|Shares Out. (in M):||0||P/E|
|Market Cap (in M):||489||P/FCF|
|Net Debt (in M):||0||EBIT||0||0|
ACI Worldwide (ACIW) is a software company with a “last-man-standing” position in its core market that offers four bagger potential with little downside risk. This market position and appreciation potential was recently confirmed by a five year warrant agreement with IBM that, if exercised, will put IBM’s total cost at $41.92 per share (3x the stock’s current price). Over the last 18 months, management has made a series of decisions that led to a large drop in GAAP results in 2007 and will continue to create a headwind over the next 4-6 quarters. Over the medium to long term, however, these actions will significantly increase the company’s revenue and profitability. This progress can presently be observed in deferred revenue and 60 month backlog which have both shown encouraging growth.
It should be noted that ACIW was formerly know as Transaction Systems Architects (Ticker: TSAI), and that their FYE has historically been September 30. The three months ended December 31, 2008 will form a transition period after which the company’s FYE will become December 31. Management has been providing guidance in calendar terms for 2007.
ACIW makes software that large banks, retailers, and payment processors use to facilitate electronic payments. Approximately 60% of ACIW’s business comes from software used to facilitate retail payments—the credit, debit, and ATM transactions that most people initiate on a weekly, if not daily basis. The balance comes from retail-related software (i.e. fraud detection) and software used to facilitate wholesale payments—the large transfers that occur among banks and enterprises.
Retail Payment Engines
Small and medium size banks and retailers usually outsource payment processing to third party processors such as First Data. The scale and complexity of large banks, however, means that they can realized significant control and cost benefits by performing these functions in-house. A large bank, for example, would have to pay a third-party processor $0.02-$0.05 per transaction. Using software like ACIW’s, this cost falls to $0.0001 to $0.001 per transaction. I estimate that ACIW’s average customer in this division processed roughly 160MM transactions in FY06, and this figure is expected to continue growing 7-12% per year for the foreseeable future. (This implies an average savings of 3MM to 8MM per year, which will grow at a 7-12% annual rate.)
ACIW’s retail payments software facilitates all of the underlying steps involved in processing credit and debit card payments, including (but not limited to):
There are more steps than I’ve outlined above, and they vary significantly by the transaction’s origin, which payment networks are used to communicate the information, and which financial institutions are involved. In some cases, multiple entities (i.e. the retailer or ATM owner, network operator, and bank) could each be using ACIW software to handle their part of the transaction.
Large retailers use ACIW’s software for a number of functions such as aggregating their electronic transactions. Third party processors use ACIW’s software to process payments for smaller banks and retailers who lack the scale to operate this type of software in-house. This means that ACIW is a supplier to the processors who are in some cases ACIW’s competitors. In such cases, ACIW will still benefit some because its contracts include a volumetric component.
In the retail payments area, ACIW has a “last man standing” position among the vendors who are capable of serving Tier 1 banks on a global basis. When I first spoke to the company over three years ago, they listed three companies as competitors: Mosaic, S2, and eFunds.
Mosaic was a South African company with a product on a Windows platform that competed with ACIW in mid-sized banks. Mosaic struggled to compete with ACIW among large banks, however, because Windows wasn’t perceived as robust enough for datacenters. S1 acquired Mosaic in late 2004, intending to sell Mosaic’s mid-sized software to large banks, but this strategy proved unsuccessful. S2 used to be one of ACIW’s strongest competitors, but ACIW bought them out in mid-2005. eFunds has a division that competed with ACIW for decades, but this division eventually morphed towards a processor type business model and lost its way. Today, that unit has 50MM of revenue (out of eFund’s 400MM of total revenue) and installations at 30 of the world’s top 500 global banks (vs. 120 for ACIW). Fidelity National recently acquired eFunds and has announced their intent to reduce costs by 60MM, which happens to be the amount eFunds was spending on the unprofitable division that competes with ACIW.
Internationally, ACIW competes with various regional players, but a global support infrastructure is proving increasingly important in serving global banks. ACIW’s global support network took years to build and thus serves as a competitive advantage. In addition, ACIW is offers the most comprehensive solution in the industry. It’s competitors, by contrast, only provide pieces of the overall solution.
Other Retail Products and Wholesale Payment Engines
Roughly 20% of ACIW’s revenue come from products that either compliment its payment engines or facilitate other back office activities. These include fraud detection and anti-money laundering products, products to manage smart cards, and products that allow heterogeneous legacy computer systems interact with other systems.
Roughly 20% of revenues come from software that facilitates wholesale electronic payments. This includes software for handling very large wires and transfers between banks as well as software used by enterprises’ finance departments to manage cash balances, initiate wires, and similar activities. One of ACIW’s competitors in this space is FundTech, though FundTech tends to focus on the middle-market.
ACIW has traditionally had a less complete product offering in the wholesale payments area than in its core retail payments division. Over the last couple of years, management has worked to fill out this product line, primarily through acquisitions.
While ACIW has historically had some third party competitors in the retail payment space, its real competition has been the homegrown systems that banks built decades ago. The newest of these systems is 15 years old, and ACIW believes that such systems represent at least 34% of the market among large banks. The main sources of stress on these systems comes from rising payment volumes and new regulatory mandates from bodies such as Visa, MasterCard, and the Office of the Comptroller of Currency. These mandates usually change how transactions have to be processed or encrypted and thus require updating the software.
Coming into Y2K, many banks considered upgrading to a third-party solution, but companies like ACIW had limited conversion resources which forced these banks to instead heavily remediate their homegrown systems. This remediation left these homegrown systems well prepared for the higher volumes and mandates they would face during the early 2000’s. It was analogous to sinking a lot of money into jalopies to get them ready for a big state inspection. Such efforts extended the lives of these beaters, but they’ve put on a lot of miles over the last eight years, and the engines are starting to come under strain again. This has been especially pronounced in Europe where there have been far more regulatory mandates.
ACIW’s flagship retail payment engine, BASE24 was developed decades ago to run on the HP Non-Stop hardware platform, which was the leading edge hardware for such applications at the time. BASE24 eventually became the industry’s gold standard, but HP Non-Stop gave way to mainframes and servers. This was problematic for ACIW since the need to buy Non-Stop hardware became a “Non-Starter” for many prospective customers. Many banks appreciated the quality of ACIW’s products and staff, but were simply unwilling to buy a Non-Stop machine just so they could run BASE24. Doing so would have created an island in their IT departments which were already built around other hardware platforms like mainframes.
To address this limitation, ACIW introduced an open version of BASE24 in 2002 called BASE24es (now called BASE24eps) that would run on mainframes and other hardware platforms. The ability to address mainframes alone doubled or tripled the addressable market. The first four years, however, were slow because it was difficult to recruit launch customers for such a mission-critical application, especially since the entire market had so recently overhauled their legacy systems. In addition, the few customers ACIW did attract tended to be very large and complex, which led to lengthy implementations (12-24 months). These factors meant that the product got off to a very slow start and took four years to build a set of referencable accounts—a key step in selling mission-critical software.
By March 2006, BASE24eps had 22 customers. Five of these were “live” on four different hardware platforms in four different countries. One particularly high profile installation was VISA Europe’s network switch which demonstrated the tremendous scalability of the product. By late 2007, BASE24eps had signed over 60 customers, 31 of which had gone live. This progress suggests that the product has crossed the “chasm” and gained industry acceptance. This acceptance may have been helped by IBM’s publication of two “Red Books” which are highly detailed technical manuals that discuss the finer points of implementing and operating the software on IBM hardware. As part of this collaboration, ACIW began to fine-tune BASE24eps for running on the IBM Z-Series (i.e. mainframes). This collaboration recently grew into formal agreement which is encouraging because IBM is the leading IT supplier to financial institutions. (ACIW’s CEO, Phil Heasley, appears to have been instrumental in repairing and cultivating the company’s relationship with IBM which had been adversarial at times in the past.)
What Phil Has Done
The management team in place during the late 1990’s had hoped to spin off two of ACIW’s three divisions during the tech boom. Even though these bubble burst before these units could be spun out, they had still been maintained in their full glory, with separate CFO’s, etc. In addition to being expensive, this led to an uncoordinated sales effort as these three divisions each called on the same prospects separately. Lastly, it underutilized the strength of the company’s ACI Worldwide brand since this was only used by the retail payments division. Phil Heasley joined the company as CEO in 2006 and proceeded to restructure the firm into a single company, operating under the ACI Worldwide brand. This has resulted in more coordinated sales efforts, more effective cross selling, and better positioning for the smaller two divisions.
Under Phil’s leadership, the company has also made a number of acquisitions which have filled out the company’s product line and improved its distribution and support network internationally.
Phil’s most consequential (and painful) decision, however, was changing the sales forces’ incentives and how the company goes to market. ACIW’s products have three dimensions to their price. Customers pay based on:
1) The term of their license (usually five years)
2) The breadth of the solution they are buying (i.e. the number of modules)
3) The number of transactions they are allowed to process
This creates recurring revenue because the licenses must be renewed every five years. A second recurring element is that customers must periodically buy “capacity upgrades” that give them the right to process more transactions. (It is analogous to how people with prepaid phones are required to periodically purchase more minutes.)
This business model brings tremendous financial stability, especially since ACIW’s renewal rates are 98%. Installing this software is similar to getting a heart transplant. You could theoretically switch to another transplant, but virtually no one is willing to accept that much risk and pain. The switching costs are evident in the fact that many of ACIW’s customers are in their fifth five year term extension.
This financial model, however, created two problems. The first is that it discouraged the company from selling new products. Renewing a legacy BASE24 contract allowed the company to start recognizing license revenue immediately because the software was already running and installed. In the short term, this was far more lucrative than selling a BASE24eps contract since the BASE24eps implementation would take at least 6-9 months, delaying revenue recognition for that amount of time. (This timetable can elongate to as much as 24 months if ACIW is selling multiple products to a completely new customer.) Over the last few years, ACIW’s European staff rose to the occasion and seized on the flurry of European mandates (i.e. SEPA, Faster Payments, etc.) to persuade new customers to sign up for BASE24eps and associated products. Their American counterparts, however, had evolved into relationship managers who just renewed existing contracts. (Management has turned over most of the American sales organization.)
The second shortcoming of this financial model is that it presents the opportunity to pull revenue forward in order to meet quarterly numbers. If software is already installed and running, high margin renewal revenue can be recognized immediately if the customer pays up front. (If the customer pays on a monthly basis, revenue is recognized monthly.) In some cases, ACIW was proactively approaching customers three years into their five year agreements and offering them large discounts (as high as 40%) if they would renew early and pay up front. Customers eventually became conditioned to this and realized that they could wring large discounts out of ACIW if the company was trying to meet its quarterly numbers. When Phil discovered this activity, he labeled it “puffing” and quickly recognized how much long-term value was being left on the table.
In late FY06, Phil changed the sales forces’ incentives to redirect them to:
1) Sell new products instead of renewing old products. A basic new product would involve a sales cycle, followed by a 9-12 month implementation period. Revenue recognition under this scenario occurs much slower than if an existing license is renewed and paid up front (immediate recognition) or paid monthly (monthly recognition that starts immediately).2) Sell multiple products instead of individual products. This elongates the implementation cycle by another 6-12 months, pushing revenue recognition even further out.3) Stop offering discounts to customers who were willing to renew licenses or buy capacity upgrades early. This activity was more or less banned, and created a two year hiatus in this revenue since it would take 8-10 quarters for the existing licenses to start expiring under their original contracts.
Any one of these headwinds would have been manageable in isolation, but taken together, they created a “hole” in organic revenue in FY07, especially for license revenue which, of course, carries the highest margins.
During this period, ACIW became mired in a voluntary review of its historical stock option practices, and combed through every option granted since 1995. While this study exculpated current management, it found that backdating was common under the management team in place in the early 2000’s (three CEO’s ago and two CFO’s ago). This wasn’t surprising since that CEO and CFO had been forced to leave, the auditors had found material weaknesses in the accounting, and the results from that period had been restated twice. The practical impact, however, was that ACIW’s executives were distracted by an internal investigation and financial restatement for about a year. Shortly before this investigation, ACIW had made a large acquisition of a company in the wholesale payments area, and the investigations delayed its integration (and expected synergies) by about a year.
I think few managements have the backbone to do what Phil and his team have done to maximize the long-term value of this business, and I am thankful for the changes they have made. The near term consequence, however, is that GAAP revenue has fallen short of expectations, and given the fixed cost nature of the business, EPS has been crushed.
Why I Think ACIW Is Going to Work
While the GAAP results have been poor, I derive enormous comfort from the progress ACIW is showing in the marketplace as evidenced by the huge increase in BASE24eps signings and start ups in 2007. Because ACIW sells five year licenses, they have visibility into revenues that will occur contractually over the next 60 months. The trends in this backlog and the company’s deferred revenue also attest to their success in the marketplace as shown below (in $MM’s):
2Q06 3Q06 4Q06 1Q07 2Q07 3Q07 4Q07 1,031 1,050 1,072 1,055 1,072 1,095 1,144 4.0% 4.3% 6.7% 101 95 95 n.a. 110 110 116 9.8% 15.9% 21.8%
60 Mo. Organic Backlog
% Change (Yr./Yr.)
Tot. Organic Def. Rev.
% Change (Yr./Yr.)
Most encouraging, however, is a recent agreement with IBM that extends their relationship and dramatically improves ACIW’s ability to execute on its goals. While much could be said about the relationship, the highlights are that:
1) IBM paid $33.3MM for warrants to buy 2.854MM ACIW shares during the next five years at an average price of $30.25 per share. (ACIW ended FY07 with about 35.7MM Diluted Shares Out.) If exercised, this means that IBM will have paid an effective price of $41.92 per share. The effective price would be $53.59 per share if you include an additional $33.3MM that IBM will pay ACIW for meeting certain objectives by March 31, 2008 that management thinks will be easy to achieve.2) ACIW will further optimize BASE24eps to run on the Z-series, along with several other products that have yet to be optimized for this platform. This will create an integrated product line that has been optimized on the most popular banking hardware platform. It will also move ACIW closer to realizing its vision of “convergence.” Banks currently use different engines to process the various types of payments (credit, debit, ATM, wire, ACH, etc.). These processes vary some, but often share similar steps, and ACIW believes there is the opportunity to develop “payment hubs” that use common components to handle every type of payment. This would yield tremendous operating and security improvements at the banks. Since ACIW’s engines handle retail and wholesale payments—the most difficult types—management believes that ACIW is well positioned to develop this next generation of technology. ACIW also employs the largest number of experts in this field, which contributes to its position. Payment hubs would result in larger sales since the solution would be more comprehensive.
3)ACIW and IBM will form a joint sales force to sell ACIW’s products on the Z-Series. ACIW will realize the same margins under this arrangement as it would have on a stand alone basis, but I think IBM’s endorsement and a coordinated sales effort will dramatically improve ACIW’s ability to sell to Z-Series users.4) IBM will create a “Migration Factory” to help customers switch from legacy systems to BASE24eps on the Z-Series. Because ACIW had been renewing customers on the same product for 25 years, they have little migration experience, and some of the migrations undertaken to date have been inefficient and expensive. This part of the agreement removes an significant source of execution risk and will allow ACIW to sunset its legacy products much sooner, improving operating efficiency. IBM will benefit by being well positioned to capture ACIW’s 460 legacy customers that currently run on HP Non-Stop.
I believe that IBM entered into this relationship because they recognized the enormous market opportunity that ACIW has been talking about since they launched BASE24eps in 2002. The existing set of systems that process payments are archaic, ranging from 15 to over 30 years old, and these systems are starting to wear past their overhauls of the late 1990’s. In addition, M&A has left many banks with redundant payment systems. Merging banks often choose to maintain both of their legacy systems since neither system was robust enough to handle the combined volumes from both banks. Citigroup, for example, has 17 retail payment engines, three of which are homegrown. This is very inefficient since it requires far more IT resources to continually remediate these three homegrown systems and update the 14 third party systems. Using disparate systems also complicates risk management and fraud detection.
ACIW appears to be the only company of size that can address these needs, and its next generation product has now been thoroughly tested and proven in the marketplace. 2009 is expected to be the beginning of a growth period for the company. This will be driven by:
1) The resumption of the natural renewal cycle for term extensions and capacity upgrades. This two year revenue “hole” will get filled sometime between 1Q09 and 3Q09.
2) Revenue beginning to be recognized from lengthy implementations currently underway. While poor from a GAAP perspective, 2007 was a successful year for signings. Translating one year’s signings into another year’s revenues oversimplifies the situation because the company is a few years into signing larger contracts with various implementation timetables. Still, management seems to have begun placing more focus on multi-product deals in late 2006, so a 18-24 month implementation cycle would imply that revenue would begin to improve in 2009.
3) The initial fruits of the IBM agreement.
The number of BASE24eps implementations has been building for some time, and it’s possible that some of these will begin to convert to revenue in 2008. The street is not anticipating much revenue improvement in 2008, so such a development would be a plus.
Financial Projections & Valuations
The timing and trajectory of ACIW’s revenue ramp is difficult to predict. What we do know is that ACIW has a dominant position, a proven product that is well matched to an emerging industry need, and 460 customers that will be forced to migrate away from its legacy products in the coming years. Pinning down the cadence of EPS over this period is tough, but I think that EPS will be in the range of $1.90 to $2.10 around 2010 and $3.10 to $3.50 by 2013. Applying a 15x multiple to these would imply a stock price of $30.00 by 2010 and $52.00 by 2013. The price that IBM paid for its warrants suggests that they are looking at numbers as good or better than these.
Another way to look at the valuation is to look at ACIW’s earned before management created a “crater” in FY07 and FY08’s revenues. In FY09, this crater will naturally fill and the growth trajectory will resume. In the figures below, I have taken the normalized Net Income and FCF for FY04 through FY06 and divided by the current diluted share count. I have used the current share count because management repurchased 6% of the diluted shares in FY07. (Management has been buying stock for their personal accounts since this summer. The CEO has bought over $1MM.)
FY04 FY05 FY06 $1.01 $1.23 $1.36 13.6 11.1 10.0 $1.38 $1.21 $1.30 9.9 11.4 10.6
Multiple at $13.70
Multiple at $13.70
For those of you who think about P/S, I’d point out that ACIW is trading at 1.26x CY07 sales. This compares to an industry norm of around 3-5x.
As a practical matter, I think the stock will be back into the low $20’s within 12-18 months as the natural license renewal cycle and the associated high margin revenues resume. (That’s over a 30% annualized return from today’s price and the reason I'm recommending the stock today, even though the catalysts are as far as 18 months away.) Investors’ confidence will also probably start to improve as they get more visibility into the IBM relationship and get closer to its initial contributions in 2009.
I think that the downside risk is very limited. After the initial 33.3MM from IBM, ACIW probably has about 99MM in cash and 75MM of debt, leaving them with a net cash position of 24MM. Over half of the company's revenues come from recurring sources such as maintenance and monthly license revenues. Even more of the revenue would be recurring if you factored in the 98% retention rate and five year terms of their contracts. Lastly, the capital requirements are low and the business has traditionally been a strong FCF generator. Beginning in FY07, FCF has become significantly higher than NI because FY06’s acquisitions added significant Intangibles Amortization.
|Subject||Free Cash Flow|
|Entry||01/29/2008 06:39 PM|
|Great write up. Agree w/ thesis 100%. The other thing that people miss is that there is a real cash flow story here. We expect ACIW to conservatively generate approximately $57m in FCF in '08 (management roughly estimates FCF at 15% of revenue) growing to $70m+ in '09 and $85m in '10 as UK fasterpay and SEPA roll outs take place in Europe... In a worst case scenario, assuming you believe no one unplugs ACIW, even in the event no one upgrades, and simply renews their license contracts and pays their maintenance, ACIW should consistently generate $45-$50m of FCF per year (see FCF generation in past years), which would imply a 10%+ yield over ACIW's current enterprise value. |
|Subject||Q on system z|
|Entry||01/29/2008 08:42 PM|
|Thanks for the write-up.|
I got the impression that ACIW's success is (to a large extent) tied to the success of system z. Is this correct? If so, could you share the relevant information you may have on the market in which system z competes.
|Entry||01/29/2008 10:31 PM|
|Thanks for the interesting idea. A few questions|
1) If the revenue gap in license is primarily due to the less aggressive renewal practices, then why are we seeing monthly license revenue declining? I'd think that you would see it in the nonrecurring portion of revenue. If the monthly license fee is paid in equal installments and recurring throughout service, it shouldn't be affected by the factors you mentioned. Rather, the up-front payments you describe would be affected, which I would expect to hit the non-recurring line. What am I missing? It looks like monthly revenues have been declining for the past several years.
2) What accounts for the variance in operating margin by region? Is there a reason why EMEA margins are much less than those experienced in Asia and the Americas? Do you expect this discrepancy to narrow over time?
3) It looks like gross margins across the board have compressed this year, not just in the license segment. Is this compression primarily due to the revenue lag that is occurring because of the longer lead times on new sales, or is there something else going on here? Would you expect margins to revert to their historical levels in 09-10?
|Entry||01/29/2008 11:06 PM|
|thanks for a nice writeup.|
i am new to this space and want to understand the competition more. if efunds has 30/500, ACIW has 120/500, and roughly 33% are captive, that's still almost 200 (35-40%) banks unaccounted for. what are they using? i apologize if there's something i'm not getting.
also, do you have more detail about capex needs? there's already been some discussion on FCF, i'm just wondering how people are looking at capex.
|Subject||Lower EMEA operating margins a|
|Entry||01/30/2008 10:27 AM|
|Lower EMEA operating margins are due to new product implementations... During implementation (anywhere from 6-24 months), ACIW is recording the expenses associated with implementing the project, but cannot recognize the license revenue until "customer acceptance"... From a cash flow perspective, ACIW does receive cash upfront and throughout the implementation process, w/ my best guess being between 1/3-2/3 of the total project revenues, so it's not like ACIW is putting a lot at risk... we would expect to see the gaap revenue (and higher gaap operating margins) come into play in mid'08 and beyond as these projects go live, starting with the UK FasterPay mandate deadline of May 2008...|
By contrast, the Americas is expected to have higher margins, given that there is far less new business wins going on (mostly high margin renewal and capacity upgrade business)...
hope this helps...
|Subject||competition / capex|
|Entry||01/30/2008 10:30 AM|
|Approx 200 use captive inhouse solutions, approx 150-200 use in house solutions w/ outsourced software (ACIW/eFunds), and approx 100-150 use third party outsourcing (First Data, etc)... |
Capex should run around $8-$9m per year... 2008 will include approx. $5m of additional capex since the company is moving office buildings in Omaha...
|Subject||Re: Q on System Z|
|Entry||01/30/2008 11:12 AM|
|I'd characterize it more as incremental revenue being be tied to the Z-Series. Almost all of the installed base is on HP Non-Stop, and revenue from those customers could theoretically be held flat based on their renewals. In practice, however, some of those users are going to want to move away from Non-Stop some day which is the whole reason ACIW moved to an open platform.|
I'm not a tech expert so I can't speak authoritatively on the merits of various harware platforms. Still, the evidence suggests that Z-Series is the dominant platform, with 1200 of the world's top 2000 banks use the Z-Series. (This is why the ability to adress the Z's tripples BASE24's adressable market from the 460 existing customers.) From what I've gathered, banks build their tech infrastructures around a given platform and then want to stick to that platform. ACIW's product works on other platforms like Sun, which is what VISA Europe's switch runs on, but everything I've heard suggests that Z's are the lion's share of the market.
|Subject||Re: Margin of Safety|
|Entry||01/30/2008 11:29 AM|
|The assets of any software company are intangible, so I generally don't think the ballance sheet provides much help in deteriming any kind of "liquidation value" or other type of "rock bottom." In my opinion, the real value of a software company is in its installed base--that's what generates the high margin annual maintence revenue (an annuity of sorts), and in ACIW's case license renewals every five years.|
Your question about the credit crunch is a common one and something I used to worry about. It may make a bit of difference for some customers, but the banks really don't have much of a choice about updating their systems (either by remediating their existing system or buying a new one). They're not in a position to drag their feet on mandates from regulatory bodies like VISA or the Office of the Comptroller of Currency. In addition, these migrations take a lot of time and I think corporations are generally more committed to mission critical projects that are in the works for a long time and require a lot of time to complete.
|Entry||01/30/2008 11:39 AM|
|Just wondering if you could comment a bit on FIS. |
Do you know what kind of multiple they paid for efunds? Was efunds a way for them to enter the industry or was it complimentary in any way? How do you view them as a competitor (as opposed to efunds) - their track record has been very succesful and they seem to be a gorilla in the industry.
Could ACIW be a target for FIS?
|Entry||01/30/2008 12:09 PM|
|As you point out, Monthly License Fees have been in secular decline since 3Q04. This has been driven by an accounting rule change which dictated that Post Contract Support fees must be classified as Maintenance Revenue instead of Monthly License Fee Revenue. So as contracts roll over, the Post Contract Support part is getting reclassified as Maintenance revenue.|
(As an aside, I'd mention that ACIW is subject to complex revenue recognition rules. For existing customers, the cadence of revenue recognition varies by whether the customer pays up front or whether they pay over time. For new customers, license revenue isn't recognized until the customer "accepts" the product--probably once it's in production. This could be two years after the original contract was signed.)
I don't know the answer to your second question. I'd guess that because EMEA has been the source of many of ACIW's new customers, service revenues (for implementation)have been high in EMEA relative to total revenues. Service revenues are lower margin. This is just a guess.
Question #3: We really only have good numbers through 3Q07, so I'll adress that period. It's really only license GM that has been affected. In 9m07, license GM, gave up nearly 900bp which was partly due to the 11.8% decrease in organic license revenue. This figure may have also also been impacted by the intangibles amortization associated with FY06's acquisitions, but I'm not sure about that.
I'd expect license margins to return to their historical levels around 2H09 or 2010.
|Entry||01/30/2008 12:22 PM|
|I don't have a great answer to you're question. I know that in some cases, large banks will choose to outsource this function to a third party processor and that accounts for some of the market. Other banks will use third party software provided by regional vendors. |
The company has sent mixed signals about the competitive landscape. On one hand, they emphasize that there are a lot of other companies out there that provide pieces of the solution, though these vendors are usually geographically constrained. On the other hand, they talk about how they bought out one of their strongest competitors (S2) and one of the others (eFunds)lost its way, has been loosing money, and looks like it could be shut down.
So if you look at the market very broadly and include third party processors, regional "point-solution" providors, and in-house systems, there are definitely alternatives to ACIW. But if you look at end-to-end solutions that are modern, proven, and can be supported internationally, ACIW appears to be only real option.
Management has provided little detail on the company's capital requirements, though FY07's was kind of high because the company was investing in a number of areas such as its international distribution resources. In prior years, however, cap. ex. has been around 1% of revenue.
|Entry||01/30/2008 12:35 PM|
|I just finished reading micky's answers to the other questions, and it appears that he knows the nitty gritty details of ACIW better than myself. So I'm interested in what he has to say about this one. |
I have never heard ACIW refer to Fidelity National outside of the context that they bought eFunds and could shut down the 12.5% of eFunds that competes with ACIW. I think your multiple question is answered in another write up recently done about FundTech that looks at market multiples. I can't really answer your questions about FIS except to point out that they seem to be more of a processor. That's really a different business model that selling software to banks that want to do this themselves for economic and other reasons.
|Subject||I can't recall the multiple pa|
|Entry||01/30/2008 01:36 PM|
|I can't recall the multiple paid for Efunds, but I'm sure you can find it in an analyst report just following the announcement. |
eFunds had a lot of different technologies to offer to FIS, such as back end debit processing, stored value/prepaid, electronic benefit cards, fraud detection technology, (in addition to the debt card processing, payment engine, network access software that somewhat competes w/ ACIW)... FIS' plan is to then cross sell these additional services to their existing client base... remember FIS' transaction processing division sells turn key solutions to a client base primarily consisting of small to mid sized community banks... these smaller banks could use eFunds software solution due to thier low transaction volume requirements... where eFunds' solution falls short of ACIW's is when you move up to the larger banks or retailers... it simply does not have the scalability... think about a busy holiday shopping season when thounds and thousands of ATM cards or debit card transaction happens simultaneously... eFunds' solution would crash... ACIW's runs at 99.9999% uptime. That is why you have to think about ACIW's core market opportunity as the larger, top 500-2000 high volume users of debit transactions worldwide...
For that reason, I do not think ACIW would be a target for FIS... A better fit would be IBM... think about the amount of services and hardware that gets sold in a multi year upgrade project... that being said, its not a shock that IBM has decided to invest in ACIW...
|Subject||Outflow of talent in North Ame|
|Entry||01/30/2008 01:43 PM|
|Outflow of talent in North America is a good thing... under the old leadership, the company was EPS driven, they did not seek out new business, and they discounted heavily to drag in revenue from out years to meet near term EPS requirements... average tenure of a salesperson was 13 years... fat. dumb. happy. best job in the world. every five years, you go back to your clients, and say, hey Frank, its time to renew your license, I'll give you a 40% discount if you sign today... new CEO is doing everything to manage the business for the long term at the detriment of near term GAAP revenues, which is meaningless... cash flow tells the story|
|Entry||01/30/2008 03:08 PM|
|Thanks for the responses. This seems like an excellent set-up for a great idea.|
For what it’s worth, the sales situation here reminds me of a project I worked on with an insurance company a few years ago. They had structured their sales incentives such that the sales force received the majority of commissions based on renewals and not new business. So, as Mickey described, you had a lot of guys who joined the company, built up a big book of renewal business, and basically sat back and collected their checks. Management hired us to realign the compensation scheme so that people were incentivized to produce new business, which we did. When management presented it to the sales force, they understandably went berserk. These were guys that had built up a book of renewal business and had gotten used to coasting by. Many of them worked 5-10 hours a week and collected $100k+ salaries. Who would want to give that up?
Ultimately, as far as I know, our recommendation was never implemented because the sales force—especially the guys who had been around forever—put up a huge fuss. The main difference between the two scenarios is that insurance is basically a commodity business (built on the relationship), whereas this business is much more differentiated.
All this to say I’m not surprised the sales force here would be experiencing a lot of turnover. But, in all likelihood, the guys that are leaving are those who have just been sitting back collecting their checks, not the ones who actually generate new business. It looks as though SG&A has been fairly constant, which I imagine means that management has simply redistributed compensation to those in the sales force who are generating new business, while taking comp away from those who have been doing nothing. If it’s anything like the plan I worked on, I wouldn’t be surprised if the renewal guys saw their salaries cut 30%+, while the more aggressive salesman are likely to have seen increases at about the same rate. And, thankfully, since the product is so mission critical, it sounds as though you could basically have a monkey call these guys up five years later and they’d renew.
It’s short term pain and noise, but long term absolutely the right decision to make for the business. This is an excellent idea, though I would not be surprised to see it get cheaper in the short term.
|Subject||cash flow /acquisitions|
|Entry||01/31/2008 12:04 PM|
|Another poster said that this was a cash flow story and to ignore GAAP earnings. How do acquisitions fit into this? They've spent $200mm on acquisitions in the past 3 years, has it been money well spent? What would results look like if they just grew organically? In 2007 organic maintenance and service revs were down in the Americas, shouldn't these be unaffected by changes in their sales strategy for new business or am I misunderstanding?|
|Subject||RE: cash flow /acquisitions|
|Entry||01/31/2008 01:23 PM|
|This was a FCF story before and FCF has become even more important with FY07's acquisition of P&H, and to a lesser extent, the advent of FAS 123R.|
When ACIW bought P&H, they weren't able to recognize the deferred revenue that P&H had at the time of the acquisition. This is a wacky feature of acquisition accounting that I have seen at other software companies. You can collect the cash but you can't recognize the revenue. This means that the FY07 revenue from P&H was understated because ACIW wasn't allowed to report any of P&H's deferred rev.
The second way that P&H affects FCF is that the acquisition added significant Amortization but this won't be matched by an offsetting cash outflow the way Depreciation often approximates Capital Expenditures. The 10K just came out yesterday afternoon, and it shows that FY07 D&A was 20.5MM while Capital Expenditures (& Purchases of Software Dist. Rights) were 8.9MM--that's $0.33 difference. If you add in Stock Based Comp, you're up to a $0.53 difference between FCF and GAAP EPS. Anyone just browsing over consensus estimates would be blind to this huge discrepancy.
It is a little early to tell how well the acquisition money has been spent. Half of the 200MM spent on acquisitions was for P&H and its integration was sidelined by the stock options investigation. The strategic rational was good, but its too early to measure the fruit. In general, I have been happy with rational behind the acquisitions they've made, but it's sometimes been difficult to gauge their success. For example, the company acquired a German company called "eps" (totally unrealated to the eps in BASE24eps). They only kept two pieces of eps, and one of the big motivations for the acquisition was to get feet on the ground in Germany, where they had struggled before. Since then, they've had more success in Germany and France, and there is good interest in Central / Eastern Europe. So would ACIW have won these new contracts anyway (as BASE24eps proved itself on live installations), or was it the new distribution that sealed their success? It's hard to be definitive, but I think it was a good deal.
I'm not sure how to answer your last question because I'm not sure where you're getting revenue line item information by geography. The numbers I'm looking at only give total revenue by geography; they don't break it out by license, maint, and service. The MD&A does say that service revenues were down in the Americas but that is consistent with the fact that the American sales team was not good at signing up new accounts (a large source of service revs, if not the main source of service revs).
The 10K has some pro forma information that shows how much ACIW would have grown in FY06 and FY07 if they had owned all of the companies they bought at the beginning of FY05. On this "if owned" basis, revenues would have grown 2.9% in FY06 and -6.5% in FY07. The drop in FY07 is because of the hiatus in renewals that I described in the report.
|Subject||question on IBM payment|
|Entry||02/26/2008 04:35 PM|
|Mickey & Tumnus,|
How do you look at the IBM payment in 2008? From what I understand, in 2008 ACI will receive $33m in IBM incentive payments minus about $16m in capex, so a net $17m benefit. Do you view this as one-time or ongoing? They incorporate this into the $65m OFCF CY 2008 guidance.
|Subject||RE: question on IBM payment|
|Entry||02/28/2008 11:49 AM|
|I would view this as one time. There's two 33.3MM payments under their agreement. The first was consideration for IBM's warrants. The second is for meeting milestones that management thinks will be easy to achieve.|
|Subject||RE: RE: question on IBM paymen|
|Entry||02/28/2008 12:07 PM|
|The basic story makes sense to me, but I am struggling to understand why cash flows aren't stronger. If the underlying business has been doing so well in the past few years, and the company has made $200m in acqisitions, why is OFCF flat-to-down?|
Year OFCF Note
FY 2004 $54m CFO - capex
FY 2005 $48m CFO - capex
FY 2006 $45m reported
FY 2007 $38m reported
CY 2006 $39m reported
CY 2007 $43m ex-$9m IBM payment
CY 2008 $50m ex-$15m IBM payment
In addition, the 2008 number gets the benefit of the UK/Middle East/"discrete deal" mentioned on the cc of $6-10m. So if move that, call it $6m, back to 2007, you have OFCF declining in CY 2008, from $49m in CY 2007 to $44m in CY 2008.
Maybe I am missing the forest from the trees or some basic adjustments, but they have switched metrics just enough without providing details that it worries me.
|Subject||Update on ACIW|
|Entry||02/28/2008 12:13 PM|
|For anyone out there who's still tuned in, I have updated my model. 2008 is really murkey, so I'm being very conservative with it, but I'm more comfortable with my estimates for 2009 and beyond. Here are my FCF estimates:|
2008: $0.24 ($0.80 with a normalized Cap. Ex. level; I'm not counting the second 33.3MM payment from IBM as part of FCF)
2009: $1.41 to $1.52
2010: $1.98 to $2.25
2011: $2.54 to $3.03
2012: $3.18 to $3.91
Here is the e-mail that I sent to my boss about the most recent conference call:
ACIW showed good orders and revenue in calendar 4Q07. In the previous four quarters, organic revenue growth ranged from -15.3% to +0.4%, but in the December quarter, organic revenue grew 7.7%. Organic license revenue grew 12.3% organically and was the third highest in over three years. This was a huge improvement since organic license revenue growth had ranged from -32.6% to -6.6% in the previous four quarters. New bookings were also strong in 4Q07 as 60 month organic backlog increased 10.1% Yr./Yr. and 2.7% sequentially. Though difficult from a GAAP revenue perspective, CY07 was a banner year in terms of signings. The company signed 49 new customers in CY07 (vs. 31 in CY06) and sold 212 new applications (vs. 147 in CY06). The SVP of Operations noted that this appears to be the highest number of new customers the company has signed in his 23 years with the firm.
It should be noted that while the December quarter was particularly strong, fourth quarters are usually robust as salespeople work to meet their deadlines. ACIW appears to be in good shape going into 2008, in part because they have four large deals that slipped from CY07 into CY08, and these represent about 15-20MM of revenues.
Information given on the call suggests that 2007 was the nadir for sales and earnings and things will start to improve going forward. Forecasting the trajectory of improvement, however is difficult, and I am taking the safe route and projecting modest revenue improvement in 2008. I am also projecting high expenses as the company continues to invest in its alliance with IBM and other forms of forward investment. Beginning in 2009, however, revenue is likely to accelerate and the company should begin to reap the benefit of the forward investments they've been making over the last two years. My 2008 estimates are very low because I'm being very conservative and the company is investing heavily on Capital Expenditures this year. I'm expecting FCF of $0.24 this year, which would be $0.80 with a more normalized Cap. Ex. budget. I expect FCF of $1.47 in 2009 and about $2.10 by 2010. I have attached my model if anyone wants to look at it; I still think the stock will reach $55-$70 by 2012, and my confidence is building.
In general, the market opportunity over the next five years appears to be playing right into ACIW's hands. They are one of the only company of size that still makes this type of software, and banks will increasingly need to update their legacy systems. In addition, customers are increasingly asking for more comprehensive solutions--something that ACIW has spent years investing in. This improves ACIW's competitive position since their competitors can only provide "point solutions." The IBM relationship should also help in this area.
Management addressed two points of concern on the call. The CFO discussed his departure, explaining that another opportunity had come up that was a better fit for what he wanted to do and for undisclosed personal reasons. The company also addressed the capital spending environment for banks. ACIW has yet to see any slow down in their niche, even though it is possible that aggregate banking cap. ex. could decline in 2008. Management explained that they have been through banking crises before, but these have never affected ACIW unless the crises were specifically related to payments. This isn't surprising to me since maintaining your payments infrastructure is mission critical and far less discretionary than adding branches and ATM's. Gartner is expecting banks to actually increase their IT spending since this yields productivity improvements and cost reductions.
Lastly, I'm proud to say that the CEO referenced my VIC report during the call.
|Subject||RE: RE: RE: question on IBM pa|
|Entry||02/29/2008 05:50 PM|
|Your concern is understandable. There are a lot of moving parts to understanding their guidance--especially since they have moved away from providing discrete guidance altogether. This is why I've set my expectations low for FY08; I just don't think it's realistic to try to be precise with a business that is so lumpy and in a transition. (Incidently, this is the reason that I choose not to go into great detail about future projections in my original report.) |
Looking back a year ago, my notes have incredibly detailed information about the amount (and sources) of near-term dilution from the P&H acquisition, how much they'd spend on the stock options investigation, and the amount of start-up costs they'd incur in their Romanian and Irish operations. Since then, the estimates for those various items changed, new items were introduced (like non-recurring severance costs), and some large contracts slipped. Creating a bridge analysis between then and now would indeed be very difficult. This is especially true since their guidnace framework has changed--as you point out.
I ultimately draw a lot of comfort from the amount of stock the insiders have bought over the last 6 months. I can't see the CEO buying this much stock, and other insiders buying as well if this were a fraud. I also derive comfort from IBM's entry into the picture. I'm in the cheap seats, but IBM is down on the court.
I should clarify what I mean by FCF because it is different than the OFCF that management talks about. I only incorporate things into FCF that happen every year (or are large one-time items) and can be forecasted. For me, FCF is:
+Non-Cash Non-Recurring Gains (Losses)
-Purchases of Software Dist. Rights
So my calculation doesn't incorporate things like working capital, deferred income taxes or the IBM payments. I don't think that the company has given enough information for us to really bake the IBM payments into the equation. We know ACIW is getting 66.6MM, but we don't know exactly how much they are putting into the relationship in terms of incremental op. and cap. expeditures. Come to think of it, I think ACIW might be getting some reimbursements in addition to the second 33.3MM (I'd have to check). The point is that we just don't have all of the information and they've proven unwilling to share it.
That said, I'll take a stab at why FCF was generally flat from FY04 to FY06, has dropped in FY07, will remain low in FY08, and then begin increasing in FY09.
From FY04 to FY06, the company started to make innitial progress "selling" BASE24eps and got some traction with some other products like Proactive Risk Manager. (Importantly, when they say "sales," they mean "orders." They don't equate sales to revenue the way most managements do.) These orders had long implementation periods so they moved into GAAP revenue gradually. I had previously thought that these implementations would build up in a way that would lead to a revenue acceleration by FY08, though that was just a gut feel--I never had visibility into the number and size of implementations underway or when they'd be complete. But management drastically changed the sales practices at the end of FY06, and that had a profound impact on FY07 and FY08 (possibly a much greater impact than they had anticipated).
In FY07, license revenue dropped 29.6MM, "primarily" due to the discontinuance of heavily discounting on paid-up-front deals (according to the 10K). So if we assume that "primarily" means something like 20MM, FY07 saw 20MM of license revenue disappear, and license rev's drop straight to the bottom line. This business went away in 1Q07 and it won't return until mid-2009 when those contracts start to naturally expire again. So that's 20MM of FCF taken from FY07 and FY08. I think of it as "paying for sins of the past" or the pain ACIW has to go through to get back to a natural, full-price renewal cycle. Pursuing large complex deals has also hurt FY07 and FY08 results because it means ACIW traded contracts that would convert to revenue in 6-9 months for larger contracts that would convert to revenue in 12-24 months. It is great that their customers want more comprehensive solutions, but this pushed the revenue recovery furthur into the future.
With respect to acquisitions, the P&H acquisition accounts for about half of the 200MM they've spent in recent years. The Stock Options Review sidelined the integration of P&H for a year, and this naturally blunted the near-term benefit that they'd get from P&H. I don't know as much about the other acquisitions, but they have all been strategic in nature. With eps, for instance, I think they only kept two parts of the buisness--they were really trying to buy a salesforce in Germany and France.
FY07 results were also impacted by the host of non-recurring items as mentioned above. The stock options review ended up costing over 11MM when you factor in the cost of settling employee stock options that were going to expire in FY07 but that employees couldn't exercise due to the review. The company also incurred significant start-up costs in Romania and Ireland.
So FY07 was a bad combination--they gave up a lot of high-calorie license revenue and added a lot of non-recurring costs. FY08 won't have the same non-recurring costs that FY07 had, but it will have a lot of upfront investment in the IBM alliance and possibly more sales commissions like we saw in the December 2007 quarter. It remains to be seen how high expenses will be in 2008, but I have taken the December quarter as a guide and assumed that they'll reamin high for all of FY08.
Lastly, I would be reluctant to think about the large UK and ME deals they way that you have suggested. The reality is that ACIW has a lumpy business with some large deals and we seldom have visibility into the details. The reason they brought these deals up in the September and December calls was because their slippage had major ramifications relative to FY07 guidance. I draw some comfort from the fact that 1H08 comes pre-loaded with some solid revenue, but I'm not sure that it's a good idea to treat it as incremental because we don't have visibility into the other large deals.
Hope that helps.
|Entry||04/03/2008 09:33 PM|
|Congrats. Any updated thoughts given the run-up? Stock no longer looks nearly as cheap as it was.|
|Subject||RE: excellent call|
|Entry||04/08/2008 09:00 AM|
|Thanks for the compliment, though I want to caution you that I think we're still early in this recovery. The stock might still be vulnerable to another downdraft given the distance to the catalyst (5 quarters) and the potential that the market could get "pissy" again. I'd be surprised if the stock swooned past $18.00, but you never know--five months ago, I thought we had hit the bottom at $22.00. |
Notwithstanding this disclaimer, I still think that ACIW is still going to be a big winner from here and the risk of a permanent capital loss is low. It is always harder to buy more of something after it has returned from the "pit of despair", but this one is still an extremely attractive risk reward if you can hold it for a few years.
|Subject||RE: RE: excellent call|
|Entry||04/08/2008 07:40 PM|
|Take a look at Mastercard's recent announcement on its new debit processing platform called Integrated Processing Solutions (IPS)... For background, I would refer you to the note Bear Stearns put out today on MA... great job walking through on the merits of the IPS platform... and it helps frame the challenges that legacy systems face... |
to quote the Bear note "IPS is a direct replacement of the services provided through e-funds when MasterCard had a contract w/ e-funds"
The next question to ask is, whose software did MasterCard use? Visa's US debit platform runs on Base24.
|Subject||Recent Qtrly earnings|
|Entry||05/15/2008 06:57 PM|
|Thank you for the well-researched writeup. Very interesting idea. Are you still as constructive on the stock given the recent decline and its earnings miss. The story still seems intact to me. Thanks.|
|Subject||RE: Recent Qtrly earnings|
|Entry||05/16/2008 10:10 AM|
|Yes, the story is still in tact, and I'm still constructive on the stock. The analyst day that they held a month or two ago was very helpful and clarified a number of issues, such as how the IBM reimbursements work and affect FCF vs. GAPP results. |
Here is a copy of the e-mail / report that I sent to my PM about the 1Q08 CC:
Financially, ACIW delivered a weak 1Q08, with revenue growth of 2.9% (2.1% organic), and a major EPS decline. ACIW's GAAP results are being challenged by a host of issues, but there are two headwinds that stand out. The first is incremental expenses ACIW is incurring as they begin to implement the record number of contracts they signed in 2007. GAAP requires that such costs be expensed up front and revenues be deferred until the projects are completed. (Some cash is collected during the implementation period in order to cover some of ACIW's cash costs.) This doesn't bother me because it's a harbinger of strong license revenue in the future. The second headwind was incremental expense and attention devoted to the IBM agreement. While much of this cost is being offset by cash receipts from IBM, ACIW is still left with incremental expenses. While this relationship is requiring a lot of investment in 2008 and 2009, I expect it to deliver significant benefits in late 2009 and beyond.
1Q08's higher expenses were also coupled with lighter revenue and bookings. (ACIW's revenue and bookings are lumpy.) Bookings were weak as the company came off of a record December 2008 quarter and the sales force diverted their attention to joint opportunities with IBM. Bookings and revenue should both improve in 2Q08. In May, ACIW signed a very large contract with a network switch in Spain, which will help 2Q08 bookings. On the revenue front, ACIW should benefit from a number of projects which should go live around 2Q08 including a major project with Mastercard, and 25MM of other large projects that were originally expected to go live by YE07.
Notwithstanding these short term results, the company is making tremendous progress operationally and strategically. It still looks like GAAP results could snap back in 2H09. On the call, management noted that their deferred revenue growth is decelerating and the mix of deferred revenue is shifting towards current deferred revenue. This suggests that projects are starting to enter the 12 month window. (For several quarters, projects kept piling up in the 5 year backlog without any indication of when they'd begin to roll into GAAP results.) So while we're still in the vortex, and near term results are darn hard to forecast / model, the company still appears to be headed in the right direction. I was also encouraged to see that they repurchased 4.6% of their diluted shares out during 1Q08 at an average price of $18.33.
I think that the stock has sold off because it had gotten ahead of itself after such a strong December 2007 quarter. After seeing good booking and revenue growth in December, people forgot that this is a lumpy business, and that we're still just 5 quarters through a 10 quarter transition period.
|Entry||05/16/2008 03:21 PM|
|Thanks for a very interesting idea. I recall you citing some of your 2009/2010 projections somewhere in this chain... what level of sales were you assuming in 2010 in your projections? The reason why I ask is that I'm trying to think through what ACI's ultimate sales opportunity is over the next three years. The most tangible driver in my mind is selling into IBM's base of banks that are currently on homegrown systems. I understand that represents another 400 or so banks, so would the theoretical opportunity be to double their existing BASE24/BASE24eps customer base? Curious to hear how you thought through this as you built your projections.|
|Subject||RE: Market Opportunity|
|Entry||05/22/2008 11:26 AM|
|The revenue estimate for 2010 is 480-494MM. (I run two scenarios.) I recently spoke with the company, however, and got more clairity into the cadence of the revenue recovery. I won't, however, be updating my estimates until after the 2Q08 CC.|
The issues that I think about when forecasting the top line are:
1) The timing with which license renewals come back.
2) The timing of when large projects underway reach completion.
3) The timing of when new orders signed with IBM reach completion.
4) The migration of legacy customers to BASE24eps, which will result in significant service revenues and probably a bit of license revenue.
Yes, there is the opportunity to double the size of this company and the IBM relationship has dramatically improved the odds of realizing that.
Here is a copy of an e-mail that I sent to a friend of mine (cbubba, actually) that details my conversation with the company:
I spoke with ACIW briefly on Friday to discuss the cadence of their revenue recovery.
The first item of interest is the cessation of "puffing," or heavily discounting multi-year contracts to get clients to renew early. A basic example would be offering a customer a 35-40% discount on a five year contract if they'd renew two years early and pay everything up front. GAAP accounting allowed such renewals to be recognized all at once, and since it was license revenue, it dropped straight to the bottom line. Phil Heasley banned this behavior, and the last puff was in 3Q06. Management indicated that it would take 8-10 quarters before the renewal revenue began to flow again (since ACIW had been renewing 3 years into 5 year contracts), which suggested that this revenue would start to return in late 2008 or early 2009. This time table still sounds realistic--and what I like about it is that it's so visible: the contracts are going to expire and the customers will have to renew.
But returning to a "natural" renewal cycle is less simplistic than I had previously thought. Consider the following example of a 5 Yr, 5MM contract that management had been in the habit of renewing every 3 years at a 40% discount. Under this meathodology, they'd get 3MM of revenue in Years 1, 4, and 7 of the relationship.
Now let's assume that Phil Heasley comes in in year 4 and says, "No more Puffing. No More Heavy Discounting. I'd rather them pay ratably over the life of a contract than give them a discount for receiving the payment up front." Given this change, revenue would be 3MM in Year 1 (Phil wasn't around in Year 1), and then 1MM every year beginning in Year 6.
So you can see that Phil creates a revenue "hole" in Year 4 when revenue would have normally occurred, AND when it comes back, it comes back in a smaller amount but as an annuity type flow. ACIW has a whole portfolio of these, of course, so the "hole" actually spans years 4 and 5, which in the real world corresponds to late 2006 through late 2008. The drop off in 2007 was to the tune of 17.8MM. The way that this rolls back in won't be as simple as what I've shown above because ACIW may not be able to get all of the way back to full price on the first renewal ("Oh by the way, your renewal will be 67% more expensive this time.") and because some customers prefer to pay it all up front due to budgeting or other reasons.
ACIW told me, however, that the bigger drag on their revenue has been that they have sold so much more product that needs to be installed and takes a long time to install--versus selling renewals or "pots and pans" (i.e. add on modules) that are easy to add on to existing installations (both of those become revenue quickly). In 2007, 70% of their orders were from new clients where the solutions have to be installed (and it will be about 80% in 2008). I don't have great data on this, but the indications are that ACIW's new signings started to really take off in 2007. They were winning new installations in 2006, but 2007 was a banner year from a new order standpoint. Since most of these need to be installed and will take 18-24 months to do so, this implies that these will start to convert to GAAP revenue in 2009. Again, I derive comfort from the visibility of these revenues. Unless a client wants to pull the plug and start over, they're going to finish the implementations, so it is just a matter of when revenue occurs, not if. (And I think it is very unlikely that anyone who signed on with ACIW will abort the implementation and go back to the drawing board--it's too time consuming, there aren't that many good options anyway (think Advent Axys), and they may have a regulatory deadline they're trying to meet.)
I don't plan on updating my projections until after the next call, but thought that you might be interested in how these pieces seem to be lining up.
|Subject||RE: RE: Market Opportunity|
|Entry||05/22/2008 11:38 AM|
Do you have a sense of absolute dollar values of 2005-2007 sales? I cannot find these numbers, just the March 2007 quarter ($125m sales), December 2007 quarter ($132m sales), and March 2008 quarter ($64m sales) that were reported for, I think, the first time in the most recent release.
Thanks for the continued updates.
|Subject||RE: RE: RE: Market Opportunity|
|Entry||05/22/2008 02:57 PM|
I don't know what their "sales" (what most people would call "orders") were for the 2005 to 2007 period. As you suggest, this isn't a figure that they have given out routinely in the past (or at least not that I'm aware of). Unfortunately, I don't think it would be possible to back into it through revenue and backlog because some of their orders in the past have been renewals or "pots and pans"--things that would turn too quickly to be captured in the backlog figure.
|Entry||08/24/2009 07:53 AM|
ITumnus, wonder if you're still involved and, if so, can provide a quick update. Thanks in advance.
|Subject||RE: SONE Acquisition|
|Entry||09/01/2011 02:16 PM|
Let's start with the simple question about ACIW's valuation without S1. By way of background, ACIW was a super-show-me stock for a few years, and I wrote my original write up at the beginning of that period. We exited this chapter about a year ago as management's long-standing claims were validated, and the Sell-Side has since shown a remarkable turn around in their apparent understanding and attitude towards the company. (I've sometimes been surprised on the earnings calls as developments that have been underway for years are treated like they're new.) Anyway, sentiment has really changed. Furthuremore, things are coming together much better than I had expected as:
1) ACIW's core products such as Base 24-eps have had plenty of time in the market now, builing track records, referencable accounts, running on IBM Mainframes, etc.
2) ACIW's bidding and implementation processes have been greatly improved so they can more effectively bid and execute projects. This used to be a big weakness and an impediment to profitable growth.
3) ACIW's go-to-market strategy has been greatly improved and is more consistent with what clients can absorb. Instead of offering a single big package for a forklift upgrade, they've broken the system down into pieces. So you can start with one componet, and purchase only that componet if you want, but the adjacent componets are already integrated so one componet provides a natural path towards gradually upgrading the entire system.
4) Most importantly, the Durbin Amendment is dramatically reducing interchange fees and thus the profitability of transaction processing. This should motivate banks to finally consolidate or replace their antiquated legacy systems in order to lower the costs structures of these divisions and preserve some of the profits that the Durb is taking away. This might represent a huge, albeit slowly moving upgrade cycle.
These things are all coming together at the same time, so the company should be very well positioned. It's one of those situations that feels like it could turn out better than I'm forecasting, but I'm modeling for FCF to range between $2.16-$2.34 by 2013 and to range between $2.61-$2.98 by 2015. So the returns should be very good over that time frame because I think you could use multiples ranging from 16-18x, and the cash balance should be building nicely. I'm expecting FCF of $1.75 and $2.09 in 2011 and 2012, respectively which yields Net P/FCF multiples of 15.0 and 12.8x, respectively (at a $29.37 stock price). Anyway, it's at a good price, though the same could be said for most of my stocks right now.
With respect to SONE, I've been following the situation, but I'm still coming up to speed. (I got sacked by a lot of travel as well as a move during earnings season.) The reasons given in the press release for the acquisition sound good; there appear to be a lot of ways for ACIW to win. And I'm amazed that SONE's board is rejecting the offer as this would seemingly expose them to considerable legal liability. Unfortunately, ACIW's prior acquisitions (S2, P&H, EPS) were made around the 2006-2008 period which was a time of great upheaval in other parts of the business. Consequently, we don't really know how successful they were, though the strategic rationals for each were good going into the deals. Phil Heasley and his team took on a ton of heavy lifting in the 2006-2009 period, and I think they did a great job persevering through their show-me chapter and "getting it done", so I lean towards trusting them in this situation.
|Entry||09/19/2012 03:51 PM|
Anyone following ACIW now? Further thoughts on S1?
ACIW's organic growth was negative last quarter. Growth has slowed markedly. Organic backlog is down y/y.
Cash flow from ops in the last six months was weak. It was down y/y even adjusting for the one-time S1 acquisition integration costs.
A lot of the decline in cash flow is due to the big climb in DSOs, which is especially interesting in light of the slowing growth.
ACIW generated about $60m of FCF in 2011 and 2010. Of course last year's cash flow doesn't include S1 or anticipated cost savings. S1 had around $34m in FCF in 2011 (I'm making some estimates here, but close enough) so it should/will add cash flow, but it hasn't yet (unless ACIW's cash flow dropped a huge amount and S1 is making up for it). Adding in management's $50m of "cost synergy benefits by 2013" and we get $60+$34+$50m = $143m for the combined company in 2013. You might be able to add growth on that. $1,670 market cap / $143 is 12x 2013 cash flow. What do you guys think, can they do that FCF or better in 2013? Am I way off? What are "cost synergy benefits" anyway; in plain english, cost reductions?
I don't know the space very well....so sorry if this is a dumb question, but do Verifone's recent issues portend anything for ACIW?
IBM is going to exercise their warrants. Does this imply anything? Do we know if they are going to sell the stock? Does it mean anything that ACIW terminated its IT outsourcing agreement with IBM in April?
|Subject||RE: Online Resources|
|Entry||02/25/2013 09:46 PM|
I'm still getting my arms around this transaction, but I'll do my best.
It seems pretty clear that ACIW is primarily attracted to ORCC's end-to-end electronic bill payment and presentment network that connects individuals to >9,000 billers and facilitates low cost bill payment. Based on the call, ACIW's large bank customers are keenly interested in improving bill payment effeciency, and ACIW intends to use this infrastructure to drive down bill payment costs. It will fill a hole in their product line and their long-term plan appears to be to offer customers a lower cost bill pay solution and improve penetration. (I'm not 100% clear on how the mechanics of this type of electronic bill payment differ from conventional online bill payment, but this biller-centric electronic bill payment appears to be an underpenetrated niche, and ORCC's division in this area was growing much faster than the overall industry.)
ORCC's hosted online-banking division that targets smaller banks and credit unions is clearly a less attractive division, but combining it with SONE's community banking division should be extremely accretive since these businesses do the same thing and can share a single hosting infrastructure. Doubling SONE's community banking division's size will also improve its competitive positioning.
I find the multiple to be very attractive--an EV / EBITDA of 5x after currently known synergies. And that multiple is likely to fall lower after ACIW identifies additional synergies like they did with SONE. (Also, there's 80MM of NOL's to boot.)
So my take is that 1/2 of this transaction is "not so hot," but they're not paying much and the other half will create attractive cross selling opportunities in a high growth area. It basically looks like a take-under to get technology that they need and a network that would be time consuming and expensive to recreate.