Model N - Remain On The Sidelines After An Almost 50% Jump

| About: Model N (MODN)

Last week, Model N (NYSE:MODN) made its public debut on Wednesday the 20th of March. Shares of the company, which provides revenue management solutions for the life science and technology industry, ended their first trading day with gains of 28.9% at $19.97 per share. Shares have traded around the $20 level ever since, currently exchanging hands around $19 per share.

The Public Offering

Model N is a provider of revenue management solutions aimed to maximize revenues for its customers. The company offers key functions including pricing, contracting, incentives and rebates to maximize revenues through its web-based platform which works in the cloud as well as on traditional platforms.

Model N sold 6.0 million shares for $15.50 apiece. The company raised $93 million in gross proceeds in the offering process, valuing the company at $332 million. Selling shareholders offered some 700,000 shares in the offering.

The offering was a success. The offer price was set above the midpoint of the preliminary $12.50-$14.50 price range set by the firm and its bankers. Some 31% of the shares outstanding were offered in the public offering. At Friday's closing price of $18.45, the firm is valued at $395 million.

The major banks that brought the company public were J.P. Morgan, Deutsche Bank, Stifel and Piper Jaffray, among others.


Model N offers two complementary pieces of software applications. The company offers Revenue Management Enterprise and Revenue Management Intelligence services. The former automates pricing, contracting, incentives etc., while the latter offers analytical solutions services.

For the year of 2012, Model N generated the majority -- some 85% of total revenues -- from its Revenue Management Enterprise solutions. Model N's customers include blue-chip names including Abbott Laboratories (NYSE:ABT), Amgen (NASDAQ:AMGN), Johnson & Johnson (NYSE:JNJ), Dell (NASDAQ:DELL) and Nokia (NYSE:NOK).

The company reported annual revenues of $84.3 million for the full year of 2012, up 29% on the year before. The company reported a full year loss of $5.7 million as gross margins fell by almost 700 basis points to just under 52%.

Fourth quarter revenues rose almost 24% compared to the year before, coming in at $22.3 million. Net losses doubled to $1.3 million for the period.

The company raised $93 million in gross proceeds in the offering process. As such net proceeds are expected to come in around $85 million. The company operates with $12.6 million in cash and equivalents and $4.5 million in short and long term debt. As such, Model N will operate with roughly $90-$100 million in net cash.

Based on Friday's valuation of $395 million, the market values the firm's operating assets around $300 million. This values the firm at roughly 3.6 times 2012's annual revenues.

Note that billings for the year of 2012 grew by 31% to $101.3 million. The strong revenue growth resulted in a book-to-bill ratio of 1.20.

Investment Thesis

As noted above, the offering of Model N has been a great success. Shares were offered above the midpoint of the preliminary offering range and close 47.9% above the preliminary midpoint range at the first trading day.

The immediate outlook for Model N remains good. The book-to-bill ratio came in at 1.20 for 2012, resulting in a growing backlog of future expected revenues. The long term growth prospects for cloud-based services remain good, especially during harsh economic times.

A key risk for many small growing technology companies is the lack of diversification among its key customers. Merck & Co. (NYSE:MRK) and Amgen combined accounted for almost a quarter of total revenues. The top 15 customers account for roughly three quarters of total revenues.

Furthermore, technology changes result in fast growing developments within the industry and fierce competition, possibly from new entrants. As a result Model N employs some 200 in staff dedicated to Research & Development alone, roughly a third of its total workforce. Large customers often tend to develop own applications, while Model N competes with the likes of ERP providers such as Oracle (NASDAQ:ORCL) and SAP (NYSE:SAP) in the medium-sized segment of the market.

The current valuation of Model N is high and competition is fierce, putting pressure on margins. Yet the revenue multiple at 3.6 times annual revenues is in line with some of its larger competitors and the company is close to break even. At the same time, higher billings will result in further expected revenue growth into 2013.

While a 95% renewal rate for its customer base is impressive, growth is slowing down a bit. After a 48% jump in the first trading day as a publicly listed company, shares are valued a little too rich. Valued at 3.6 times annual revenues, factoring in slower growth and the lack of profitability make be hesitant to pick up any shares at the moment.

Yet Model N is not directly an obvious short. Other cloud-related public offerings such that of Guideware Software (NYSE:GWRE) and Workday (NYSE:WDAY) have been a huge success, as each of those companies have seen their shares price more than doubled ever since.

I remain on the sidelines.

Disclosure: I am short WDAY. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.