ClickSoftware Technologies: Smallcap Value Investment

ClickSoftware Technologies (NASDAQ:CKSW) is a supplier of workforce and service management software products and solutions.

The company exhibits a stable and sustainable business model. The historical rate of growth, roster of clients (announced deals), and the recent global reselling agreement with SAP speak well of CKSW in the eyes of clients, and of its competence in delivering service. The expertise of the CEO and founder energizes such competence.

There is no evidence of outsized risks embedded in the business. Business risk is all operational; customers are large and well-established companies. Financial risk – given a debt-free balance sheet and a significant cash cushion – is minimal. All around, risk seems to be well within the company’s risk-taking ability. The CEO seems to be hands-on.

Economic Equation

Free cash flow (FCF) generation allows for rapid growth (23% revenue growth in 2007) without debt, while building up cash (about 24.0 million as of 9/30/08). This self-financing feature is relevant given the envisioned rapid growth. Future growth relies on the development of software products and delivery of solutions to clients. Future growth does not require increasing the risk profile by the use of debt.

Contract accounting and deferred income recognition combine into a continuing source of funds, provided revenue growth is continuing. This accounting stabilizes revenues and earnings and promotes visibility.

Growth in Operating Fixed Assets, largely software development, is measured and within the technical competence of the firm.

In 12/31/07 FYE FCF was $1.34 million.

FCF = $1.34MM in NOPAT + $0.60MM Increase in NOWC - $0.60MM Increase in OFA

NOPAT = Net Operating Profit After Taxes = EBIT (1-Tax Rate)

NOWC = Net Operating Working Capital

OFA = Operating Fixed Assets

Fundamental Value

The Present Value (PV) computed below results in a stock value of $2.56. This compares with recent trading prices around $1.85/share.

PV = FCF (1 + g) / (WACC –g)

The PV of a perpetuity is the next period’s FCF discounted by the spread between the constant discount and growth rates.

  • Estimated 12/31/08 FYE FCF = $3.2 million = $2.8MM in NOPAT + $0.60MM NOWC Increase - $0.20MM OFA Increase (expected FYE 12/31/08 FCF is based on 9/30/08, actual 9-month results and assumed FYE 12/31/08 revenues of $58.5MM)
  • Growth 6.0% (modest in comparison to historical growth rates)
  • WACC (Weighted Average Cost of Capital) 13.0% (note the impact of the cash balance and low beta)
  • $24.4 million in cash balances are added to the PV (assumes that the entire cash is cash surplus)
  • 28.5 million shares.

If you feel that the assumptions are too conservative and that a more realistic growth rate is say, 8.0% (instead of 6.0%) and 10.0% WACC (instead of 13.0%), then your PV is $6.92 (instead of $2.56).

Alternatively, a growth rate of 2.0% (instead of 6.0%), and 13.0% WACC, would result in a $1.90 stock value, very close to $1.85, the market’s stock price.

Best wishes for 2009.

Disclosure: I hold a long position in CKSW