Workstream Inc.: High Risk, High Reward

| About: Workstream Inc. (WSTMF)

A recent infusion of big-time talent has things looking up for a beaten-down microcap software play in the human resource management sector.

After years of largely profit-less growth, Burlingame, Calif.-based Workstream Inc. (Nasdaq: WSTM) could finally be poised to turn the corner under a recently revamped management team. In February, Deepak Gupta, the former general manager and founder of PeopleSoft’s On Demand software unit, was named chief executive of tiny $56 million Workstream. Prior to PeopleSoft, Gupta was the chief architect of Oracle Corporation’s (Nasdaq: ORCL) hosting business and the global leader for the software giant’s middleware line.

Since the hiring of Gupta, a string of heavy hitters from established enterprise software leaders have also joined Workstream’s executive ranks. This impressive group of new sales & marketing hires hail from Oracle, PeopleSoft, International Business Machines Corp. (NYSE: IBM) and Kronos among other well-known software companies. While it remains to be seen if Gupta can charge up Workstream’s top-line growth and lead this microcap software play to profitability, he certainly has attracted a high-caliber management team that has tasted success before.

Founded a little over a decade ago, Workstream has historically focused its efforts on selling compensation, performance and talent management solutions to large enterprises (over 2,500 employees). Workstream’s 400 customers include such brand names as Wells Fargo & Company (NYSE: WFC), Nordstrom, Inc. (NYSE:JWN), Chevron Corporation (NYSE: CVX), E. I. du Pont de Nemours and Company (NYSE: DD), The Home Depot Inc. (NYSE: HD), the American Red Cross and the U.S. Federal Bureau of Investigation. In a bid to significantly expand its market opportunity, Workstream unveiled last month three new on-demand solutions for mid-sized businesses (between 100 and 2,500 employees). Workstream’s software frees companies from having to manually manage human resources processes using spreadsheets and paper documents for tracking.

Workstream expects its new mid-market business to generate revenue “on a small scale” in the latter part of the year. Thus, over the short term, the company’s results could continue to be lackluster.

For the fiscal quarter ended February 28, Workstream posted revenue of $7 million, up just 4% from a year earlier, and an EBITDA (earnings before interest, taxes, depreciation and amortization) loss, before non-cash compensation expense, of $1.4 million. This loss was down modestly from an EBITDA loss of $1.8 million the year before. Reviewing the first three quarters of its fiscal year, Workstream’s revenue increased a healthier 7.9% to $21.9 million and its EBITDA loss, before non-cash compensation expense, improved by 58% to $2.3 million.

The company ended this most recent quarter with just $3.7 million in cash on hand. Through the restructuring of a credit facility, Workstream appears to have approximately $5 million in debt outstanding. Clearly, Workstream has a thin balance sheet, which doesn’t provide it with margin for error and arguably limits its growth opportunities. Gupta addressed this challenge o Workstream’s last earnings conference call by saying that the company is exploring ways to improve ts financial flexibility. Gupta doesn’t sound interested in doing an equity financing at the stock’s current depressed valuation.

Based on 51.5 million shares outstanding, at a recent price of $1.09 a share, Workstream commands an enterprise value of just $57 million. This values the company at 2x its run-rate revenue of $28 million, which is cheap for a company with 70% gross margins. Granted, Workstream remains unprofitable and with a meager balance sheet that risks impairing stockholders. Further, while Workstream’s annual revenue has almost doubled from $14.8 million in fiscal 2002 to $28.1 million in fiscal 2006, it has only generated positive cash flow in one full year ($0.97 million in fiscal 2004) during that stretch.

Back in 2004, when things were last really looking up for Workstream, the company traded for 4x revenue, according to Reuters data. Kenexa Corporation (Nasdaq:KNXA), a profitable, fast-growing $935 million employee recruitment and outsourcing services provider, with gross margins similar to Workstream, trades for 3.5x its expected revenue for the next fiscal year. Workstream has presented at several investment conferences in recent months, but doesn’t have any analyst coverage currently.

The company hit a high of over $5.00 a share in early 2005, but it has been largely downhill for Workstream shares since. The stock has moved off its 52-week low of $0.70 set last November, but is still well below its August 2006 52-week high of $1.60. There has been more than $88,000 worth of insider buying in the stock over the past 52-weeks, with Workstream CEO Gupta last buying $36,000 worth of stock at the $1.21 level in May. Encouragingly, there has been no insider selling in Workstream over the past year.

Workstream looks to us like a classic “high-risk, high-reward” micro cap special situation. If Gupta’s turnaround strategy clicks, and the company starts posting accelerating growth and sustained profitability over the next few quarters, Workstream shares could see an upside move of 50% or more. On the flipside, it takes more than big names to turn a business around, and with a few more missteps, Workstream’s equity value could be hammered.

Bottom-line, Workstream looks like a gutsy “value find” for aggressive accounts.

WSTM 1-yrchart


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