ClickSoftware: Is Shelf-Registration Getting in the Way of Operating Success?

Severe declines in the price of an investor’s stock are not fun. Since the beginning of the year, ClickSoftware (NASDAQ:CKSW)’s stock price has dropped by some 25%. The more recent market down-draft suggests continuing fragility in the stock.

A previous article (ClickSoftware: A Leap in Growth and Value) discussed the positive prospects of an envisioned acquisition -- rapid growth and acceleration in the increase of fundamental value driven by increased size. The context considered strong operating management and a favorable financial track record. Implicit in the assessment was, at a minimum, a relatively steady stock price. By omission, the article failed to anticipate the negative market reaction to the shelf registration. In this article we reassess and correct.

A sterling track record of operating performance including rapid growth, significant product development, commanding competitive leadership, attractive growth prospects, a promising and effective partnership eco-system, a strong and liquid balance sheet, a high-single-digit fundamental value, and on-track performance to meet FYE 12/10 guidance, now seem insufficient to support a healthy enterprise valuation. On its face this is an oxymoron.

While the company has proven very adept in the operating management of the workforce management and service optimization business, the risk implications of the recent shelf registration, within the broader subject of financial management, have evidently heightened investor uncertainty and hampered maximization in shareholder value.

Financial Management

The 4/13/10 shelf registration for up to 15.0 million of shares, effective for a period of three years, was not well received in the market. A concern lies in the possibility of major dilution for the existing 32.0 million of shares currently outstanding. Uncertainty regarding the ultimate size of the acquisition and the related size of stock issue can reasonably turn into aversion to growing risk and result in increased cost of capital. These depress the present value of future free cash flows from any acquisition.

The continuing absence of substantive follow-up information, since the date of the shelf registration, reinforces uncertainty and upholds questions regarding the essence of the embedded financial plans. Some questions are; why was the registration the chosen alternative, why for such a large number of shares, and why so early? What are the alternatives for sourcing of capital and in the capital structure? More specifically, is the potential size of the acquisition too large of a bite? In other words, does risk-taking stretch beyond investors’ boundaries?

To be sure, the benefits of the shelf registration are unclear and yet-to-be realized. The costs, however, are real, present, and major. Beyond contributing to losses in market capitalization, the cost of any prospective acquisition has been raised and the concomitant investment returns lowered. An albatross is hanging from the price of the stock.

Strategic Acquisition vs. Ordinary Capital Budgeting

The risk of a potentially large acquisition is much greater than the risk involved in relatively small organic capital expenditures in product expansion, or in small product/asset acquisitions, like those made in 2009. Capital budgeting is largely a routine, operating exercise; in contrast, corporate acquisition is a custom-made, strategic transaction. To treat them alike is to misunderstand the market perception of risk.

CKSW is proven successful at “making and selling products” but the company’s skill at “buying companies” is unknown. The firm’s competence is in the nuts and bolts of workforce management and service optimization. By contrast, competence is not proven in customer-made acquisition design, related corporate finance assessment, acquisition finance, or major businesses’ integration; albeit in the same general line of business.

The acquisition risk is major due to its potential size relative to the resources available to the company. An acquisition in the order of $100 million (“proposed maximum aggregate offering price” in the registration statement) by a $160 million market cap company elicits the image of a far-too-many-eggs-in-one-basket bet.

Market Response

Abrupt and major changes in financial policy do change the risk profile of firms and expose their stock to sudden reaction. Increase in the stock's risk profile beyond the boundaries of risk acceptability causes investors to rearrange their portfolios and sell increasingly risky stocks to restore the desired risk/reward preferences. In the process, stock prices and the cost of capital are adjusted in the marketplace, as is the profile of the investor willing to accept increased risk.

The notion that no undue weight should be given to the shelf registration because of the historical track record of the management team in careful, deliberate, and balanced decision-making tests the boundaries of risk acceptability in the marketplace. The logic that the registration is of secondary importance because it only represents an administrative step that needs to be taken, and that actually no acquisition is imminent, and perhaps only a portion of the total amount of shares registered would be actually issued, equally misses the risk escalation embedded in the registration announcement. Finally, the continuing favorable operating performance, including on track current performance to meet FYE 12/10 earnings guidance, does not by its nature explain, or support, the financial management issues discussed here.

The presumption that the shelf registration represents a deliberate intent by management to increase risk may not be correct. In fact, management may not intend to make an unreasonably large acquisition or issue the entire block of 15 million new shares registered. If this is so, the apparent contradiction between management intent and the company’s communications to investors represents a self-inflicted wound that needs prompt attention.

Conclusion

CKSW gets kudos for the historical track record of operating management success. Historically the management team has proven to be careful, deliberate, and able to strike a balance between investing in future opportunities while delivering strong results, quarter after quarter. Meanwhile, the FYE 12/10 guidance remains on track. The company also gets positive recognition for the drive to compound strong organic growth with strategic acquisitions.

Consistent and reliable operating performance has effectively earned the management team strong shareholder support. In contrast, financial management is unnecessarily ambivalent. The registration is an uncharacteristic and a surprising event, falling outside the realm of shareholders’ expectations.

It would seem fitting for the company to clarify intent and elevate the profile of its financial management role. Deliberate financial management and clear investors’ communications, particularly concerning company-changing events, are important along with the true-and-tested excellence in operating management.

On a positive note, the financial management issues discussed here are very important, but not complex or difficult to resolve. It is a reasonable expectation to regain investors’ confidence once clarity of purpose is established. Therefore, the case can be made for the inherent opportunity in the current stock price relative to its high single-digit fundamental value.

Disclosure: I hold CKSW stock.