Rainmaker Systems (NASDAQ:RMKR) provides business-to-business ((B2B)) e-Commerce solutions. The Company's solutions, which are offered on a global basis, drive online sales and renewal for products, subscriptions and training for large companies in the computer hardware, software and information services industries. Rainmaker's three primary solutions (Transact, Renew, and Educate) are designed to deliver maximum revenue in its client's mid-market. The transformation of the business model from telesales to e-Commerce should drive margin expansion and growth.
B2B versus B2C
With the rise of the internet in the past decade it was a natural that online shopping would take a greater and greater piece of the consumer dollar. On-line shopping offers easy comparability of products from your own home. Consumers only need an on-line connection, a credit card, and a place for the product to be delivered. This one size fits all "vending machine" model helped push the business to consumer ((B2C)) market place in the US as e-commerce sales grew from $995.0 billion in 1999 to $2,385 billion by 2006. (www.azgovernor.gov/TPT/documents/Materia...)
While often lumped together in the same breath as B2C, the Business to Business ((B2B)) e-Commerce market place is a much different entity. Transactions can be complex involving several decision makers, channels, and complex technical specifications. That complexity often pushes the B2B buyers to consult a sales agent before committing several thousand dollars.
A successful B2B E-Commerce platform should include
Ø Multi-Channel Functionality
Ø Banded pricing
Ø Offer the ability to communicate with a sales agent
Transformation of the Business Model
Rainmaker has two primary business lines; Telesales and e-Commerce.
In February 2005, Rainmaker bought Sunset Direct, which gave the firm a telesales presence. Telesales is the generation of sales leads, or lead generation, for clients. Sunset Direct provided the firm with new clients for its service contract sales solution.
Through two separate acquisitions in October 2009, (e-Commerce technology of Grow Commerce) and January of 2010 (Optima Consulting Partners Limited) Rainmaker assembled its e-Commerce platform. Grow Commerce provided hosting of fan club and membership websites that offered monthly subscriptions and the ability for fee-based downloading of music, videos and other items, while Optima was primarily a B2B lead development provider.
After acquiring and building the business lines, the firm receives revenue four different ways,
Ø The online sale of client's products to their SMB customers.
Ø The sale of service contracts and maintenance renewals.
Ø Lead development and other telesales services.
Ø Software subscriptions for hosted internet sales of web-based training.
The Transformation of the business model from the majority of sales coming from telesales to e-Commerce should transform the company's margin and growth characteristics to that of a high margin/ high growth profile. Management has targeted a 70-30 mix with 70% coming from e-Commerce. e-Commerce enjoys significantly higher margins, stickier revenues, and longer contracts (e-Commerce contracts typically 1 to 3 years, telesales contracts are typically 3 months to 1 year). The transformation will also serve to decrease Rainmaker's reliance on a low number of clients for revenue.
Rainmaker is experiencing increased pipeline activity on the e-Commerce side of the business while the firm's Lead Development business remains solid. Recent client wins will help drive sequential revenue growth as well as margin growth.
Rainmaker remains well-positioned to achieve solid revenue growth and operating leverage as a B2B grows given the company's competitive advantage led by innovation. The firm has four things that separate it from the pack in our opinion.
Ø A technologically superior product.
Ø A growth platform in B2B software that looks to be larger than the size of the B2C market.
Ø Growing margins as e-Commerce takes the lead from Telesales.
Ø The ability to shed non-core assets to strengthen the balance sheet.
We valued the firm with a combination of a valuation model and our two-stage growth model. Both assume the firm captures a modest piece of the B2B market for 10 years then settles down and looks more like the overall economy. The valuation model is essentially a price to sales model valued at year 5 and discounted back to the present day.
Ø The firm is expected to grow at a higher growth rate in the first period.
Ø The growth rate will drop at the end of the first period to the stable growth rate.
Rationale for using the Model
As the e-Commerce business ramps up to a higher percentage of total revenues we expect the firm to grow margins and earnings at a higher rate than the overall industry. As these products mature and the firm faces more competition we expect the growth rate to level off.
Weakness of the Model
As you add more layers to the model it is more sensitive to the assumptions you make. The growth may look more "lumpy" than we have it in the model.
We used the following inputs:
Ø A 10-year period with an earnings growth rate of 8.5% and a discount rate of 12.75%.
Ø A continuing period assumed to go on forever, with earnings growing at 5% and a discount rate of 10.00%.
With these inputs we arrive at a target price of $2.00.
Our price target of $2.00 per share is the average of our valuation model and our two-stage model. We would add shares at these levels.