Inflection Poin...'s  Instablog

Over the past twelve months, two of the best performing cloud plays have been Rightnow (RNOW) and Liveperson (LPSN). Both have had impressive runs, with each doubling in price since last summer. While the long-term future for RNOW and LPSN looks bright, one has to wonder how much upside remains for their stocks, with each trading for 4-5X sales; on an earnings basis, LPSN trades for a 35X multiple and RNOW trades for a 53X multiple. By all measures, both seem pricey to us. This brings us to eGain Communications, one of the original cloud plays from the 90’s that has been flying under the radar of most investors for the past decade. Our thesis for investing in eGain (EGAN.OB) is quite simple: EGAN’s current valuation does not reflect the accelerating fundamentals of the company. In comparison to both LPSN and RNOW, EGAN’s stock is cheap. As new investors discover the story in the coming quarters, this valuation disconnect will narrow, resulting in a much higher stock price from current levels.

Earlier this week the company pre-announced another very upbeat quarter. Here is what eGain had to say about the quarter:

• The company currently expects to report total revenue between $12.0 million and $12.5 million for the fourth quarter ending June 30, 2011, an increase of 82% to 89% from the comparable year-ago quarter.
• The company currently expects to report new hosting and license bookings of approximately $6.7 million, an increase of 139% from the comparable year-ago quarter. The company currently expects to report earnings from operations between $1.5 million and $2.0 million for the fourth quarter, compared to a loss from operations of $1.2 million in the comparable year-ago quarter.

Total revenue is now expected to increase by 45% to 47% to $43.5-$44 million for the fiscal year ending June 30, 2011. Perhaps the most compelling metric for the company is the acceleration they have seen in new hosting and license bookings, which increased 82% from the prior year to $23.9 million. For the year, earnings will rise by 700% to $8.8M-$$9.3M, equating to $.36 a share.

Looking ahead, the company seems poised for further growth:

“Our strong preliminary revenue for the fiscal fourth quarter was driven by several license transactions signed during the quarter, including the recently announced agreement with Canon U.S.A. to deply our eGain 10 software suite for multichannel customer service,” said Ashu Roy, eGain CEO. “These recent customer wins and our bookings growth for the fiscal year demonstrate the strong business momentum we are generating as we enter fiscal 2012.

Earlier this year, CRM commended eGain for its comprehensive Social Experience Suite, calling the company “The One-Stop Shop” for customer interaction and knowledge management. By empowering contact agents and community managers to respond to customer’s needs across both traditional and social channels, eGain® Social Experience Suite™ can be integrated with Facebook, Twitter, and Web search. Perhaps this is why Vodafone, Canon, Avis and Hertz all signed big license agreements with eGain last year?

CRM also highlighted another product offering, eGain® Multisearch™, describing it as an “all-in-one search solution that is designed to dramatically improve the user experience.” In the eyes of Esteban Kolsky, principal and founder of CRM intelligence and strategy firm ThinkJar, “eGain has evolved its product to include a new model of search that allows it to deliver better service to users. They can find information faster and easier and with a better overall experience.”

Hoping to seize upon its growing momentum, eGain is currently in the process of doubling its sales force. Although it will take a few quarters before these new sales reps will make any contribution to eGain’s top-line, we feel that these long-term investments are prudent and a wise move on management’s part. Ultimately these new reps should allow the company to accelerate its growth in the back half of its new fiscal year which just began on July 1^st, giving investors an important catalyst to look forward to early next year.

Investors have certainly caught wind of the story. The stock has tripled since the beginning of the year. We see additional upside with the stock trading at an 11x P/E multiple. In the near-term, we envision the stock moving above $4. Such a move would open the door to an important Nasdaq up-listing, a big catalyst that will allow new institutional investors to move into the name.

Once the company is able to list its shares on the Nasdaq we would expect analyst coverage to follow thereafter. In a certain sense, eGain reminds us of Interclick (ICLK) and ZAGG before they got up-listed to the Nasdaq over the past two years. As soon as both companies moved to the Nasdaq, new analyst coverage brought new institutional investors into the story, ultimately leading to much higher prices for both stocks. We expect the same pattern to occur with eGain.

As analysts model $60 million in sales for the company on a forward basis, we envision eGain trending toward $7 by the first quarter of next year. At $7, the stock would trade for a 3X sales multiple based on a fully diluted share count of 26 million shares. While certainly not cheap, we view a 3x forward sales multiple as more than reasonable for a company that is rapidly expanding market share and which could very well be on its way toward $100 million in sales and $1 in earnings in a few years. As such, we remain patient and steady buyers of eGain shares on pullbacks to the low-to-mid $3’s.

In September of last year, we outlined why Fossil Inc. (FOSL) had the potential for a 25-30% move up to the mid-to-high $60’s (seekingalpha.com/article/227148-fossil-g...). After quickly reaching our price target in late November, Fossil then proceeded to spend the following three months consolidating its substantial move higher. It now looks as though this consolidation is over. With FOSL breaking out to new highs late last week, it may appear to some investors that the train has already left the station. However, we believe the stock is just beginning to rev its growth engine on a trip to $100 and possibly beyond.  Here are ten reasons why we feel FOSL could provide investors with another profitable ride:

#1:  Watch Cycle is in the Early Innings. While it is difficult to get an exact read on just how long the current up-cycle in watches will last, many indicators point to the beginnings of a multi-year cycle. On the last conference call in mid-November, Fossil’s management pointed to the previous 5-year up-cycle for watches in the early 90’s. Using this as their precedent, they stated that “we have just entered the early innings of this cycle.”

On Monday afternoon we spoke with J.P. Morgan analyst, Anna Andreeva. According to Anna, the up-cycle in watches seems poised to meaningfully accelerate internationally throughout 2011. When you consider that FOSL’s international revenues carry a 500-600 basis point step-up in margins, an expansion of the “watch cycle” to international markets will usher in an additional layer of growth for the company this year. Keep in mind, that FOSL is very much an international based company, with 52% of its revenues coming from overseas.

#2:  Additional Room for P/E Expansion. Before DECK and CROX went parabolic years ago, both companies posted multiple quarters of accelerating growth in both sales and earnings. As earnings caught up to their stock prices, new institutional investors moved into these two stories aggressively, resulting in a dramatic revaluation for both stocks. We feel that the same process is close to occurring for Fossil. On pace to nearly double its earnings in 2010, we expect to see fresh institutional money move into FOSL over the coming months as 2011 estimates eventually trend to $5.50 by the second half of this year. If this market continues to move higher, a P/E of 20 would not be out of the question for FOSL, thus allowing for a $100 price target for the stock.

#3:  Record Operating Margins and Profitability in Q4 are On The Way. Fossil’s management exuded confidence at its presentation to investors in mid-January. With a penchant for deliberately low-balling forward estimates, we expect another big beat when Q4 numbers are reported next Tuesday, February 15^th. Over the past seven years, fourth quarter earnings have historically represented 40% of the entire year’s net income for Fossil. With current Q4 estimates of $1.33 representing 36.4% of the $3.66 consensus for FY2010, estimates seem way too low. Perhaps this is why management seemed so upbeat last month when presenting to investors?

#4:  Expect Fossil to Announce New Operating Margin Targets on the Feb. 15^th Earnings Call. During the late 1990’s Fossil was able to achieve peak operating margins of 21%. We feel the company could very well offer up 20-21% as their new operating margin target. This should sit very well with institutional investors. The big boys love margin expansion. With international markets becoming a bigger mix of the company’s overall revenue structure this year and beyond, a higher operating margin target could be a big catalyst for shares over the next 3-6 months.

#5:  International Growth is Booming and Set to Accelerate Further in 2011. FOSL’s accessory lines from Michael Kors and Armani were both big successes domestically in 2010. On the conference call in mid-November, Fossil’s management was very upbeat concerning the potential for these lines to boost international sales in 2011. As current international sales trend from 52% toward 60% of the company’s overall sales mix during the next few years, FOSL stands to see its top-line continue to grow above current estimates. 

#6:  Top-Line Estimates for 2011 are WAY TOO LOW. In Q3, Fossil’s 40% sales growth, on a constant-currency basis, was the company’s highest percentage increase in 13 years. With consumers opening their wallets once more in Q4, we believe Fossil’s sales growth may have accelerated even further. Keep in mind that Q4 has consistently been Fossil’s most profitable quarter of the year. A big beat on the top-line in Q4 will be very significant for the company on the bottom-line. If we are right, this would automatically re-set the bar on the amount of sales the company will be able to achieve in 2011.

As for earnings, with international sales poised to become a bigger part of the overall revenue mix this year, we feel the company could easily grow its net income by 40-45%. Do the math. Working from our estimated $3.90 in 2010 earnings, 2011’s numbers could easily trend toward $5.50 when all is said and done.

#7:  FOSL is Retail’s 2011 Anti-Inflation Play. Unlike Coach, which spooked investors a few weeks ago with talk of margin pressure on their leather goods, Fossil should not have any issue with higher costs this year. First of all, labor is only 10% of the company’s overall cost structure. International expansion and licensing growth will more than offset any rise there. With respect to raw materials, as we observed in LVMH’s recent earnings report, Fossil should be able to raise prices on its leather goods to offset any rise in its leather costs this year. LVMH raised prices by 8% and was still able to grow its leather sales quite nicely last quarter. The same should hold true for Fossil.

#8:  In 2011, Fossil Plans to Accelerate New Store Openings and Increase Its Overall Square Footage. In addition, the company plans on increasing its marketing spend into such areas as social networking, a trend that should result in higher-than-expected sales for the year. While SG&A will move higher because of these growth initiatives, higher sales will more than make up for these increased costs.

#9:  Fossil is in a Strong Industry Group. After being shunned by institutional investors for most of January, many growth-oriented retail stocks have recently sprinted to new all-time highs. Look no further than LULU and UA to see what we mean. With money flows once again being directed to the retail space, another beat and raise by FOSL should attract the “hot-money” back into the stock next week.

#10:  The Bulls are In Control! Having just emerged from a two-month, base-on-a-base pattern late last week, the stock is in great shape technically. Unlike its previous earnings report in mid-November, FOSL’s current share price is not extended. Instead it sits just above its 50-day SMA, an ideal entry point for most institutional investors. Even if the stock should gap higher to the low $80’s on February 15^th, we feel the big boys will have no problem buying into the stock for this very reason.  Take a look at the 6-month, daily chart below to see what we mean:

FOSL 6-Month Chart

Source:  StockCharts.com

Add it up, and we like the odds of being long FOSL into Q4 numbers. We remain buyers on pullbacks to $73-$75 in the coming days leading up to the report on Tuesday, February 15^th.

DISCLOSURE:  We are long FOSL stock and FEB/MARCH calls.