i2 Stuck in Neutral - Next 6 Months Are Critical

[This post is an excerpted from an MGI Research Note published Nov. 19, 2007.]

The one-time darling of supply chain management (“SCM”) software, i2 Technologies (NASDAQ: ITWO) announced on Nov. 1, 2007 its Q3CY2007 financial results and the formation of a “strategic review committee”. The company also disclosed that JPMorgan has been retained since early this year to assist with a “strategic review” of the business.

We believe i2 could be an attractive and, under certain conditions, an accretive acquisition target for companies such as Infor or JDA Software (JDAS). Alternatively, the company could survive as an independent player and command a higher valuation assuming it implements a major restructuring plan.

Introduction -- Current State of the Business
I2 faces multiple challenges: Shareholders are agitating for a sale, a CEO search is underway, and results so far this year are lackluster. At the same time, the company’s MGI benchmark scores have been improving – an early indicator that the business has at least stabilized a bit, if not progressing modestly.

Former CEO Mike McGrath departed semi-abruptly in August, with the turnaround effort unfinished. He made strides in paring expenses and focusing the business along a handful of vertical industries (consumer goods, automotive, high technology and retail). The company today bears the imprint of his tenure, and herein lays the challenge for i2.

McGrath’s background was in consulting, and that was reflected in the resumes of many of the people he brought into the company such as the current CMO and recently departed chief customer officer Barb Stinnett who was responsible for bookings and revenue. McGrath eliminated i2’s pre-sales team – forcing the sales reps to be product/domain experts and relationship managers. In addition, he slashed the marketing spend. With limited funds to spend on lead generation, a bruised corporate brand, and a weak channel (over 50% of i2’s sales reps have been with the company for 12 months or less), i2's depleted pipeline is no surprise and unlikely to change without investment. Interim CEO Pallab Chatterjee has consolidated the vertical business unit structure put in place by McGrath and Stinnett and netted immediate cost savings. Chatterjee is widely respected within i2’s R&D organization, but is not viewed by the Board and investors as a long-term CEO.

On the maintenance front, i2 has stabilized its recurring revenue stream, albeit by cutting deals that reduce the company’s future revenues e.g., through offering multi-year contracts with discounted upfront payments. We believe there is still more room to improve maintenance renewal rates and increase the satisfaction of the installed base.

On the product front, we estimate that 75-85% of i2’s product and IP portfolio is sitting on the shelves. Many of the products i2 acquired have not been carried forward, in part due to key staff attrition, and the fact that i2’s R&D processes have yet to reach the same level of maturity as the business. With 70-80 products/solutions currently on offer, the opportunity for product rationalization is ripe.

The core i2 product-set in transportation management (TMS) is still viable – it is estimated to represent $65-$75 million in revenue or 25-30% of a projected $261M in ’07. While i2 has signed some notable FreightMatrix (part of the TMS offerings) deals, an unconfirmed source indicated that i2 has not sold an ITLS (the core of the TMS offerings) deal in over 6 months. Nonetheless, with nominal investment and focus, TMS could easily be a healthy stand-alone business generating $15 - $20 million in EBITDA giving it an implied valuation of $180 - $240 million. Another positive note is i2’s ABPP (“Agile Business Process Platform”), often referred to as “Chatterjee’s brainchild”.

Leading-edge customers such as Panasonic have adopted this “outsourced business process” with great success. Panasonic now relies on i2 to build their forecast for flat-panel TV screens, and i2 serves as an intermediary between Panasonic and key customers like Best Buy. Unfortunately for i2, and in spite of its benefits, the ABPP vision is difficult to grasp for mainstream customers. The solution's complexity coupled with i2’s reputation as a company “long on vision, short on execution” and a limited marketing spend limit ABPP in gaining momentum in the market.

Relative to where it was three years ago, i2 has made progress in its business. Its situation is neither as dire as its detractors would hope, nor as promising as its promoters would like to believe. The next six months are critical for i2.

By airing its laundry in public (management instability, intent to find a buyer, et al), it is putting its already-weak sales pipeline in further jeopardy. Only the most fervent i2 prospects and customers will sign contracts in Q4, as everyone awaits the outcome of the JPMorgan-led sales process.

A Sale of the Company
Finding a buyer for i2 at today’s valuation is very difficult – but not impossible. The large industry buyers – SAP and Oracle, are doubtful to take the bait. SAP is fully engaged with acquiring Business Objects and rolling out BusinessByDemand. Recently SAP has been getting enough traction with its own supply chain capabilities that it does not perceive i2 as a real threat. Moreover, SAP has gone on record that it prefers smaller “tuck-in” technology based deals rather than larger acquisitions. Oracle has a full plate, and thanks to its acquisition of G-Log and resurgence in the retail industry is not seeing much of i2 competitively. SAP and Oracle could benefit from parts of i2’s product portfolio (notably in supply chain and retail), yet so far both have avoided buying “fixer-uppers”.

The two most probable buyers of i2 are Infor and JDA Software. Privately-held Infor is the tenth largest software company in the world, and i2’s products would fit neatly into Infor’s grab-bag of manufacturing, supply chain and CRM offerings. Despite Infor’s recent announcement that it will take a breather from its acquisition binge (31 and counting), i2 would make sense for Infor. Most importantly, it likely would be accretive in the first year. Infor would do what i2 could do itself – if i2 had the leadership. Namely, Infor would pare the business down, reduce/eliminate the expensive cost of sales chasing large deals, reduce R&D spending, slash G&A, and focus on delivering and deriving value to/from the installed base of customers. Although i2 executives have been spending time in Atlanta, it would not be surprising for Infor to continue to wait. The valuation expectation of the i2 board will grow more realistic with the passage of more time in Q4.

For JDA Software, the deal is compelling even at $22-$23/share for ITWO (including the assumption of debt). Having digested Manugistics, JDA CEO Hamish Brewer is on record that JDA is looking for a larger deal. With the addition of i2, JDA would jump from a $90 million/quarter business to a $140-$150 million/quarter software company. It would be a supply chain and retail industry powerhouse, and could produce $150 million in combined EBITDA. Even assuming a minor drop in JDA’s current multiple, the merged i2-JDA entity could claim a valuation in the range of $1.5 - $1.7 billion – creating $200 to $400 million in value.

Bottom line: i2 has come a long way, and has plenty of room for further progress. In its current state, the company is stuck in neutral – unattractive to most buyers in the market, and seemingly unwilling to sell at the current or a (future) lower valuation.

Without an aggressive management team driving the business forward, the company, customers, and employees will likely drift. Revenues will continue to slide, morale will suffer, and customers will tighten their purse strings until the future becomes more certain.