Selectica SLTC
January 06, 2006 - 2:44pm EST by
2006 2007
Price: 2.66 EPS
Shares Out. (in M): 0 P/E
Market Cap (in $M): 88 P/FCF
Net Debt (in $M): 0 EBIT 0 0
TEV (in $M): 0 TEV/EBIT

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Selectica has net cash of $2.82 and trades at $2.66. I will cut and paste their business description for efficiency’s sake:

We develop, market, sell and support software that helps companies with multiple product lines and channels of distribution to effectively configure, price, quote and manage the contracting process for their products and services. Our products enable customers to increase revenue and profit margins and reduce costs through seamless, web-enabled automation of the “quote to contract” business processes, which reside between legacy CRM and ERP systems. Over the past number of years, Selectica solutions have been successfully implemented at a number of companies such as IBM, Cisco Systems, Dell, Rockwell and GE Healthcare. However, these types of large system sales have declined significantly over the past several quarters due, we believe, to reduced IT spending, reluctance of customers to undertake large, custom project implementations, our target customers’ growing preference for smaller scale, more focused system implementations and increased competition from suite vendors such as Oracle, SAP and Siebel and point application software vendors like Comergent Technologies, Firepond and Trilogy.
In response to this development over the past year, we developed and introduced a “next generation” product family branded as EPS-M, which utilizes state-of-the-art technology and the power of our configuration, and pricing engines in a less expensive, more application focused offering. We have also been focused on expanding our product footprint and value proposition by extending into the growing contract management and compliance market. We began to achieve this objective shortly after the close of fiscal 2005 with the acquisition of certain of the assets of Determine Software Inc. (Determine). The products acquired also extend our business model by permitting us to offer an on-demand/hosted software-as-a-service solution for our customers. This on-demand/hosted solution model focused around contract management and now our EPS-M offering as well. We also intend to integrate contract management and compliance functionality into our EPS-M product during the remainder of fiscal 2006. With these new products, we are seeking to attract a small and medium sized market customer segment interested in using application software to manage complex product and service offering data, pricing management, contract management, compliance and speed new product or brand launches. Concurrent with the development, marketing and sales of these new products, we will continue to sell and support our existing platform products.

Basically, the company has an excellent software product which has mostly penetrated its large customer market. As a result, the company shifted gears and is now focusing on smaller, less customized, applications that can be targeted to specific verticals and sold through VARs.

Here is the thesis in a nutshell:

1) The operating business is being given a negative value by the market
2) The operating business is based on solid technology and is seeing some decent traction, and doesn’t deserve a negative value
3) The company has a good chance of being sold in the near future
4) Cash burn is low and management is not entrenched

Let me elaborate on each of these points

The operating business is based on solid technology and is seeing some decent traction, and doesn’t deserve a negative value
Based on the quality of the installed base and comments from several industry participants, the technology is best in breed—that is not the problem with the business model. The company has the same problem as many small software vendors selling into the enterprise market, which is the ability to compete against software that is effectively given away as a bundled solution by the ERP vendors. Like many other small vendors’ products, the software works much better than the bundled option; it just comes down to whether customers really need/want it or not. After having spoken with the CEO and head of sales, there is real optimism that the business is gaining traction. Placement on the on-demand portal is bringing in a lead a day. Their contract management solution (Determine) is growing extremely quickly. Contracts are being signed.
The cost structure is around 6m a quarter. Roughly $4.5m of this is maintenance revenues from their installed base. $1m a quarter is the current run-rate for Determine. This means they only need to make ½ a sale a quarter at $1m a pop to breakeven, which is a low hurdle even for them. By means of comparison, they mentioned $1m of deals that were closed in the week before I spoke with them (mid November)

The company has a good chance of being sold in the near future
There are many companies who could buy SLTC, but one stands out. Trilogy is a private company that competes with SLTC in certain business lines. They made an offer in January to buy the company for $4/share which was rejected at time (SLTC was trying to merge with IMNY at the time; IMNY’s shareholders subsequently rejected the merger). In April, Trilogy bought 7% of the company and things haven’t really changed since then. Additionally, Trilogy had sued SLTC in April of 2004 for patent infringement (read: to slow down SLTC from taking away their installed base)- SLTC countersued. This lawsuit has recently begun trial—it is unclear who has a stronger case, but the CEO thinks any impact would be minimal either way.
So why would Trilogy buy SLTC? Here is what they could do:
a) reduce their own litigation expenses, say $1m/quarter
b) strip out corporate overhead and public co expenses, say $1.5m/quarter
c) protect their installed base from leaving, which I believe generates $20m/yr of ebitda from maintenance fees.
So Trilogy could pay $4/share, which would be a net cost of $35m, save themselves $5m in litigation costs (also avoid potentially losing the lawsuit), and have a profitable business from day one after stripping out the overhead. In speaking with Trilogy’s former CEO, he made the following comments: 1) Trilogy’s insurance product was losing significant share to SLTC and was the weakest part of their offering and 2) Trilogy has a lot of internal pride in the quality of their software and wouldn’t acquire a company (in fact, to his knowledge they had never acquired a company) unless the technology were the best available.
Other companies could buy SLTC also, given the consolidation happening in the industry, but Trilogy has the most to gain.

Cash burn is low and management is not entrenched
I believe that cash burn from operations is essentially zero, though they will spend around .02/quarter on legal expenses until the Trilogy trial concludes (est. 3q06). Management is not tied to the business and is focusing on maximizing shareholder value. They are buying back shares (up to 25% of the outstanding—and will buy blocks from large holders if the price is under cash value) and will “call it quits”—sell the company—by the end of 2006 if they are finding that they cannot operate profitably as a small player. In short, the risk of the cash balance dwindling to nothing is remote.

All in all, I believe that the risk/reward is compelling. I frankly see very little downside here, as cash/share is unlikely to fall below the current share price. Upside is around 50% (to the $4 Trilogy bid), and I think this could happen in the next 6 months.


good quarter
trilogy or another company acquires them
end of litigation
significant share buyback
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