BroadVision, Inc. BVSN
March 27, 2008 - 10:37am EST by
sea946
2008 2009
Price: 1.10 EPS
Shares Out. (in M): 0 P/E
Market Cap (in $M): 123 P/FCF
Net Debt (in $M): 0 EBIT 0 0
TEV ($): 0 TEV/EBIT

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Description

BroadVision shares are once again dirt cheap, offering strong downside protection and compelling upside. Even if one adopts an unreasonably pessimistic outlook, it is hard to see how shareholders buying at this price suffer permanent impairment of capital.

BroadVision has a market value of $123 million ($1.10 per share times 112 million shares outstanding). If $44 million of $54 million in net cash is considered excess cash, enterprise value is $79 million. Assuming an enterprise fair value multiple of ten times interest-adjusted net income, the current trading level implies an income expectation of $8 million in 2008.
 
Several arguments can be made for why a multiple of ten times is low for BroadVision, including (i) high returns on capital employed in the business; (ii) large and growing market opportunity; (iii) global business, with nearly 40% of revenue coming from Europe and Asia; (iv) recent release of upgraded version of core software products; (v) recent launch of new web-based product in China; (vi) strong balance sheet; and (vii) alignment of interests through large stock ownership by the founder and CEO.
 
Rather than discussing the multiple of earnings that might be appropriate, however, I want to focus on the likely level of earnings going forward. Specifically, I want to show why an implied expectation of $8 million in after-tax income (excluding interest income) is simply too low.
 
Note that in order to earn $8 million of interest-adjusted after-tax income, BroadVision needs to earn $8 million of EBIT. The company does not pay taxes and is unlikely to do so for a long time. BroadVision has a usable NOL of more than $700 million, expiring through 2022. The NOL easily exceeds the earnings BroadVision will generate from current operations over the next fifteen years. One could perhaps even argue that the large NOL makes BroadVision’s substantial cash balance worth more than “par,” as the company could acquire profitable businesses and use the NOL to shield income. (The company has so far not stated a desire to make acquisitions.)
 
BroadVision earned GAAP EBIT of $15 million in 2006 and $16 million in 2007. Pro forma EBIT, as calculated by the company, was $13 million in 2006 and $18 million in 2007. While BroadVision has stated an intention to expand the sales team and increase marketing spending to boost sales of its new software product suite (BroadVision 8.1), neither the announced S&M expansion nor a potential slowdown in IT spending support an expectation of a 50% drop in operating income during 2008. Perhaps “the market” knows something about the very short term, and given the recent price action of BroadVision stock, I would be surprised if the March quarter does not come in weak. However, even if some funds have correctly “sniffed out” recent weakness, nobody can accurately predict how the rest of the year will evolve. In the following two sections, I make some (hopefully) rational assumptions in an attempt to analyze how EBIT might be impacted by factors such as potential revenue performance and the anticipated increase in S&M expenses. The conclusion is that, while the market may have thrown in the towel on BroadVision, the underlying revenue dynamics are quite favorable -- and therefore likely to yield positive surprises for shareholders as the year unfolds.
 
Revenue Dynamics: On The Cusp Of Renewed Growth?
 
One of the reasons BroadVision shares have pulled back more than 75% from their 52-week high may be the fact that the company failed to achieve revenue growth in 2007, with revenue declining 4%. What seems to be missed is that growth was stunted by declining service revenue, primarily a reflection of past declines in license revenue. BroadVision had an unbalanced license/service revenue mix of 29%/71% in 2006. Service revenue declined 21% in 2007, while license revenue grew 39%, resulting in a healthier license/service revenue mix of 42%/58%.
 
Revenue, Growth, And Mix, 2000-2007:
 
2000
2001
2002
2003
2004
2005
2006
2007
Revenue ($mn)
 
 
 
 
 
 
 
 
License
251
101
40
30
27
15
15
21
Service
165
147
75
58
51
45
37
29
   Total
415
248
116
88
78
60
52
50
Revenue Growth
 
 
 
 
 
 
 
 
License
233%
-60%
-60%
-25%
-11%
-45%
3%
39%
Service
310%
-11%
-49%
-23%
-12%
-11%
-19%
-21%
   Total
260%
-40%
-53%
-24%
-11%
-23%
-14%
-4%
Revenue Mix
 
 
 
 
 
 
 
 
License
60%
41%
35%
34%
34%
24%
29%
42%
Service
40%
59%
65%
66%
66%
76%
71%
58%
 
Three Potential Scenarios For Revenue Growth
 
Scenario One. If license and service revenue simply continued their 2007 trend (up 39% and down 21%, respectively), overall revenue would grow 4% in 2008 and 13% in 2009. Here is the hypothetical breakdown of revenue assuming a continuation of recent trends:
 
Hypothetical Revenue Performance In 2008 And 2009 (“Scenario One”)
 
2002
2003
2004
2005
2006
2007
'08E
'09E
Revenue ($mn)
 
 
 
 
 
 
 
 
License
40
30
27
15
15
21
29
41
Service
75
58
51
45
37
29
23
18
   Total
116
88
78
60
52
50
52
59
Revenue Growth
 
 
 
 
 
 
 
 
License
-60%
-25%
-11%
-45%
3%
39%
39%
39%
Service
-49%
-23%
-12%
-11%
-19%
-21%
-21%
-21%
   Total
-53%
-24%
-11%
-23%
-14%
-4%
4%
13%
Revenue Mix
 
 
 
 
 
 
 
 
License
35%
34%
34%
24%
29%
42%
56%
70%
Service
65%
66%
66%
76%
71%
58%
44%
30%
 
While license revenue growth of 39% appears aggressive, note that license revenue remains well below levels reached earlier in the decade. Meanwhile, the addressable market for BroadVision software has likely grown. In addition, BroadVision achieved 39% growth in 2007 while selling the previous version of its software (BroadVision 8.1 was not released until the beginning of Q4). Finally, the company operated with a small sales team in 2007 and expects to hire additional salespeople to market BroadVision 8.1. It therefore seems conceivable that the company could maintain or even exceed recent growth rates in license revenue.
 
As for service revenue, the company notes in a recent 10-K that the “most significant change was the year-over-year decline in consulting revenues, which was because our customers purchased existing versions of our products. However, on a more positive note, we released new version of our product in the second half of 2007.” The 10-K also states that “consulting projects tend to trail license revenues between six to twelve months.” Given these factors and the fact that license revenue has resumed strong growth over the past several quarters, it appears likely service revenue will at least stabilize in the near future.
 
Scenario Two. If recent license revenue growth continued and service revenue stabilized, overall revenue would grow 16% in 2008 and 20% in 2009. The following table shows this scenario:
 
Hypothetical Revenue Performance In 2008 And 2009 (“Scenario Two”)
 
2002
2003
2004
2005
2006
2007
'08E
'09E
Revenue ($mn)
 
 
 
 
 
 
 
 
License
40
30
27
15
15
21
29
41
Service
75
58
51
45
37
29
29
29
   Total
116
88
78
60
52
50
58
70
Revenue Growth
 
 
 
 
 
 
 
 
License
-60%
-25%
-11%
-45%
3%
39%
39%
39%
Service
-49%
-23%
-12%
-11%
-19%
-21%
0%
0%
   Total
-53%
-24%
-11%
-23%
-14%
-4%
16%
20%
Revenue Mix
 
 
 
 
 
 
 
 
License
35%
34%
34%
24%
29%
42%
50%
59%
Service
65%
66%
66%
76%
71%
58%
50%
41%
 
Scenario Three. As a final top-line scenario, assume that license revenue grows not 39% but 17%, the rate achieved in Q4, while service revenue stays flat. As the following table shows, the resulting growth in total revenue would equal 7% in 2008 and 8% in 2009:
 
Hypothetical Revenue Performance In 2008 And 2009 (“Scenario Three”)
 
2002
2003
2004
2005
2006
2007
'08E
'09E
Revenue ($mn)
 
 
 
 
 
 
 
 
License
40
30
27
15
15
21
25
29
Service
75
58
51
45
37
29
29
29
   Total
116
88
78
60
52
50
54
58
Revenue Growth
 
 
 
 
 
 
 
 
License
-60%
-25%
-11%
-45%
3%
39%
17%
17%
Service
-49%
-23%
-12%
-11%
-19%
-21%
0%
0%
   Total
-53%
-24%
-11%
-23%
-14%
-4%
7%
8%
Revenue Mix
 
 
 
 
 
 
 
 
License
35%
34%
34%
24%
29%
42%
46%
50%
Service
65%
66%
66%
76%
71%
58%
54%
50%
 
While it’s impossible to accurately predict BroadVision’s revenue growth in 2008 and 2009, the above analysis suggests that after seven years of declining revenue, we may be on the cusp of a trend reversal.
 
Changing Revenue Mix Bodes Well For Gross Margin
 
The increasing proportion of license revenue within the overall mix implies that gross profit dollars may grow faster than revenue dollars. In fact, the company grew gross profit by $2 million in 2007, even as revenue fell by $2 million. The following table shows gross profit in 2008 and 2009 under each of the three revenue scenarios above. The table assumes that profit margins for license and service revenue will equal the margin levels reported in 2007.
 
 
Scenario One
Scenario Two
Scenario Three
 
'08E
'09E
'08E
'09E
'08E
'09E
Gross Margin
 
 
 
 
 
 
License
100%
100%
100%
100%
100%
100%
Service
69%
69%
69%
69%
69%
69%
Gross Profit ($mn)
 
 
 
 
 
 
License
29
41
29
41
25
29
Service
16
12
20
20
20
20
   Total
45
53
49
61
45
49
Incremental GP vs 2007
$4mn
$12mn
$8mn
$20mn
$4mn
$8mn
 
As the table shows, BroadVision could generate incremental gross profit of $4-$8 million in 2008 and $8-$20 million in 2009 (increases for both years are measured against the level of gross profit earned in 2007). Alternatively, if we assume a decline in service gross margins from 69% in 2007 to 60% in 2008 and 2009 due to a higher ratio of consulting to maintenance, incremental gross margin would amount to $1-$6 million in 2008 and $5-$17 million in 2009.
 
Let’s assume that BroadVision maintains research and development expenses at $10 million and general and administrative expenses at $6 million in each of 2008 and 2009. This assumption may not be far-fetched, because even if G&A creeps up, R&D could decline somewhat due to recent new product releases. With sales and marketing expenses amounting to $8 million in 2007, BroadVision could use the incremental gross profit dollars shown in the above table to boost S&M expenses by 50%-100% in 2008 and 100%-250% in 2009 (versus the 2007 level) while keeping EBIT constant. Even if service gross margin dropped to 60% in 2008 and 2009, the company could generate incremental gross profit dollars sufficient to boost S&M by 12%-70% in 2008 and 60%-210% in 2009 while keeping EBIT unchanged from 2007.
 
Confusion Regarding Outlook May Stem From Q4 Earnings Call
 
Investors may have irrationally judged the downside scenario for 2008 (i.e., EBIT down 50% or more) to be the likely scenario, partly because the company lacked clarity in the outlook it provided on the Q4 2007 earnings call (available in the investor relations section of www.broadvision.com, or directly at http://www.broadvision.com/attachment/downloads/videos/Q4-2007-Earnings.wav). Due to the uncertainties involved in the ongoing turnaround and the general lumpiness of revenue, BroadVision has had a policy of not providing earnings guidance.
 
The company did share some thoughts on the margin outlook for 2008, and this is where it may have confused investors. Management talked about boosting spending on marketing programs (excluding personnel) from under 2% of revenue in 2007 to 4%-5% of revenue or more in 2008. The company also stated it would accept meaningfully lower profit margins (15%-20% operating margin) as it invests in S&M and generates higher consulting services revenue (which would lower gross margin). CEO Chen later seemed to backtrack a bit, indicating that the outlook for operating margins in a range of 15%-20% might depend on positive revenue growth. If revenue failed to grow as expected, operating expenses might grow less than planned. Specifically, Chen stated in response to a question regarding operating expenses in 2008, “If you look at our ’07 as a baseline, I think we are relatively in line with that right now. So take that as a baseline… and then we believe that if our revenue is doing very well, we then would use the 15%-20% margin as the target to slide up or down with that. That’s kind of how we think we’ll be able to manage this… with a pretty healthy bottom line, but be able to really give our business that jolt, that extra investment that will be required.”
 
While no one can reliably predict BroadVision’s operating income in 2008, the revenue and gross profit dynamics discussed earlier suggest that the company will have quite a bit of room to maneuver on operating expenses as revenue likely grows in 2008 and gross margin stays strong due to continued growth in licenses. Certainly, management could choose to spend so much on sales and marketing that operating profit declines to $8 million or even lower. However, with management having executed the turnaround fairly well so far, and with 38 cents of every operating expense dollar indirectly coming from the CEO’s pocket, it appears unlikely that management will suddenly abandon its commitment to profitability and free cash flow.
 
History Provides Context To Management’s Focus On Profitability And The Desire To Resume Revenue Growth
 
BroadVision was a “dot com” highflier that made founder and CEO Pehong Chen #167 on the Forbes 400 list eight years ago, ahead of Ron Burkle, Donald Trump, and Henry Kravis. Based in Redwood City, Calif., BroadVision employs 195 people (+23% y-y) and sells software that helps companies run transaction-intensive websites featuring sophisticated personalization and customer service functionality. It has a blue chip global client list, including Baker Hughes, Citibank, Epson, Fiat, Hilti, Iberia, ING, Prime Polymer, Renault, Sony, Vodafone, and Xerox (close to 40% of revenue comes from Europe and Asia). Pehong Chen still runs the company and owns 38% of shares. Palo Alto Investors owns 14% and appears to have increased its position over the past year.
 
As a major provider of software to run large websites, BroadVision became one of the most prominent Internet infrastructure firms in the late 1990s, reaching a peak market value of more than $25 billion. Then the bottom fell out (demand from dot coms evaporated), and the painful six-year slide began (2001-2006). BroadVision shares fell from a high of $800 to under $1 as the company posted steep revenue declines, took asset write-offs, incurred restructuring charges, worked to eliminate large liabilities such as office leases, and saw shareholders’ equity turn negative.
 
BroadVision’s incredible fall from grace came with a worthwhile lesson: Striving to meet the sometimes capricious demands of Wall Street, such as the imperative of growth at any price in the late 1990s, may not always coincide with the long-term interest of shareholders. CEO Chen learned the hard way that survival and prosperity could be assured only through sustained profitability. In 2006, Chen saved the company by cost-cutting his way to profitability, stabilizing license revenue, and personally investing millions of dollars to buy out and retire debt (later converted into equity, followed by a rights offering). In 2007, BroadVision experienced a major positive inflection point in license revenue, aided by renewed client confidence in the company’s financial position and product roadmap.
 
Valuation Limits Downside, Allows for Significant Upside
 
As discussed above, I conservatively calculate a “market expectation” of $8 million in EBIT embedded in BroadVision’s current stock price. Also as presented, it appears likely that EBIT will come in substantially higher than $8 million. In fact, if revenue growth materializes, EBIT may not decline much from 2007. In an aggressive but not impossible scenario, EBIT may stay flat or even increase in 2008, assuming that existing and new clients quickly embrace the company’s new product lineup. Meanwhile, it is exceedingly difficult to conceive a scenario in which profitability completely evaporates. Therefore, if fundamentals evolve worse than expected, i.e., EBIT declines by 50%, BroadVision’s stock price may simply remain unchanged. On the other hand, the upside remains impressive, driven both by the potential for strong revenue and income growth over the next several years, as well as the potential for significant revaluation of the multiple investors are willing to pay for the company.
 
Key Risks And Concerns
 
Potential drop in EBIT. Clearly, “the market” expects BroadVision’s operating income to plunge in 2008. In addition to the EBIT analysis presented above, I believe it is important to note that an operating income drop would not represent an adverse exogenous event, such as product obsolescence or the loss of a major client. Rather, an EBIT drop would reflect a strategic choice by management to invest in the business to maximize net present value for shareholders. With CEO Pehong Chen (i) owning 38% of the company and (ii) having taken BroadVision to the pinnacle of the Internet software world once before, I am quite comfortable with management’s choice to reignite top-line growth. An alternative but likely inferior choice would be to continue maximizing EBIT while keeping revenue fairly constant. If management wanted to run the business strictly for cash, the company could curtail R&D expenses, thereby saving up to another $10 million per year. Having released an upgraded product lineup, BroadVision could keep revenue constant, or even growing slightly, while earning EBIT of more than $20 million per year (assuming some curtailment of R&D). At that rate, the entire market cap would be in cash in just three years.
 
Competition from larger competitors. BroadVision competes against a number of companies that may have greater resources and deeper customer relationships, including Art Technology Group, BEA Systems (Oracle), IBM, and Vignette. However, BroadVision has been able to maintain its client roster even as it has gone through financial distress. Now that the company can go to existing and prospective clients with a new product lineup and a strong balance sheet, the selling proposition has improved.
 
Impact of recession. The company has clients across a wide range of industries, including financial services (filings do not break out revenue by industry). A prolonged recession would certainly impact BroadVision’s ability to achieve meaningful revenue growth. However, whether the company succeeds or not may depend less on the economic environment than on its ability to execute. As CEO Chen noted on the Q4 2007 earnings call, “Being small in our footprint right now, we are operating under a law of small numbers. We ought to be able to handle what we need to handle despite the macro conditions.”
 
Catalysts
  • Continued strong free cash flow generation
  • Growth of overall revenue, not just license revenue
  • Partial reversal of valuation allowance for deferred tax assets
  • Move to Nasdaq over next 12-18 months
 
Disclaimer
This is not a solicitation to buy or sell stocks. Please do your own independent analysis before buying or selling BVSN (or any other stock). We have a long position in BVSN at the time of this write-up that can change at any time without notice. There are no plans to provide future updates on our BVSN buying or selling activities.

Catalyst

(1) Continued strong free cash flow generation;
(2) Growth of overall revenue, not just license revenue;
(3) Partial reversal of valuation allowance for deferred tax assets;
(4) Move to Nasdaq over next 12-18 months
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    Description

    BroadVision shares are once again dirt cheap, offering strong downside protection and compelling upside. Even if one adopts an unreasonably pessimistic outlook, it is hard to see how shareholders buying at this price suffer permanent impairment of capital.

    BroadVision has a market value of $123 million ($1.10 per share times 112 million shares outstanding). If $44 million of $54 million in net cash is considered excess cash, enterprise value is $79 million. Assuming an enterprise fair value multiple of ten times interest-adjusted net income, the current trading level implies an income expectation of $8 million in 2008.
     
    Several arguments can be made for why a multiple of ten times is low for BroadVision, including (i) high returns on capital employed in the business; (ii) large and growing market opportunity; (iii) global business, with nearly 40% of revenue coming from Europe and Asia; (iv) recent release of upgraded version of core software products; (v) recent launch of new web-based product in China; (vi) strong balance sheet; and (vii) alignment of interests through large stock ownership by the founder and CEO.
     
    Rather than discussing the multiple of earnings that might be appropriate, however, I want to focus on the likely level of earnings going forward. Specifically, I want to show why an implied expectation of $8 million in after-tax income (excluding interest income) is simply too low.
     
    Note that in order to earn $8 million of interest-adjusted after-tax income, BroadVision needs to earn $8 million of EBIT. The company does not pay taxes and is unlikely to do so for a long time. BroadVision has a usable NOL of more than $700 million, expiring through 2022. The NOL easily exceeds the earnings BroadVision will generate from current operations over the next fifteen years. One could perhaps even argue that the large NOL makes BroadVision’s substantial cash balance worth more than “par,” as the company could acquire profitable businesses and use the NOL to shield income. (The company has so far not stated a desire to make acquisitions.)
     
    BroadVision earned GAAP EBIT of $15 million in 2006 and $16 million in 2007. Pro forma EBIT, as calculated by the company, was $13 million in 2006 and $18 million in 2007. While BroadVision has stated an intention to expand the sales team and increase marketing spending to boost sales of its new software product suite (BroadVision 8.1), neither the announced S&M expansion nor a potential slowdown in IT spending support an expectation of a 50% drop in operating income during 2008. Perhaps “the market” knows something about the very short term, and given the recent price action of BroadVision stock, I would be surprised if the March quarter does not come in weak. However, even if some funds have correctly “sniffed out” recent weakness, nobody can accurately predict how the rest of the year will evolve. In the following two sections, I make some (hopefully) rational assumptions in an attempt to analyze how EBIT might be impacted by factors such as potential revenue performance and the anticipated increase in S&M expenses. The conclusion is that, while the market may have thrown in the towel on BroadVision, the underlying revenue dynamics are quite favorable -- and therefore likely to yield positive surprises for shareholders as the year unfolds.
     
    Revenue Dynamics: On The Cusp Of Renewed Growth?
     
    One of the reasons BroadVision shares have pulled back more than 75% from their 52-week high may be the fact that the company failed to achieve revenue growth in 2007, with revenue declining 4%. What seems to be missed is that growth was stunted by declining service revenue, primarily a reflection of past declines in license revenue. BroadVision had an unbalanced license/service revenue mix of 29%/71% in 2006. Service revenue declined 21% in 2007, while license revenue grew 39%, resulting in a healthier license/service revenue mix of 42%/58%.
     
    Revenue, Growth, And Mix, 2000-2007:
     
    2000
    2001
    2002
    2003
    2004
    2005
    2006
    2007
    Revenue ($mn)
     
     
     
     
     
     
     
     
    License
    251
    101
    40
    30
    27
    15
    15
    21
    Service
    165
    147
    75
    58
    51
    45
    37
    29
       Total
    415
    248
    116
    88
    78
    60
    52
    50
    Revenue Growth
     
     
     
     
     
     
     
     
    License
    233%
    -60%
    -60%
    -25%
    -11%
    -45%
    3%
    39%
    Service
    310%
    -11%
    -49%
    -23%
    -12%
    -11%
    -19%
    -21%
       Total
    260%
    -40%
    -53%
    -24%
    -11%
    -23%
    -14%
    -4%
    Revenue Mix
     
     
     
     
     
     
     
     
    License
    60%
    41%
    35%
    34%
    34%
    24%
    29%
    42%
    Service
    40%
    59%
    65%
    66%
    66%
    76%
    71%
    58%
     
    Three Potential Scenarios For Revenue Growth
     
    Scenario One. If license and service revenue simply continued their 2007 trend (up 39% and down 21%, respectively), overall revenue would grow 4% in 2008 and 13% in 2009. Here is the hypothetical breakdown of revenue assuming a continuation of recent trends:
     
    Hypothetical Revenue Performance In 2008 And 2009 (“Scenario One”)
     
    2002
    2003
    2004
    2005
    2006
    2007
    '08E
    '09E
    Revenue ($mn)
     
     
     
     
     
     
     
     
    License
    40
    30
    27
    15
    15
    21
    29
    41
    Service
    75
    58
    51
    45
    37
    29
    23
    18
       Total
    116
    88
    78
    60
    52
    50
    52
    59
    Revenue Growth
     
     
     
     
     
     
     
     
    License
    -60%
    -25%
    -11%
    -45%
    3%
    39%
    39%
    39%
    Service
    -49%
    -23%
    -12%
    -11%
    -19%
    -21%
    -21%
    -21%
       Total
    -53%
    -24%
    -11%
    -23%
    -14%
    -4%
    4%
    13%
    Revenue Mix
     
     
     
     
     
     
     
     
    License
    35%
    34%
    34%
    24%
    29%
    42%
    56%
    70%
    Service
    65%
    66%
    66%
    76%
    71%
    58%
    44%
    30%
     
    While license revenue growth of 39% appears aggressive, note that license revenue remains well below levels reached earlier in the decade. Meanwhile, the addressable market for BroadVision software has likely grown. In addition, BroadVision achieved 39% growth in 2007 while selling the previous version of its software (BroadVision 8.1 was not released until the beginning of Q4). Finally, the company operated with a small sales team in 2007 and expects to hire additional salespeople to market BroadVision 8.1. It therefore seems conceivable that the company could maintain or even exceed recent growth rates in license revenue.
     
    As for service revenue, the company notes in a recent 10-K that the “most significant change was the year-over-year decline in consulting revenues, which was because our customers purchased existing versions of our products. However, on a more positive note, we released new version of our product in the second half of 2007.” The 10-K also states that “consulting projects tend to trail license revenues between six to twelve months.” Given these factors and the fact that license revenue has resumed strong growth over the past several quarters, it appears likely service revenue will at least stabilize in the near future.
     
    Scenario Two. If recent license revenue growth continued and service revenue stabilized, overall revenue would grow 16% in 2008 and 20% in 2009. The following table shows this scenario:
     
    Hypothetical Revenue Performance In 2008 And 2009 (“Scenario Two”)
     
    2002
    2003
    2004
    2005
    2006
    2007
    '08E
    '09E
    Revenue ($mn)
     
     
     
     
     
     
     
     
    License
    40
    30
    27
    15
    15
    21
    29
    41
    Service
    75
    58
    51
    45
    37
    29
    29
    29
       Total
    116
    88
    78
    60
    52
    50
    58
    70
    Revenue Growth
     
     
     
     
     
     
     
     
    License
    -60%
    -25%
    -11%
    -45%
    3%
    39%
    39%
    39%
    Service
    -49%
    -23%
    -12%
    -11%
    -19%
    -21%
    0%
    0%
       Total
    -53%
    -24%
    -11%
    -23%
    -14%
    -4%
    16%
    20%
    Revenue Mix
     
     
     
     
     
     
     
     
    License
    35%
    34%
    34%
    24%
    29%
    42%
    50%
    59%
    Service
    65%
    66%
    66%
    76%
    71%
    58%
    50%
    41%
     
    Scenario Three. As a final top-line scenario, assume that license revenue grows not 39% but 17%, the rate achieved in Q4, while service revenue stays flat. As the following table shows, the resulting growth in total revenue would equal 7% in 2008 and 8% in 2009:
     
    Hypothetical Revenue Performance In 2008 And 2009 (“Scenario Three”)
     
    2002
    2003
    2004
    2005
    2006
    2007
    '08E
    '09E
    Revenue ($mn)
     
     
     
     
     
     
     
     
    License
    40
    30
    27
    15
    15
    21
    25
    29
    Service
    75
    58
    51
    45
    37
    29
    29
    29
       Total
    116
    88
    78
    60
    52
    50
    54
    58
    Revenue Growth
     
     
     
     
     
     
     
     
    License
    -60%
    -25%
    -11%
    -45%
    3%
    39%
    17%
    17%
    Service
    -49%
    -23%
    -12%
    -11%
    -19%
    -21%
    0%
    0%
       Total
    -53%
    -24%
    -11%
    -23%
    -14%
    -4%
    7%
    8%
    Revenue Mix
     
     
     
     
     
     
     
     
    License
    35%
    34%
    34%
    24%
    29%
    42%
    46%
    50%
    Service
    65%
    66%
    66%
    76%
    71%
    58%
    54%
    50%
     
    While it’s impossible to accurately predict BroadVision’s revenue growth in 2008 and 2009, the above analysis suggests that after seven years of declining revenue, we may be on the cusp of a trend reversal.
     
    Changing Revenue Mix Bodes Well For Gross Margin
     
    The increasing proportion of license revenue within the overall mix implies that gross profit dollars may grow faster than revenue dollars. In fact, the company grew gross profit by $2 million in 2007, even as revenue fell by $2 million. The following table shows gross profit in 2008 and 2009 under each of the three revenue scenarios above. The table assumes that profit margins for license and service revenue will equal the margin levels reported in 2007.
     
     
    Scenario One
    Scenario Two
    Scenario Three
     
    '08E
    '09E
    '08E
    '09E
    '08E
    '09E
    Gross Margin
     
     
     
     
     
     
    License
    100%
    100%
    100%
    100%
    100%
    100%
    Service
    69%
    69%
    69%
    69%
    69%
    69%
    Gross Profit ($mn)
     
     
     
     
     
     
    License
    29
    41
    29
    41
    25
    29
    Service
    16
    12
    20
    20
    20
    20
       Total
    45
    53
    49
    61
    45
    49
    Incremental GP vs 2007
    $4mn
    $12mn
    $8mn
    $20mn
    $4mn
    $8mn
     
    As the table shows, BroadVision could generate incremental gross profit of $4-$8 million in 2008 and $8-$20 million in 2009 (increases for both years are measured against the level of gross profit earned in 2007). Alternatively, if we assume a decline in service gross margins from 69% in 2007 to 60% in 2008 and 2009 due to a higher ratio of consulting to maintenance, incremental gross margin would amount to $1-$6 million in 2008 and $5-$17 million in 2009.
     
    Let’s assume that BroadVision maintains research and development expenses at $10 million and general and administrative expenses at $6 million in each of 2008 and 2009. This assumption may not be far-fetched, because even if G&A creeps up, R&D could decline somewhat due to recent new product releases. With sales and marketing expenses amounting to $8 million in 2007, BroadVision could use the incremental gross profit dollars shown in the above table to boost S&M expenses by 50%-100% in 2008 and 100%-250% in 2009 (versus the 2007 level) while keeping EBIT constant. Even if service gross margin dropped to 60% in 2008 and 2009, the company could generate incremental gross profit dollars sufficient to boost S&M by 12%-70% in 2008 and 60%-210% in 2009 while keeping EBIT unchanged from 2007.
     
    Confusion Regarding Outlook May Stem From Q4 Earnings Call
     
    Investors may have irrationally judged the downside scenario for 2008 (i.e., EBIT down 50% or more) to be the likely scenario, partly because the company lacked clarity in the outlook it provided on the Q4 2007 earnings call (available in the investor relations section of www.broadvision.com, or directly at http://www.broadvision.com/attachment/downloads/videos/Q4-2007-Earnings.wav). Due to the uncertainties involved in the ongoing turnaround and the general lumpiness of revenue, BroadVision has had a policy of not providing earnings guidance.
     
    The company did share some thoughts on the margin outlook for 2008, and this is where it may have confused investors. Management talked about boosting spending on marketing programs (excluding personnel) from under 2% of revenue in 2007 to 4%-5% of revenue or more in 2008. The company also stated it would accept meaningfully lower profit margins (15%-20% operating margin) as it invests in S&M and generates higher consulting services revenue (which would lower gross margin). CEO Chen later seemed to backtrack a bit, indicating that the outlook for operating margins in a range of 15%-20% might depend on positive revenue growth. If revenue failed to grow as expected, operating expenses might grow less than planned. Specifically, Chen stated in response to a question regarding operating expenses in 2008, “If you look at our ’07 as a baseline, I think we are relatively in line with that right now. So take that as a baseline… and then we believe that if our revenue is doing very well, we then would use the 15%-20% margin as the target to slide up or down with that. That’s kind of how we think we’ll be able to manage this… with a pretty healthy bottom line, but be able to really give our business that jolt, that extra investment that will be required.”
     
    While no one can reliably predict BroadVision’s operating income in 2008, the revenue and gross profit dynamics discussed earlier suggest that the company will have quite a bit of room to maneuver on operating expenses as revenue likely grows in 2008 and gross margin stays strong due to continued growth in licenses. Certainly, management could choose to spend so much on sales and marketing that operating profit declines to $8 million or even lower. However, with management having executed the turnaround fairly well so far, and with 38 cents of every operating expense dollar indirectly coming from the CEO’s pocket, it appears unlikely that management will suddenly abandon its commitment to profitability and free cash flow.
     
    History Provides Context To Management’s Focus On Profitability And The Desire To Resume Revenue Growth
     
    BroadVision was a “dot com” highflier that made founder and CEO Pehong Chen #167 on the Forbes 400 list eight years ago, ahead of Ron Burkle, Donald Trump, and Henry Kravis. Based in Redwood City, Calif., BroadVision employs 195 people (+23% y-y) and sells software that helps companies run transaction-intensive websites featuring sophisticated personalization and customer service functionality. It has a blue chip global client list, including Baker Hughes, Citibank, Epson, Fiat, Hilti, Iberia, ING, Prime Polymer, Renault, Sony, Vodafone, and Xerox (close to 40% of revenue comes from Europe and Asia). Pehong Chen still runs the company and owns 38% of shares. Palo Alto Investors owns 14% and appears to have increased its position over the past year.
     
    As a major provider of software to run large websites, BroadVision became one of the most prominent Internet infrastructure firms in the late 1990s, reaching a peak market value of more than $25 billion. Then the bottom fell out (demand from dot coms evaporated), and the painful six-year slide began (2001-2006). BroadVision shares fell from a high of $800 to under $1 as the company posted steep revenue declines, took asset write-offs, incurred restructuring charges, worked to eliminate large liabilities such as office leases, and saw shareholders’ equity turn negative.
     
    BroadVision’s incredible fall from grace came with a worthwhile lesson: Striving to meet the sometimes capricious demands of Wall Street, such as the imperative of growth at any price in the late 1990s, may not always coincide with the long-term interest of shareholders. CEO Chen learned the hard way that survival and prosperity could be assured only through sustained profitability. In 2006, Chen saved the company by cost-cutting his way to profitability, stabilizing license revenue, and personally investing millions of dollars to buy out and retire debt (later converted into equity, followed by a rights offering). In 2007, BroadVision experienced a major positive inflection point in license revenue, aided by renewed client confidence in the company’s financial position and product roadmap.
     
    Valuation Limits Downside, Allows for Significant Upside
     
    As discussed above, I conservatively calculate a “market expectation” of $8 million in EBIT embedded in BroadVision’s current stock price. Also as presented, it appears likely that EBIT will come in substantially higher than $8 million. In fact, if revenue growth materializes, EBIT may not decline much from 2007. In an aggressive but not impossible scenario, EBIT may stay flat or even increase in 2008, assuming that existing and new clients quickly embrace the company’s new product lineup. Meanwhile, it is exceedingly difficult to conceive a scenario in which profitability completely evaporates. Therefore, if fundamentals evolve worse than expected, i.e., EBIT declines by 50%, BroadVision’s stock price may simply remain unchanged. On the other hand, the upside remains impressive, driven both by the potential for strong revenue and income growth over the next several years, as well as the potential for significant revaluation of the multiple investors are willing to pay for the company.
     
    Key Risks And Concerns
     
    Potential drop in EBIT. Clearly, “the market” expects BroadVision’s operating income to plunge in 2008. In addition to the EBIT analysis presented above, I believe it is important to note that an operating income drop would not represent an adverse exogenous event, such as product obsolescence or the loss of a major client. Rather, an EBIT drop would reflect a strategic choice by management to invest in the business to maximize net present value for shareholders. With CEO Pehong Chen (i) owning 38% of the company and (ii) having taken BroadVision to the pinnacle of the Internet software world once before, I am quite comfortable with management’s choice to reignite top-line growth. An alternative but likely inferior choice would be to continue maximizing EBIT while keeping revenue fairly constant. If management wanted to run the business strictly for cash, the company could curtail R&D expenses, thereby saving up to another $10 million per year. Having released an upgraded product lineup, BroadVision could keep revenue constant, or even growing slightly, while earning EBIT of more than $20 million per year (assuming some curtailment of R&D). At that rate, the entire market cap would be in cash in just three years.
     
    Competition from larger competitors. BroadVision competes against a number of companies that may have greater resources and deeper customer relationships, including Art Technology Group, BEA Systems (Oracle), IBM, and Vignette. However, BroadVision has been able to maintain its client roster even as it has gone through financial distress. Now that the company can go to existing and prospective clients with a new product lineup and a strong balance sheet, the selling proposition has improved.
     
    Impact of recession. The company has clients across a wide range of industries, including financial services (filings do not break out revenue by industry). A prolonged recession would certainly impact BroadVision’s ability to achieve meaningful revenue growth. However, whether the company succeeds or not may depend less on the economic environment than on its ability to execute. As CEO Chen noted on the Q4 2007 earnings call, “Being small in our footprint right now, we are operating under a law of small numbers. We ought to be able to handle what we need to handle despite the macro conditions.”
     
    Catalysts
    • Continued strong free cash flow generation
    • Growth of overall revenue, not just license revenue
    • Partial reversal of valuation allowance for deferred tax assets
    • Move to Nasdaq over next 12-18 months
     
    Disclaimer
    This is not a solicitation to buy or sell stocks. Please do your own independent analysis before buying or selling BVSN (or any other stock). We have a long position in BVSN at the time of this write-up that can change at any time without notice. There are no plans to provide future updates on our BVSN buying or selling activities.

    Catalyst

    (1) Continued strong free cash flow generation;
    (2) Growth of overall revenue, not just license revenue;
    (3) Partial reversal of valuation allowance for deferred tax assets;
    (4) Move to Nasdaq over next 12-18 months

    Messages


    SubjectMoat?
    Entry03/27/2008 01:29 PM
    MemberCoyote05
    Would you talk about the product? How is it superior to the offering of competitors?

    Thank you,

    VL

    SubjectRE: Margin
    Entry03/27/2008 01:37 PM
    Membersea946
    I believe R&D spending of roughly $10 million per year has been and will continue to be sufficient going forward. However, in order to grow sales at any meaningful clip, they will have to invest more in sales and marketing. Management has talked about this, and I think the fear of major margin compression is a key reason the stock has declined so much. The company has stated it would be willing to accept a margin range of 15%-20% in order to boost top-line growth. I think a key driver for the stock going forward will be whether higher spending on sales and marketing actually translates into revenue growth. If it does not, then a margin range of 15%-20% would imply an EBIT decline of as much as 50%. I address this issue in more detail in the write-up (see section about Q4 earnings call).

    SubjectBroadvision expectations
    Entry04/11/2008 03:01 PM
    Memberspecialk992
    Hello- I am new to this board but I own Broadvision stock, follow the company closely and keep my own model. I generally agree with you that BVSN is a high potential return investment with somewhat limited risk, but I don't agree with the revenue and earnings scenarios you lay out. I only expect $8M to $9M in EBIT this year and will tell you why.

    First, I don't think you can extrapolate the 39% license growth or anything close to it from last year to this year. As you note BVSN has under-invested in sales and marketing the last few years, and have added very few new customers. The growth from last year was a result of existing customers growing their usage of BVSN, but also of a license enforcement program where BVSN made sure customers were not using more SW licenses then they were entitled to. I think this program has been mostly finished so it will not contribute much to growth going forward.

    I also think it is going to take a while to ramp up new license sales. In the beginning I think the company is focused on upgrading existing customers to 8.1, and this should generate some new license sales as customers buy new capabilities. However they are starting from a cold start in gaining new customers- BVSN has to hire new sales reps, train them and send them out in a tough new license sales environment with a long sales cycle product. I don't expect the fruits of these efforts to show up until 2009.

    So I expect license sales to be anywhere from down a little to up a little. Services revenue will probably continue to decline as parts of the legacy customer base churn off. I also don't see a big increase in GM because as more of the services revenue is implementation work upgrading BVSN customers to 8.1 the cost of services might go up. I put all this together and see an 18%ish operating margin.

    Overall I think the re-acceleration of the company will take a while, but I own the stock because I think if successful the company could easily be worth 4-5x its current EV given its market opportunity and position, and even if Pehong is not successful re-igniting growth acquirers in the software space would be willing to pay at least 5x EV/maintenance revenue or $1.50 per share. Note that I don't think Pehong will consider selling any time soon because I think he wants to redeem himself by making BVSN a real company again, but that option is there if this plan does not work out.

    I want to be here because the valuation is low and I could be too pessimistic, but I just think this one is going to require patience. I will be delighted if one of your scenarios comes true.

    SubjectRE: Broadvision expectations
    Entry04/11/2008 05:33 PM
    Membersea946
    specialk-- Thanks for your perspective. I agree that it's best to have modest expectations for '08 as the company ramps up sales and marketing. The purpose of my write-up was essentially to make the point that the sky is not falling at BroadVision, as seems to be implied by the fact that the stock ranks in the Top 25 cheapest companies in the entire U.S. equity universe based on the criteria used at www.magicformulainvesting.com. Statistically, stocks on that list should, on average, handily outperform the market, and I think BroadVision is one of the better companies on the list.
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