ClickSoftware Technologies Ltd. (NASDAQ:CKSW) provides workforce and service management products and solutions. This article discusses the competitive attributes inherent in the company's business model.
The business model is the representation of balance among three basic components; Value Proposition (Client benefit in the eyes of clients), Economic Equation (Financial statements and risk-adjusted return to shareholders), and Management Effectiveness (Core competence and effective organization of resources) that achieve a strong value proposition and favorable economic returns.
The article makes the case that ClickSoftware’ business model is robust. It comprises valuable services to clients and attractive returns to shareholders. Industry leadership, client wins, financial results, and superior ROIC, support the view that the company’s business model is robust, durable, and fast-growing.
Embedded in the model are the company’s working capital and capital investment processes. At the operating level the processes entail productive relationships with stakeholders (read: clients, echo-system partners, and suppliers of technology) and investments that produce software solutions that generate attractive FCF and ROIC. Powering the business model is management effectiveness – in developing leading products; and in managing client relationships, and a cost-effective sales chain.
As a framework to discuss ClickSoftware’s model, here we review the characteristics of an ideal company.
Arguably, an ideal company would have the following attributes:
(1) High ROIC, well in excess of WACC (metrics are defined below). This means high NOPAT due to strong gross margins utilizing relatively little OC
- Clients pay cash in advanced of services received and/or suppliers provide generous (long) payment terms
- Little capital investment in OLTA. Investment in developing products is small relative to prospective revenue and NOPAT generation
(2) Rapid rate of FCF growth (g)
- Rapid growth in FCF requires sizeable market opportunity that enables rapid organic growth. This requires rapid and uninterrupted revenue growth
(3) Represents an attractive investment opportunity; that is FV > Current stock price.
Metrics are defined as follows:
o ROIC (Return on Invested Capital) = NOPAT / Operating Capital
o FCF (Free Cash Flow) = NOPAT – Increases in OC. As an approximation FCF = Cash Flow from Operations minus Depreciation and Amortization
- FV (Stock Fundamental Value) = (Present Value of future FCF, growing at g, discounted at WACC + Surplus Cash – Debt) divided by # Shares
- NOPAT (Net Operating Profit after Taxes) = EBIT (1- Tax Rate)
- OC (Operating Capital) = NOWC (Net Operating Working Capital) + OLTA (Operating Long-Term Assets)
- Capital Allocated = Increases in OLTA (principally due to strategic acquisitions)
- WACC (Weighted Average Cost of Capital)
- EVA (Economic Value Added) = NOPAT – (Operating Capital x WACC)
At the extreme end of positive performance, the ideal company's NOPAT would be sufficiently strong to finance increasing OC requirements to support revenue growth without using debt, and to generate surplus cash after paying juicy dividends; a tall order indeed.
I submit that such superior attributes actually belong to ClickSoftware. To underscore ClickSoftware’s uniqueness it is worth noting that, in my opinion, any list of businesses conforming to the attributes of the ideal company would be very small indeed.
|ClickSoftware Chart --Selected Metrics|
|(Amounts in millions of US$, unless otherwise noted)||FYE 12/07||FYE 12/08||FYE 12/09||FYE 12/10||4-Yr. Avg.||Q 9/10||Q 9/11|
|Revenue Growth (y-o-y)||23%||31%||17%||16%||22%||32%|
|NOPAT / Revenues||3%||12%||18%||13%||12%||13%||20%|
|OC / Revenues||-19%||-6%||17%||19%||6%||17%||15%|
|ROIC = NOPAT / OC||-18%||-194%||105%||66%||n/a||75%||131%|
|FCF / Revenues||11%||15%||10%||21%||14%||30%||13%|
|FCF Growth (y-o-y)||-18%||82%||-21%||146%||47%||-43%|
|FCF(Last 12 mos)||12.27||12.52|
|FCF(Last 12 mos) / Revenues||70%||54%|
|FCF (Last 12mos) Growth||2%|
The chart confirms that ClickSoftware is unique; it tells us the following:
ROIC is very high. ROIC in Q 9/11 (annualized) was 131%. Negative ROIC in years 2007 and 2008 reflects the fact that in those years it did not require any equity capital to run the business. OC was actually a source of funds (importantly due to deferred revenue from clients).
- How common is a business model where robust NOPAT is generated without capital provided by shareholders?
- Very rare. It represents a truly unique business with a very competitive product suite.
FCF grows rapidly. It grew an average of 47% during the four year period ending FYE 12/10. Last 12-month FCF grew 54% over the previous comparable period.
- The same question, again; how prevalent is for business to achieve such organic growth in a slow-growth world?
- Not prevalent at all (note the small acquisition in early 2009; seekingalpha.com/article/130058-an-early...).
Worth noting is steady revenue increase, even during periods of economic uncertainty in 2008, 2009. There is no better proof of a value proposition than steady growth in revenue from both new and repeat clients.
To recap, ClickSoftware has strong gross margins and strong NOPAT using very little OC. This results in exceptional ROIC, enabled by rapidly growing FCF. Adept management of relationships with clients and stakeholders translates into sizeable funds flow to run the business and to return capital to shareholders via dividends. Product leadership in the eyes of clients and the stable nature of the relationships with stakeholders serve to characterize the financial attributes as favorable to the business and shareholders, durable in time, and as a major competitive advantage.
ClickSoftware is indeed a unique company. Management has been able to construct a very efficient business model –a model that provides a valuable proposition to clients in a vast market, where the company has undisputed and growing leadership. Economic returns are extraordinary; ROIC is exceptional and continuing, and enabled by efficient use of OC.
Steady growth in revenue and FCF, absence of debt, and abundant surplus cash, are proxy indicators of relatively low business risk. Management’s undistracted focus on automated workforce management solutions sustains the view that related business risk remains well within management competence.
Rapid growth in FCF is a main driver in FV. As discussed in a previous article the FV of the stock is conservatively estimated at $12.00 - $12.50, based on ongoing FCF of $13.50 - $14.00 million per year growing at 10% per annum for the next four years and at 5% thereafter in perpetuity; and a cost of capital of 10% p.a.
Note that the 10% FCF growth assumption pales in comparison with 47%, average FCF growth during the last four years ending on FYE 12/10.
A word of caution regarding conventional measures of stock valuation, which portray ClickSoftware as a relatively high-priced stock. Conventional measures often overlook principal drivers in fundamental value, such as FCF generation, low relative business risk, or the rate of growth of FCF.
All in all, ClickSoftware is the picture of an ideal company with a strong and well balanced business model, where extraordinary ROIC is supported by efficient use of OC and rapidly growing FCF. Meanwhile, business risk is relatively low. Not to forget, the company also returns capital to stockholders via cash dividends.
PS. If you know of a stock with metrics comparable to, or better than those of ClickSoftware, please let me know.
Disclosure: I am long CKSW.
Disclaimer: The views expressed represent a personal opinion, not an investment recommendation. The methodology of analysis, including financial computations, presentation, and views, also reflect personal preferences. Presentation and computations entail a probability of error, which is entirely possible. Please do not rely on this analysis; do your own due diligence.