com became a one-stop shop in the first place.

All the market seems to see, though, is the $300 million in new debt Web.com used to finance the acquisition. That raised net debt to $738 million, a large sum for a company that has reported losses four of the past five years, which brings us to the utter confusion that is Web.com’s financial statements.

Crouching Tiger,
Hidden Cash Flow

Web.com’s business is simple enough, but because of years of acquisitions, tax oddities and maladjusted accounting requirements for subscription-based businesses, its financials are a jumble only a forensic accountant can unravel.

The bottom line is that things are a lot better than they look.

Web.com reported losses until last year. Earnings in this case aren’t as important as cash flow, and Web.com gushes it—$153 million in 2015 and on track to keep growing.

Against this backdrop, the company’s debt is entirely manageable. In fact, in the four months since the acquisition, Web.com has already reduced net debt by $42 million.

Three other financial highlights: Thanks to earnings losses in years past, Web.com won’t be paying taxes through at least 2018; the company is disciplined at reducing costs as it grows. Marketing and tech development have each steadily decreased as a percentage of revenue, so that more of each new dollar turns into cash flow. Plus, Web.com has a track record of cutting costs at the companies it acquires and is already on track to remove $32 million of Yodle’s annual expenses.

When We Would Sell

The greatest risk to Web.com is not slower growth in the number of customers. That’s a certainty. It also isn’t a decrease in customer retention. That, too, will happen. Customers paying $300 per month are more cost sensitive than those paying $2 per month, plain and simple. Neither is a true risk.

Ironically, the greatest risk is that Web.com’s management team caves to pressure from Wall Street to care about either of those metrics. If we see Web.com water down its strategy or divert resources to battle Squarespace, we’ll consider selling.

I expect management to focus on the high end and ignore the low end. I also expect the company’s cash-generating properties to shine through on its financials over the next 18 months. As these things happen, the market should awaken to the company’s true value, which I peg around $31 per share. If the stock approaches this price, I may recommend selling on valuation grounds.

Recommendation

Web.com is misunderstood and for good reason: It’s in the middle of a brilliantly executed strategy shift, its financials obfuscate underlying profitability, and its customer metrics distract from the competitive strength of the business. At $17 a share, the stock is priced for a future of doom and gloom. Anything else—and we see nothing but clear skies ahead—means shareholders are in for a treat.

BTP Contributor Alex Pape, CFA, does not own shares of Web.com.