Description

Harris Interactive (HPOL)

 Harris Interactive (HPOL) is an under-valued leading global custom market research firm that uses web-based, telephone, and other research methodologies to provide clients with information about the views, behaviors, and attitudes of people worldwide.  HPOL provides its services to a diversified customer base of approximately 1,400 customers. 

HPOL has LTM revenues of about $160m, a net cash position of $6m at 3/31/12, and an EV of about $57m.  HPOL’s market research services are discretionary and it has struggled through the recession.  However, in early 2011, HPOL started working with Al Agrisani, initially on a consulting basis, then in June 2011, as Interim CEO and, recently, Angrisani was made permanent CEO.  Angrisani is a turnaround specialist with a strong track record in businesses which are related to or similar to HPOL, including a highly successful turnaround at Greenfield Online, which was sold to Microsoft in October 2008 for $500m.  (See his website at www.alangrisani.com which includes his track record and “formula” approach to turnarounds).  Angrisani has implemented dramatic cost reductions at HPOL, closing or downsizing several under-performing international and North American offices and reducing headcount – the primary cost component in HPOL’s cost structure – from 750 to about 650 at 3/31/12.  While we are always wary about “turnarounds”, these can create meaningful “alpha” when successfully executed, and we think HPOL has an excellent chance to work.

 We think HPOL is under-valued compared to where it could trade if Angrisani is able to execute this turnaround.   The company has a well-known brand name and a diversified customer base and a large base of existing revenue. HPOL’s EV of $57m is about 35% of revenues and 5.7x LTM adjusted EBITDA of $9.9m with about $1m in LTM capital expenditures.  We believe HPOL can achieve adjusted EBITDA of about $15m in FYE 6/30/13 with capital expenditures of about $3m and generate about $10m of FCF or more for an unleveraged FCF yield of close to 18% based on our projected FY13 results.  We believe adjusted EBITDA is likely to increase due to improved EBITDA margins as the turnaround program described below fully takes effect.

 HPOL has a solid balance sheet with a net cash position of $6m at 3/31/12.  Importantly, HPOL’s net cash position has been steadily improving over the past eight quarters - see Detailed Quarterly Balance Sheets below - from a net debt position of $6m at 12/31/09 to a net cash position of $6m at 3/31/12 and we believe it can continue to improve.  It is particularly impressive that HPOL has improved its net cash position throughout FYE 6/30/12 to date, over which time it funded close to $5m in cash restructuring expenses.

 One sign that HPOL’s turnaround  might be gaining momentum occurred  on 3/8/12 when HPOL issued a press release stating that management believed its stock was under-valued, that it was implementing a $3m share buyback program, and that it was issuing guidance of $9.5m to $11.5m of adjusted EBITDA before items for FYE 6/30/12.  Further, when HPOL released Q3 results, it slightly increased to bottom end of this range, to adjusted EBITDA of $10.5m to $11.5m for FYE 6/30/12.  Based on guidance mid-point of $11m of adjusted EBITDA and a $6m net cash position at 3/31/12, HPOL is trading at 34% of LTM revenues and 5x adjusted EBITDA for FYE 6/30/12.

 HPOL’s business is not capital-intensive with capital expenditures of $1.2m, $1.6m, and $0.8m for FY09, FY10, and FY11 and under $2m projected for FY12.  Angrisani is very focused on free cash flow generation and improving liquidity, including tighter working capital management – one of his reported mantras is: “Cash is King”.  We note the $81m of cumulative cash generated from operations by HPOL from FY05 to FY08 and since FY05 only FY09 has been negative cash from operations.  Clearly, this was a different, pre-recession environment, with higher revenues and higher gross margins, but we believe it speaks to HPOL’s long-term opportunity.

 Turnaround Plan

 Angrisani joined HPOL and started the turnaround program in mid-2011.  We believe he has made a lot of progress in a fairly short period of time.  He has laid out a very methodical and logical turnaround plan and, so far, he has executed it well.  His focus has been on right-sizing the company’s cost structure, selling higher-margin research services, and improving liquidity.  We recommend a reading of the last several conference calls to get a sense of Angrisani - he strikes us as someone who under-promises and over-delivers.  We have appreciated his very clear and straightforward strategy outline and honest appraisal of the challenges of the turnaround effort.   In summary, we believe Angrisani can improve HPOL’s profitability by making it a smaller, more geographically-focused, niche player focused on certain specific products and verticals that does not attempt to go head-to-head with the large industry players.

 The first phase of the turnaround included a very major reduction of HPOL’s cost structure and a significant improvement in its liquidity, some of which occurred under the prior management team.  Specifically,

In Q2 and Q4 of FY11, HPOL reduced headcount at its U.K. operations by 27 FTE’s;

We estimate FTE’s at HPOL are down near 650 as compared to about 750 at FYE 6/30/11.  The large reduction in FTE’s has reduced direct labor which is a large component of COGS.  Gross margin improved to 39% in Q3 of FY12 as COGS declined to $20m versus $24m in prior year. 

 On the most recent (Q3) conference call, Angrisani discussed an increased focus on higher margin revenue or “good revenue” and a gradual de-emphasis or re-pricing of lower margin revenue or “bad revenue”.  Prior management was more focused on revenue than margins.  Angrisani wants the sales force to generate revenue with acceptable margins, while concurrently shedding revenue with unacceptable margins.  He is putting in place incentives for the sales force to focus on margins.  He is also working on precisely understanding profitability on a project by project basis, which was apparently not in place prior to Angrisani’s arrival.  We are told senior management now reviews every project to make sure it has adequate gross margin to cover its fully allocated costs.  Angrisani and his team are also working to better understand which types of projects offer the acceptable margins in order to focus sales efforts in those areas.  The basic plan is for HPOL to be a smaller, more efficient, and more focused custom market research firm which carefully selects its niches and does not try to compete for commodity-type business against the major global market research firms.

A major objective of the turnaround plan is to improve gross margins.  Gross margins declined steeply from 56% in FY05 to 34% in FY11.  Clearly, some of this is related to the recession, increased competition, and the discretionary nature of HPOL’s services.  Despite this, we believe there is a niche for HPOL’s brand name and services. 

Financial Results in FY12 Under Angrisani

Under Angrisani in FYE 6/30/12, gross margins have steadily improved:

• Q1 gross margins were 37.3% vs. 34.6% in prior year;
• Q2 gross margins were 37.4% vs. 34.2%; and
• Q3 gross margins were 39.1% vs. 34.0%. 

However, revenue declines have also continued:

• Q1 revenue increased 3.5%;
• Q2 revenue decreased 12.9%; and
• Q3 revenue decreased 7.8%.

(Some of this revenue decline was due to the closure/downsizing of under-performing offices).  For nine months of FY12, gross profit dollars have increased 5.8% to $42.2m in FY12 vs. $39.9m in FY11. 

Angrisani has cited the revenue decline and “structural sales problem” as the major challenge of the turnaround.  Stabilizing and reversing revenue declines will be a critical factor in how successful the turnaround is.  Angrisani compared the challenge of replacing low-margin revenue with higher-margin revenue while stabilizing a decline in revenues to “changing the tire while the car is moving”…not an easy task. 

However, we believe Angrisani’s focus on sales stabilization and improving the margins on sales dollars has only recently started.  This will include a more focused approach to selling services than the cumbersome product-matrix approach prior to his arrival (six or seven industries were overlaid by five or six basic service products).  We believe a handful of key products where HPOL can achieve acceptable margins will be the focus going forward.  We expect HPOL’s sales force - we are told about 60 FTE’s “touch sales” at  HPOL - are having their incentive structure changed to drive a focus on growing gross profit dollars instead of  simply growing sales.  On the Q3 conference call, Angrisani seemed to indicate the current size of the sales force was sufficient to achieve the turnaround but it was a matter of revising their focus.  We believe HPOL can grow gross margin dollars in FY13 and FY14.  For competitive reasons, management has been reluctant to identify specific product areas where they are achieving higher margins, other than to state that these product areas do exist.  Conversely, management has identified projects with lower margins, which do not adequate cover their costs, and they will seek to either adjust pricing or gradually replace these types of projects with higher-margin projects.

Under Angrisani, Adjusted EBITDA before items has shown steady improvement in FY12:

• Q1 Adjusted EBITDA was $2.8m vs. $0.9m;
• Q2 Adjusted EBITDA was $3.8m vs. $3.7m; and
• Q3 Adjusted EBITDA was $1.5m vs. $0.6m.

Nine months Adjusted EBITDA FY12 was $8.4m vs. $5.0m in prior year and, for FYE 6/30/12, the mid-point of most recent guidance for adjusted EBITDA before items is $11m vs. $6.8m in prior year.

Regarding the systematic sales challenges going forward, Angrisani stated on the Q3 call:

• “At this stage of the turnaround, it’s really all about profitable sales growth.  As my team here has heard me say, so many times over and they are probably tired of hearing me say it, sales are now job one at Harris Interactive.  And in looking at the numbers, you can see that bookings are up 3% in constant currency.  However, to really understand where we are in the turnaround effort, as especially it relates to sales, it’s important to note that the increase we saw was really in part due to some timing differences.  But I will take it and it should not be taken to mean that we are resolving this systematic sales challenges that I have spoken about on other calls, it just means that we are beginning to take the first steps, if not baby steps, in this area”.

FY13 Estimates & Valuation

In FYE 6/30/13, we believe HPOL can achieve a 10% EBITDA margin on revenue of $150m or about $15m of EBITDA.  We believe that capital expenditures are not likely to exceed $3m.  Angrisani stated on the Q3 conference call that he does not think the turnaround of HPOL will require a lot of additional capital.  Consequently, HPOL could generate substantial free cash flow in FY13, probably close to $10m.

Regarding the margin potential for HPOL, Angrisani stated on the Q3 call:

• “you probably know better than I do, what I think the rule of form in the industry is that custom market research companies, which I believe we are the classic definition”….”I would say that if you can work to get your business operating at a 10% margin, you are operating at the very top echelons of the industry.  So we are trying to get to be the best, so we will see how that comes out next year”

Further, if HPOL can profitably grow revenues, adjusted EBITDA could go significantly higher than our $15m estimate for FY13 over time.  We also believe HPOL will increase its net cash position over time.  From a net cash position of about $6m at 3/31/12, we think HPOL will increase its net cash position to $15m or more by the end of FYE 6/30/13.  Based on a multiple of 6.5x adjusted EBITDA, plus a projected net cash position of about $15m by end of FY13, we believe HPOL could have an enterprise value (EV) of about $115m or $2 per share (or 75% higher than the current price of $1.15 per share).

Seasonality

HPOL is a seasonal business with Q1 (ended 9/30) usually weaker, partly due to summer in Europe, Q2 (ended 12/31) and Q4 (ended 6/30) are usually stronger quarters.  Q3 (ended 3/31) is typically weaker than Q2.  In our discussions with management, we have the sense that H1 is generally similar to H2, with both periods having a stronger quarter and a weaker quarter in them.  Importantly, these are just general historical trends and not absolute certainties.

Business Description

HPOL is a professional services firm that serves clients in many industries and many countries.  It provides full service market research and polling services which include ad-hoc and customized qualitative and quantitative research, service bureau research (conducted for other market research firms), and long-term tracking studies.

HPOL conducts market research projects for clients in many industries, including automotive, transportation, travel, tourism, energy, professional services, consumer goods, restaurants, retail, financial services, healthcare, public affairs and policy, technology, media and telecommunication industries.  HPOL has approximately 1,400 clients with no single client representing more than 10% of consolidated revenue.

HPOL provides many types of custom research including customer satisfaction surveys, market share studies, new product introduction studies, brand recognition studies, reputation studies, ad concept testing, and more.  A custom research project has three basic phases – 1) survey design; 2) data collection; and 3) weighting, analysis, and reporting.

HPOL also does tracking study research for clients in a broad range of industries around the globe.  Tracking studies regularly ask identical questions to similar demographic groups within a constant interval (once a month, etc.) to feed business decision makers with dynamic data and intelligence to measure and improve customer loyalty, gather market and customer intelligence, detect emerging market trends, and identify opportunities for growth. Tracking studies are about 15% of total revenues and are generally about one year assignments,

HPOL’s revenue base is comprised of a large number of discreet projects.  The company might have 1,500 to 2,000 projects going on at any one point in time with projects diversified across a fairly large number of customers.  Most non-tracking study projects are shorter term in nature, generally about 60 to 120 days and generally range in amount from $50k to $100k.  Tracking study projects can be as large as $1m to $2m.  In fact, the losses in recent quarters of some larger tracking studies have helped put substantial downward pressure on total revenues.

HPOL does a significant portion of its market research using online data collection but also conducts data collection through mail and telephone surveys, focus groups, and personal interviews.  HPOL’s custom research could be for almost any brand, including Pepsi, Coke, Revlon, National Physicians Association, etc.  The chief marketing officer of the organization is often the decision-maker and will typically get multiple bids for a specific project.  There is also generally a budget person at the customer who negotiates pricing and terms.  There are typically several discussions about how the study is to be completed and pricing is one factor in the purchase decision.  Sales people at HPOL typically have established relationships with the chief marketing officers at customer organizations and these relationships are one important asset of HPOL.  In terms of execution, HPOL has a “seller-doer” model where very often employees will typically be involved in both selling and delivering on the project.

HPOL has operations in North America and Europe with international operations in Canada, the U.K., France, and Germany.  Operations in Asia ceased as of Sept. 30, 2011.  European operations were about 25% of revenues for nine months of FY12.

Market Research Industry

The top companies in the market research industry by sales in 2010 and their global market shares were as follows:

• Neilsen Company (USA) - $5.0 b sales – 15.9% market share;
• Kantar Group (owned by WPP Group Plc) (U.K.) - $3.2b sales – 10.2% market share;
• Ipsos (including Synovate) (France) - $2.4b sales – 7.6% market share;
• IMS Health (USA) - $2.2b sales – 7.1% market share;
• Gfk Group (Germ) - $1.7b sales – 5.5% market share.

These are very large organizations that are generally located in many countries around the world.  Synovate is also a competitor and was recently acquired by Ipsos in December 2011 for about $860m.  Miller Brown is a competitor which is owned by WPP.

HPOL believes it can compete with these large firms on certain types of projects and in certain specific industries where its employees have meaningful experience.  HPOL believes it continues to have a good brand name and reputation in the custom market research industry as well as many strong relationships with customers, all of which enable it to win business.

We would not be surprised to see further consolidation activity in the custom market research industry by strategic or private equity players.  HPOL’s diversified base of customers, its employees experience and relationships, and its well-known brand name could make it an attractive acquisition.  Ipsos bought Synovate - a unit of British market firm Aegis Group - for about $860m in mid-2011 and WPP bought TNS in 2008 for about $2b and GfK bought Knowledge Network in late 2011.  IMS Health was taken private in 2010 by TPG Capital for about $5b.  Neilsen Company was owned by private equity investors.

Strong Cash Flow Generation and Solid Business Model

HPOL has a solid business model with limited capital expenditure and working capital investment requirements.  Since FY05, HPOL has generated over $80m in cumulative cash from operations - see financial results below.  While the pre-recession environment was different, we think the business model retains a high ROIC and should be highly cash-generative.  Further, Angrisani is highly focused on tight management of working capital and cash generation.

HPOL’s balance sheet has steadily improved over the past twelve quarters – see Quarterly Balance Sheets below – from a net debt position of $4.2m at 3/31/10 to a net cash position of $6m at 3/31/12.  Furthermore, the improvement in the net cash position during FYE 6/30/12 to date has been achieved while HPOL funded close to $5m of cash restructuring expenses.  We expect these cash restructuring expenses to drop off sharply in FYE 6/30/13, resulting in strong free cash flow generation.

Based on EBITDA of $15m or more in FYE 6/3013 - 10% EBITDA margin - HPOL could generate free cash flow of $10m or more.  Capital expenditures have recently been about $1m per year and we estimate $2m in FY13 and FY14.  HPOL has an NOL of about $25m which should result in minimal cash taxes for several years.

Successful Turnaround Manager With Sensible Plan Focused On Long-Term Value Creation Which is Beginning to Show Results

Al Angrisani has had impressive results with previous turnarounds in similar industries.  He joined HPOL in mid-2011 and immediately started to right-size the company to get a more appropriate cost structure as offices in the U.S. and U.K. were downsized and Asian operations were closed.  His focus has been on right-sizing the company’s cost structure, selling higher-margin research services, and improving liquidity.  We estimate the employee base has been reduced by over 100 FTE’s since 6/30/11 or over 15% of the workforce.  We are starting to see the benefits of these actions as gross margins have steadily improved throughout FYE 6/30/12 and peaked at 39% in Q3. In the second phase, his focus is on project profitability and pursuing projects with higher margin revenues to gradually replace projects with lower-margin revenue.  He is creating incentives to focus the sales force on gross margins and project profitability, making sure new projects are profitable on a fully allocated basis.  He has also been able to improve liquidity, with net cash increasing by $6m in FY12 to date, despite funding close to $5m in cash restructuring costs.  Angrisani has had success with other turnaround projects, including Greenfield Online in October 2008 (see www.alangrisani.com).

Strong Relationships with A Diversified Customer Base Leads to Solid Competitive Position

We think HPOL’s diversified customer relationships with many customers and its well-known brand name help give it a solid competitive position in its industry.  HPOL’s relationships with a diversified group of well-established companies should allow it to find a sustainable niche position in the market research industry.  HPOL has approximately 1,400 clients with no single client representing more than 10% of consolidated revenue.  HPOL employees also have expertise and reputations in specific vertical industries and with specific research projects.  These customer relationships, employee reputation and knowledge base, and its brand name give HPOL some competitive advantages.

Industry Consolidation Prospects

We believe that HPOL’s relationships with a diversified customer base are a valuable asset.  We think there could be strategic purchasers who might be attracted by HPOL’s brand name and customer base.  

Large marketing research industry players like Ipsos (IPS.FP) and GfK (GFK.DE) trade at significant premiums to HPOL (1.3x and 1.5x revenues versus 0.3x for HPOL), although they are larger, more diversified companies and HPOL does purely custom research.  These large competitors have shown a strong interest in expanding through strategic acquisitions.  There is also a fair amount of private equity investment around the industry, as both IMS Health and Neilsen (NLSN) have private equity investors.

It is also interesting that HPOL’s largest shareholder is Vincent Bollare, who is a French billionaire and activist investor in Europe with a successful track record.  He currently owns a 26% stake in Aegis, a large, U.K.-based marketing company which recently sold Synovate to Ipsos.

Strong Nine Month Results in FY12 Should Bode Well for FY13

Nine months results for FYE 6/30/12 have indicated the start of the turnaround program, with improved gross margins and higher gross profit dollars.  Nine month revenues for FY12 were $111m versus $117m in prior year while nine month FY12 gross margin improved to 38.0% versus 34.2% in prior year, resulting in gross profit of $42.2m in FY12 versus $39.9m in FY11.  This reflects the strategy of focusing on higher gross margin revenues and eliminating lower margin revenue.  FYE 6/30/12 projected adjusted EBITDA is about $11m versus $6m in prior year.  We like this focus on profitability over growth.  We believe the company will be able to stabilize and grow its revenue base but this is the biggest question in the turnaround.

Solid Balance Sheet and Expected Steady Build Up in Cash Position.

HPOL has a solid balance sheet, which has been consistently improving its net cash position over the past eight quarters.  At FYE 6/30/09, HPOL had a net debt position of $6m and this has improved to a net cash position of $6m as of 3/31/12.  HPOL was able to remain cash flow breakeven even in the very depressed economic conditions of 2009.  We believe the net cash position could improve by up to $10m in FYE 6/30/13. 

Conclusion and Target Price

Based on 6.5x our EBITDA estimate of $15m for FYE 6/30/13 and including a $15m estimated net cash position, HPOL could trade for $113m market cap or $2 per share or more vs. $1.15 per share today (+75%).  If HPOL’s management team continues to execute and the custom market research industry performs reasonably, we think our target prices will be achieved.  If HPOL is successful in achieving revenue growth, we believe its share price could increase well beyond our target price.

Detailed Quarterly Balance Sheets

Geographic Summary

Revenue from services

Industry Comparable Public Companies

Catalysts

1. Low valuation of 35% of LTM revs, 5x FYE 6/30/12est EBITDA and 3.7x FY13est EBITDA.
2. Turnaround plan improves gross profit and adjusted EBITDA margins and FCF.
3. Steady improvement of net cash position, which could build to $15m at FYE 6/30/13.
4. Projected adjusted EBITDA of $15m and FCF of $10m in FY13 (18% unleveraged FCF yield).
5. Potential stabilization and growth of revenue in FY13.
6. Share repurchases and dividends from excess cash and FCF generation.
7. Possible acquisition of HPOL by a strategic or financial purchaser.
8. Increased analyst coverage and recognition of HPOL’s improved business model and focus.

Risks

1. The North American and/or global economies turn down.
2. Exposure to Europe (about 25% of revenues).
3. Demand for custom research - a discretionary service - declines.
4. Revenue declines continue, and faster than gross margins are improved.
5. Approximately 15% of revenues are from tracking studies and the non-renewal of a large tracking study, which can represent $1m to $2m in annual revenue, can impact quarterly results.
6. Misallocation of capital into a poor acquisition.
7. $4.5m of annual debt amortization payments plus some cash restructuring obligations could pressure cash flows.
8. New technologies or services have a material impact

Disclaimer

Disclaimer:  We own shares of HPOL.  We may buy or sell these shares at any time without notice.  The information in the write-up is believed to be correct as of the date written but VIC members should do their own verification of this information and analysis of this potential investment.  We undertake no obligation to update this write-up if new information arises at a future date.

Catalyst