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, Gino Verza (6 clicks)
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Previous articles discussed market mispricing in ClickSoftware’s (CKSW) stock relative to its fundamental value with focus on the company’s financial performance. Here we address the same issue by comparing ClickSoftware with Interactive Intelligence (ININ), a small cap, software application provider. The context for this analysis is free cash flow, determinant of fundamental value.

The comparison involves various metrics with particular emphasis on the Dollar size and on the rate of growth of free cash flow (FCF) relative to the companies’ own stock prices (charts). The issue to resolve is the extent to which the companies’ performance metrics are reflected on their respective stock prices.

The analysis, presented below, shows that CKSW stock is significantly underpriced relative to ININ’s. By and large, the market attaches a lower price per unit of performance metric to CKSW’s stock than it does to ININ’s. Such discrepancy is apparent in various performance metrics discussed, and particularly significant in the FCF, a key determinant in fundamental value.

No apparent reason due to company-specific factors, or to their market growth opportunity, as discussed below, explain the bias.

This work adds confidence and confirms the investment opportunity in CKSW based on the significant discount in the current price of the stock ($6.60/share) relative to $10.27/share, fundamental value estimated in the article dated 10/13/10.


Comparable Attributes

Described below are a number of similarities in various attributes and in the risk profile of ClickSoftware and Interactive Intelligence.

Operating Attributes

  • Leading providers of software applications for enterprise use, globally. Their purpose is to improve the business process of their clients.
  • Clients can deploy solutions provided on-premise or as a service.
  • Clients are supported by global support networks of company professionals and implementation partners.
  • Solutions are scalable and integrated with business systems; they enhance workforce mobility, workflow management, and facilitate communications and management interaction.
  • Products and strategies gain leadership recognition in their respective fields by independent industry experts (Gartner)

Financial Attributes

  • Revenue growth is steady and largely organic. Gross profit margins are at the high-end.
  • Extended history of net profits; no losses.
  • Ample availability of capital and of market opportunity to growth.
  • Ample FCF generation satisfies growth requirements and generates surplus cash. No debt.
  • Efficient use of capital; outsized returns measured by FCF/Capital and ROIC.
  • Use of Net Operating Working Capital (NOWC) and in Operating Net Fixed Assets (OLTA) is low relative to FCF and NOPAT. [NOPAT = EBIT x (1-Tax Rate)]. (Capital = NOWC + OLTA). (ROIC = NOPAT/Capital).
  • Small caps. Enterprise value below $400.0 million (FYE 12/10 estimate).

Business Risk

  • Relatively young companies with low business risk. Operational risk (EBIT stability and growth; generally only minor, or no concentration risk, in clients or in geography) and financial risk (FCF generation, surplus cash, no debt) are relatively low.

Market Opportunities

  • Market and related growth opportunities seem attractive and supportive of continuing expansion.


Comparison of Stock Prices (relative to performance metrics)

Selected metrics in the charts below compare the historical performance, including FYE 12/10 Estimates.

ClickSoftware (CKSW) Chart --Selected Metrics

(Amounts in millions of US$, unless otherwise noted)

FYE 12/07

FYE 12/08

FYE 12/09

FYE 12/10 Estim.

4-Yr. Avg.

Revenues

40.02

52.26

61.12

72.54

Revenue Growth (y-o-y)

23%

31%

17%

19%

22%

Revenue per Sh. ($/Sh.)

1.40

1.77

1.92

2.20

EBIT

1.36

6.28

11.14

12.82

EBIT / Revenues

3%

12%

18%

18%

EBIT per Sh.($/Sh.)

0.05

0.21

0.35

0.39

Cash Flow from Ops.

4.91

8.54

7.55

12.00

CF f/Ops.Growth (y-o-y)

-13%

74%

-12%

59%

27%

CF f/Ops.per Sh.($/Sh.)

0.17

0.29

0.24

0.36

Free Cash Flow

4.29

7.79

6.15

10.00

FCF / Revenues

11%

15%

10%

14%

FCF Growth (y-o-y)

-18%

82%

-21%

63%

26%

FCF per Sh.($/Sh.)

0.15

0.26

0.19

0.30

Cash (& Market.Secs.)

24.70

32.00

34.97

50.00

Cash Growth (y-o-y)

28%

30%

9%

43%

27%

Cash per Sh.($/Sh.)

0.87

1.08

1.10

1.52

# Shares

28.50

29.50

31.81

33.00

# Shares Growth (y-o-y)

0%

4%

8%

4%

4%

Stock Price (PPS)

6.60

Revenues per Sh./PPS

0.333

EBIT per Sh./PPS

0.059

CF f/Ops. per Sh./PPS

1.818

Free CF per Sh./PPS

0.046

Cash per Sh./PPS

0.230

Interactive Intelligence (ININ) Chart --Selected Metrics

(Amounts in millions of US$, unless otherwise noted)

FYE 12/07

FYE 12/08

FYE 12/09

FYE 12/10 Estim.

4-Yr. Avg.

Revenues

109.90

121.41

131.42

156.00

Revenue Growth (y-o-y)

32%

10%

8%

19%

17%

Revenue per Sh.($/Sh.)

5.71

6.48

7.19

8.31

EBIT

7.99

6.76

14.44

19.35

EBIT / Revenues

7%

6%

11%

12%

EBIT per Sh.($/Sh.)

0.42

0.36

0.79

1.03

Cash Flow from Ops.

20.15

15.18

15.08

16.00

CF f/Ops. Growth (y-o-y)

90%

-25%

-1%

6%

18%

CF f/Ops per Sh.($/Sh.)

1.05

0.81

0.83

0.85

Free Cash Flow

17.49

11.52

10.91

11.60

FCF / Revenues

16%

9%

8%

7%

FCF Growth (y-o-y)

100%

-34%

-5%

6%

17%

FCF per Sh.($/Sh.)

0.91

0.61

0.60

0.62

Cash (and Market.Secs.)

46.33

45.52

64.98

85.00

Cash Growth (y-o-y)

71%

-2%

43%

31%

36%

Cash per Sh.($/Sh.)

2.41

2.43

3.56

4.53

# Shares

19.25

18.74

18.27

18.77

# Shares Growth (y-oy)

5%

-3%

-3%

3%

1%

Stock Price (PPS)

24.23

Revenues per Sh./PPS

0.343

EBIT per Sh./PPS

0.043

CF f/Ops.per Sh./PPS

0.035

Free CF per Sh./PPS

0.026

Cash per Sh./PPS

0.187

Presented in the lower section of each chart are ratios quantifying specific metrics per Dollar of current stock price. Generally the ratios point to significant discrepancies between the stock prices of ININ and CKSW relative to their respective performance metrics.

At current stock prices ($6.60/Sh. CKSW and $24.23 ININ) the market requirements implicit in the prices of the stocks, inter alia, are as follows:

  • For each Dollar in the stock price of CKSW, the market requires 33.3 cents of revenues, 5.9 cents EBIT, $1.82 cash flow from operations, 4.6 cents FCF, and 23.0 cents of cash.
  • For each Dollar in the stock price of ININ, the market requires 34.3 cents of revenues, 4.3 cents EBIT, 66.0 cents cash flow from operations, 2.6 cents FCF, and 18.7 cents of cash.

FCF is particularly important among the measures. Note that the market requires 4.6 cents of CKSW FCF per Dollar vs. only 2.6 cents of ININ FCF. Conversely, the market price for $1 Dollar of CKSW FCF is $21.74 (1/0.046 = 21.74), and $38.46 (1/0.026 = 38.46) for $1 Dollar of ININ FCF. The difference is major; the price of ININ’s FCF is 77% higher than CKSW’s.

The question is, why?

A comparison of broader measures of historical performance for both companies (in the charts), and of the attributes of the companies, their growth prospects, and risk (in the “Comparable Attributes” section), reveals no good, or evident reason, that explains why the price of CKSW's FCF is so low.

The case can be made, I would argue, that based on the performance metrics, growth prospects, and business risk, the market is not valuing the FCF from CKSW adequately and that, at a minimum, the market price per unit of FCF should be the same for both companies.

  • Four-year averages in growth of Revenues, Cash Flow from Operations, and FCF are more favorable to CKSW than ININ (upper portion of the charts)
  • The operational, financial profile, and growth prospects of the companies are similar, as is their business risk (see “Comparable Attributes”).


Based on this point of view, and assuming equality of FCF prices, the price of CKSW stock would then be $11.54/share (0.30 FCF/share : 0.026 FCF/Stock Price = $11.54).

If we used Cash flow from Operations instead of FCF as the yardstick for comparison, and assumed equality of Cash-Flow-from-Operations prices, the price of CKSW stock would be $10.28/share (0.36 CF from Operations/share : 0.035 CF from Operations/Stock Price = $10.28).

In both cases, the CKSW’s prices constructed under the noted assumptions, are significantly higher that $6.60/share, CKSW’s current stock price. They are also directionally consistent with $10.27/share, fundamental value of the CKSW stock, conservatively estimated in the recent article.


Comparison of Stock Fundamental Values (relative to market prices)

The estimation of the fundamental value of ININ stock under the same methodology used to estimate the $10.27/share, fundamental value of CKSW (in previous article) results in a fundamental value of $22.00/share for ININ.

The discount in current price of CKSW stock ($6.60/share) relative to its fundamental value ($10.27/share) points to an attractive investment opportunity. Meanwhile the relative closeness between the current price of ININ stock ($24.23/share) and its fundamental value ($22.00/share) suggests that the stock is about fully priced. The result of this comparison of fundamental values relative to market prices is entirely consistent with the earlier view that the market is not adequately pricing CKSW.


Summary

The analysis quantifies underpricing of CKSW stock in comparison with ININ’s using as a yardstick various performance measures, principally FCF. The reason for relatively low market pricing is not explained by reason of performance metrics, or business risk, or growth prospects, but attributed to the market’s own pricing imperfection.

The comparison between the estimated fundamental values of the stocks relative to their current market prices (see Comparison of Fundamental Values relative to market prices) confirms the negative bias in market pricing and adds confidence in the views presented in this analysis.

While the focus of this article is ClickSoftware, the attributes of Interactive Intelligence, as discussed in this document, outline a very attractive business; a relatively fast grower with high ROIC. ININ is an efficient user of capital able to finance growth internally and grow surplus cash (no debt) while reducing the number of shares outstanding. At this point, however, the stock seems to be about fully priced.

All in all, this exercise confirms the opportunity for major gains in ClickSoftware due to the sizeable gap between the current price of the stock ($6.60/share) and its fundamental value (10.27/share).

Disclosure: Long CKSW. Do not own ININ, but would buy it at a lower price.

Source: ClickSoftware: A Comparison With Interactive Intelligence