SoftBrands, Inc. SFBD.PK
October 10, 2005 - 12:38pm EST by
2005 2006
Price: 1.70 EPS
Shares Out. (in M): 0 P/E
Market Cap (in $M): 68 P/FCF
Net Debt (in $M): 0 EBIT 0 0

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SoftBrands is a “Phoenix rising from the ashes” story. It is the orphan left over from the highly publicized AremisSoft (“AREMQ”) fraud of 2001. The stock has been wallowing unappreciated in the Pink Sheets since then. All of that is about to change now that a self-imposed quiet period has ended and the company is ready to divulge the fruits of its labor and future plans. Beneath this façade is a leader in providing ERP solutions for small to medium-sized businesses (SMB) worldwide (over 4000 customers in 60 countries) in the manufacturing and hospitality segments. SoftBrands trades at a 30% discount to its peers, has a 60% maintenance revenue make-up, is partnered with software giant SAP, and is led by George Ellis - previously of Sterling Software and Sterling Commerce. With its final restatement done (as of last week) the Company just applied to list it shares on the AMEX and management is preparing to conduct a road show to tell their story for the first time. Not only do we see the valuation gap closing, we see a Company poised for significant growth, both organically and through accretive acquisitions in the highly fragmented SMB space.

Valuation – A 30% discount:

1.1x EV/This Year Sales vs. 1.9x for Comp Group puts SFBD at $2.75
10.5x EV/LTM EBITDA vs. 13.5x for Comp Group puts SFBD at $2.13
2.58x P/B (Pro Forma Book) vs. 3.7x for Comp Group puts SFBD at $2.63

Manufacturing comp group includes: EPIC, QADI & SSAG
Hospitality comp group includes: RADS, PEGS & MCRS
Miscellaneous Enterprise Software comp group includes: INFA & AZPN
(comp average is an aggregate of these 8 names)

Bloomberg data indicates an average revenue multiple of 2.4x for five M&A transactions in the small-mid cap Enterprise Software sector during 2005 (RETK, ASCL, MAPX, CCRD & CRIO). The lowest of such deals was at 1.77x which would value SFBD at $2.50 whereas the average multiple would create SoftBrands at $3.22.

SFBD has a strong relative value thesis based solely on its historical performance (which is not indicative of ongoing operations in our opinion). The real meat to this story is behind the numbers. Their customer centric focus has evolved into a solid platform for growth. They have righted their balance sheet, built a motivated management team and workforce, and solidified their posts in the most strategic worldwide regions (including India and China).

George Ellis:

Until we learned the SoftBrands story, we wondered why someone of George Ellis’ pedigree was at the helm. George was the CFO at Sterling Software (as well as a co-founder and CFO of its spin-off Sterling Commerce) from 1985-1996. During that time, Ellis and co-founders Sam Wyly and Sterling Williams grew combined revenues from $60 MLN to $700 MLN and market cap from $195 MLN to $3.4 BLN (both companies were subsequently sold for a combined $7 BLN in 2000 to Computer Associates and SBC Communications). Upon leaving Sterling in 1996, Sterling Williams said, “George’s contributions to Sterling Software and Sterling Commerce have been invaluable. In my opinion, he is the finest CFO in the industry and has attained the pinnacle in the corporate world.” Over the years of our involvement with SoftBrands we have observed Ellis as honest, straightforward and modest among other positive attributes.

SAP Alliance:

On February 23, 2004 SAP and SoftBrands announced they were teaming to integrate Fourth Shift, SoftBrands leading manufacturing software, into the SAP Business One product suite to provide small and midsized manufacturers with a cost-effective solution that streamlines operations, improves efficiencies and maximizes profitability. This partnership combines the enormous marketing and distribution network of SAP with the proven manufacturing expertise of Fourth Shift. The two companies spent over a year on the integration and made it commercially available in the U.S. in April 2005 with a UK release slated for 2006. The SMB market is a significant opportunity for both SAP & SFBD. The SMB market is growing at 14% per year worldwide with a total market of $9 BLN. The US alone is a $4 BLN market with over 15,000 potential sites. SAP’s is focused on internal growth and innovation where as much of the software industry trends toward consolidation. A significant part of SAP’s growth story is geared toward the SMB market which is why SAP has chosen SFBD to fill a void in its SMB portfolio that targets the manufacturing sector. SAP has the largest manufacturing client base of all ERP providers and this partnership gives SoftBrands access to the SMB pieces of SAP’s extensive customer base (24,000 companies around the world), such as subsidiaries, affiliates or business units of larger organizations that already utilize SAP. Additionally, this relationship opens the door to a whole new client base within the SMB market that previously could not afford the SAP brand. Thru June 30th, the Company has announced 12 SAP/SFBD sales and has just started to recognize revenues from these sales. The fourth quarter of 2005, which ended on September 30, will be the first full quarter of revenue recognition from the SAP collaboration. The initial success and positive reviews in trade publications has opened the door to other potential partnerships with SAP which SFBD has answered by hiring ex-SAP executives and staff. At the present time, SAP and SoftBrands are in early discussions regarding a potential alliance that would utilize SoftBrands Hospitality platform.

High Maintenance Revenue & Scalability:

The consolidation in the software industry has been about gaining scale and the associated steady source of cash flows. In the software world, maintenance revenues are the “razorblade” or recurring revenue stream that offers high profit margins. For that reason, among others, potential acquirers often focus on maintenance revenues as their primary metric. Amidst the AremisSoft Bankruptcy and subsequent reorganizations, SFBD has managed to keep a loyal base of customers that provides maintenance revenues which account for 60% of total revenues. This significant portion of revenue from customers such as Molex, Honeywell, Yamaha, Holiday Inn, and Ritz Carlton among others provides a solid platform for the company to grow from, shield it from industry downturns and speaks clearly to the credibility and reliability of the SoftBrands name.

As highlighted above, the consolidation in the industry is all about capturing scale and steady cash flows. George Ellis has consistently stated that SoftBrands near-term goal is to get to $100 MLN in revenues as soon as possible. SoftBrands can support nearly twice its current revenues without significant cap ex needs. Its maintenance revenue base of $44 mln illustrates such capability. If maintenance revenues were to comprise 40% of total revenues as aligned with the industry norm, SFBD would have total revenues $110 MLN. There is significant operating leverage at the $100+ MLN revenue base where operating margins could approximate industry averages as illustrated below. Our estimates of operating leverage equate to several percentage points every $25 MLN and management confirmed that operating margins can reach industry norms once they achieve a critical operating mass.

Estimated Operating Leverage:
$71 MLN in revenue = EBITDA margins of 10.3% or $7.35 MLN in EBITDA (current op’s)
$100 MLN in revenue = EBITDA margins of 12.5% - $12.5 MLN in EBITDA
$125 MLN in revenue = EBITDA Margins of 15.5% - $18.75 MLN in EBITDA

$12.5 MLN in EBITDA x 13.5 (avg. comp EV/EBITDA multiple) would provide a SFBD stock price of $3.06. $18.75 MLN in EBITDA x 13.5 would put the stock at $4.25.
Note: Management has indicated they may begin to provide guidance in FY 2006.

Management and Employees are Highly Incentivized and Motivated:

Every SFBD employee has stock options. Current outstanding options represent
17% of the company’s fully diluted share count. While this may seem steep, consider that SFBD has been undergoing a deep reorganization/comeback for over four years. Also, a large chunk of these options strike at $3 per share (this price was set at a time when the stock was trading at $.35) most of which are held by senior management (e.g. of Ellis’s 1.85 MLN options, 1.35 MLN are struck at $3). Keep in mind, Ellis made vast sums on Sterling, fully devotes his time to SoftBrands, and is likely looking to make a big hit here, not a couple million bucks. Additionally, he could have walked away from the mess of a situation four years ago to any number of higher profile positions in the industry, instead, he embrace it. These guys are highly motivated to increase shareholder value.

Employee Option Table:
4.64 MLN – $1.50 Strike – 37% of total option pool
413K - $1.75 Strike – 3% of total option pool
4.62 MLN - $3.00 Strike – 37% of total option pool
2.728 MLN – Strike TBD – 22% of total option pool is unissued
12.4 MLN – total options available under plan

ABRY Partners:

On August 18th, SoftBrands announced a preferred stock investment by ABRY Partners. ABRY is one of the largest private equity funds in North America with $7 BLN of assets under management. “ABRY seeks to invest in companies with predictable recurring revenues, high operational leverage and the opportunity to significantly increase profitability.” SoftBrands fits that criteria and ABRY’s $15 MLN investment (convertible at $2.06 per share) eliminated SoftBrands debt overhang and restrictive covenants which will now afford the company the ability to pursue a number of organic and acquisition led growth initiatives. Of note, their purchase agreement stipulates that ABRY can demand for SFBD to file a registration statement on their behalf registering the resale of shares they hold or can acquire thru exercise/conversion should the stock price exceed $5.76/shr. Another interesting tidbit from the purchase agreement involves a covenant that SFBD could not to sell the Company during the first three years without approval or unless a sale generates in excess of 175% of their purchase price which equates to $3.70/shr.

Litigation Trust:

On top of an asset trading at a considerable discount to its peers and private market values, SFBD is entitled to 10% of the net recoveries of the trust that was established to pursue actions against former executives of AremisSoft. The SEC and private attorneys are co-prosecuting the case and seeking damages of up to $500 mln (any and all proceeds go to the trust, none to the SEC). Since the civil actions have commenced, SFBD has received over $15 mln in cash distributions including $12.5 mln from a $200 MLN SEC securities fraud settlement with one of the founder’s of AREMQ. From information gathered in the recent settlement and guilty plea by co-CEO Roy Poyaidjis, a new lawsuit was filed in July 2005 against the other founder, Lycourgos Kyprianou. Estimates of his net worth range from $100 - $500 mln (mostly from illegal AREMQ share sales). With that in mind, another settlement of similar size would not be out of the question. The Cyprus Court has issued a freeze on his assets while prosecutors pursue their case and attempt to capture such assets.

Ownership Breakdown:

Capital Resource Partners (CRP): 8.89 MLN – 12.6%
ABRY Partners: 8.46 MLN – 11.9%
Mason Capital Management: 1.97 MLN – 2.8%
George Ellis (CEO): 1.85 MLN – 2.6%
Randy Tofteland (COO): 1.16 MLN – 1.6%
Dave Latzke (CFO): 800K – 1.1%
Total Employee Option Plan: 12.4 MLN – 17.5%
*Total Fully Diluted Shares: 70.8 MLN

*Assumes full conversion of all preferred stock and all options/warrants

China-India Growth Opportunities and Low - Cost Infrastructure:

SoftBrands is well positioned to capitalize on the growth in the manufacturing and hospitality sectors in China. Their presence in China dates back to 1989 and they are the only tier 3 ERP software company in China with a strong direct sales, support and services team. They currently have over 31 employees in China devoted to manufacturing software development. Additionally, SoftBrands has the opportunity to leverage its China connections within the hospitality market. Many leading international hotel chains have an aggressive growth strategy in China. Their significant hospitality user base and existing Chinese infrastructure could become an instrumental part of the Company's growth. SoftBrands recently released Medallion, its leading property management solution in China and made its first sale to the Swiss-Belhotel Hualan in Hefei, China. SoftBrands also makes efficient use of its low cost infrastructure. In 2003, they opened their development and client support center in Bangalore, India and as of June 30, 2005 have 67 employees located there. The Company continues to grow its business outside of North America and has focused its resources on hiring talented and cost-efficient employees abroad. Management has indicated that they get 2x the return on investment overseas when compared to domestic support & development operations.

Software Consolidation/Vertical Market Expansion:

As the Company's strategy is to grow both organically and thru acquisition, there is opportunity to expand into other vertical markets. George has significant experience enhancing shareholder value thru accretive acquisitions. SoftBrands could target the distribution/warehouse/supply chain market as well as evolve into a provider of property management software for the real estate market. These are just two of the potential verticals that SoftBrands could seek out.


Why do we anticipate all this growth? Management is very forthright in acknowledging that this is not a space where a small player can thrive or even survive in today’s market. Specifically, they acknowledge that they need to get revenue above $100 MLN ASAP as that is a barrier one needs to cross to even be on the map in the SMB ERP space. The following are public comments made as to growth at SFBD.

“These investors share our belief in the future potential of SoftBrands and their participation will help us with our growth objectives.” – George Ellis, on the $18 MLN raise.

“ABRY’s investment in SoftBrands was made to better capitalize the Company to pursue a number of organic and acquisition led growth initiatives.” – ABRY, on the $18 MLN raise.

We believe SFBD has specific plans on their desk. They have the credibility and endorsement of SAP. They have a proven, highly respected and highly motivated leader in charge. With their self imposed quiet period now over and the road show pending, we believe they are ready to start telling the investment community about their mission.


Conclusion of self imposed quite period
AMEX Listing by the end of November 2005
Management Road Show – November 2005
Revenue Recognition from SAP partnership
Potential of SAP partnership with SFBD Hospitality unit
Anticipated organic growth
Anticipated accretive acquisitions
Potential litigation trust settlement/distributions
Potential for Management Guidance in FY 2006
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