Harris Interactive (HPOL) is an under-valued leading global custom market research firm that uses web-based, telephone, and other research methodologies to provide clients with information about the views, behaviors, and attitudes of people worldwide. HPOL provides its services to a diversified customer base of approximately 1,400 customers.
HPOL has LTM revenues of about $160m, a net cash position of $6m at 3/31/12, and an EV of about $57m. HPOL market research services are discretionary and it has struggled through the recession. However, in early 2011, HPOL started working with Al Agrisani, initially on a consulting basis, then in June 2011, as Interim CEO and, recently, Angrisani was made permanent CEO. Angrisani is a turnaround specialist with a strong track record in businesses which are related to or similar to HPOL, including a highly successful turnaround at Greenfield Online, which was sold to Microsoft in October 2008 for $500m. Angrisani has implemented dramatic cost reductions at HPOL, closing or downsizing several under-performing international and North America offices and reducing headcount - the primary cost component in HPOL's cost structure - from 760 to about 650 at 3/31/12.
We think HPOL is under-valued compared to where it could trade if Angrisani is able to execute this turnaround. The company has a well-known brand name and a diversified customer base and a large base of existing revenue. HPOL's EV of $57m is about 35% of revenues and 5.5x LTM adjusted EBITDA of $9.9m with about $1m in LTM capital expenditures. We believe HPOL can achieve adjusted EBITDA of about $15m in FYE 6/30/13 with capital expenditures of about $3m and generate about $10m of FCF or more for an unleveraged FCF yield of close to 20% based on our projected FY13 results. HPOL is trading at about 3.7x our FYE 6/30/13 estimated EBITDA. We believe adjusted EBITDA is likely to increase due to improved EBITDA margins as the turnaround program described below fully takes effect.
HPOL has a solid balance sheet with a net cash position of $6m at 3/31/12. Importantly, HPOL's net cash position has been steadily improving over the past eight quarters from a net debt position of $6m at 12/31/09 to a net cash position of $6m at 3/31/12 and we believe it can continue to improve. It is particularly impressive that HPOL has improved its net cash position throughout FYE 6/30/12 to date over which time it funded close to $5m in cash restructuring expenses.
HPOL has 55m shares outstanding and trading volume is 65,000 shares per day. HPOL's shares are currently valued at about $1.15 per share for a market cap of $61m. HPOL had net cash of about $6m as of 3/31/12 for a total EV of $55m. LTM revenues are about $160m and LTM adjusted EBITDA is $9.9m. LTM FCF (cash from operations less capital expenditures) is about $6m. We believe HPOL can generate $10m of FCF in FY13.
One sign that HPOL's turnaround might be gaining momentum occurred on 3/8/12 when HPOL issued a press release stating that management believed its stock was under-valued, that it was implementing a $3m share buyback program, and that it was issuing guidance of $9.5m to $11.5m of adjusted EBITDA before items for FYE 6/30/12. Further, when HPOL released Q3 results, it slightly increased to bottom end of this range, to adjusted EBITDA of $10.5m to $11.5m for FYE 6/30/12. Based on guidance mid-point of $11m of adjusted EBITDA and a $6m net cash position at 3/31/12, HPOL is trading at 34% of LTM revenues and 5x adjusted EBITDA for FYE 6/30/12.
HPOL's business is not capital-intensive with capital expenditures of $1.2m, $1.6m, and $0.8m for FY09, FY10, and FY11 and under $2m projected for FY12. Angrisani is very focused on free cash flow generation and improving liquidity, including tighter working capital management - one of his reported mantras is: "Cash is King". We note the $81m of cumulative cash generated from operations by HPOL from FY05 to FY08 and since FY05 only FY09 has been negative cash from operations.
Angrisani joined HPOL and started the turnaround program in mid-2011. We believe he has made a lot of progress in a fairly short period of time. He has laid out a very methodical and logical turnaround plan and, so far, he has executed it well. His focus has been on right-sizing the company's cost structure, selling higher-margin research services, and improving liquidity. We recommend a reading of the last several conference calls to get a sense of Angrisani (he strikes us as someone who under-promises and over-delivers). In summary, we believe Angrisani can improve HPOL's profitability by making it a smaller, more geographically-focused, niche player focused on certain specific products and verticals that does not attempt to go head-to-head with the large industry players.
The first phase of the turnaround included a very major reduction of HPOL's cost structure and a significant improvement in its liquidity, some of which occured under the prior management team.
We estimate FTE's at HPOL are down near 650 as compared to 750 at FYE 6/30/11. The large reduction in FTE's has reduced direct labor which is a large component of COGS. Gross margin improved to 39% in Q3 of FY12 as COGS declined to $20m versus $24m in prior year.
On the most recent (Q3) conference call, Angrisani discussed an increased focus on higher margin revenue or "good revenue" and a gradual de-emphasis or re-pricing of lower margin revenue or "bad revenue". Prior management was more focused on revenue than margins. Angrisani wants the sales force to generate revenue with acceptable margins, while concurrently shedding revenue with unacceptable margins. He is putting in place incentives for the sales force to focus on margins.
A major objective of the turnaround plan is to improve gross margins. Gross margins declined steeply from 56% in FY05 to 34% in FY11. Clearly, some of this is related to the recession, increased competition, and the discretionary nature of HPOL's services. Despite this, we believe there is a niche for HPOL's brand name and services.
Financial Results in FY12 Under Angrisani
Under Angrisani in FYE 6/30/12, gross margins have steadily improved:
· Q1 gross margins were 37.3% vs. 34.6% in prior year;
· Q2 gross margins were 37.4% vs. 34.2%; and
· Q3 gross margins were 39.1% vs. 34.0%.
However, revenue declines have also continued:
· Q1 revenue increased 3.5%;
· Q2 revenue decreased 12.9%; and
· Q3 revenue decreased 7.8%.
(Some of this revenue decline was due to the closure/downsizing of under-performing offices). For nine months of FY12, gross profit dollars have increased 5.8% to $42.2m in FY12 vs. $39.9m in FY11.
Angrisani has cited the revenue decline and "structural sales problem" as the major challenge of the turnaround. Stabilizing and reversing revenue declines will be a critical factor in how successful the turnaround is. Angrisani compared the challenge of replacing low-margin revenue with higher-margin revenue while stabilizing a decline in revenues to "changing the tire while the car is moving"…not an easy task.
However, we believe Angrisani's focus on sales stabilization and improving the margins on sales dollars has only recently started. This will include a more focused approach to selling services than the cumbersome product-matrix approach prior to his arrival (six or seven industries were overlaid by five or six basic service products). We believe a simple focus on a handful of key products where HPOL can achieve acceptable margins will be the focus going forward. We expect HPOL's sales force are having their incentive structure changed to drive a focus on growing gross profit dollars instead of simply growing sales.
Under Angrisani, Adjusted EBITDA before items has shown steady improvement in FY12:
· Q1 Adjusted EBITDA was $2.8m vs. $0.9m;
· Q2 Adjusted EBITDA was $3.8m vs. $3.7m; and
· Q3 Adjusted EBITDA was $1.5m vs. $0.6m.
Nine months Adjusted EBITDA FY12 was $8.4m vs. $5.0m in prior year and, for FYE 6/30/12, the mid-point of most recent guidance for adjusted EBITDA before items is $11m vs. $6.8m in prior year.
FY13 Estimates & Valuation
In FYE 6/30/13, we believe HPOL can achieve a 10% EBITDA margin on revenue of $150m or about $15m of EBITDA. We believe that capital expenditures are not likely to exceed $3m. Angrisani stated on the Q3 conference call that he does not think the turnaround of HPOL will require a lot of capital and, consequently, we think HPOL could generate substantial free cash flow in FY13.
Further, if HPOL can profitably grow revenues, adjusted EBITDA could go significantly higher than our $15m estimate for FY13 over time. We also believe HPOL should also increase its net cash position over time. From a net cash position of about $6m at 3/31/12, we think HPOL will increase its net cash position to $15m or more by the end of FY13 (ended 6/30). Based on a multiple of 6.5x adjusted EBITDA, plus a projected net cash position of about $15m by end of FY13, we believe HPOL could have an enterprise value (EV) of about $115m or $2 per share (or 75% higher than the current price of $1.15 per share).
HPOL is a professional services firm that serves clients in many industries and many countries. It provides full service market research and polling services which include ad-hoc and customized qualitative and quantitative research, service bureau research (conducted for other market research firms), and long-term tracking studies. (See HPOL 10K.)
HPOL conducts market research projects for clients in many industries, including automotive, transportation, travel, tourism, energy, professional services, consumer goods, restaurants, retail, financial services, healthcare, public affairs and policy, technology, media and telecommunication industries. HPOL has approximately 1,400 clients with no single client representing more than 10% of consolidated revenue. HPOL provides many types of custom research including customer satisfaction surveys, market share studies, new product introduction studies, brand recognition studies, reputation studies, ad concept testing, and more.
HPOL's revenue base is comprised of a large number of discreet projects. The company might have 1,000 projects or more going on at any one point in time with projects diversified across a fairly large number of customers. Most non-tracking study projects are shorter term in nature and smaller in amount. Tracking study projects can be as large as $1m or more.
HPOL has operations in North America and Europe with international operations in Canada, the U.K., France, and Germany. Operations in Asia ceased as of Sept. 30, 2011. European operations were about 25% of revenues for nine months of FY12.
Market Research Industry
The top companies in the market research industry by sales in 2010 and their global market shares were as follows:
· Neilsen Company (USA) - $5.0 b sales - 15.9% market share;
· Kantar Group (U.K.) - $3.2b sales - 10.2% market share;
· Ipsos (including Synovate) (France) - $2.4b sales - 7.6% market share;
· IMS Health - $2.2b sales - 7.1% market share;
· Gfk Group (Germ) - $1.7b sales - 5.5% market share.
These are very large organizations that are generally located in many countries around the world. Synovate is also a competitor and was recently acquired by Ipsos in December 2011 for about $860m. Miller Brown is a competitor which is owned by WPP.
HPOL believes it can compete with these large firms on certain types of projects and in certain specific industries where its employees have meaningful experience. HPOL believes it continues to have a good brand name and reputation in the custom market research industry as well as many strong relationships with customers, all of which enable it to win business.
We would not be surprised to see further consolidation activity in the custom market research industry by strategic or private equity players. HPOL's diversified base of customers, its employees experience and relationships, and its well-known brand name could make it an attractive acquisition. Ipsos bought Synovate - a unit of British market firm Aegis Group - for about $860m in mid-2011 and WPP bought TNS in 2008 for about $2b and GfK bought Knowledge Network in late 2011. IMS Health was taken private in 2010 by TPG Capital for about $5b. Neilsen Company was owned by private equity investors.
Strong Cash Flow Generation and Solid Business Model
HPOL has a solid business model with limited capital expenditure and working capital investment requirements. Since FY05, HPOL has generated over $80m in cumulative cash from operations. While the pre-recession environment was different, we think the business model retains a high ROIC and should be highly cash-generative. Further, Angrisani is highly focused on tight management of working capital and cash generation.
HPOL's balance sheet has steadily improved over the past twelve quarters from a net debt position of $4.2m at 3/31/10 to a net cash position of $6m at 3/31/12. Furthermore, the improvement in the net cash position during FYE 6/30/12 to date has been achieved while HPOL funded close to $5m of cash restructuring expenses. We expect these cash restructuring expenses to drop off sharply in FYE 6/30/13, resulting in strong free cash flow generation.
Based on EBITDA of $15m or more in FYE 6/3013 - 10% EBITDA margin - HPOL could generate free cash flow of $10m or more. Capital expenditures have recently been about $1m per year and we estimate $2m in FY13 and FY14. HPOL has an NOL of about $25m which should result in minimal cash taxes for several years.
Successful Turnaround Manager With Sensible Plan Focused on Long-Term Value Creation Which is Beginning to Show Results
Al Angrisani has had impressive results with previous turnarounds in similar industries. He joined HPOL in June 2011 and immediately started to right-size the company to get a more appropriate cost structure as offices in the U.S. and U.K. were downsized and Asian operations were closed. His focus has been on right-sizing the company's cost structure, selling higher-margin research services, and improving liquidity. We estimate the employee base has been reduced by over 100 FTE's since 6/30/11 or over 15% of the workforce. We are starting to see the benefits of these actions as gross margins have steadily improved throughout FYE 6/30/12 and peaked at 39% in Q3.
In the second phase, his focus in on project profitability and pursuing projects with higher margin revenues to gradually replace projects with lower-margin revenue. He is creating incentives to focus the sales force on gross margins and project profitability, making sure new projects are profitable on a fully allocated basis. He has also been able to improve liquidity, with net cash increasing by $6m in FY12 to date, despite funding close to $5m in cash restructuring costs. Angrisani has had success with other turnaround projects, including Greenfield Online in October 2008.
Strong Relationships with A Diversified Customer Base Leads to Solid Competititve Position
We think HPOL's diversified customer relationships with many customers and its well-known brand name help give it a solid competitive position in its industry. HPOL's relationships with a diversified group of well-established companies should allow it to find a sustainable niche position in the market research industry. HPOL has approximately 1,400 clients with no single client representing more than 10% of consolidated revenue.
HPOL employees also have expertise and reputations in specific vertical industries and with specific research projects. These customer relationships, employee reputation and knowledge base, and its brand name give HPOL some competitive advantages.
Industry Consolidation Prospects
We believe that HPOL's relationships with a diversified customer base are a valuable asset. We think there could be strategic purchasers who might be attracted by HPOL's brand name and customer base.
Large marketing research industry players like Ipsos (IPS.FP) and GfK (GFK.DE) trade at significant premiums to HPOL (1.3x and 1.5x revenues versus 0.3x for HPOL), although they are larger, more diversified company and HPOL is purely custom research. These large competitors have shown a strong interest in expanding through strategic acquisitions. There is also a fair amount of private equity investment around the industry, as both IMS Health and Neilsen have private equity investors.
It is also interesting that HPOL's largest shareholder is Vincent Bollare, who is a French billionaire and activist investor in Europe with a successful track record. He currently owns a 26% stake in Aegis, a large, U.K.-based marketing company which recently sold Synovate to Ipsos.
Strong Nine Month Results in FY12 Should Bode Well for FY13
Nine months results for FYE 6/30/12 have indicated the start of the turnaround program, with improved gross margins and higher gross profit dollars. Nine month revenues for FY12 were $111m versus $117m in prior year while nine month FY12 gross margin improved to 38.0% versus 34.2% in prior year, resulting in gross profit of $42.2m in FY12 versus $39.9m in FY11. This reflects the strategy of focusing on higher gross margin revenues and eliminating lower margin revenue. FYE 6/30/12 projected adjusted EBITDA is about $11m versus $6m in prior year. We like this focus on profitability over growth. We believe the company will be able to stabilize and grow its revenue base but this is the biggest question in the turnaround.
Solid Balance Sheet and Expected Steady Build Up in Cash Position
HPOL has a solid balance sheet, which has been consistently improving its net cash position over the past eight quarters. At FYE 6/30/09, HPOL had a net debt position of $6m and this has improved to a net cash position of $6m as of 3/31/12. HPOL was able to remain cash flow breakeven even in the very depressed economic conditions of 2009. We believe the net cash position could improve by up to $10m in FYE 6/30/13.
Conclusion and Target Price
Based on 6.5x our EBITDA estimate of $15m for FYE 6/30/13 and including a $15m estimated net cash position, HPOL could trade for $115m market cap or $2 per share or more vs. $1.11 per share today (+75%). If HPOL's management team continues to execute and the custom market research industry performs reasonably, we think our target prices will be achieved. If HPOL is successful in achieving revenue growth, we believe its share price could increase well beyond our target price.