|Shares Out. (in M):||0||P/E|
|Market Cap (in $M):||238||P/FCF|
|Net Debt (in $M):||0||EBIT||0||0|
Growth investors have piled out of Actuate, leaving this cash-rich
enterprise software company trading at an EBIT/EV yield of over 16%, and
EV/EBITDA of 5.7X. My conservative target is $6.50/share.
Why is it down so much!—Nearly a 2-year low!
The stock has gotten hammered because about 40% of their revenue comes from financial service customers and there is general softness in enterprise software sales. Furthermore management gave disappointing 2008 guidance. Instead of guiding for EPS growth in 2008, the company guided for flat earnings. They did this because they have exposure to the US financial services sector where IT spending is being delayed.
Why is it not as bad as it looks:
While there is definitely softness in their market, this is a temporary situation because Actuate’s products are essential for their customers. Furthermore, Actuate has increased its addressable market tenfold through its open source strategy, and has introduced several new products to augment growth. A prolonged delay in new customer orders is mitigated by recurring and growing maintenance/service revenues which account for about 58% of Gross Profit. Furthermore, management has demonstrated in the past that they are able to improve profitability in a soft environment.
What’s it worth:
I believe that Actuate is worth conservatively $6.50/share representing a 67% return, and could be worth as much as $9/share in a takeout by a strategic buyer who can leverage cost and sales synergies.
Brief Description of Actuate’s Business
Actuate provides software and services that enable its customers to bring interactive content to its customers, employees and partners. The software space that they are referred to is Business Intelligence. Applications built on Actuate’s open source-based platform provide all users inside and outside the firewall, including employees, customers and partners with information that they can easily access and understand to maximize revenue, cut costs, improve customer satisfaction, streamline operations, create competitive advantage and make better decisions. In other words, Actuate’s products enable an employee, partner or customer of a company to view and create reports that draw information from various sources into a web-based application.
For companies with significant customer, transactional and operational information, Actuate’s products help deliver this data to the most appropriate users, such as employees, management, business partners and customers, in the most efficient manner. Actuate’s reporting platform enable customers like American Express to provide a portal for customers to access account information online.
There are many customer examples on Actuate’s website but here are a few that give you a sense of what their customers use them for:
Huge Open Source Opportunity
Actuate has grown earnings in slowdowns before
Management does a great job in maintaining or growing earnings in tough operating environments. They are able to do this because maintenance/services is a steady growing business and they are able to cut sales and marketing costs fairly easily. In 2004 software license sales dropped 18%, but was mitigated by an 11% growth in maintenance/services. Despite this, Actuate was able to grow adjusted EBIT by 33% in 2004. Again in 2005, license sales dropped 13.5% while maintenance/services grew 12%. Despite, this environment, the company grew adjusted EBIT by 157%. This was followed by 30% growth in 2006 and 48% in 2007. Fortunately, management has been able to get ahead of the curve on softness in their business and they should be able to do the same in the current environment.
The Maintenance/Service Business is Steady and Growing
The nature of Actuate's business model is that they sell a perpetual software license which is lumpy in nature and then sell essential maintenance and services relating to the license indefinitely into the future. Since the software is mission critical, renewals of maintenance is high, and it essentially becomes an annuity stream that keeps compounding. Margins are excellent in this revenue stream because it doesn't require too much sales, marketing or R&D. The recurring nature of this business provides really good stability and is an important valuation metric to a would-be acquirer. Here is the impressive years of growth and earnings in this side of the business:
CEO and CFO Buying/Company Buyback
Over the past 6 months and as early February the CEO bought 37,000 shares at an average cost of $5.78. The CFO bought 130,000 shares at an average price of $5.47. The company also has been buying back stock regularly and will continue to be aggressive at these levels.
The best way to analyze Actuate's financial statements is on a proforma basis particularly since they expense stock options and the expense number can fluctuate. Stock compensation expense is NON-CASH but I do take options into consideration when I calculate Enterprise ValueI also exclude certain non-cash charges to focus on the cash earnings power of the business.
|Sales and Marketing||55.3||50|
|Amort of Intang.||1|
|Amort of Intangibles||1.5||1.5|
|Duplicate Rent Exp.||.7|
|Stock Comp Exp||9||9|
The company has a boatload of stock options which quite frankly I am not all too excited about because it complicates analysis and dilutes everyone. On the flip side, these options are a healthy incentive to get the stock price up.
|Options Outstanding (including non-exercisable)||18.1|
|Market Cap after all options exercised||308|
|Cash on Balance Sheet||68.4|
|Cash from all Options Exercised||64.8|
|Adjusted Enterprise Value||175|
I like to value the company based on how an acquirer would look at it which is why I take into consideration all the options getting exercised and thus included in share count. In addition, there is about 15-20mm in sales marketing/overhead that could be taken out by a strategic buyer should that occur. My target on the stock assumes that it should trade at an EBIT/EV yield at about 9.5% which is somewhere comparable enterprise software companies are (INFA, COGN acquired by IBM, and SPSS). Software companies are also valued on an EV to sales, and EV to maintenance revenues but I'd rather focus on earnings (But if you put an EV/Sales multiple on Actuate it would be considerably higher than my target price).
Speaking of Cash, I am modeling that they bring in about 25mm in free cash flow in 2008, which is higher than 2007 due to a high receivable balance in December that was collected. With an adjust EV of $175mm, this is how the valuation looks based on 2007, 2008, 2009.
|Target EBIT/EV Yield||9.5%|
|Cash on Balance Sheet plus Option Cash||133|
|Total Market Cap||523|
|Target Price (Market Cap/FDS)||523/79.5= $6.58/share|