This article discusses the investment opportunity in American Software (AMSWA), despite persistent problems in the Enterprise Resource Planning segment.
AMSWA develops software and provides services that deliver enterprise management and supply chain solutions designed to support business operations and enhance enterprise value in companies of all sizes. Solutions are provided by the company and its wholly-owned subsidiaries through three major business segments; Supply Chain Management (SCM), Enterprise Resource Planning (ERP), and Information Technology (IT) Consulting.
SCM (Logility, Inc.) provides supply chain solutions to streamline and optimize forecasting, production, distribution and management of products between trading partners. Customer base is 1,250 companies worldwide; one of the largest bases of customers among application software vendors.
ERP (American Software ERP and New Generation Computing) provides solutions in purchasing and materials management, customer order processing, financial, e-commerce and manufacturing. NGC focuses in industry-specific business software to both retailers and manufacturers in the apparel, sewn products and furniture industries.
IT Consulting (The Proven Method, Inc.) is an IT staffing and consulting services firm.
Sales and marketing are carried out directly and indirectly through a network of agents who sell products globally. These independent software and service distributors and resellers distribute products domestically and in foreign countries, typically selling their own consulting and systems integration services in conjunction with AMSWA's products. Global distribution consists of 47 organizations with sales, implementation and support resources serving customers in more than 75 countries.
Improving the performance of supply chains is strategically important for firms in general and particularly those with large investments in Net Operating Working Capital (NOWC). Optimizing NOWC strengthens intrinsic value.
- 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). As an approximation FCF = CFO (Cash Flow from Operations) minus Depreciation and Amortization
- EV (Enterprise Value) = PV of prospective FCF, growing at g; discounted by WACC
- Stock Value = (EV + Surplus Cash - Debt) / # Shares
AMWSA upgrades clients' operating processes by improving the effectiveness of day-to-day interaction with their customers (clients of clients) and supply chain stakeholders. This strengthens customer experience, reduces clients' operating assets, and shortens their cash conversion cycle.
In financial terms, AMSWA improves clients' Enterprise Value by means of higher Revenues, higher Net Operating Profit after Taxes (NOPAT), and optimized Operating Capital. These energize ROIC and growth, drivers of fundamental value.
While the market for supply chain improvement is evidently sizeable, competition is intense. Among the recognizable competitors are SAP (SAP), Oracle (ORCL), JDA Software (JDAS), Manhattan Associates (MANH), and Lawson Software. Many competitors have significantly greater financial, marketing, technical and other competitive resources, greater name recognition, and larger client rosters.
The table shows the substantial improvement in AMSWA's ROIC during the last four years, driven by growth in NOPAT and tight Operating Capital.
|AMSWA Table --Selected Value Metrics|
|(Amounts in millions of US$, unless otherwise noted)||FYE 4/09||FYE 4/10||FYE 4/11||FYE 4/12||4-Yr.Avg.||Q 7/11||Q 7/12|
|Revenue Growth (y-o-y)||-12%||-4%||14%||20%||5%||9%|
|EBIT / Revenues||9%||10%||11%||16%||11%||15%||14%|
|NOPAT / Revenues||6%||6%||7%||10%||7%||10%||9%|
|Operating Capital / Revs.||24%||30%||26%||19%||25%||27%||20%|
|Cash Flow from Ops. (excl. Security Transact.)||11.04||10.15||11.28||18.87||12.84||0.05||2.60|
|CF f/Ops. / Revenues||14%||13%||13%||18%||15%||0%||10%|
|CF f/Ops.Growth (y-o-y)||6%||-8%||11%||67%||19%||nm|
|Free Cash Flow||4.39||4.65||5.95||12.83||6.96||-0.70||6.73|
|FCF / Revenues||6%||6%||7%||13%||8%||-3%||26%|
|FCF Growth (y-o-y)||-17%||6%||28%||116%||33%||nm|
|Cash & Mkt. net of Debt||71.09||53.88||55.41||66.87||61.81||52.79||66.27|
|# Shares Growth (y-o-y)||-3%||0%||1%||4%||1%||3%|
|Dividends: $ / Share||0.36||0.36||0.36||0.36||0.36||0.09||0.09|
The improvement in ROIC is a major accomplishment that cannot be overstated, particularly when coupled with growing Revenues and FCF. ROIC was 21% in FYE 4/10 and 52% in FYE 4/12, well in excess of 10%, estimated WACC.
Accounting for the improvement in NOPAT is the substantial growth in EBIT in the Supply Chain Management (SCM) segment. This segment's EBIT increased by 48% in FYE 4/12 (to $20.84 million), and by 18 % in FYE 4/11 (to $14.07 million), more than offsetting -$6.44 million (negative EBIT) from the Enterprise Resource Planning (ERP) in FYE 4/12. Financial notes indicate that negative EBIT was due to the loss of a large ERP client in August 2010 ($1.1 million in revenues per quarter) and to $2.2 million in R&D (16% of FYE 4/12, ERP revenues) to energize the segment.
In the last few years, Operating Capital has been steady in the $18.00 million - $20.00 million range. Contributing to reducing OC requirements is the net release of funds by NOWC (amounting to -$6.86 million as of FYE 4/12), which helps to offset $26.65 million in Operating Long Term Assets.
The point of this analysis is the strong performance of AMSWA during the last few years, notably in ROIC and in growth of Revenues and FCF. Driving such performance and fundamental valuation is SCM, a rapid-growth, high-ROIC segment.
The ERP segment, on the other hand, detracts from shareholder value. Negative EBIT accumulated over the last four years amounts to minus $21.09 million.
The jury is out on management's decisions regarding ERP. It is unsettling that with the time elapsed and resources devoted, ERP continues to exhibit weakness in revenues and growing operating deficits. It would seem that symptomatic solutions are not resolving root causes.
This condition is worrisome since a growing level of accumulated investment (operating losses and capital invested) decreases the likelihood of achieving an eventual ROIC in excess of WAAC. ERP's operating deficits dampen AMSWA's overall ROIC.
Resolving ERP is strategically critical and financially time-sensitive.
The question for the board of directors and management is: Are conditions in AMSWA -skills, inter-segment linkages, distribution channels, governance, etc. -consistent with ERP adding to shareholder value?
Management needs to put a light on how it is facing this critical matter from a fundamental value perspective; strategy, rationale, skills, timelines, etc.
AMSWA's fundamental value is conservatively estimated at $11.60/share on the basis of $11.00 million FCF in FYE 4/13, growing at 12% in FYE 4/14, 10% in the following two years, and 5% thereafter in perpetuity. WACC discount rate is 10%.
These assumptions propose that the SCM segment will continue to drive intrinsic value and that ERP will not deteriorate further. Thus, resolution of ERP weaknesses would provide additional impetus to support stronger metrics and a higher intrinsic value estimate. The opposite is also true.
Dividends ($0.36/share) provide additional investment incentive.
Steadiness in absolute EBIT and improvement in EBIT/Revenues, along with focus in the businesses managed, suggest relatively low operating risk. Prospective EBIT will, by necessity, be conditioned to the resolution of the ERP condition.
Financially, the firm exhibits a stable condition; substantial free cash flows, no debt, and robust cash. Dividends in FYE 4/12 ($9.75 million) amounted to 75% of FCF.
ROIC and growth metrics indicate substantial progress of AMSWA as a whole in the last few years, notwithstanding the ERP problem.
The fundamental value of the stock is substantially lower than market price.
It is not clear that the ERP segment is capable of eventually generating acceptable ROIC. Management needs to shed light on how it is facing this critical matter from a fundamental value perspective. Lack of disclosure or symptomatic solutions will surely continue to put downward pressure in the price of the stock.
Disclosure: I am long AMSWA.
Additional disclosure: The 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.