Lionbridge Technologies (LIOX) is a language technology company that provides testing and developing of translation services for Fortune 100 companies. It is coming off of $17 million in restructuring charges since 2009, which have disrupted earnings and lowered the Street’s expectations. LIOX is currently trading at $2.70/share and we believe it is worth $5.50 to $6.00/share.
Drivers that will push LIOX to a higher share price are:
- Roll off of restructuring costs, giving clear earnings visibility to sell-side analysts
- Ramp up of Geofluent program (JV with IBM) in 2012
- Clients like Apple (AAPL), Disney (DIS) and CBS downsizing call-centers into a single multilingual-capable facilities
- Rising demand for multi-language translations of products and services by large businesses to generate revenues in non-English speaking markets.
Estimated 2012 EBITDA and EPS of $30 million and $0.35/share, respectively. At 8-11x EBITDA multiple and 15-25x P/E, LIOX is worth $5.50 – $6.00/share.
LIOX is among the largest publicly traded language technology companies. Founded in 1996, LIOX IPOed in August 1999, as a language service company, primarily as a translator of web content and software. CEO Rory Cowan has been with the company ever since and sought to grow the company via acquisitions, most notably of Bowne Global Solutions in 2005. Annual revenue increased 70% to $420m the following year and service offerings increased. But high costs of running its European office and non-realized synergies forced LIOX to take a $120 goodwill impairment charge in 2008 and $23m in restructuring charges since 2009.
Below is the restructuring cost impact on EPS:
|Yr. Ended Dec. 31,||2006||2007||2008||2009||2010|
|Restructuring charges (mill.)||-2.4||-3.7||-1.0||-6.8||-7.8|
As shown above, unrealized synergies led to a string of charges and the 2008 financial crisis also contributed to its drop in shares from $6 to $1/share from 2007 to 2009.
Since 2009, management has cut annual SG&A by 16%, retained and added blue-chip customers [Caterpillar (CAT), Cisco (CSCO), Google (GOOG)], introduced real-time automated translation programs (IBM JV called Geofluent), and ramped up its Service-as-a-Software (SaaS) offerings to expand its turnkey capabilities of initial testing, development, and post-sale maintenance.
1) Global language and Content Services (GLC) – 72% of 2010 revenue
a) Product localization – localization of client software and hardware. For example, Nokia (NOK) makes phones that are used in over 100 countries. LIOX is the company that translates and localizes the language configuration of the phone. The phone language will be English in the U.S., Mandarin in China, Italian in Italy, and so on.
b) Content Translation – translation of client web content, marketing information, and operating manuals. Also provides technical support and content management for clients. For example, Google wants to advertise to non-English speaking web users. LIOX takes the English version from a client, translates to the desired language, and Google advertising sends it to non-English speaking users that match its proprietary Google search index.
c) Language Technology – real-time multilingual translation system called Geofluent. In April 2010, LIOX and IBM’s Watson Research Laboratory formed a joint venture where LIOX’s cloud based database would train IBM’s translation engine to refine real-time translation capabilities. IBM chose LIOX because it has the largest translation database that has been cumulatively built over the years by the individual and enterprise translators the company has worked with in the past. Applications of this include pre and post-sale online support – i.e. a DELL call center in Nebraska, helping its German and Chinese customers real-time, from English-German to German-English and English-Chinese to Chinese-English.
Geofluent is in beta-testing phase with its clients Cisco, Intel (INTC), and Symantec. Human evaluators rated the usability of the output, and it was very successful. Usability and comprehension of translated words are rated from 0 to 5 (0=no translation, 5= perfect human translation) with 3 being the cutoff of being decent. Geofluent is getting 4s.
2) Global Development and Testing Services (GDT) – 23% of 2010 revenue
a) Product Engineering – IT services for client’s product. Veritest – LIOX tests clients’ products so it meets the needs of international market and end customers. Global Crowdsourcing – LIOX provides multilingual search relevance, keyword optimization for client’s web engines and online advertising. Please see Google example above.
3) Interpretation Services – 5% of 2010 revenue
On-site human translation and interpretation services for government and healthcare industry.
There are three major translation qualities. One can think of a pyramid consisting of three stages – top, middle, bottom. At the top is the highest quality translation done by humans – think of a university professor translating ancient Greek poems into English. At the bottom is the freeware that's available through Google or Bing where you cut and paste a foreign language to get a rough English translation. At the middle is the “usable” or “actionable” translation. This could be translating a blog, newspaper article, or chat session from one language back to another. LIOX focuses on the top and middle of the pyramid such as human translation, medical device operating manuals, and multilingual company websites.
The industry is highly fragmented with mostly private companies. Lionbridge and SDL Plc (a London-listed company) are the two biggest pure-play language companies. Bigger companies like Tata and Wipro are competitors because they have language translation subsidiaries, but do not contribute meaningful earnings. SDL has a near monopoly position in its Trados translation platform for individual freelancers and enterprises. Trados is a computer-assisted translation (CAT) platform where translators would pay to use its translation memory (TM) – a database of previously translated words – to do the job faster. Trados has been the standard for the past 20 years but it is outdated. Freelancers still use it because most do not need to collaborate outside of their individual projects and it is simple and cost-effective. The mentality of, “If it’s not broken, don’t fix it,” has allowed Trados to survive. LIOX’s Geoworkz is a direct competitor, which allows faster interactive collaboration among translators and has a cloud-based, real-time T M system.
Since 2009, the industry landscape has changed greatly as individuals and corporations realized that the highest translation quality (top of pyramid) demand would always be there but the low hanging fruit was in the middle of the pyramid. The global explosion of web content, blogs, and enterprise necessitated a multi-lingual capability for LIOX’s clients. The highest translation quality was expensive, time-consuming, and was often one-off projects. Clients and users alike wanted fast, interactive, and “actionable” translation. For example, if an English-speaking reader wanted to translate comments on a Spanish blog, he would be happy with an “actionable” translation, which means it is 80-85% accurate, and they want it immediately. As a result, a long as you can have adequate comprehension level, you can strip out the excess time and resources spent on traditional translation. With the importance of real-time translation rising, LIOX secured a joint venture with IBM in April 2010, to develop a real-time translation platform called Geofluent for online chats and call centers, web content, and social media to name a few. The IBM Watson Lab’s statistical language translation engine would be trained by LIOX’s cloud-based T M – which is the largest in the world. Not to be outdone, SDL acquired DreamWeaver in July 2010, to compete with Geofluent. We believe that Geofluent will be a major revenue driver for LIOX.
Currently, Trados allows its users to retain a copy of their (T M) – effectively the translators’ assets – while Geoworkz does not. This has disincentivized human translators to use Geoworkz, but our view is that its impact is marginal because 1) Current and future supply of human translators overwhelmingly exceeds translation jobs available and 2) The lion’s share of LIOX’s business comes from large enterprises in the Fortune 100.
What is the market opportunity?
The following are the demand drivers for LIOX’s language technology:
- 83% of internet users are non-English speaking
- US companies are increasingly deriving revenue from ex-US. For larger companies, it’s 50%+
- Large companies such as Microsoft (MSFT) and Nokia (NOK) etc. must have their products translated and localized
- LIOX clients’ are actively expanding into emerging markets, which require their products and their post-sale process to adapt multilingual capabilities
- Web users are twice as likely to make a purchase if website is in their own language
Value proposition of LIOX’s services – the client side
When large corporations such as Dell, Motorola (MMI) or Philips need to translate their products for various foreign language customers, they have two choices: 1) Build in-house capabilities, or 2) Hire a vendor.
Increasingly, those that have an in-house group are realizing that outside vendors – especially those with a full-suite offering like LIOX – are cheaper and have faster turnaround times without sacrificing quality.
Also, as corporations seek to cut capital expenditure costs, retaining services of LIOX is highly attractive. For example, Dell may have 14 call centers, hiring people with multi-lingual capabilities. LIOX can offer its platform to reduce the call centers to 1 or 2. One call center can communicate with Dell’s clients in 11 different languages via real-time online chat. The language hit-rate would be 80-90% with just a few call centers. As this directly reduces internal IT spending, the value proposition is compelling.
LIOX’s business is sticky. LIOX has-long standing business relationships with companies like Microsoft, Hewlett-Packard (HPQ) and Motorola, going back 10+ years before its IPO. In 2008, LIOX won Vendor of the Year award at Microsoft, the only one chosen out of 15,000 other vendors such as Grubb & Ellis and Toshiba.
90% of enterprise content is not translated today. As companies seek to diversify their business outside the U.S., translation of their products for both physical and online markets requires multilingual capabilities. They either use companies like LIOX or spend building an in-house team. Our view is that the vendor option is more compelling for clients.
Valuation and Investment Thesis
As mentioned above, LIOX has gone through many negative changes since 2009 and as a result the Street has lost interest in its story. Its continuous restructuring costs have dampened its future prospects.
Lost in this view are the positive changes that management has executed:
- 16% decrease in annual SG&A in ’09 and ‘10
- Improving balance sheet as management paid down debt outstanding from $72 to $25 million from 2007 to present
- No share dilution
- Sustaining key customers and adding other blue chip customers
Current valuation of LIOX is high at 11x EBITDA, 4x price-to-book, and negative net income due to restructuring charges. For 2011, management has guided a flat 1H and a stronger 2H with 5-10% top-line growth. They’ve also guided gross margin improvement above the normalized 33%, but we assign no margin improvements to be conservative. Restructuring charges should be less than $4m in 2011.
Our view is that 2011 is a base-building year and 2012 will be the growth year as Geofluent revenue ramps up significantly from $4-5 million in 2011 to $10-20 million in 2012. Further cost-cutting flows to the net income and $99 million in NOLs is another benefit to earnings.
For 2011, with 5% revenue growth ($425m), $29m in EBITDA, and $15m in net income, and we get $0.27 earnings per share. For 2012, we have 10% revenue growth ($470m), $33m in EBITDA, and $20.9m in net income, we get $0.36 earnings per share.
Below is the range of EBITDA and EPS multiples for LIOX:
Valuation with EBITDA Multiples:
|EBITDA (mill.)||Multiple of 8x||Price Per Share||Multiple of 9x||Price Per Share|
At $32m EBITDA with 8-9x, LIOX is worth $4.43-$5.62/share (in bold).
Valuation with P/E Multiples:
|Earnings Per share (EPS)||15x P/E||Price per Share||20x P/E||Price per Share||25x P/E||Price per Share|
At $0.35 EPS at 15-25x gives us $5.25-$8.75 per share (bold and italicized).
The last time LIOX traded around $7.50 was in 2006, when it generated $420m in revenue, $34m in EBITDA, and traded around 14.5x EBITDA. Due to LIOX’s roll off of its turnaround situation, IBM JV (Geofluent), the demand growth of multilingual translation services, and the dearth of publicly traded language technology companies that investors can get exposure in, we are comfortable in giving LIOX 8-10x multiple.
- Ramp up of Geofluent in 1H:2012
- Roll off of restructuring costs giving clearer earnings visibility to sell-side analysts
- Increasing bigger project wins from pipeline consisting of Apple, Disney, CBS, Honeywell (HON) and GM
- Major clients reduce product roll outs, decreasing demand for LIOX services
- More unexpected restructuring in late 2H:2011 and 2H:2012, depressing earnings
- LIOX is slow to monetize Geofluent offering to prospective customers
Disclosure: I am long LIOX.