Technology turnarounds, particularly in the software sector, can sometimes make for profitable investments. The reason is that assuming the "broken" company has a strong balance sheet and a decent product portfolio, with time, a good management team can re-ignite high-margin license sales, yielding substantial and sustainable free cash-flow growth for quite a few years. At the same time, the downside for the business and investment is protected by recurring, albeit low-margin, service/maintenance revenue, assuming that the software is being used by customers.
Furthermore, investors generally ignore the fact that the enterprise software business is very lumpy and as such, they get too optimistic when sales (on the license end) are booming and conversely become too pessimistic when sales slow. The whole business is quite cyclical, though. Therefore, assuming the stock of such a "broken" software company is trading at a low multiple to service revenue and at a value which implies zero growth in new licenses, the stock usually offers a good investment "gamble" on a potential license or product "cycle" upturn.
Now with that introduction out of the way, I´m offering up my next software turnaround play: SupportSoft, Inc. (NASDAQ:SPRT), which as of the writing of this post is trading at about $3.95.
Before getting to the business and investment thesis, I´ll provide a bit of background data.
SPRT Share Price as of this post: $3.95
Approximate Shares Outstanding: 44 million (as of April 2006)
Net Cash: $123 million
Market Cap: $175 million
Enterprise Value (Market Cap - Cash + Debt): $52 million
Estimated Service/Maintenance Yearly Revenue: $25 million
Enterprise Value[EV] to Service Revenue: 2.0X
Average Total Revenue Last Three Years: $58 million
EV to Total Revenue Possibility (Zero Growth Assumption): <1X
So what does SupportSoft Do?
In plain English, the main business of the company, and where its growth lies, is providing automated customer support software to triple-play service providers (triple-play refers to bundled offerings by service providers for high speed data, VoIP, and digital video services, the growth of which was incidentally the main reason why I recommended Redback Networks, (RBAK), as the first stock pick on this blog).
For a decent description of SupportSoft´s current product offering, please click here to read a recent press release. The following quote from the company provides a good summary of the company´s main product:
SmartAccess builds on the software's current Web-based installation features, and adds the ability for broadband customers to more easily install next-generation services such as IPTV or VoIP or value-added services such as wireless networking. SmartAccess is designed to help digital service providers scale to meet the demand of broadband growth by automating service installation, and help service providers grow in the future by providing a platform for future service delivery.
Another good summary of SupportSoft´s product can be accessed by clicking here to read a press release about a recent customer win with The Carphone Warehouse, Europe's leading independent mobile communications retailer. A decent quote from that press release is: "With the rapid roll-out of our broadband service, we want to ensure that we have solutions in place to deliver superior customer service while scaling to meet demand," said Paul Halliwell, chief operating officer of TalkTalk.
I encourage interested investors to read up on SupportSoft by reading the company´s SEC filings and visiting their website at: www.supportsoft.com
Why is an investment in SupportSoft low risk?
As I´ve noted on this blog in past writeups, the main thing I look for in any investment is low downside risk. In other words, I want to make sure that my odds of a capital loss are low, even assuming a worst case scenario. Of course, some investments don´t end up working out, but if my losses in the losers are low, the gains from the winners will far outpace my losses and provide me with exceptional returns.
With regards to SupportSoft, I think the risks are minimal for the following reasons:
* Strong balance sheet with cash greater than 70% of the market value of the company.
* Low Valuation with the stock trading at less than 1X my estimated revenue for the company on a non-growth assumption.
* Decent Client Base that is providing a recurring base of support revenues for a product that is in demand (more on that below).
* Cash-Flow profitability has been reached in the past and has been maintained in the current weak environment, despite sharp declines in license revenue. As such the company is operating under a very lean cost structure and should show profits on only a slight uptick in sales.
* Stock down more than 50% over the last two years, so the company is way out of favor on Wall Street.
* Option strike prices for recently hired top executives are about equal to the current market price, allowing minority investors to get in at similar prices to executives.
My basic position is that in the worst case, assuming the company cannot close any more license deals, and/or product development comes to a halt, SupportSoft is worth about $150 million (Cash + Modest Valuation for existing business) or about $3.40 per share, implying a worst case loss of about 12%.
Why might investors get excited about SupportSoft again?
I think there are two primary reasons why SupportSoft´s stock could regain favor with investors:
* SupportSoft´s product has excellent long-term potential with little current competition.
In terms of the potential of SupportSoft´s product, I think it is important to note that automated customer support software companies have, on the whole, not been good investments over the years. Some of the smaller software leaders in the industry (e.g. Kana, Motive, eGain) are currently trading on the pink sheets or bulletin board at multi-year lows.
However, despite the fact that automated customer support software companies may have failed to live up to expectations in the past, I think that the disappointment may have more to do with the markets that were targeted, rather than the product offerings per se. In other words, the timing may have been wrong and more importantly the right market for the product may not have yet existed.
With that said, I do believe that with the continued worldwide proliferation of broadband Internet connections on all sorts of devices, delivering all sorts of services, the need for workable automated customer support software for triple-play providers, especially in developing countries, will grow dramatically in the coming years. In other words, the growth of the Internet, related Internet-based services, and Internet-enabled devices in the hands of non-technical consumers will provide the biggest market yet, in my opinion, for automated support software.
Just imagine the customer support that is going to be needed as broadband connections proliferate to all sorts of devices being used by non-technical customers? It is a potential nightmare for service providers. The only way they will be able to provide service (and probably the only way in which they want to provide service) is via some sort of automated software package, like that offered by SupportSoft.
Furthermore, Motive (MOTV.PK), SupportSoft´s main competitor for the automated customer support software for triple-play service providers is still facing many challenges, as evidenced by a revenue recognition scandal that is still being played out with the SEC.
In sum, I believe that because of various macro trends and because of limited competition, SupportSoft´s products will be in strong demand in the years ahead, implying a potential for healthy revenue growth, assuming that the company can execute well on the marketing and sales end.
* SupportSoft has a new CEO with an impressive resume and incentives to increase SupportSoft's stock price.
Investing alongside proven leaders who have already successfully executed in similar situations usually improves your investment odds. With regards to SupportSoft, in early April of 2006, the company hired Joshua Pickus as the new President and Chief Executive Officer. Mr. Pickus´s claim to fame was the successful turnaround of Niku Corporation, a software company in which he held the CFO and later the CEO position. Niku was eventually sold to Computer Associates in 2005. In looking at past SEC filings it would appear that Niku appreciated four-fold while Mr. Pickus was managing the company.
Of course, it´s not entirely clear whether Mr. Pickus will be able to repeat his success with Niku at SupportSoft, but the fact remains that he has implemented a successful turnaround in the past, in a similar situation, so I am willing to bet that with time he will be able to turnaround and grow SupportSoft.
Importantly, Mr. Pickus has a large financial incentive in turning around SupportSoft and increasing the stock price. Specifically, he was given 200,000 shares at about $4, and was offered additional share grants when the SupportSoft´s stock exceeds $6 for for 20 consecutive trading days; and Additional Grants if the stock exceeds $9 for 20 consecutive trading days.
So what´s my target price for SupportSoft?
Assuming a successful turnaround, I´ll go with a $6 price target in one to two years. I reach that by reference to the option strike prices mentioned above and by noting that the company was profitable in past years to the tune of nearly $10 million. So applying a 15X multiple to that and adding back the cash yields a target of $6. This target is also about 2X average yearly revenue plus cash.
In summary, I believe that as SupportSoft´s top-line and bottom-line growth resumes over the next year or two, via new licensing deals and new products developed under the new CEO, the stock price can appreciate by up to 50% from current levels. At the same time, the company´s strong balance sheet, and existing revenue streams should protect shareholder value, in a worst case scenario.
Please Note: We hold a position in SupportSoft. All ideas, opinions, and/or forecasts, expressed or implied herein, are for informational purposes only and should not be construed as a recommendation to invest, trade, and/or speculate in the markets. Any investments, trades, and/or speculations made in light of the ideas, opinions, and/or forecasts, expressed or implied herein, are committed at your own risk, financial or otherwise.
SPRT 1-yr chart: