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Winston Churchill's famous quote, "a riddle wrapped in a mystery inside an enigma," might as well have been targeting Ebix Inc. (EBIX). EBIX has been an aggressive acquirer of a variety of companies over the years, many of which focus on the insurance industry. The company's offering mix is a confusing amalgamation of niche products that all have a "roll-up" stench. Robin Raina, EBIX's CEO, has liberally described his business with the buzz words du jour, such as "exchanges," "CRM," "The Cloud," and "SaaS."

The stock has performed well, fueled by retail investor interest, momentum publications like Investors' Business Daily and minimal scrutiny from analysts. We believe that EBIX is nothing more than a roll-up that has materially misrepresented its business (relative to the CEO's buzz words) as well as its organic growth. Its business model is predicated on two principals: tax arbitrage and dramatic cost cuts (headcount reductions and offshoring), neither of which is sustainable. Further, the company's tax arbitrage may be more than "just" unsustainable, it may actually be illegal.

EBIX's problems run deeper than unusual accounting. The EBIX story also comes with multiple auditor resignations, governance abuses, misrepresented organic growth, questionable cash flow and a contentious CEO. Below we address these concerns in great detail. Given the gravity of these issues, we have notified the IRS and the SEC of the material abuses at EBIX. We hope the warranted scrutiny saves investors from significant losses as the true EBIX story gets told.

EBIX shares are worth no more than $9.00, a level that would represent a 65% decline from current prices. We arrive at our target by adjusting current consensus estimates for a 35% tax rate (where it will likely go), and applying a generous market multiple of 12x normalized earnings (consensus estimates include assumptions that are unattainable and adjust for oddities such as amortization, while failing to contemplate massive underinvestment in sales and R&D). We estimate that the company has less than $0.75 of de novo earnings power.

Part I of this his report will detail:

1) The History of a Roll-up & Its "Slash & Burn" Strategy. The $970 million of "value creation" imbedded in EBIX's valuation is likely to collapse given the myriad of issues the company currently faces.

2) EBIX's Atrocious Organic Growth and Manipulative Metrics. Investors have a distorted view of the company's growth profile. We estimate organic growth was negative in 2009 and was less than 4% in 2010. Management's definition of organic growth is highly manipulative and demonstrates the deceptive nature of the CEO.

3) Growth Crippled by Suspiciously Low Sales and R&D Expense. EBIX's extremely low sales and marketing and product development expenses are not consistent with a technology company. EBIX's company-wide sales and marketing expense was $2 million less than the stand alone run-rate of a recent acquisition. This acquired company that outspent EBIX was 1/20th of EBIX's size. EBIX's margins are overstated and will be crippled by massive reinvestment to avoid larger declines in organic growth. The only segment of EBIX's business that has not benefited from a recent acquisition declined 27% in the fourth quarter.

4) ADAM Assumptions are Incomprehensible and Will Drive Disappointment in 2011. EBIX recently closed its largest acquisition to date. EBIX must improve ADAM's margins by 2,500 basis points on day one, grow faster than ADAM did in the previous 3 years, recognize no D&A expenses and recognize a zero percent tax rate to generate the $0.15 of accretion that the company has guided to. This overly aggressive guidance will result in negative earnings revisions relative to analyst's elevated expectations.

Part II of this his report will detail:
5) Potentially Illegal Tax Strategy and Impact on Earnings and Valuation.

EBIX utilizes two strategies to reduce taxes to nearly zero. The first strategy suggests a lack of oversight from auditors and earnings manipulation. The second is more sinister and potentially illegal. Through a series of superficial transactions that pose no business purpose other than to avoid U.S. taxes, EBIX was able to turn each dollar of foreign revenue into $1.40 of profits in 2010. This tax strategy is not sustainable in the near, or intermediate, term. A higher tax rate in the future will dramatically change the economics of EBIX's business, significantly impair its earnings expectations, and could subject the company to significant fines, penalties and back taxes.

6) Free Cash Flow Myth. Many investors use free cash flow to justify EBIX's valuation. We believe EBIX's free cash flow is a highly distorted metric given limited cash R&D expense and its questionable tax strategy. In fact, if investors simply adjust for a normalized tax rate, then EBIX trades at 37x free cash flow. Taken a step further, and adjusting for R&D expense for acquired technology costs (acquisitions in the cash flow from investing segment), then EBIX trades at nearly 50x free cash.

7) Significant Quality of Earnings Issues. EBIX appears to manage earnings through accounting shenanigans, including accounts receivable and its allowance for doubtful accounts. The very low level of acquisition price allocated to non-indefinite intangibles is highly suspicious for a technology company and points to a lack of auditor oversight and a desire to overstate earnings through lower amortization. In 2010, EBIX generated almost $0.20 of earnings that are unlikely to repeat in 2011, which could drive incremental earnings disappointment.

Part III of this his report will detail:

8) History of Auditor Turnover, Shockingly Low Audit Fees and Accounting Red Flags. Investors should view EBIX's stated financials with extreme skepticism given the myriad accounting and oversight issues. EBIX has had four different auditors over the past seven years. Management's explanation for the high auditor turnover does not reconcile with the company's filings. EBIX pays its tiny regional auditing firm less than $350,000 a year in audit fees, a tiny fraction of the audit fees that are paid by companies EBIX's size.

9) Controversial CEO Appears to Demonstrate a History of Misrepresentation. EBIX's CEO does not allow analysts or investors access to other members of his management team. This alone is cause for concern about what Robin is hiding. The CEO makes 1,250% more than any other employee. The company's lack of bench strength will again be on full display at their second ever analyst day on April 1st. The CEO's charity appears to make outlandish claims relative to its size and scope.

10) SaaS Provider? We Think Not. EBIX's management and analysts claim EBIX is the next great SaaS provider. This is a gross misrepresentation. SaaS companies measure their deferred revenue in quarters and years due to the subscription nature of the business. EBIX's deferred revenue can barely be measured in days and weeks. As a result, EBIX has minimal visibility relative to real SaaS providers. Also, management misrepresents its products by classifying the majority of its business as "exchanges." These misrepresentations are consistent with management's historical actions.

1) The EBIX Roll-up & Its "Slash & Burn" Strategy

EBIX current business has been cobbled together from 18 acquisitions, spanning the past seven years. Prior to this acquisition spree, EBIX had no growth, less than $15 million in revenue, and at times in 2003 traded with a NEGATIVE enterprise value ($6.2 million market cap with $6.8 million of cash). Today, the company's controversial CEO has pulled off one of the most unique acquisition arbitrages in history. He has turned $276 million of acquisitions (Table 1) and very little starting enterprise value into a company with $1.2 billion of enterprise value. The $970 million of "value creation" imbedded in EBIX's valuation is likely to collapse given the myriad of issues the company currently faces.

Table 1 - Acquisition History vs. Current Enterprise Value

Estimated

Date

Price

1

Lifelink

2/04

10,500

2

Heart Consulting

7/04

7,000

3

Infinity Systems

5/06

7,400

4

Finetre

10/06

13,000

5

IDS Jenquist

11/07

12,250

6

Telstra eBusiness

1/08

44,000

7

Periculum

4/08

1,300

8

Acclamation

8/08

22,000

9

ConfirmNet Corporation

11/08

10,460

10

Facts Services

5/09

6,500

11

Peak Performance

10/09

9,500

12

E-Z Data

10/09

50,400

13

MCN Technology

1/10

2,900

14

Trades Monitor

4/10

2,750

EBIX

15

Connective Technologies

5/10

1,300

Diluted shares

42,068

16

E-Trek

7/10

1,000

Diluted market cap

1,238,903

17

USIX

9/10

7,600

Cash

29,697

18

ADAM Inc.

2/11

66,000

Debt

35,575

Difference

Total

275,860

Enterprise value

1,244,781

968,921

Source: Company filings and estimates

The economics of the company's acquisition strategy is relatively simple: tax arbitrage (described later) and dramatic cost cuts (headcount reductions and offshoring to India). An example of this is the acquisition of E-Z Data in October 2009. A San Gabriel Valley Tribune story highlighted how EBIX fired 49 of the company's roughly 100 employees within a week of that acquisition. One former E-Z Data employee remarked: "it was a wonderful family organization, but this is just a slash and burn."

Synergies are okay. Calling inorganic growth organic is not. This strategy has avoided criticism and scrutiny by Wall Street analysts, a fact that will likely change when EBIX begins missing numbers.

2) EBIX's Phantom Organic Growth and Mysterious Metrics

Investors have a distorted view of the company's organic growth profile (historically roll-ups trade at low earnings multiples). This confusion exists because the company stopped disclosing revenue from acquisitions in the fourth quarter 2008. EBIX previously provided revenue contributions from each acquisition. The following was the disclosure from the BPO segment in the 2008 10-K :

BPO division revenues increased $7.1 million which includes revenue increases of approximately $5.5 million from EbixBPO’s-Hemet, CA operations (formerly IDS; acquired in November 2007), $596 thousand from the EbixBPO’s-Portland, MI operations (formerly Periculum; acquired in April 2008), and $1.1 million from EbixBPO’s-San Diego, CA operations (formerly ConfirmNet; acquired in November 2008).

This disclosure allowed investors to calculate organic growth, a critical disclosure for a roll-up strategy. With the collapse in organic growth in 2009, the company has ceased providing these disclosures.

EBIX has also stopped disclosing the impact of foreign exchange on revenue in the fourth quarter of 2009. This happened to be the same quarter that foreign exchange became a tailwind to growth. The pattern of selective disclosures does not stop there.

Management set its organic growth goal of 10% to 15% for 2010. On its fourth quarter 2010 conference call, management stated that the company's organic growth was 11% in 2010. We believe the company lied. EBIX had organic growth that was significantly below this figure. Instead of confessing, management appears to have "redefined" organic growth to include acquisitions. If management is willing to manipulate the metrics around growth, what else might management be manipulating?

Our analysis suggests that EBIX management is actually recognizing the benefit of a target's growth BEFORE they were acquired by EBIX. Below is the company's calculation of organic growth from the 2010 10-k .

Table 2 - EBIX's Calculation of Organic Growth

As Reported

Pro Forma

As Reported

Pro Forma

2010

2010

2009

2009

Revenue

132,188

139,047

97,685

125,612

Net income

59,019

59,635

38,822

38,032

Basis EPS

1.69

1.71

1.24

1.69

Diluted EPS

1.51

1.52

1.03

1.01

Source: company filings

Below we diagram a hypothetical example of a company growing at 1%, acquires a company that, previous to the acquisition, was growing at 50%. According to EBIX's math, this 1% grower had a 24% "organic" growth rate in 2010. Conversely, if the same target's revenue declined 50% year over year, this 1% grower would have had a -27% organic growth rate under EBIX's distorted metric. It is clear from this example how irrelevant EBIX's "definition" of growth has become and that management is trying to hide a collapsing organic growth profile.

Table 3 - Illustration

Acquirer

2009

2010

Revenue

$ 10.0

$ 10.1

organic growth

1%

Scenario I - Target - $6mm revenue 50% through 2010

Acquired Rev

$ 3.0

Total revenue

$ 10.0

$ 13.1

Reported revenue growth

31%

Target's grew 50% in 2010

Acquired Rev

$ 3.0

$ 6.0

Pro Forma Rev under EBIX's method

$ 13.0

$ 16.1

Organic growth under EBIX's method

24%

Scenario II

Target's declined 50% in 2010

Acquired Rev

$ 12.0

$ 6.0

Pro Forma Rev under EBIX's method

$ 22.0

$ 16.1

Organic growth under EBIX's method

-27%

The REAL organic growth over the past two years appears to be relatively minimal. We caution that this is only an estimate as the company no longer provides enough disclosure, but estimating the contributions of acquired businesses leads to the conclusion that EBIX has no growth. Additionally, foreign exchange was a large benefit to growth given the weakness in the dollar over the past two years. As stated above, management stopped disclosing this impact. As a result, our organic growth estimates are likely too high. Table 4 suggests organic growth that was negative in 2009 and only 4% in 2010, FAR BELOW management's goal and insinuations.

Tablx 4 - EBIX Estimated Organic Growth

Close

Date

2009

1Q10

2Q10

3Q10

4Q10

2010

Total Revenue

97.7

31.6

32.2

33.3

35.1

132.2

Acquisitions

IDS Jenquist

11/07

Telstra

1/08

Periculum

4/08

0.3

Acclamation

8/08

6.9

ConfirmNet

11/08

5.5

Facts

5/09

2.3

0.7

0.7

Peak

10/09

1.8

1.8

1.8

1.8

5.3

E-Z Data

10/09

6.3

7.0

6.5

6.3

19.8

MCN

1/10

0.4

0.4

0.4

0.4

1.5

Trades Monitor

4/10

0.3

0.4

0.4

1.1

Connective

5/10

0.1

0.4

0.4

0.9

E-Trek

7/10

0.2

0.2

0.3

USIX

9/10

0.2

1.0

1.2

E. rev from acq

23.0

9.8

9.0

9.5

2.3

30.6

E. organic rev

74.7

21.8

23.2

23.8

32.8

101.6

E. organic rev gr

0%

6%

3%

2%

5%

4%

Source: Estimates based on public disclosure.

EBIX stopped disclosing acquired revenue in 4Q08.

3) Growth Crippled by Suspiciously Low Sales and R&D Expense

The atrocious growth profile is not surprising given the cost cutting strategy. EBIX spent $6.4 million on sales and marketing in 2010, or less than 5% of revenue. As we discuss below, this absolute spend was less than ADAM's stand-alone sales and marketing expense. ADAM was 1/20th the size of EBIX. We believe this level of sales and marketing expense is SEVEN to TEN times lower than many of EBIX's comps as a percent of revenue (Table 19 below).

In addition, the company only spent $13.6 million on product development (10% of sales) and less than $2 million on capex in 2010. Product development costs of 10% are more consistent with companies in mature industries like industrials, not in fast growth markets as EBIX would have investors believe. As a result, EBIX's margins are overstated and will be crippled by massive reinvestment to avoid larger declines in organic growth.

4) ADAM Assumptions are Incomprehensible and Will Drive Disappointment in 2011

In August 2010, EBIX announced the acquisition of ADAM Inc, its largest acquisition to date. This acquisition closed in February 2011. Like most roll-ups, the music stops as the acquisitions become too large. It appears this may be the case with ADAM.

Management outlined aggressive assumptions to justify the ADAM acquisition. Management expects ADAM to be $0.15 accretive in its first year. It is our understanding that this assumption requires minimal growth of ADAM's revenues. ADAM represents the first public company that EBIX has acquired, which allows us to scrutinize the company's assumptions for the first time. According to ADAM's SEC filings, it generated $27.8 million of revenue (down year-over-year) and a 15.1% operating margin during the trailing twelve months ending September 30, 2010 (last data available).

Table 5 - ADAM's Income Statement

12/31/09

3/31/10

6/30/10

9/30/10

LTM

Revenue

7,429

6,722

6,728

6,898

27,777

YoY growth

0.3%

0.8%

-4.9%

-1.3%

-1.3%

Operating income

332

1,121

1,108

1,634

4,195

Operating margin

4.5%

16.7%

16.5%

23.7%

15.1%

Source: company filings

In reviewing two earnings models for EBIX from November 2010 (before ADAM assumptions were added), we estimate that to generate $0.15 of accretion, ADAM must generate around $11.5 million in net income to offset 3.6 million shares issued to ADAM shareholders (see Table 6).

Table 6 - ADAM Accretion Calculation

Northland

Singular

2011 Revenue assumption pre ADAM

143,716

150,278

Net income pre ADAM

52,802

55,152

Diluted shares

39,383

39,275

2011 EPS Estimate Pre-deal

$1.34

$1.40

New shares issued to ADAM

3,651

New pro forma diluted shares

43,034

42,926

Total net income needed to add 15c per share

64,152

66,718

Assumed ADAM net income

11,350

11,566

Source: Reuters and estimates

To generate that type of income, ADAM must grow revenues by roughly 4% (the fastest growth in over three years), improve its operating margin by 2,500 basis points on day one to 40%, have no D&A costs (more of this later), and recognize a zero percent tax rate. These assumptions appear outlandish and make us wonder what is really driving the financial expectations. ADAM already had a 24% operating margin in the last reported quarter before the acquisition. This overly aggressive guidance will result in negative earnings revisions relative to analyst's elevated expectations.

Table 7 - ADAM's Aggressive Assumptions

2011

LTM

Growth

2011

Actual

Assumption

Estimates

Revenue

27,777

4%

28,888

Operating income

4,195

11,555

Operating margin

15.1%

40.0%

D&A

0

Amortization of software development

0

Stock-based compensation

0

Amortization of purchased intangibles

0

Pretax

11,555

Tax rate

0.0%

Aftertax contribution

11,555

Accretion to EBIX

$0.15

It will be very difficult for EBIX to "slash and burn" ADAM's expenses and still maintain franchise value and current revenue levels. ADAM was an efficiently run business that generated a 16.5% median operating margin over the previous five years. The Bynergy sales cycle was lengthy and required an educated and dedicated sales force. ADAM employed 36 sales people and spent nearly $8 million a year in sales and marketing expense. EBIX, on the other hand, employs only 72 sales people across the entire company and only spent $6 million in sales and marketing in 2010.

It is worth noting that EBIX had over 20x the enterprise value of ADAM prior to the acquisition (and $2 million less in sales and marketing). We believe ADAM's Bynergy business could collapse without the support of a dedicated sales force. As management discussed in the past, its 3rd party indirect channel of insurance brokers had been largely ineffective - a fact EBIX will not be able to change. We believe the company's sell side analysts have provided minimal scrutiny on these assumptions (unfortunately a recurring theme).

Please see Part II and Part III for additional research and our conclusion.

Source: Ebix: Not a Chinese Fraud, But a House of Cards Nonetheless, Part I