In some those articles, I compared ClickSoftware with Interactive Intelligence (ININ) and concluded that CKSW's stock was relatively and absolutely underpriced. The reason for relative low market pricing was not explained by differences in the performance of the two companies, or in their business risk, or growth prospects. By default, mispricing was attributed to the market’s own pricing imperfection.
Here I will compare CKSW with RightNow (RNOW), a provider of on-demand solutions that help clients in their customer service relationships with their own customers.
The reason for choosing RNOW is to examine a business which, a priori, exhibits a relatively elevated enterprise value and is also capable of attracting substantial institutional ownership interest (73.3% for RNOW vs. 32.1% for CKSW in the most recent NASDQ reports) and broad analyst coverage (18 analysts are listed in RNOW home site vs. 2 listed by CKSW). These are characteristics the market yet needs to ascribe to ClickSoftware.
This exercise focuses on the market pricing of CKSW stock relative to RNOW’s.
The methodology in this analysis is similar to the one used in the comparison with ININ.
Attention is focused on financial performance, business risk, market opportunity, competitive position, as elements of comparison between the two companies’ stock prices. Particular emphasis is placed on FCF.
Comparison of Attributes
Described below are similarities and differences in selected attributes for both companies for the period 2007-10.
- Both companies are leading providers of software solutions for companies of all sizes, globally. Their purpose is to improve the business process of their clients and their relationships with their own customers.
- RNOW business is a niche within CRM; CKSW business is field service optimization.
- Clients can deploy solutions provided on-demand (RNOW); on-premise or as a service (CKSW).
- Solutions and products are sold mostly through direct sales and to a lesser extent through partner channels (RNOW); through a combination of both (CKSW).
- Solutions are scalable and integrated with business systems (CKSW and RNOW).
- Products and strategies have gained leadership recognition for both companies in their respective fields by independent industry analysts (Gartner)
- Revenue growth is steady (CKSW) and largely organic (CKSW and RNOW). Gross profit margins are at the high-end (CKSW and RNOW)
- Steadily growing EBIT (CKSW and RNOW).
- Large cash on hand and large market opportunity for growth (CKSW and RNOW).
- Current FCF generation is ample to support organic growth and generate surplus cash (CKSW and RNOW).
- No debt (CKSW). In November, 2010, RNOW announced issuance of $150 million in convertible senior notes (more, later).
- Efficient use of capital; relatively large returns measured by FCF/Capital and ROIC (CKSW and RNOW).
- Use of Net Operating Working Capital (NOWC) and Operating Net Fixed Assets (OLTA) is low relative to NOPAT and FCF, for both companies.
- NOPAT = EBIT x (1-Tax Rate)
- Capital = NOWC + OLTA
- ROIC = NOPAT/Capital.
- Enterprise value is below $300 million for CKSW; below $800 million for RNOW.
- CKSW and RNOW embody relative moderate business risk.
Moderate operational risk; generally there is only minor or no concentration risk in clients or in geography. Low EBIT volatility is a plus for CKSW.
Financial risk is moderate; generally there is adequate FCF generation and cash on hand (CKSW and RNOW); no debt is a plus for CKSW.
[Business risk connotes probability of default in meeting business and financial obligations. Simplistically, components of overall business risk are operational risk (closely connected with industry risk) and financial risk].
- Market and related growth opportunities seem attractive and supportive of continuing expansion in both companies (more, later).
Comparison of Performance
Selected metrics in the charts below compare historical the performance of CKSW and RNOW.
|ClickSoftware (CKSW) Chart --Selected Metrics|
|(Amounts in millions of US$, unless otherwise noted)||FYE 12/07||FYE 12/08||FYE 12/09||FYE 12/10 Estim.||4-Yr. Avg.|
|Revenue Growth (y-o-y)||23%||31%||17%||19%||22%|
|Revenue per Sh. ($/Sh.)||1.40||1.77||1.92||2.20|
|EBIT / Revenues||3%||12%||18%||18%|
|EBIT per Sh.($/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.($/Sh.)||0.87||1.08||1.10||1.52|
|# Shares Growth (y-o-y)||0%||4%||8%||4%||4%|
|Stock Price (PPS)||6.62|
|Revenues per Sh./PPS||0.332|
|EBIT per Sh./PPS||0.059|
|CF f/Ops. per Sh./PPS||0.055|
|Free CF per Sh./PPS||0.046|
|Cash per Sh./PPS||0.229|
|RightNow (RNOW) Chart --Selected Metrics|
|(Amounts in millions of US$, unless otherwise noted)||FYE 12/07||FYE 12/08||FYE 12/09||FYE 12/10 Estim.||4-Yr. Avg.|
|Revenue Growth (y-o-y)||2%||25%||9%||20%||14%|
|Revenue per Sh.($/Sh.)||3.39||4.21||4.72||5.40|
|EBIT / Revenues||-20%||-7%||3%||6%|
|EBIT per Sh.($/Sh.)||-0.67||-0.30||0.13||0.33|
|Cash Flow from Ops.||21.03||14.72||16.10||19.50|
|CF f/Ops. Growth (y-o-y)||-22%||-30%||9%||21%||-5%|
|CF f/Ops per Sh.($/Sh.)||0.64||0.44||0.50||0.57|
|Free Cash Flow||13.76||6.95||8.61||11.91|
|FCF / Revenues||12%||5%||6%||6%|
|FCF Growth (y-o-y)||-36%||-49%||24%||38%||-6%|
|FCF per Sh.($/Sh.)||0.42||0.21||0.27||0.35|
|Cash (and Market.Secs.)||96.32||90.78||96.53||109.02|
|Cash Growth (y-o-y)||23%||-6%||6%||13%||9%|
|Cash per Sh.($/Sh.)||2.91||2.72||2.98||3.21|
|# Shares Growth (y-oy)||3%||1%||-3%||5%||1%|
|Stock Price (PPS)||25.34|
|Revenues per Sh./PPS||0.213|
|EBIT per Sh./PPS||0.013|
|CF f/Ops.per Sh./PPS||0.023|
|Free CF per Sh./PPS||0.014|
|Cash per Sh./PPS||0.127|
The lower section of each chart show ratios quantifying metrics per Dollar of current stock price. At current stock prices ($6.62/Sh. CKSW and $25.34 RNOW) the ratios show the buying power of the stocks as follows:
- Each dollar in the stock price of CKSW buys 33.2 cents of revenues, 5.9 cents EBIT, 5.5 cents cash flow from operations, 4.6 cents FCF, and 22.9 cents of cash.
- Each dollar in the stock price of RNOW buys 21.3 cents of revenues, 1.3 cents EBIT, 2.3 cents cash flow from operations, 1.4 cents FCF, and 12.7 cents of cash.
Notice that each dollar of stock price buys 4.6 cents of CKSW FCF, and only 1.4 cents of RNOW FCF. Conversely, the price per dollar of CKSW FCF is $21.74 (1/0.046 = 21.74) vs. $71.43 (1/0.014 = 71.43) per Dollar of RNOW FCF.
The price of a unit of RNOW FCF is 3.29 times the price of a unit of CKSW FCF.
Why is ClickSoftware’s FCF so inexpensive?
Why are investors willing to pay that much more for FCF from RNOW than from CKSW?
A comparison in the historical performance and in the attributes of the companies (see “Comparison of Attributes”) does not explain the discrepancy.
The charts show that the 4-yr. averages are higher for CKSW than for RNOW. Revenues, EBIT, Cash Flow from Operations, and FCF for ClickSoftware have grown more rapidly and generally with less volatility than in the case of RNOW.
One would think that investors would bid higher prices for higher levels of performance and for greater stability in performance, and that they would pay a premium for ClickSoftware’s FCF (relative to RNOW’s FCF), instead of the other way around.
Either this analysis is missing the mark, or investors are underpricing CKSW. Now that we have discussed metrics performance and business risk, let’s examine market opportunity. Perhaps that is the missing link in explaining the investors' pricing logic.
RNOW explains that it helps the world’s largest organizations deliver exceptional customer experiences across the web, social networks, and contact centers. Cloud-based solutions reduce customer interaction costs and drive revenue while improving the customer experience.
The company presents (here - pdf) that megatrends (consumer empowerment, cloud computing, proliferation of online interactions, and contact center replacement) provide a strong tailwind for sustainable growth in a $5 billion addressable market today, growing to 15 billion in 3-5 years.
CLSW explains (here - pdf) that it provides solutions in the workforce optimization market. CKSW helps clients in proactive management; in anticipation of the service, in execution during the day of service, and in intelligence and analysis after service is accomplished. Solutions are available to companies of all sizes, on premises and on demand.
The company presents that services business account for 70% of the world economy, and that the service market is under-automated and under-optimized. The estimated size of the market is $30 billion.
The estimates portraying market opportunity are sizeable for both companies. There is no assurance that the estimates are either comparable in size, or in meaning of opportunity. One way or another, the estimates portray ample room for potential growth.
However, once the room for potential growth has been estimated, the capacity to make good on the promise of growth and actually deliver good prospective results depends, among many factors, on the companies’ own strategies, financial strength, and on the competitive position within their respective industries.
The company describes its leadership in terms of the having developed the best solution for multi-channel service, and achieving “the highest total ranking across the three experiences that matter the most: eService (web), social, and contact center”. RNOW services some 1900+ customers in a variety of industries, globally.
RNOW has maintained a 90% customer retention rate over the last few years. Meanwhile, the number of clients served has not significantly increased, but increasing business volumes with larger clients have helped in revenue and margin expansion.
Some analysts consider that RNOW has developed a good value proposition on the customer service niche on the cloud, but that longer term its business mass may prove of insufficient financial capacity to expand into the broader customer relationship management space and keep up with larger competitors’ expenditures to expand product suite and market presence.
Competition in the customer service software market is intense and RNOW faces substantial competitors. Particularly prominent among many is Salesforce.com with its growing market presence, expanding client relationship management product suite, now encompassing the cloud, and strong momentum in financial results.
Industry conditions portray the pressure of competition and the need for RNOW to acquire clients quickly to address the shortcomings in business mass and financial capacity discussed above.
The recent offering of $150 million of 2.5% convertible senior notes due 2030 represents a major capital infusion for RNOW; $145 million in proceeds, or $170 million, if the over-allotment is exercised. (see announcement here). When added the offering to the existing $109 million of cash in the balance sheet, total cash on hand will be close to $300 million. This adds fuel to the expectation that an acquisition is now probable; certainly more than likely.
The flow of funds in RNOW are such, that on a current operating basis, internally generated NOPAT is more than sufficient to meet the needs in NOWC, and in OLTA without the need of the offering. Likewise, the announced increase in share repurchase by $15 million (to a total of $25 million) is not of sufficient size to require the sizeable financing from the offering. Consequently, the only plausible explanation for the recent offering is to finance an acquisition. This is also in line with the sense that competitive pressures are high sources of motivation in the plan to acquire.
In the presentation linked above, CKSW describes its clear industry leadership; Gartner positions the company in the Visionaries Quadrant and among the top two field service management software vendors. Aberdeen, in turn, ranks CKSW as the Champion in the mobile field service market.
Well over 150 clients around the world have employ ClickSoftware solutions.
Like in the case of RNOW, CKSW has also indicated the goal of substantially increasing its business mass through acquisition. On 4/13/10, the company registered a secondary equity issue for 15 million ordinary shares, amounting to $100 million (the announcement is here).
The company indicated that it would be unlikely to issue the entire 15 million shares. Before issuing equity, it would use the $48 million of cash on the balance sheet and also consider outside debt financing. In any event, there is potentially $148 million in cash available for an acquisition, exclusive of outside financial debt which could be serviced by steadily growing EBIT (and EBITDA).
By necessity, acquisition follow up information has been scarce, although management has summarily noted that acquisition work is continuing.
The position of both companies seems to be strong in their industries.
RNOW has built a strong niche within the CRM space which it needs to defend from competitors that have broader market sights and ample financial resources and market clout.
CKSW is a leader in its space. It continues, offensively, to strengthen its economic moat by expanding customer coverage, product suite and a partner echo-system which effectively delivers substantial revenues.
CKSW compares very favorably against RNOW on various operational and financial attributes and business risk (see “Comparison of Attributes”), as well as on performance metrics (chart), market opportunity, and competitive position.
The comparisons do not support any basis for explaining “Why is ClickSoftware’s FCF so inexpensive?" or "Why do investors pay that much more for FCF from RNOW than from CKSW?”
In fact, the comparisons lead to the conclusion that CKSW is underappreciated and underpriced in the market relative to RNOW. None of the measures of comparison point to a comparative weakness on CKSW that warrants the discount in stock price discussed above. In fact, the comparisons point to relative strenghts instead of weaknesses.
The market does not seem to be adequately pricing ClickSoftware’s revenues, or EBIT, FCF, or growth history; or to give appropriate consideration to prospective growth opportunity, low business risk, or economic moat.
If we consider that at the minimum, the FCF of CKSW should be priced at parity with RNOW’s, then the price of a CKSW share would be $21.42 (ClickSoftware’s $0.30 FCF/share divided by RightNow’s $0.014 FCF /PPS = $21.42/share).
On this basis, the computed price of CKSW stock ($21.42) would be over three times its current market price ($6.60/share).
At $21.42/share for CKSW and $25.34/share for RNOW investors would be equally pricing each Dollar of FCF generated by either company.
Perhaps all the excitement associated with the shift to on-demand services and the robust growth, market gains, an upside price objective revisions behind Saleforce.com (CRM) performance is adding fuel to the total cloud industry and providing the impetus for optimistic valuations (here). (By the way, our valuation of Salesforce.com shows a fundamental value substantially below its current stock price above $142/share).
It is reasonable to surmise that such high cloud industry expectations may rub off on the various industry participants; in infrastructure, platform, and applications; therefore contributing to expansion in institutional investment ownership and in analyst coverage.
RNOW’s fundamental value is estimated at $13.35/share. This is based on $11.91 million FCF in FYE12/10, 20% annual FCF growth in the three years following 2010, and 5% growth in perpetuity thereafter. The cost of capital estimate is 10%.
Assumptions are reasonable in comparison with historical results; prospective 20% FCF growth is in line with the growth in the two latest years (2009-2010).
RNOW stock’s current market price ($25.35/share) is 1.9 times fundamental value ($13.35/share).
In contrast, CKSW’s current market price ($6.62) is 0.64 times fundamental value of 10.27/share (see 10/13/10 article; 20% FCF growth, 10% cost of capital).
If we were to apply RNOW’s 1.9x factor to CKSW's fundamental value, the resulting price of CKSW stock would be $19.51/share ($10.27/share x 1.9).
From a different perspective, the divergence between current market prices and their respective fundamental values connotes a much lower investment risk in CKSW than in RNOW stock.
Considering the cumulative analysis work done on ClickSoftware and recorded on this site, this new comparison adds weight to the investment thesis previously advanced and the related opportunity embedded in CKSW stock.
By all measures of comparison, the market is not adequately pricing ClickSoftware’s revenues, or EBIT, FCF, growth history; nor is it giving appropriate consideration to prospective growth opportunity, low business risk, or economic moat.
Rational expectations, fundamental valuation, and risk/benefit arbitrage ought to advance greater investor appreciation for the value attributes of ClickSoftware, and in doing so provide impetus to closing the price/value gap.
Divergences between fundamental value and market prices are part and parcel of market dynamics and security analysis; savvy investors not only live by mis-alignment in the market, but thrive on it.
In closing, two relevant thoughts; the sources I cannot remember:
Opportunity rarely rests in plain view or a crowded place; more often than not real value awaits discovery off the beaten path.
Patience is the best part of wisdom.