Consider a business with the following attributes:
1. Returns over 20% on capital invested, with free cash flow growing at over 30% a year.
2. Revenues are recurrent and diversified; market opportunity and adept use of technology enable continuing growth.
3. Business risk embedded in activities and strategy is relatively low. Performance is steady; there are no "bet the ranch" plays, or financial engineering convolutions.
4. Financial policy is conservative. Debt servicing capacity is ample, stock buybacks are well timed, dividends are growing, dilution is minimal.
5. Management is capable and stockholder friendly. There is clarity in vision and message. Execution is in line with strategy. Agency risk is minimal; management ownership in the firm is substantive and stable.
First, a brief background; EBIX is a leading provider of software and e-commerce solutions to the insurance industry. The vision is to focus on the convergence of all insurance channels, processes and entities in a manner such that data can seamlessly flow once a data entry has been made. The mechanism involves an exchange(s) that facilitates B-to-B electronic interaction in insurance transactions.
Benefits to industry participants and to the insurance consumer in cost and convenience are major.
This article discusses EBIX from the perspective of shareholder value creation, addressing the following performance attributes:
1. Return on capital (ROIC) well exceeds the cost of capital; and growth is strong, not only in top-line revenues but more importantly in free cash flow (FCF). EBIX creates shareholder value day-in and day-out, rain or shine, during periods of macro-economic uncertainty and in benign times.
2. Business risk is relatively low. Strong ROIC and fast-growing FCF do not entail high-risk-taking. Instead, execution is based on client / industry focus and supported by management competence. Hail Mary plays are not part of the game.
Worth noting at the outset is the opportunity of substantial investment gain due to market miss-pricing; the price of the stock is substantially below $32 / share, estimated fundamental value (see Fundamental Value below).
|EBIX Table --Selected Metrics|
|(Amounts in millions of US$, unless otherwise noted)||FYE 12/06||FYE 12/07||FYE 12/08||FYE 12/09||FYE 12/10||FYE 12/11||6-Yr. Avg.||Q 12/10||Q 12/11|
|Revenue Growth (y-o-y)||21%||46%||74%||31%||35%||28%||39%||43%||25%|
|Revenue per Sh. ($/Sh.)||1.04||1.36||2.03||2.57||3.39||4.13||2.42||0.91||1.12|
|NOPAT / Revenues||21%||29%||37%||39%||39%||39%||34%||35%||33%|
|Operating Capital / Rev's||114%||116%||152%||227%||185%||200%||166%||174%||192%|
|NOWC / Revenues||0%||1%||-3%||6%||1%||-5%||0%||1%||-5%|
|OLTA / Revenues||114%||115%||155%||221%||183%||206%||166%||173%||197%|
|Cash Flow from Ops.(NASDAQ:CFO)||4.15||15.04||26.83||33.88||52.78||71.29||18.94||19.40|
|CF f/Ops. / Revenues||14%||35%||36%||35%||40%||42%||34%||54%||44%|
|Free Cash Flow||2.35||12.44||23.52||29.92||46.74||63.78||17.33||17.50|
|FCF / Revenues||8%||29%||31%||31%||35%||38%||29%||49%||40%|
|FCF Growth (y-o-y)||-44%||429%||89%||27%||56%||36%||99%||1%|
|FCF per Sh.($/Sh.)||0.08||0.39||0.64||0.79||1.20||1.56||0.78||0.45||0.44|
|Cash & Mkt. net of Debt||-6.93||-12.10||-42.26||-39.30||-6.97||-18.57||-6.97||-18.57|
|# Shares Growth (y-o-y)||1%||12%||16%||3%||3%||5%||7%||2%|
- ROIC (Return on Invested Capital) = NOPAT / Operating Capital
- NOPAT (Net Operating Profit after Taxes) = EBIT (1- Tax Rate)
- OC (Operating Capital) = NOWC (Net Operating Working Capital) + OLTA (Operating Long-Term Assets)
- WACC (Weighted Average Cost of Capital)
- EVA (Economic Value Added) = (ROIC - WACC) OC
- FCF (Free Cash Flow) = NOPAT - (Changes in OC).
- FCF = CFO (Cash Flow from Operations) minus Depreciation and Amortization, as an approximation
- EV (Enterprise Value) = PV of prospective FCF discounted at WACC
- Stock Value = (EV + Surplus Cash - Debt) / # Shares.
The chart tells us the following:
1. ROIC in 2011 is 20% (21%, six year average)
This means that the company is able to access capital from investors at 10% WACC and to deploy it in a business that yields 21%. With inflation in the low single digits, EBIX's ROIC is not easily matched in the marketplace.
In 2011 shareholder value added (EVA) amounted to $33.8 million (10% x $338.3 million). Note that EVA measures net benefit to the shareholders, after deducting the cost of the capital. This is in stark contrast with Net Profits under GAAP - the surplus or deficit that results after deducting Expenses from Revenues, but without (repeat without) deducting the firm's cost of capital.
A quick detour. It is quite possible for firms presenting their earnings reports to show (positive) GAAP Net Profits while on an EVA basis, they are actually detracting shareholder value (negative EVA). Negative EVA means that ROIC is lower than WACC. Negative EVA is not all that rare, and should not be surprising. In fact, many companies, including some with high profile, high P/E ratios, and strong street following, exhibit negative EVA, or are inconsistent in producing positive EVA. Thus, investing in firms with negative EVA (presumably temporary) requires deliberate analysis.
The point is that EBIX's ROIC and EVA track record is evidently strong on its own. I venture to say that such track record would also rank very high in comparison with companies in general in the marketplace. This view is only an extrapolation from my own anecdotal observations.
2. FCF growth in 2011 is 36%
Fast growth in FCF points to (A) ample market opportunity to expand products and clients, and (B) management competence in allocating OC productively. Note in the chart the steady improvement of FCF / Revenues.
The observation that FCF grows faster than Revenues ought to be fully considered. Easy reference to headline Revenue growth does not convey the insight in FCF performance.
3. Business risk is relatively low.
The time series of Revenues, NOPAT, and FCF in the chart evidence reliability; due to steady product demand, sustained pricing power, and revenue diversification, even during periods of economic uncertainty like in 2008-2009.
Reliable FCF denotes low risk. Low risk lowers WACC and boosts fundamental value.
How does management achieve such reliable FCF? Or to ask the same question differently, what kind of management actions entail low risk and when carried out result in reliable FCF?
The simple answer is the execution of the network strategy -the development of products, internally or by acquisition; expansion in market coverage and client base within the insurance industry. The purpose is to facilitate interaction and end-to-end paperless transactions among industry participants by accessing data and taking it across all entities in the industry and across all product lines seamlessly.
A lot of good things are embedded in the execution of the network strategy -good for clients and costs, good for competitiveness, good for FCF and ROIC, and good for risk (network strategy is discussed here.)
Operational Risk involves NOWC activities implicit in the company's day-to-day relationships with stakeholders, such as (low concentration risk with) clients, suppliers, and other stakeholders. It also involves Mergers and Acquisitions (M&A), which feed OLTA and OC. Judging by results, EBIX is proficient at capital allocation, and acquiring businesses and integrating them into the mainstream organization.
Financial Risk entails capital structure and dividend policy. Ability to service debt is ample; in FYE 12/11 CFO was 3.8 times the amount of net debt, $18.6 million.
Dividend policy is conservative. Annual dividend of $0.20/share represents a $7.9 million outflow, or 12% FCF in FYE 12/11. Thus, 88% is available for allocation to growth opportunities and stock repurchases (in practice, debt is a growing net source of funds).
In 2011 3.5 million shares were repurchased in the year at a cost of $63.7 million. This restrained equity dilution.
To sum up, this analysis points to conservative operating and financial management and to low business risk. EBIX produces high ROIC and rapidly growing FCF, while assuming modest business risk. Risk is constrained by strategy and competence. Both are grounded in the insurance industry, in the needs of clients, and in the enabling power of technology.
The low risk assessment notwithstanding, there is always plenty of risk that can upset any business. Natural catastrophes, or a major loss of operating capacity, or the loss of key managers, are easy examples that come to mind. Further, a track record free of major risk events does not preclude future negative risk events.
This article does not cover all the conceivable risk events (read: Low-probability-high-impact) that could potentially harm the business. Instead, it focuses in the level of risk involved in the actions and activities involved in the ordinary course of business and in their enablement by the apparent skill and management competence.
FYE 12/11: Results and Conference Call
On March 13, the company announced Q 12/11 and FYE 12/11 results (here). On the same day, the company announced the increase in quarterly dividends, from $0.04/share to $0.05/share.
Not to belabor a point already made, metrics in the chart indicate a strong 2011 performance -ROIC was 20%; FCF was $63.8 million representing a 36% rate of growth, y-o-y.
Following is my take of the key points covered in the conference call:
- Convergence continues to be the technology vision. It defines EBIX's end-to-end role in facilitating straight-through processing throughout the insurance industry.
- Growth should continue; 2012 should be another good year. Opportunities are many, particularly in International and in the expansion of product capability, developed internally or externally acquired. New growth initiatives are coming down the pike.
- Enhanced Business Stature. Having reached the current mass of client / industry coverage, knowledge, products, and people resources, EBIX is now in the position where it can organize that power to capture first mover advantage (and do larger deals) in new and growing markets.
- Cash Flow is a Key Metric. Paraphrasing CEO Robin Raina, cash flow is the single most important metric that EBIX monitors at all times. Recurring revenues (83% in 2011) and cash flow are catalysts for funding future growth.
- Business Risk Remains in Check. Expansion in products, services, and markets, follows a rationale of improvement on EBIX's current end-to-end role and on the existing focus on convergence of all insurance channels, processes and entities in a manner such that data can seamlessly flow once a data entry has been made.
- Growth is grounded on existing competence. Risk boundaries remain clearly within management competence.
The fundamental value of the stock is conservatively estimated at $32 based on $71 million in FYE 12/12 FCF growing at 7% in each of the following 2 years, 6% in FYE 12/15 and growing 4% in perpetuity thereafter. Cost of capital is maintained steady at 10% p.a.
EBIX's network franchise is strengthening year after year. This increases clout and energizes competitiveness and enables trailblazing -more complex roles, larger clients, pioneering new markets.
The firm's multi-year track record is truly remarkable. In 2011 EBIX accomplished 20% ROIC, 36% FCF growth, and a growing dividend. Business risk remained modest.
Importantly, there were no unusual or major one-off events boosting results.
Continuing progress is expected in 2012; in products, clients, markets, and metrics. Business risk remains in check. Technology enabled vision, strategy, expansion, risk-taking, and execution, are solidly connected by reason and competence.
All in all, EBIX is long on results and performance, and short on market recognition, as evidenced by the severe miss-pricing of the stock.
In closing, excerpts from thoughts attributed to Charlie Munger regarding investing. The wisdom belongs to him. Any blame for meaning lost in paraphrasing is mine.
…… investing is the equivalent of going out and betting against the pari-mutuel system. We look for a horse with one chance in two of winning, and that pays three to one. In other words, we're looking for a miss-priced gamble. That's what investing is, and you have to know enough to know whether the gamble is miss-priced.
……money is not made when you buy the stock, or when you sell the stock. You make money by waiting; waiting for the right pitch and waiting many years for the right pitch. The single biggest advantage a value investor has is not IQ, it is patience and waiting.
And a thank you note. As an EBIX shareholder, I praise EBIX CEO Robin Raina for the great work and the multiple achievements in 2011; my appreciation goes to him and to the entire EBIX team.
Additional disclosure: Material presented here is for informational purposes only. Nothing in this article should be taken as a solicitation to purchase or sell securities. Before buying or selling any stock you should do your own research and reach your own conclusion. Views and opinions in this article may be wrong. The analysis, including financial computations, presentation, and views, do not necessarily conform to any sanctioned or accepted standards. Presentation and computations entail a probability of error, which is entirely possible. I am not an investment management professional; please do not rely on this material, do your own due diligence.