After the market close on Thursday, January 26, 2012, Ariba (ARBA) announced its fiscal 2012 first quarter results, for the quarter ending December 31, 2011. Ariba is a holding in our Crabtree Technology model on Covestor.
Ariba had non-GAAP earnings per share of $0.23, two cents ahead of the $0.21/share consensus estimate of the 13 analysts covering the company. Revenue in the quarter was $125.7m, up 39% year-over-year, and ahead of the $124.6m consensus. Revenue was also at the high end of guidance, previously given as a range of $122m - $126m.
- Recurring subscription software revenue was $84 million for the quarter, up 67% year-over-year and up 26% organically. This was at the high end of prior guidance.
- The network revenue component showed continued strength at $41.6 million, up 201% year-over-year, and up 42% organically. This compares favorably with management's strategic goal of 20%-30% network revenue growth.
- Customer renewal rates continue to hold steady, with Ariba Network-driven business at around 95% and other applications around 90%.
- Subscription backlog up 21% (organically) year-over-year, within management's strategic goal of 15% to 25% growth.
- Total Cash Flow was negative at ($58.1m) owing to a) the $47.7m acquisition of b-process; and b) $16.7 spent re-purchasing stock.
- Cash Flow from Operations was $8.3m in the quarter.
- A total of 244 Buyer solution customers in the quarter, of which 48 were brand new to Ariba.
For FQ2 (March):
- Revenue: $126.5m - $130.5m;
- Subscription Revenue: $84.5m - $88.5m;
- Non-GAAP EPS: $0.21 - $0.23 (current consensus is $0.22)
For full Fiscal 2012 (September):
- Revenue: $520m - $530m;
- Subscription Revenue: $357m - $365m (mid-point = 31% y/y growth);
- Non-GAAP EPS: $0.92 - $0.96 (raised from prior range of $0.90 - $0.94; current consensus is $0.93).
What It Means:
Ariba's December quarter performance was very solid, and supported all of the company's major strategic plans. In particular, the 42% organic growth in business driven across the Ariba Network is very impressive and that segment now represents fully 1/3rd of Ariba's revenue, up from approximately 15% one year ago. Interestingly, about 20% of Ariba Network transaction revenue comes from enterprises that are not otherwise Ariba customers. That is, they are neither Ariba software customers, nor subscription customers. Obviously, these enterprises represent qualified leads for Ariba's sales force.
Deferred revenue rose about $5.5m sequentially but was up on $4m y-o-y. Deferred revenue growth decelerated from prior quarters, though the figures used to calculate it are clouded by various adjustments. For example, it includes maintenance revenue, which is declining as more customer move to subscriptions and away from traditional license / maintenance agreements. Thus, we are not especially concerned about the declining trends in Deferred Revenue.
We do have some concern about the implied deceleration in subscriptions, with organic revenue growth of 26%, but backlog growth of 21%. We don't believe there is anything untoward going on -- just the law of large numbers at work. And with network revenue growth of 42%, the larger growth trajectory for the company remains high enough to support its premium valuation.
This fact solidifies our belief in Ariba as a desired monopoly, a trusted intermediary supporting ever-larger transaction volumes and crowding out competing trading methods.
Valuation (DCF and Comparative Analysis):
As part of our continuing analysis of Ariba, we maintain a Discounted Cash Flow (DCF) model for the company. We have updated it with the Ariba's most recently quarterly performance. The following parameters and values are used to arrive at our DCF value:
- Term: 5 years;
- Initial Cash Flow: $40.742m (this represents the estimated annualized free cash flow for the current fiscal year);
- Short Term Cash Flow Growth Rate: 10% (Ariba's Free Cash Flow 12-Year CAGR = 10%);
- Long Term Cash Flow Growth Rate: 6%;
- Discount Rate: 7% (conservatively high - a discount rate using the CAPM model - e.g., reflecting currently low Treasury bond rates of around 3% yields a calculated discount rate of just 4.60%);
- Current Share Count: 94.537 million.
Using these inputs, our calculated DCF value per Ariba share is $54.80. This is more than double Ariba's current $26 share price. While it reflects extremely conservative assumptions, it is also true that both the starting cash flow figure and our cash flow growth estimations are smaller than when we first performed this exercise last September. We believe the deceleration is normal for a company as large as Ariba, but it's a trend that we'll watch carefully for further deceleration.
The following table is a comparative analysis of Ariba and six other software and software-as-a-service companies:
Op CF Margins
MRQ Rev Growth
Float: Shares Out
LTM=Last 12 months, CF=Cash Flow, MRQ=Most Recent Quarter
The primary conclusion we draw from this table is that Ariba's PEG ratio (i.e., its P:E to Earnings Growth) ratio is close to 1.0. Note that the 39.0% growth in the table reflects the contribution of Quadrem, which Ariba acquired during the past year. As mentioned earlier in this report, Ariba's organic revenue and earnings growth is closer to 22-23%.
A PEG ratio of 1 places Ariba in line with these peers, and should keep Ariba shares somewhat safe from any abrupt valuation compression (and along with it a decline in price).
What You Should Do About It (Buy, Sell or Hold?):
We are maintaining our "Buy/Long" rating on shares of Ariba based on the following conclusions:
- Ariba management is meeting their own and the Street's expectations for strategic and financial goals;
- The company continues to generate significant cash flow, which is being put to productive uses (e.g. acquisitions, share buybacks);
- Ariba continues to solidify its pre-eminent position in Spend Management, and we do not detect any share loss or threat to that position in the company's December quarter performance.
- Ariba's premium valuation is warranted, owing to the company's superior performance, proven business model and rate of growth.
Please see our complete research report on Ariba, published on Seeking Alpha last September.
Additional disclosure: I am long ARBA and RHT in the Separately Managed Account product for which I am the portfolio manager and in which I am an investor.