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Mark Gomes, PTT Research (1,249 clicks)
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Since 2009, I've been introducing SeekingAlpha readers to stocks that have the potential to triple in value. In this article, I will provide an update on our historical performance and an update on why QAD Software (QADA) and Facebook (FB) were added to our Poised To Triple portfolio.

Let's start by reviewing our past picks. You can see a complete performance chart and listing of initiation pieces on my Instablog. A few things stand out:

The Bad News: 20% of our picks drop more than 20%

That's a lot of losses. However, the other 78% of our picks have gone up an average of 77%. Fortunately, you can enjoy big gains and avoid big losses by employing a 20% loss limit, which we highly recommend and use in our performance tracking (see our Stocks To Triple Instruction Manual for our complete investing methodology).

The Good News: At their peaks, our picks average a 100% gain

Of course, nobody can sell a stock at its absolute peak with regularity. However, if your picks double on average, you have ample room for error. Using our methodology, you would attain an average profit of 53%. Without it, the average is still a respectable 27%.

The Best News: 33% of our picks have tripled or been acquired

We're most proud of the latter. Long-time readers know that our picks are "real companies." This statistic should give new readers a similar level of confidence. The "secret" is our research method. We employ industry experts (often at a considerable expense) to investigate our investment candidates before recommending them to readers. Not surprisingly, large corporations also use these experts for advice on strategic planning and M&A.

The Latest News: Our newest picks have gained over 50%

The chart below depicts our latest picks. As you can see, Rainmaker Systems (RMKR) was a major disappointment and triggered our 20% loss limit. The rest have picked up the slack, leading to an average gain of 55% (and 83% at their respective peaks). Our highlight to date has been Himax Technologies (HIMX), which rose 60% last month after we released an analysis showing near-irrefutable evidence that the company will likely power Google Glass.

FYI, today we are shifting our classification of HIMX to "Wait Time" (see our Three-Stage Classification System for details). Most investors are now well aware of the company's prospects, so the "Great Find" phase should soon transition into a wait for proof that the company will fulfill its substantial promise. We will be monitoring its progress for an eventual upgrade to "Gold Mine."

Poised to Triple Portfolio

Company

Ticker

Initial Price

Peak Price

Peak Return

Current Price

Current Return

Current Classification

Seagate

STX

17.94

37.94

111%

41.37

131%

Gold Mine

Lions Gate

LGF

12.14

25.35

109%

26.16

116%

Gold Mine

Attunity

ATTU

3.36

9.75

190%

5.50

64%

Wait Time

Lantronix

LTRX

1.82

2.45

35%

1.80

-1%

Wait Time

Rainmaker

RMKR

1.04

1.37

32%

0.57

-20%

Stopped Out

Facebook

FB

18.06

32.51

80%

28.27

56%

Gold Mine

Himax

HIMX

3.44

6.63

93%

6.49

89%

Wait Time

QAD Software

QADA

11.73

13.35

14%

12.12

3%

Value Stock

Averages

83%

55%

Excluding RMKR, which reached our loss limit, this is our current official portfolio. We believe that each of these picks remain poised to triple (or be acquired). As always, stocks with a "Wait Time" classification should be approached cautiously until upgraded to "Gold Mine" status.

Running down the list, Seagate, Attunity, Lantronix, and Facebook all recently announced their earnings results. Consistent with their Wait Time designations, ATTU and LTRX reported lackluster results. Meanwhile, STX and FB with their Gold Mine designations, each reported stellar results.

As for LGF, our last SeekingAlpha article continues to ring true. The company is riding the "content is king" wave and has a strong slate of upcoming releases, including the first "Hunger Games" sequel, as well as "Ender's Game" and the highly anticipated 'Divergent." For those who haven't heard of "Divergent", it is considered by many to be the next hit young-adult franchise a la "Twilight" and "The Hunger Games". The latest Google Trends report shows that interest in this franchise is going parabolic. If the movie fulfills its potential, LGF will be in possession of every major young-adult title at a time when Harry Potter has left a lucrative gaping hole for the company to walk through.

Moving on, our three favorite selections at present are QAD Software, Facebook, and our latest selection, BlackBerry (BBRY). We initiated coverage on BBRY last week, so we'll focus on QADA and FB today. Both companies have been underperforming the market of late. Also, each is trading well off of its respective 52-week highs. In other words, investor sentiment is low or indifferent -- and sentiment is well-known to be a contrary indicator.

QAD: Value Stock With Potential To Triple

We initiated coverage on QADA last month. In that piece, we stated that its shares are poised to rise 50%. In reality, the shares could triple. We recently performed an updated analysis of QADA's recurring revenue stream and operating structure. Starting with its recurring revenue stream, a few things stand out:

1. Deferred revenue rebounded sharply in fiscal 2013. As you can see in the chart below, deferred revenue growth is a leading indicator of recurring revenue growth. Thus, investors can bank on stronger recurring revenue growth in the coming year.

FY Ended Jan

2009

2010

2011

2012

2013

Maintenance and other

132,354

129,658

130,104

137,659

138,563

Subscription Fees

3,507

4,009

5,773

9,787

14,838

Total Recurring Revenue

135,861

133,667

135,877

147,446

153,401

Growth

-2%

2%

9%

4%

Deferred Revenue

81,392

85,745

94,453

93,871

101,193

Growth

-10%

5%

10%

-1%

8%

2. The quality of QADA's deferred revenue has also improved. In fiscal 2012, over 5% represented services and R&D, which are low-margin sources of deferred revenue. In fiscal 2013, that number dipped below 3%, while deferred revenue from maintenance (+3%), subscriptions (+49%), and licenses (+283) all grew at a favorable pace.

3. QADA's total recurring revenue balance now stands at $153 million. In other words, the company's enterprise value is about equal to one year's worth of recurring revenue. Its entire market cap is just 1.6 times maintenance. This is a remarkably low ratio, historically reserved for unprofitable, small, and/or volatile software companies like Astea (ATEA). QADA is none of these things. In fact, even companies that are going through hard times, like Progress Software (PRGS), command multiples in excess of 3 as long as they are somewhat stable and profitable.

Symbol

Name

Market Cap

Maintenance Multiple

TIBX

TIBCO

$2,974,000,000

12

DWCH

DATAWATCH

$82,700,000

12

GUID

GUIDANCE SOFTWARE

$261,400,000

10

SABA

SABA SOFTWARE

$246,300,000

6

BVSN

BROADVISION

$39,200,000

5

CPWR

COMPUWARE

$2,385,000,000

5

PMTC

PARAMETRIC

$2,619,000,000

5

BIRT

ACTUATE CORP

$271,100,000

4

PRGS

PROGRESS SOFTWARE

$1,151,000,000

3

QADA

QAD

$225,000,000

1.6

ATEA

ASTEA

$11,400,000

1

In M&A situations, the typical maintenance multiple has been between 4 and 6 (and often higher), as you can see below.

Symbol

Name

Buyout Price

Maintenance Multiple

VTAL

VITAL IMAGES

$860,000,000

34

PVSW

PERVASIVE SOFTWARE

$161,900,000

20

RTLX

RETALIX

$650,000,000

13

JDAS

JDA SOFTWARE

$1,900,000,000

11

UNCA

UNICA

$480,000,000

11

LWSN

LAWSON

$2,000,000,000

6

EPIC

EPICOR

$976,000,000

5

LGTY

LOGILITY

$90,500,000

5

ITWO

I2 TECHNOLOGIES

$346,000,000

5

CHRD

CHORDIANT

$161,500,000

4

VIGN

VIGNETTE

$310,000,000

4

SUMT

SUMTOTAL

$160,000,000

4

MSCS

MSC SOFTWARE

$360,000,000

3

The reason for this is simple. Older enterprise software companies generally have large installed bases of customers, 90%+ of which typically renew their maintenance contracts year after year. That maintenance revenue usually carries gross margins in excess of 75% and require little in the way of operating expenditure. However, rather than let that profitability drop to the bottom line, most public software companies tend to use it to fund R&D projects. Many (if not most) have a growth-company mentality, but should be acting more like cash cows.

Oracle (ORCL) astutely caught on to this about 10 years ago and started acquiring such companies, beginning with PeopleSoft in 2004. By cutting R&D and SG&A, we estimate that ORCL (and other such acquirers) have been able to increase the operating margins of its targets by 20-40 percentage points. At the low-end of that range, QADA's operating profits would increase five-fold.

Thus, we can envision how shares of QADA could triple utilizing two different methodologies:

1. If QADA were to be acquired at the midpoint of the typical M&A maintenance multiple, the shares would triple. The typical multiple (as stated above) has been 4-6. The midpoint of that range is 5. QADA is currently trading with a multiple of 1.6. A multiple of 5 would represent more than three times its current valuation.

2. Assessing the impact of ORCL's past acquisitions on its operating margins, we estimate that ORCL typically cuts its acquisitions' operating expenses by upwards of 50%. If QADA cut its operating expenses by just 20%, its operating profits would triple. Assuming that its valuation multiple remained stable, the stock would also triple by default.

Keep in mind, 20% is a fraction of the cuts that often get enacted by acquirers. However, in this case, it would be enough to make shares of QADA triple. Of course, the company would have to actually cut expenses or be acquired to unlock this potential. We believe that one of these scenarios will eventually play out.

In the meantime, the company has been buying back shares while offering a solid 2.4% dividend. Both provide a nice floor under the shares, giving QADA one of the most attractive risk/reward ratios we have encountered. Accordingly, QADA remains one of our top picks.

Facebook: Monetization Will Send The Shares To $50+

Back in October, amid similarly negative investor sentiment, we stated that Facebook would find a way to successfully monetize its mobile traffic. A few months later, the company reported better than expected Q4 results, including exceptional mobile revenue growth. The news sent the stock to a new 6-month high (and nearly double its September lows).

More recently, the company topped Q1 revenue expectations. EPS fell shy, but only because management decided to step on the investment accelerator, which is a bullish sign. Of equal importance, daily active users (DAU), monthly active users (MAU), and mobile revenue growth all came in stronger than expected.

The shares remain well above its 52-week low of $17.55 (as well as our initiation price of $18.03), but subsequently retreated from 32 to the mid-20s. We view current levels as an opportune entry point. Bears have been arguing that traffic and new user growth have flattened out. The Q1 results tossed some cold water on that thesis. More importantly, as far as valuation arguments go, the bear thesis is flawed. Indeed, changes in user and traffic growth have virtually zero impact on revenue, especially when compared to the growth in monetization of its user base.

Going forward, FB will accelerate the introduction of new capabilities, even as it cashes in on established features. As a result, its revenue-per-user will continue its steady ascent (see chart below). Thus, growth in revenue per user will far outpace any degradation that may occur in user growth and/or traffic.

Consider this -- just $1 of profitability per user per month would represent a current P/E of 5. At that level of profitability, a P/E of 25 would necessitate a quintupling from current levels. Bears should consider the risk/reward involved with attempting to gain 50% on a short that could just as easily rise 400%, especially when their case is misguidedly based on user and user-growth statistics.

Again, our math assumes just one dollar of profit per user. As you can see in the table below, revenue per monthly active user (MAU) has steadily risen and stood at $1.56 as of December 31, 2012. Operating margins in the quarter approached 50% (about 42 cents per MAU). With FB's enviable operating leverage, the path to $1 in net income per MAU is not difficult to envision. Of equal importance, few would argue that FB's user count or traffic will decline by over 90% in the coming years. However, that's what it would take to keep earnings in check under this scenario.

Facebook: WW Revenue Per MAU

Quarter

MAU (000)

Revs ($000)

Revs/MAU

MAU Growth

Rev Growth

Mar-09

197,000

125,000

$ 0.63

-

-

Jun-09

242,000

160,000

$ 0.66

-

-

Sep-09

305,000

220,000

$ 0.72

-

-

Dec-09

360,000

272,000

$ 0.76

-

-

Mar-10

431,000

345,000

$ 0.80

119%

176%

Jun-10

482,000

431,000

$ 0.89

99%

169%

Sep-10

550,000

467,000

$ 0.85

80%

112%

Dec-10

608,000

731,000

$ 1.20

69%

169%

Mar-11

680,000

731,000

$ 1.08

58%

112%

Jun-11

739,000

895,000

$ 1.21

53%

108%

Sep-11

800,000

954,000

$ 1.19

45%

104%

Dec-11

845,000

1,131,000

$ 1.34

39%

55%

Mar-12

901,000

1,058,000

$ 1.17

33%

45%

Jun-12

955,000

1,184,000

$ 1.24

29%

32%

Sep-12

1,007,000

1,262,000

$ 1.25

26%

32%

Dec-12

1,056,000

1,585,000

$ 1.50

25%

40%

Mar-13

1,100,000

1,458,000

$ 1.33

22%

37%

Jun-13 (est)

1,155,000

1,600,000

$ 1.39

21%

35%

Sep-13 (est)

1,200,000

1,700,000

$ 1.42

19%

32%

Dec-13 (est)

1,250,000

1,950,000

$ 1.56

18%

23%

Source: Facebook and Pipeline Data, LLC estimates

It's more likely that Facebook will continue to advance its lock-in and monetization strategy. For example, over the past few months, the company has positioned itself to become more of a direct competitor to Google's (GOOG) search business. Each company has its strengths and weaknesses, but the match-up has the feel of a legitimate fight. We would give the clear nod to GOOG, but not without ceding some valuable market share in the process.

From a valuation perspective, GOOG has an enterprise value (EV) of $220B. FB's EV is less than a quarter of that ($50B). At 50% of GOOG's EV, FB will be valued at $110 billion. That figure may prove conservative. New research begs to argue that Facebook users are worth $175 apiece. Using that figure, we would derive a market cap of closer to $200 billion.

The lower figure ($110 billion) equates to about $50 per share, nearly a triple from our initiation price of $18.03. It won't happen overnight, but a couple of years from now, we expect Wall Street analysts to be projecting earnings of $2.00 per share. Give that a P/E of 27 (it's currently trading at 33x next year's estimate) and the stock will be $54, a triple from our initiation price.

Source: Stocks To Be Acquired Or Triple