On Sunday, June 29, 2014, Bloomberg published an article titled "Soros Caught in ClickSoftware Rout that Puzzles Analysts." ClickSoftware Technologies (NASDAQ:CKSW) optimizes field service management. Soros Fund Management owned 9.9% of the stock as of March 31, 2014. In a nutshell, the article discusses the unfavorable performance of the stock price in recent times despite the seemingly positive prospects and the analysts' positive prognosis for the stock. The analysts' average 12-month target for the stock is $13.33 per share. The morning following the day of the article, the stock jumped over 6 percent to $8.07 on strong volume.
Below I summarize why I believe Soros and the analysts are right in their view of the company, and why the current stock price is substantially below its fundamental value. Many of the issues discussed are covered in greater detail in previous articles in Seeking Alpha.
The market opportunity in field service management is extensive and growing at a fast pace. Field service management application revenues are estimated at $1.2 billion in 2012, with a compounded annual growth rate of 12.7% (Gartner, 2013). Service businesses comprise more than 70% of the world's economy and continue to grow.
Year after year, the company is positioned in the Leaders Quadrant of Gartner's Magic Quadrant for Field Service Management. The growing list of clients, customer wins and the accolades from industry sources attest to the company's leadership position, which in recent years is getting progressively stronger due to sizable investment in R&D and expanding sales infrastructure.
Competitiveness is buttressed by an ecosystem of partners who collaborate and distribute ClickSoftware products. Realistically the ecosystem cannot be duplicated.
Products and apps cover the end-to-end needs of a wide range of firms, with as few as five employees to as many as 50,000 employees. Apps can be purchased alone as point solutions, or in bundles for bigger needs, or even larger transformation projects. Strategies in response to new technologies over recent years are now converging to match market demand and industry trends. ClickSoftware's software is designed to work in harmony with leading platforms and infrastructures (IBM (NYSE:IBM), Salesforce (NYSE:CRM), SAP (NYSE:SAP)), and are device agnostic to run on iOS, Apple (NASDAQ:AAPL), Android (NASDAQ:GOOG) (NASDAQ:GOOGL) and Windows 8 (NASDAQ:MSFT).
The acquisition of Xora, a California-based provider of software-as-a-service products for small and middle market companies dependent on mobile workforce proficiency, extends ClickSoftware's coverage into the small-middle market and opens distribution channels through wireless carriers. The $12.7 million price paid seems very attractive relative to some $20.0 million in annual revenues attributed to Xora. The acquisition in 1Q 2014, was paid from surplus cash.
Revenues have grown rapidly, from $61.1 million in 2009, $103.2 million in 2013, and $126.0 - $132.0 million guided for 2014. Net profits have not grown as rapidly, or as steadily, for the following reasons:
(A) P&L charges for heavy investment in R&D and sales' infrastructure in anticipation of revenue growth. (See article: ClickSoftware 1Q14 Results: Reaffirmation Of A Value Opportunity).
(B) GAAP accounting treatment of R&D as an operating expense. The conversion of R&D from an operating expense into a tax-advantaged expenditure reveals concealed value. Net income (after taxes), after the R&D conversion, is substantially higher than net income under GAAP. Likewise, EPS, after R&D conversion, is substantially higher than EPS under GAAP (see article: Will The Real ClickSoftware Please Stand Up?). This explains the apparent high PE for the company in comparison with similar firms who capitalize R&D and report higher net profits.
(C) Acceleration of revenue deferral due to rapidly-growing cloud sales understates current revenue and puts y-o-y revenue growth comparison in a negative (distorted) light.
Increased earnings can be expected due to the normalization in the P&L (as cloud-based products gain in bulk and in relative importance to total revenues) and due to the increased revenues brought about by the outsized selling and marketing infrastructure. Future performance will be driven by the strategies carried out in recent periods, such as robust product development (R&D) and speed of client acquisition (selling and marketing infrastructure). See article: ClickSoftware: Upcoming Shift in Major Factors Should Move The Stock.
ROIC and Growth
Notwithstanding the headwinds in earnings discussed above, the company produces exceptional ROIC. Four-year average, 2010-2013, ROIC is 46%, well in excess of the 10% to 12% estimated cost of capital. Given industry structure and the company's competitiveness, we propose high ROIC is a rather permanent attribute. Under these circumstances revenue growth is a mandatory strategy - high ROIC and high rapid revenue growth (and rapid free cash flow growth) are complementary conditions in accelerated value creation.
ClickSoftware achieves adequate balance in the interplay among Value Proposition (client benefit in the eyes of clients), Economic Equation (risk-adjusted return to shareholders), and Management Effectiveness (organization of resources). Together they result in strong client relationships, favorable economic returns to shareholders, and durable core competence. See article: 3 Good Reasons To Own ClickSoftware: Value Proposition, Economic Returns And Management Competence.
Industry leadership, client wins and superior ROIC support the view that ClickSoftware's business model is robust, durable and difficult to replicate. Embedded in the model is strong cash generation which more than self-finances working capital requirements and capital investment, even during periods of rapid revenue growth. This results in ample surplus cash (without bank debt).
2014 Momentum and 2014 Guidance
Growth in 1Q 2014 "Revenues + Deferred Revenues" y-o-y is a whopping 27%, much higher than the 15% four-year average. This measure of operational client performance eliminates the distortion in the comparison of "revenue" growth between a period of rising revenue deferrals (3% revenue growth in 2013) due to low cloud sales, and a period of low revenue deferral (15% revenue growth in 2012) due to growing cloud sales. In other words, growing cloud demand (which temporarily lowers revenues by raising revenue deferrals) does not detract from the underlying value of business done and should not impact the price of the stock negatively. Thus, the pessimism evidenced in the marketplace by the drop in stock price due to a slowdown in revenue growth in recent reporting periods (3% in 2013 vs. 15% in 2012) is not justified by this analysis.
Increased revenue stability and reduction in business risk underlie $60 million-plus in the annual run-rate of recurring revenues estimated by the end of 2014 - $26 million to $30 million from cloud revenues plus $36 million from support contracts for on-premise clients. A diversified source of revenues contributes to low risk: 53% of quarterly revenues are from the Americas, 39% EMEA, 8% Asia-Pacific.
On the 1Q 2014 earnings report, 2014 full year guidance was raised to $126.0 million to $132.0 million. Implicit (not provided by management) in $129.0 million, mid-point guidance, is $103.2 million (2013 revenues) + $5.8 million (5.6% increase) + $20.0 million (2014 revenues attributed to newly-acquired Xora). Mid-point guidance seems very conservative if the 2014 revenue attributed to Xora is in the ballpark, and $132.0 million upper-range guidance appears quite attainable. Management also called for improvement in profit margins in the second half of 2014.
The estimate of the stock's fundamental value is $10.70/share based on $12.0 million 2014 FCF growing at 15% per annum through 2017 and 5% thereafter in perpetuity. Weighted Average Cost of Capital is 10% throughout.
The fundamental value of the stock is conservative in comparison with the analysts' $13.33 average target price. The day following the date of the Bloomberg article, the stock jumped 6.18% to $8.07/share.
Disclosure: The author is long CKSW. The author wrote this article themselves, and it expresses their own opinions. The author is not receiving compensation for it. The author has no business relationship with any company whose stock is mentioned in this article.
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