CDC Software IPO Analysis: Deal Oddities Don't Pass the 'Sniff Test'

Bill Simpson wrote an analysis of CDC Software (CDCS) to TradingIPOs subscribers. In its market debut Thursday, August 6, CDC Software sold 4.8 million American depositary receipts for $12 apiece, raising $57.6 million. CDC Software had expected the shares to price between $11 and $13.

The text of Mr. Simpson's original writeup follows:

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CDC Software plans on offering 4.8 million ADS at a price of $11-$13. Insiders will be selling 800k shares on the deal. Lazard and JMP are leading the deal, Cantor Fitzgerald, Janney Montgomery, Macquarie, and Morgan Keegan co-managing. Post-ipo, CDCS will have 29 million ADS equivalent shares outstanding for a market cap of $348 million on a pricing of $12. Ipo proceeds will be used for general corporate purposes. **Note: while prospectus states 'general corporate purposes', the ipo does not appear as if it will add any net cash onto CDCS' balance sheet. This may be due to a few inter-company back/forth loans between CDCS and parent CDC Corp. (CHINA).

CDC Corporation will own 83% of CDCS post-ipo. CDC trades on the nasdaq under the symbol CHINA. **Note** This CDCS ipo is a spin-off from CDC Corp. Oddly CHINA currently has a market cap of $324 million, while at mid-range CDCS will have a market cap of $348 million.

From the prospectus:　

'We are a global provider of a broad suite of scalable enterprise software applications to customers in select industries, which we refer to as our targeted vertical industries. Our software applications enable our customers to grow revenue and control costs by automating business processes and facilitating access to critical information.'

Enterprise management software focused on small to medium size businesses. CDCS offers a wide array of software products and it appears their goal is to be a 'one stop software shop' for small and medium size enterprises. We've seen a number of ipos that focus on a segment of enterprise software needs such as Customer Relation Management (CRM), Analytics or Business Resource Planning (ERP). CDCS, however, offers software products across the entire enterprise management spectrum.

Software offerings include Enterprise Resource Planning; Supply Chain Management; Manufacturing Operations Management; Customer Relationship Management; Enterprise Feedback Management; Human Resource Payroll; Business Analytics.

We could spend a bit of time defining each of the above and delving deeper into CDCS software products, etc...However these pieces are not industry papers, they are 'one sheet's designed to give us enough information to decide how to value CDCS' future prospects both operationally and in the stock market. I've always believed the numbers tell a much better story than attempting to dissect each and every small aspect of a tech ipo's software/hardware offerings. For our purposes, CDCS is a 'one stop' small/medium size enterprise management software operations.

To beat a dead horse, CDCS offers their products across a wide variety of end markets, believing their software products are suitable and useful for the needs of pretty much any type of small to medium size business, from financial services to heavy equipment manufacturing to retail.

CDCS has made 13 acquisitions over the past 6 years, including two currently pending. In many ways CDCS resembles a roll-up operation acquiring different type enterprise software companies instead of developing in-house. Part of the reason CDCS offers such a wide variety of enterprise software products is simply that they've acquired them over the past 6 years.

Competition in CDCS various segments includes NetSuite (N), Microsoft (MSFT), Oracle (ORCL), Lawson (LWSN), Epicor (EPIC), Infor (INFA), Salesforce.com (CRM) and a myriad of other small worldwide software operations.

**For 2008 License sales accounted for 18% of revenues, maintenance 42%, professional services 37% and hardware 2%. Licensing revenues from existing customers dropped 25% year over year in the March '09 quarter and 32% overall. Licensing revenues are crucial for CDCS as they set-up the recurring maintenance service agreement that fuels CDCS revenue stream. The steep drop in licensing revenues the past few quarters does not bode well for revenues growth over the next year. I do not believe I've ever seen a software ipo that depended on software sales/licensing for such a small percentage of revenues.

Maintenance contract retention rate has been 90% plus the past two years - very solid. Maintenance revenues consist of updates, upgrades and new releases of existing enterprise software applications licensed to customers, so one would expect retention rates to be strong as these are customers that have made the decision to license CDCS' software.

Oddly, a spin-off from a company with the symbol CHINA actually does very little business in Asia. Revenues for 2008 were split between North America/Latin America/Europe, with only 5% coming from Asia.

Financials

About $1 per share post-ipo in net cash.

In 2009, CDCS will have lower revenues than both 2007 and 2008. As noted above, license revenue (the entryway to maintenance/professional services contracts) have slowed significantly over the past few quarters. CDCS has, however, done a nice job cutting expenses. They've laid off numerous personnel in sales & marketing and have shifted the bulk of R&D efforts to lower cost India and China. The result is that operating margins have held up through the first quarter of 2009. CDCS will need to begin to grow licensing revenues at some point, though, as it appears they've cut costs about as much as possible for the current revenue stream.

2008 - $241 million in revenues. 54% gross margins, very low for a software company. Again a concern here is that CDCS derives such a small percentage of their revenues from actual software licenses. Operating expense ratio was 53%, putting operating margins at just 1%. EPS negligible.

2009 - CDCS had a much slower first quarter of 2009, led by a sharp drop in software licensing. However, they somehow managed to gut operating expenses and R&D as noted above. I'm a tad skeptical here as this is a spin-out of another company suddenly showing vastly improved operating margins just before coming public...and vastly improved operating margins while seeing much slower revenues at that! This is just a strange deal with so many odd things about it. This IPO stands out the most as potentially unbelievable.

Revenues for 2009 look to be in the $200 million ballpark, a 17% drop from 2008. Gross margins should decline 52%. **CDCS would have us believe that with declining revenues and gross margins, operating expense ratio improved significantly to 45% (from 53% in 2008) in the first quarter of 2009. Yes, they've attempted to cut back GSA and R&D expenses, however with such a drop in revenues and gross margins, it is difficult to believe they were able to gut expense ratio THIS much. I am going to bump that operating expense ratio up for the the full year as 1) this is a spin-off and accounting here can easily hide something and 2) this is a roll-up with two acquisitions pending so it is possible some expenses may be on the books of the acquiree companies. I do not know; what I do know is this does not pass the 'common sense' indicator and is one of the more unusual improvements in operating expense ratios I've seen in a decade of analyzing ipos. Scaling back a little, operating margins for full year should be 4% and with net margins of 3%. EPS should be $0.20. On a pricing of $12, CDCS would trade 60 X's 2009 earnings.

**I've little confidence in this forecast as the first quarter of 2009 does not make a lot of sense to me. CDCS does provide Q2 revenue numbers in the prospectus, but no other details. I do believe revenues should be in the $200 million ballpark, the rest though we shall see.

Conclusion - Funky and odd deal. A spin-off with a prospective higher cap than parent company; a software company with licensing of their software accounting for only 17% of revenues in 2008; parent company stock symbol of CHINA, yet only 5% of revenues were derived from Asia in 2008. Factor in too that CDCS has implemented a difficult-to-integrate and manage roll-up strategy attempting to offer 'everything to everyone' and I'm going to simply stay away from this deal. Just does not pass the sniff test at all, too many oddities.

Comments

[User 472557:]

Interesting analysis of CDCS, Bill. One thing I noticed was a stock ticker symbol for Infor, which is a private company. The symbol given is for Informatica Corp., a different company altogether.

Aug 17 09:05 AM