Description

Electronic Data Processing (LSE: EDP)

EDP is a micro-cap UK software company with two core product groups, Quantum VS and Vecta, which focuses on servicing mainly distribution oriented businesses.  It operates predominantly in its home country and tends to sell to smaller businesses.  Quantum VS is a software suite that includes product catalogue, sales management & order processing, eBusiness, inventory & purchasing management, financials, business document & data exchange, business intelligence and sales intelligence.  Vecta is a sales intelligence product. 

Despite being a UK micro-cap with limited liquidity, the company appears to be grossly undervalued.  Below are a few summary financial figures and trading statistics:

Market Cap:                              £ 7.0 mm

Net Cash:                                 £ 5.6 mm

Underfunded Pension:               £ 1.1 mm

Real Estate for Sale:                   £ 1.9 mm

   Adjusted EV:                         £ 0.6 mm

EBITDA:                                  £ 1.1 mm

FCF:                                         £ 0.73 mm

Adjusted EV/EBITDA:             0.54 x

Adjusted EV/FCF:                    0.82 x

Financials

Historical Notes

Real Estate

The company has owned a significant amount of real estate over the years, which it has been slowly selling.  Prior to the company’s recently released results, it owned four properties, three of which it was marketing for sale.  The company took a write-down of £ 0.85 mm and has agreed to sell two of the three properties it had been marketing for £ 1.86 mm.  £ 1.7 mm worth of real estate will remain on the balance sheet.  I have not factored any additional value from real estate sales into the thesis, though I will note the following:

• The company sold real estate in 2006, 2008 and 2011 recording gains on sales of 47.7%, 64.5% and 17.0% in those years.

• Prior to the recent sale and write-down, 50.6% of the deemed cost of property related to a 1988 valuation that was conducted.  The company has not disclosed which properties it sold, but I suspect it was not the properties which have a cost basis determined by a 25 year old valuation.

Tender Offer

In 2008 just before the world changed, the chairman, Michael Heller, who now owns over 25% of the company, was planning a buyout.  Instead, the financing world collapsed and the company repurchased 48.9% of the outstanding shares at 50p.  This appears to have been a superb use of capital and followed the sale of real estate in that year.  While there is a risk of a take-under, I believe a buyout by this large owner is a potential catalyst.

Business Exit

In 2007, the company finally exited a computer maintenance business that it owned.  Financials through that period reflect the exit.

Additional Notes:

• Contracted recurring revenue was 76% of total revenue in FY 2012 and 79% of total revenue in FY 2011.

• Hosted revenue was 43% of total revenue in FY 2012 and 34% of total revenue in FY 2011.

• Deferred revenue has not been strong as of late.  The most recent results show a year over year decline 1.5% and a seasonal 16.4% sequential growth (which is the best H2 growth since 2007).

• The company has indicated that the recent property sales will save approximately £ 0.1 mm in costs a year.  It is unclear how much this will benefit cash flow.

• The improvement in the earnings profile of the business over the last several years has been primarily related to cost controls.  The company has eliminated over £ 1.0 mm in administrative expenses since 2007, primarily related to property disposals and improved labor efficiency.  Further improvements in the earnings profile is less likely to come from cost cutting going forward.

• The core business generates strong returns on equity, which I estimate to be approximately 50%.  This is calculated by using NOPAT on required equity, which I estimated to be net of surplus cash and for sale real estate.  If you were to exclude the assets that support the underfunded pension the core return on the business itself would be far in excess of this estimate.

• The company pays a dividend at the current rate of 2.713p which equates to 5.0% yield at 55p.

Valuation:

Using a 10x FCF multiple plus excess cash results in a total value of approximately £ 13 mm or 104p per share.  This would be an increase of 89% from the current share price of 55p.

Based on the median EV/EBITDA of UK public software companies of 8.58x the total value would be approximately £ 15.8 mm or 126p per share.  The constituents are provided below and include companies in the UK that are below $100 mm in market cap and produce at least $1 mm in EBITDA.  This would be an increase of 129% from the current share price of 55p.

Ownership:

Risks:

• Acquisitions – While I suspect one potential catalyst is an acquisition of the entire company, the company has indicated it has an interest in making acquisitions with its cash.  These transactions could be executed poorly or consummated at silly valuations.  The most recent transaction the company executed was the acquisition of the Vecta business in FY 2007.  It has been difficult to determine the success of the business because there are no segment results.

• Pension Scheme – The company recently restated its pension liability by £ 0.691 mm net of deferred taxes.  While the full details will not be known until the annual report is filed, the restatement relates to the estimated discount rate on liabilities.  The defined benefit scheme is not open to new entrants and the company is conducting a review of the scheme.

• Customer Base – While I take some comfort in the fact that its customers are distribution businesses, the fact remains their customers are generally small businesses and likely more vulnerable to competitive forces and the business cycle.  The company has generally performed well during the difficulties in the UK economy, but this could continue to strain the business or impede growth.

• Technology – Despite spending 15.5% of revenues on R&D, the company may not be able to adequately maintain or further develop its technology offering in the face of stiff competition.

• Liquidity – EDP is an illiquid micro-cap company.  There are days when it doesn’t trade.  Additionally, it trades on the SETSqx which is not the main market of the LSE.

Catalyst