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Below is Part III of our EBIX report. Please see part one and two published earlier.

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. Two of the three auditors TERMINATED their relationship with EBIX per the company’s own filings. The only Big Four firm who audited the company was KPMG. According to the EBIX's filings, "KPMG LLP resigned as the independent registered public accounting firm of our Company" (our emphasis). Just prior to its resignation, KPMG found:

(1) delegation of authority and what KPMG considered to be inadequate reviews by a person other than the preparer of accounting information, (2) the lack of a formalized contract review process to ensure proper revenue recognition, (3) the lack of a complete understanding of the Company’s income tax positions and related accounts, (4) inadequate documentation for certain unusual transactions (including the basis for the Company’s accounting conclusions), and (5) internal control matters (documented and testable control environment) under the Sarbanes-Oxley Act.

Shortly after KPMG resigned, EBIX's new auditor, BPO Seidman, also "identified certain significant deficiencies relating to the Company’s internal control over financial reporting." In another peculiar move, "on December 12, 2008, Ebix, Inc. received notice from Habif, Arogeti & Wynne, LLP of its decision not to stand for re-appointment as Ebix’s independent registered public accountant."

This is particularly shocking because Habif, Arogeti & Wynne is a small Georgia accounting firm. A public company like EBIX would be a prized client for a small firm like this. Additionally EBIX is in their backyard geographically. However, they decided to walk away. EBIX current auditor is the tiny firm Cherry, Bekaert & Holland. Despite the complexities of EBIX's financial shelters, EBIX only paid Cherry, Bekaert & Holland $343,250 and $262,500 for their 2009 and 2008 audits, respectively.

Management has suggested to analysts and investors that they changed auditors due to high fees and lack of presence in Atlanta. We find this explanation spurious at best. First, the company's own filings do not support that conclusion. Second, the history of audit fees at the company has been extraordinarily low (Table 15). And finally, each of these accounting firms has today, and always had, a major presence in the Atlanta market (including BDO).

Table 15 - EBIX Audit Fees

2003

2004

2005

2006

2007

2008

2009

Audit fees

290,000

325,927

270,000

532,000

322,600

262,500

343,250

Audit fees as a % revenue

2.0%

1.6%

1.1%

1.8%

0.8%

0.4%

0.4%

Auditor

KPMG

BDO

BDO

BDO

HA&W

CB&H

CB&H

Auditor II

KPMG

Source: company reports

We compared EBIX's audit fees to other public companies that analysts have used as comps for EBIX (we would disagree with some as explained below). EBIX pays audit fees that are a fraction of these companies.

Table 16 - Audit Fees

2008

2009*

EBIX

262,500

343,250

salesforce.com (NYSE:CRM)

4,122,950

4,227,563

NetSuite (NYSE:N)

1,527,065

1,443,720

SuccessFactors (NYSE:SFSF)

1,287,200

1,296,200

Solera (NYSE:SLH)

3,553,000

3,768,000

ACI Worldwide (NASDAQ:ACIW)

3,674,148

2,222,651

*2009 or latest fiscal year

Source: company filings

On conference calls, the CEO has stated that some of these former accounting firms have performed non-audit work as evidence that his company is not an accounting fraud. We would remind investors that Arthur Andersen was not put out of business because of their consulting work at Enron or E&Y was not charged with fraud at Lehman because of their tax work, it was because of the audit practices and procedures (the sacred cow of the Big Four business). We believe it is well known that accounting firms are much more judicious selecting audit clients, and much less so with non-assurance engagements.

Frequent auditor changes are not the only questionable corporate governance issue at EBIX. In 2009, the board of director's approved one of the more unusual provisions that we have ever reviewed. EBIX's board "unanimously approved" a change in control provision. Under the provision, Robin Raina is guaranteed a cash payment of 20% of the difference between the transaction price and the valuation of the company at $7.95 per share in the event of a change in control.

While we highly doubt any buyer would pay anything near the current price for EBIX's hodge-podge of rolled up companies, the point is the Board is dominated by the CEO. Hypothetically, if EBIX could find a buyer, it would be Robin Raina who would get the massive payday, not shareholders.

9) Controversial CEO Appears to Demonstrate a History of Misrepresentation

The CEO of EBIX, Robin Raina, dominates the organization. According to the latest proxy statement, Raina's compensation was 1,250% higher than any other employee at EBIX. His cash compensation represented 12.3% and 15.9% of total general and administrative expenses in 2009 and 2008, respectively. To our knowledge, Raina 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 company's lack of bench strength will be on full display at their second ever analyst day on April 1st. This was apparent in the first investor day, held in December 2009.

The CEO has also sensationalized his history of charitable work. We highly admire charity work and believe people should be commended for it, especially those who conduct charitable work without the need for publicity or recognition. We do not believe Robin Raina and his "Robin Raina Foundation," fall into this category. The foundation's noble goal is to provide support for poor children in India. We commend the goal, but we question the execution. The foundation's website contains what appear to be outlandish statements, including:

He spends two continuous months every year working in the slums – meeting children, interacting with parents, helping build homes, playing cricket with blind kids etc. This is in addition to visiting India once every few months to do the same. On a typical day you could see him work 18 hours leading from the front.

Today, he his [sic] foundation has adopted in excess of 3500 children across the Indian sub continent in addition to presently carrying out the largest private charity initiative in the Indian sub-continent, in terms of building 6000 homes free of cost for the underprivileged.

FINAL SUMMARIZATION: When you consider his absolute excellence in the area of public service, it leaves you rather dazzled. When you consider that he does that while running one of the most successful companies on the NASDAQ with a shareholder return of 4,720% over the last 5 years, you marvel at his abilities to balance his zeal for charity with his work.

More troubling than the aggrandized claims is that they appear inconsistent with IRS filings. Given the claims, we assumed the foundation was a hundred million dollar organization. Information on the charity is available for 2004 through 2008. The charity is much smaller than The Raina Foundation suggests. Through 2007, the charity had less than $250,000 in assets. In 2008, assets grew with the addition of "equity securities," assumed to be EBIX stock.

Table 17 - Charity Assets

2004

2005

2006

2007

2008

Total Assets

$136,714

$232,292

$246,292

$246,794

$1,560,795

Source: IRS Form 990s

We found the 2007 IRS filing very peculiar. In 2007, the Robin Raina Foundation spent $143,933 (versus $246,794 of assets) on two fundraisers that "required a number of Bollywood singers performing for charity reasons" and "required the Indian musical legend Anup Jilota to sing his melodies to the crowd with his entire band in a live concert…at the Ashiana Restaurant." Also, in 2007 the foundation listed then EBIX CFO Richard Baum as the person responsible for the foundation's "books". In 2007 and 2008, EBIX donated $66,000 of shareholder money to the Robin Raina foundation.

In 2010, EBIX donated $39,000 to the foundation. Again, our aim in not attacking charitable work. What is apparent is that the charity seems to stroke Raina's ego by generating an enormous amount of press for the small organization and supported by the production of strange video tributes to Raina. It also appears that the enormous claims about the organization do not match the size and scope of its assets. By extension, it would seem that the charity has misrepresented its true character. We only highlight this because we see a similar misrepresentation with EBIX's businesses.

10) SaaS Provider? We Think Not

EBIX has held itself out as a SaaS vendor - a business description that couldn't be further from the truth. In its press releases, EBIX describes its business with the statement: "through its various SaaS-based software platforms." Investors and analysts apparently have taken the bait. A recent initiation report by a firm called Craig Hallum described EBIX as "a provider of SaaS-based solutions for the insurance sector." A recent article on Seeking Alpha compared SaaS darling Salesforce.com (CRM) to EBIX. We find this comparison absurd.

SaaS business models are highly attractive for good reason. With a SaaS model, a company is able to collect subscription payments quarters or even years in advance, creating large deferred revenue. The SaaS provider has visibility into its earnings model as most of the revenue and earnings are pulled from the balance sheet. As a result, deferred revenue and bookings are the most important factor for SaaS stocks. In reviewing EBIX's results, the deferred revenue is virtually non-existent and has experienced negligible growth despite all of the acquisitions.

click to enlarge

This discrepancy is even more dramatic when you compare EBIX to "real" SaaS companies like Salesforce.com (CRM), Netsuite (N), SuccessFactors (SFSF), and Taleo (NASDAQ:TLEO). As Table 19 illustrates, these companies typically have 1.5 to 4 quarters of deferred revenue on their balance sheet. In contrast, EBIX's deferred revenues can be measured in days and weeks due to its transactional nature. As a result, EBIX has minimal visibility relative to real SaaS providers.

Other parts of the income statements are also vastly different. The SaaS vendors listed below spend 40% - 50% of revenues on sales and marketing. EBIX spends 4.6% of revenues on sales and marketing, while R&D expense is roughly one-third compared to the other group.

Table 19 - EBIX Vs. SaaS Models

EBIX

9/30/09

12/31/09

3/31/10

6/30/10

9/30/10

12/31/10

Deferred revenue

6,816

8,023

8,828

7,899

7,822

8,736

Def rev to current rev

0.3x

0.3x

0.3x

0.2x

0.2x

0.2x

Sales & Mkting as % rev

5.6%

4.8%

4.2%

5.4%

5.1%

4.6%

Product dev as % rev

12.9%

9.9%

10.6%

11.1%

9.9%

9.6%

CRM

Deferred revenue

545,435

704,348

664,529

683,019

694,557

934,941

Def rev to current rev

1.7x

2.0x

1.8x

1.7x

1.6x

2.0x

Sales & Mkting as % rev

46.0%

47.6%

46.7%

46.3%

46.7%

51.0%

Product dev as % rev

9.9%

10.3%

10.6%

10.9%

11.0%

12.6%

N

Deferred revenue

69,467

72,721

76,140

77,022

75,247

81,139

Def rev to current rev

1.7x

1.7x

1.7x

1.6x

1.5x

1.6x

Sales & Mkting as % rev

46.7%

45.7%

46.1%

46.5%

49.0%

50.3%

Product dev as % rev

17.7%

17.8%

18.2%

18.9%

19.1%

16.5%

SFSF

Deferred revenue

161,016

181,624

185,910

191,812

206,087

234,445

Def rev to current rev

4.2x

4.3x

4.2x

3.8x

4.0x

3.9x

Sales & Mkting as % rev

50.6%

50.5%

50.8%

44.0%

48.8%

49.0%

Product dev as % rev

16.4%

15.3%

17.6%

17.7%

21.4%

20.3%

TLEO

Deferred revenue

85,610

91,084

92,485

94,182

90,866

109,552

Def rev to current rev

1.7x

1.8x

1.7x

1.7x

1.5x

1.6x

Sales & Mkting as % rev

32.5%

32.1%

31.0%

32.2%

31.1%

36.1%

Product dev as % rev

17.1%

17.2%

18.3%

19.3%

17.4%

18.2%

Source: company filings

Another misrepresentation is EBIX's liberal use of the word "exchanges." According to EBIX, 70% of their revenues are derived from "exchanges." Listening to EBIX, an investor might expect them to operate a vibrant exchange where insurance policies trade back and forth in huge volumes as EBIX captures a piece of the spread. The same Craig Hallum initiation report on EBIX stated that "insurance exchanges are a greenfield opportunity with few comparables in other sectors."

In reality, these niche products are simply order entry systems and comparative raters, which have been around for decades and represent a highly competitive industry in insurance. EBIX states as much in the 10-k: "We operate in highly competitive markets. In particular, the online insurance distribution market, like the broader electronic commerce market, is rapidly evolving and highly competitive." EBIX's three most important products in their "exchange" segment are Winflex, LifeSpeed and Annuitynet. In its latest 10-k, the company describes each of these products as:

"Winflex is an exchange for pre-sale life insurance illustrations."

"LifeSpeed is an order entry platform."

"This exchange [Annuitynet] is an order entry platform for annuity transactions."

Simply put, Winflex is a comparative rater and LifeSpeed and AnnuityNet are order entry systems. This view is supported by EBIX's competition. In reviewing company literature for EBIX's private comps like Blue From and iPipeline, they describe their products as "order entry," "order management," and compliance programs. The word "exchange" is not used by EBIX's private competition. This is just another attempt by EBIX to manipulate investor perception.

Conclusion

EBIX is a house of cards. EBIX currently trades at 20x 2010 EBITDA. EBIX trades at 16x 2011 EBITDA, or a 35% premium to the average multiple of high quality financial software providers that focus on banks, insurance, and other financials (SLH, SONE, ACIW, ONE, EPAY). EBIX investors face material downside and have significant exogenous risk from regulatory, tax, or oversight investigations. With a 5% organic growth rate, 28% operating margins (adjusted for the accounting irregularities and massive underinvestment in sales and R&D), and 35% tax rate, the company has less than $0.75 of earnings power currently.

This margin would still represent one of the highest in the industry. At a very generous market multiple of 12x earnings (given minimal organic growth, a roll-up strategy, and issues presented above), we believe the stock is worth no more than $9.00 per share.

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