On January 8, 2013 ClickSoftware (CKSW) announced a plan designed to accelerate revenue. This article evaluates the impact of the announcement on the growth of free cash flow, and on the intrinsic value of the stock previously discussed here.
Let's consider the following three components in a business model:
- Value Proposition -The impact of the firm's products and solution on clients (and prospects); how helpful is the solution in improving the businesses of clients.
- Economic Returns -The risk-adjusted return of value created for the shareholders of the firm.
- Management Effectiveness -Strategy and allocation of resources to achieve both, the Value Proposition and Economic Returns.
Let us organize the information in the announcement according to the components of the model.
- Value Proposition
- Expand client options to start with Mobility, as opposed to Optimization
- Deliver measurable and quantifiable value to customers, and expand their business gains; group and individual optimization with or without Mobility. Products are crucial to customers.
- Economic Returns
- 2013 revenue growth is expected to exceed 20%
- Confidence in momentum built set the stage for significant growth in 2013 and beyond
- Expand addressable market (Mobility option) to up-sell (Optimization)
- Expenditures in R&D and Sales & Marketing will impact margins in the first half of 2013; profitability will improve in the second half of the year
- Management Effectiveness
- Leverage investment made in 2012
- Establish local presence in Latin America and Eastern Europe
- Establish separate division fully dedicated to selling cloud-based solutions
- Strong partnerships helped expand the global footprint and opened new opportunities.
The announcement reinforced information previously available regarding market opportunity and growth expectations. Implicitly, it reinstated market leadership, steady performance, and relatively low business risk.
Commentary regarding continued expansion of expenditures in R&D and Sales & Marketing and slimmer margins during the first half of 2013 is in line with the current strategic play announced in 2012; capability expansion (and concomitant softness in 2012 NOPAT) -product development and capacity expansion promise fast growth and high ROIC at the price of pressure on margins and on ROIC over the short term.
- ROIC (Return on Invested Capital) = NOPAT / Operating Capital
- NOPAT (Net Operating Profit after Taxes) = EBIT (1- Tax Rate)
- OC (Operating Capital) = NOWC (Net Operating Working Capital) + OLTA (Operating Long-Term Assets)
- WACC (Weighted Average Cost of Capital)
- FCF (Free Cash Flow) = NOPAT - (Changes in OC)
- EV (Enterprise Value) = PV of prospective FCF, growing at g; discounted by WACC
Worth noting is the apparent conviction behind the 20% revenue growth bogie for 2013, and what the announcement did not say --that 2012 revenues would be coming below 2012 guidance.
All in all, the announcement is good news --if one's investment horizon goes beyond the first six months in 2013. Good news is that the Business Model is working well; Value Proposition is strong, High ROIC and rapid growth are integral in the firm's Economic Equation, and Management Effectiveness is apparent in executing for growth and high ROIC.
What is the impact of the announcement in the value of the stock?
From the viewpoint of fundamental value, the impact of the announcement is very little or none, since it conforms to the current high-ROIC/rapid-growth investment scenario.
Within such high-ROIC/rapid-growth scenario, the value of the stock is driven by the combination of (A) sustained revenue growth, and (B) achievement of normalized rate of Free Cash Flow relative to revenues (FCF / Revenues).
This is significant for investors at this particular point in time because the current FCF / Revenues rate is substantially below the historic norm -about 4% expected in 2012 vs. 13% average for the preceding three years. Thus, improvement in the ratio, to say 7% in 2013 (as investments bear fruit and margins stabilize), coupled with 20% revenue growth could result in $8.50 million in FCF for 2013. This represents a major increase over $4.33 million, FCF expected for 2012. FCF could reasonably continue to show rapid growth beyond 2013.
The point: Look for FCF growth to exceed revenue growth over the medium term.
My estimate of the fundamental value of the stock remains unchanged at between $10.0 and $10.5 per share.
Additional disclosure: The material presented here is for informational purposes only. Nothing in this article should be taken as a solicitation to purchase or sell securities. Before buying or selling any stock you should do your own research and reach your own conclusion. Views and opinions in this article may be wrong. The analysis, including financial computations, presentation, and views, do not necessarily conform to any sanctioned or accepted standards. Presentation and computations entail a probability of error, which is entirely possible. I am not an investment management professional. Please do not rely on this material, do your own due diligence.