We have written a report on EBIX Inc. (NASDAQ:EBIX) that may be of interest to shareholders, auditors, and most importantly - the IRS and SEC.
The full report can be downloaded here:
Winston Churchill's famous quote, "a riddle wrapped in a mystery inside an enigma," might as well have been targeting Ebix Inc. (ticker EBIX). EBIX has been an aggressive acquirer of a variety of companies over the years, many of which focus on the insurance industry. The company's offering mix is a confusing amalgamation of niche products that all have a "roll-up" stench. Robin Raina, EBIX's CEO, has liberally described his business with the buzz words du jour, such as "exchanges," "CRM," "The Cloud," and "SaaS." The stock has performed well, fueled by retail investor interest, momentum publications like Investors' Business Daily and minimal scrutiny from analysts. We believe that EBIX is nothing more than a roll-up that has materially misrepresented its business (relative to the CEO's buzz words) as well as its organic growth. Its business model is predicated on two principals: tax arbitrage and dramatic cost cuts (headcount reductions and offshoring), neither of which is sustainable. Further, the company's tax arbitrage may be more than "just" unsustainable, it may actually be illegal.
EBIX's problems run deeper than unusual accounting. The EBIX story also comes with multiple auditor resignations, governance abuses, misrepresented organic growth, questionable cash flow and a contentious CEO. Below we address these concerns in great detail. Given the gravity of these issues, we have notified the IRS and the SEC of the material abuses at EBIX. We hope the warranted scrutiny saves investors from significant losses as the true EBIX story gets told.
EBIX shares are worth no more than $9.00, a level that would represent a 65% decline from current prices. We arrive at our target by adjusting current consensus estimates for a 35% tax rate (where it will likely go), and applying a generous market multiple of 12x normalized earnings (consensus estimates include assumptions that are unattainable and adjust for oddities such as amortization, while failing to contemplate massive underinvestment in sales and R&D). We estimate that the company has less than $0.75 of de novo earnings power.
This report will detail:
1) The History of a Roll-up & Its "Slash & Burn" Strategy. The $970 million of "value creation" imbedded in EBIX's valuation is likely to collapse given the myriad of issues the company currently faces.
2) EBIX's Atrocious Organic Growth and Manipulative Metrics. Investors have a distorted view of the company's growth profile. We estimate organic growth was negative in 2009 and was less than 4% in 2010. Management's definition of organic growth is highly manipulative and demonstrates the deceptive nature of the CEO.
3) Growth Crippled by Suspiciously Low Sales and R&D Expense. EBIX's extremely low sales and marketing and product development expenses are not consistent with a technology company. EBIX's company-wide sales and marketing expense was $2 million less than the stand alone run-rate of a recent acquisition. This acquired company that outspent EBIX was 1/20th of EBIX's size. EBIX's margins are overstated and will be crippled by massive reinvestment to avoid larger declines in organic growth. The only segment of EBIX's business that has not benefited from a recent acquisition declined 27% in the fourth quarter.
4) ADAM Assumptions are Incomprehensible and Will Drive Disappointment in 2011. EBIX recently closed its largest acquisition to date. EBIX must improve ADAM's margins by 2,500 basis points on day one, grow faster than ADAM did in the previous 3 years, recognize no D&A expenses and recognize a zero percent tax rate to generate the $0.15 of accretion that the company has guided to. This overly aggressive guidance will result in negative earnings revisions relative to analyst's elevated expectations.
5) Potentially Illegal Tax Strategy and Impact on Earnings and Valuation. EBIX utilizes two strategies to reduce taxes to nearly zero. The first strategy suggests a lack of oversight from auditors and earnings manipulation. The second is more sinister and potentially illegal. Through a series of superficial transactions that pose no business purpose other than to avoid U.S. taxes; EBIX was able to turn each dollar of foreign revenue into $1.40 of profits in 2010. This tax strategy is not sustainable in the near, or intermediate, term. A higher tax rate in the future will dramatically change the economics of EBIX's business, significantly impair its earnings expectations, and could subject the company to significant fines, penalties and back taxes.
6) Free Cash Flow Myth. Many investors use free cash flow to justify EBIX's valuation. We believe EBIX's free cash flow is a highly distorted metric given limited cash R&D expense and its questionable tax strategy. In fact, if investors simply adjust for a normalized tax rate, then EBIX trades at 37x free cash flow. Taken a step further and adjusting for R&D expense for acquired technology costs (acquisitions in the cash flow from investing segment), then EBIX trades at nearly 50x free cash.
7) Significant Quality of Earnings Issues. EBIX appears to manage earnings through accounting shenanigans, including accounts receivable and its allowance for doubtful accounts. The very low level of acquisition price allocated to non-indefinite intangibles is highly suspicious for a technology company and points to a lack of auditor oversight and a desire to overstate earnings through lower amortization. In 2010, EBIX generated almost $0.20 of earnings that are unlikely to repeat in 2011, which could drive incremental earnings disappointment.
8) History of Auditor Turnover, Shockingly Low Audit Fees and Accounting Red Flags. Investors should view EBIX's stated financials with extreme skepticism given the myriad of accounting and oversight issues. EBIX has had four different auditors over the past seven years. Management's explanation for the high auditor turnover does not reconcile with the company's filings. EBIX pays its tiny regional auditing firm less than $350,000 a year in audit fees, a tiny fraction of the audit fees that are paid by companies EBIX's size.
9) Controversial CEO Appears to Demonstrate a History of Misrepresentation. EBIX's CEO does not allow analysts or investors access to other members of his management team. This alone is cause for concern about what Robin is hiding. The CEO makes 1,250% more than any other employee. The company's lack of bench strength will again be on full display at their second ever analyst day on April 1st. The CEO's charity appears to make outlandish claims relative to its size and scope.
10) SaaS Provider? We Think Not. EBIX's management and analysts claim EBIX is the next great SaaS provider. This is a gross misrepresentation. SaaS companies measure their deferred revenue in quarters and years due to the subscription nature of the business. EBIX's deferred revenue can barely be measured in days and weeks. As a result, EBIX has minimal visibility relative to real SaaS providers. Also, management misrepresents its products by classifying the majority of its business as "exchanges." These misrepresentations are consistent with management's historical actions.
(Due to the danger of retaliation from the company, this report was written under a pseudonym, Copperfield Research. People like Robin Raina are willing to do anything to keep the house of cards in tact. The author of this report can be contacted at firstname.lastname@example.org)