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Chan is an investor in cheap businesses. Focus on low P/E or significant events. Generally like good balance sheets unless huge upside. Chan also like momentum plays. But avoid most risks. Chan also self-appointed spiritual leader of StockTalk. Follow Chan!
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  • Innodata Has Limited Downside But Potential Upside Of 150%

    Innodata (NASDAQ:INOD) is a provider of outsourced services to the publishing and information services industry through its content services division as well as a provider of solutions to the insurance industry through its Synodex division (82.5% owned). The stock has declined due to recent unprofitability caused by INOD's significant investment in internal start-up Synodex and exacerbated by a drop in project-based e-book revenues in the core content services division. However, even at current depressed levels, content services generates solid EBIT and should provide downside protection near $2 while success with Synodex has the potential to create upside to $6.50+. Thus, at $2.50, it represents an interesting risk/reward (+150%/-20%) as the value of its existing business provides a cheap option on the massive potential of Synodex.

    Capitalization and Valuation

    INOD has 25.0mln diluted shares for a 63 million market cap at $2.50. The company has 26.2 million of cash and investments however, 89% of that cash is overseas so I use 18 million of cash net of a 20% repatriation tax as INOD has NOLs that it believes will allow it to repatriate some money at lower levels. The company also has 4.1 million of obligations which mainly consist of an unfunded Asian pension (payments very low, actual liability probably much lower), capital leases and a software purchase agreement. Including all of these liabilities, INOD has net cash of 13.9 million ($0.56per share) and a total EV of 45 million. TTM sales are 68 million (0.7x), TTM consolidated ongoing EBIT of -2 million (167x) and TTM Content EBIT of 5.6 million (8x).

    Upside

    The biggest potential source of upside for INOD is Synodex. Synodex extracts and classifies data from unstructured medical records for insurance underwriting and provides a connection platform between life insurance brokers and agents to place applications. Over the past 2 years, INOD has invested 20 million in Innodata Advanced Data Solutions which includes Synodex and DocGenix. This investment was undertaken because the company believes that Synodex has the potential to conquer a massive market.

    According to the company, Synodex has a total addressable market of $1 billion in the US and UK by providing data solutions to life insurance companies to help them process applications. The product is currently in pilot stage with 26 life insurers each of which could provide large amounts of business (10mln+ per large client). Instead of reproducing it hear, I would highly recommend reading/listening the most recent 2 quarterly conference calls (Q2-3 13) as the CEO spends a great deal of time detailing the Synodex opportunity. Due diligence has provided confidence that Synodex is a strong product with a large potential market opportunity and also supported the company's claim that the lack of current revenue generation is due to the very long sales cycle for a key product in the insurance industry. On the slower than expected sales cycle, the CEO noted on the Q3 13 CC "We are bolstered by the advice of the Vice Chairman at one of our client prospects, a company with $40 billion in assets, who told us "the (insurance) industry is slow to lead, but fast to follow."

    If successful, Synodex could generate over $100 million of revenue and $25 million of EBIT in the medium term (CEO believes it could be larger than the original business in 3-7yrs). In an upside scenario, I will value that option at $100mln (1x upside revenue, 4x upside EBIT) or $3 per INOD share. In reality, it is tough to put a precise value on Synodex but I am confident that the upside is large if it becomes successful.

    Another source of upside could come from the core content services business which is currently cyclically depressed. With a recovery in areas such as e-book publishing for overseas markets, enhanced content e-books, and other outsourcing projects content services could return to 10 million+ of EBIT (peak 15 million in 2012) which would be worth $3 per INOD share at 8x. Very close peer Aptara was acquired by UK based competitor iEnergizer for 12x EBIT.

    SOTP- Upside

    % Owned

    EBIT

    Multiple

    Value

    Per Share

    Content Services

    100.0%

    10.0

    8.0x

    80.0

    $ 2.85

    Synodex

    82.5%

    10.0

    10.0x

    82.5

    $ 2.94

      

    ----

     

    ----

    ----

    Total

     

    20.0

     

    162.5

    $ 5.79

    Cash net of Obligations and Tax

      

    17.4

    $ 0.62

      

    ----

     

    ----

    ----

    Total Value

       

    179.9

    $ 6.41

    Upside

        

    156.6%

    Downside

    Current content services EBIT of 5.6 million is cyclically depressed due to significantly lower e-book volumes as most of its English e-books have been completed and foreign and next-gen e-books have yet to generate significant revenue. If we assume these results stay depressed, content services would be worth 39mln at 7x TTM EBIT or $1.50 per INOD share. Another source of downside protection is that content services has a sticky stream of recurring revenue of ~40 million from content services providers' (Bloomberg, Reed Elsevier etc) constant need for data processing. 39 million is ~1x this high value recurring revenue and 0.6x TTM total revenue significantly below the 1.8x total revenue in the Aptara acquisition. INOD also has strong relationships with blue chip clients (the two mentioned above, Apple, Amazon, Sony, Thomson Reuters, Wolters Kluwer, Simon & Schuster, Random House etc) which speak to the quality of its content services solution. These ongoing relationships should have significant value to a strategic acquirer.

    On the Q3 13 call, INOD's CEO noted that the company would be willing to lower the cash burn from Synodex in 2014 if they did not believe it would have a significant near-term improvement in revenue outlook. Thus, I believe that Synodex cash burn will not continue for more than another 12 months.

    If we add cash less liabilities and 1 year of Synodex cash burn, then INOD should be worth $1.90 per share.

    SOTP- Downside

    % Owned

    TTM EBIT

    Multiple

     

    Value

    Per Share

    x TTM Revenue

    x Recurring Revenue

    Content Services

    100%

    5.6

    7.0x

     

    39.2

    $ 1.56

    0.6x

    1.0x

    Synodex

    83%

    (8.0)

    1.0x

     

    (8.0)

    $ (0.32)

      
      

    ----

      

    ----

    ----

      
         

    31.2

    $ 1.25

      

    Cash net of Obligations and Tax

       

    17.4

    $ 0.70

      
      

    ----

      

    ----

    ----

      

    Total Value

        

    48.6

    $ 1.94

      

    Downside

         

    -22.4%

      

    Risks- Synodex unsuccessful and burn continues.

    Content services fails to recover

    Management wastes the cash

    Disclosure: I am long INOD. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it. I have no business relationship with any company whose stock is mentioned in this article.

    Tags: INOD, long-ideas
    Jan 24 11:48 AM | Link | Comment!
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