It's not every day that you find a good company in one of the hottest (if not the hottest) industries around that has no analyst coverage, no institutional buying, a solid balance sheet, and an owner who owns 8.5 million shares (out of a total float of approximately 24 million). When you do happen to come across one of these, it's worth it to at least do a little research and see if you've really found a hidden gem.
On October 12, eGain Communications (EGAN.OB) was uplisted to the NASDAQ exchange. While listings to major exchanges are always important milestones for companies, they don't usually result in the rapid price appreciation that eGain shareholders enjoyed on Wednesday as the stock popped more than 16% on more than six times normal volume.
The price action was likely due to a combination of factors, most important of which were significantly improved liquidity (long-time shareholders are aware of the ridiculous swings of 10% on a $.05 trade on the OTC BB), and the long-awaited press of being on a massive trading exchange. eGain has been completely shunned by Wall Street analysts as it has enjoyed fantastically improved top-lines, margins, and bottom-line earnings. Even better, eGain's OTC BB listing of the past, in combination with a price below $5, delayed institutional buying.
The Business and Industry
eGain operates in what is termed "the cloud," and more specifically, the Business Software and Services industry. Its revenues are derived from three main segments:
- Licensing fees - These revenues are generated from sales of their software products. Its software has won several awards, most recent of which was its inclusion into the "Software 500." Its eGain 10 software aims to reduce costs through automation, and boosts clients' revenues with analytics analysis that detect trends in consumer, and prospective consumer behavior. eGain's product helps businesses understand their customers better, which improves efficiency as they can provide consumers with what they really want. All the while, superior automation on the platform, most notably "Chatbot," significantly reduces costs. Chatbot is programmed to reflect the brand of the business which implements it, and is fully conversational. Customer solutions are oftentimes costly and time-consuming, so being able to effectively automate the service is a huge boon for businesses. Another wonderful service is eGain's interactive sales suite, which customizes coupons, promotions, and personalizes other content for prospective and returning customers. eGain's product portfolio is overwhelmingly impressive. Licensing fees accounted for about $17 million in fiscal 2011, an exciting increase over the $7 million brought in from these fees in 2010. Licensing fees are the most important revenues; improvements here show increased market demand for its software. End demand for its software is vital, as eGain will have to have superior products relative to competitors (more on this later).
- Recurring Revenues - These revenues include hosting fees, software maintenance & support, technical support, and software upgrades & enhancements. Recurring revenues accounted for $20 million in fiscal 2011, a very solid increase over the $16.5 million generated in 2010.
- Professional Service Revenues - These revenues are derived from consulting, training, and aiding in the implementation of software that has been sold to clients. $6.6 million in revenues were generated in 2011, versus $5.8 million in 2010.
On a year-on-year basis (YoY), eGain saw approximately 47% growth in revenues, and enviable growth of 65% in gross profits. eGain's tiny market cap and small share count should allow for several years of rapid, unmatched growth relative to its peers.
eGain's CEO, Mr. Ashutosh Roy, owns nearly one-third of the outstanding shares and has been a long-term owner. There is arguably no better security than when the CEO of your investment has the exact same interests you have.
While eGain has exceptional products, and has seen rapid, healthy growth, they are a smaller player (for now) within a competitive industry. Their major, most direct competitors are:
- Rightnow Technologies (RNOW) - The company has a $1.3 billion market cap, and trades at nearly 50 times trailing earnings
- LivePerson Inc. (LPSN) - LPSN is closer in stature to eGain, with a $600 million market cap, but it trades at more than 50 times trailing earnings (compared to eGain's P/E of 19)
It should be known that eGain also indirectly competes with Oracle (ORCL), SAP AG (SAP), Saleforce (CRM), and Microsoft (MSFT), all software behemouths who have overlapping operations with eGain and its direct competitors.
For small companies, financial soundness is crucial. Smaller companies don't have the access to capital that nationally recognizable names have, in bank debt accessability, long-term structured debt obligations (bonds), or even equity (issuing more shares); even a relatively small amount in dollars for a secondary offering would have a large impact on earnings per share. Fortunately, eGain is in excellent financial shape.
A quick look at cash and cash equivalents shows more than a two-fold increase from last year: eGain has $12.46 million to its name. With only $5 million in combined short-term and long-term debt, liquidity won't be an issue for the foreseeable future.
eGain's cash flows are superb. 2011 provided about $6 million in free cash flows. The nature of eGain's business allows for very few capital expenditures, which lets eGain keep more of what it takes in. In terms of income available to common shareholders, eGain earned $8.51 million last year.
As mentioned before, eGain's main competitors, RNOW and LPSN trade at 50 times earnings. I subscribe to the Peter Lynch theory that P/E ratios should always be exceeded by earnings growth rates.
eGain, with 60% growth in profits from 2010, and more than 300% EPS growth since 2009 ($.11 per share vs. $.35 per share in 2011), more than fufills this requirement. Trading at only 19.7 last year's earnings, eGain is trading at a 60% premium to its highly followed competitors.
This premium gap is likely to close in the coming months. There is no doubt that the business fundamentals appear to be strong and improving still, while the institutional buying restrictions (lack of liquidity, price below $5, OTC BB listing) have been lifted. Additionally, lack of analyst coverage has been a huge hinder on the price, but the company has had a string of big exposure, most notably all of the press from the NASDAQ listing.
Fair Value for the stock, given the discount to competitors, business fundamentals, and share statistics (i.e. 35% insider ownership, small float, no institutional buying yet), appears to be around the $12-15 mark, which would give it a P/E in the 30-40 range.
Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. A close family member owns EGAN shares.