Acquiring Xchanging Could Be A Game Changer For Ebix

Summary

• Ebix is the current top bidder for Xchanging.
• If Ebix succeeds in acquiring Xchanging, based on Robin Raina’s track record, Ebix’s earnings per share is likely to increase substantially after Xchanging is integrated.
• Going by past acquisitions, I expect this integration to be completed in about four quarters after closing the deal.

Summary:

Ebix (NASDAQ:NASDAQ:EBIX) is the current top bidder for Xchanging. If Ebix succeeds in acquiring Xchanging, based on Robin Raina's track record with 17 acquisitions between 2006 and 2011, Ebix's earnings per share are likely to increase substantially after Xchanging has been integrated. Going by past acquisitions, I expect this integration to be completed in about four quarters after closing the deal.

Current state of the acquisition play:

On Nov 16, 2015, Ebix made an all cash offer for Xchanging. The offer was 175 pence per share which works out to about $684M. This tops the original Capita (OTCPK:CTAGY) offer of 160 pence per share and the subsequent Computer Sciences (NYSE:CSC) offer of 170 pence per share. Ebix does not have $684M lying around. Since Ebix (and other suitors) has made an all-cash offer for Xchanging, it's likely that some or all of this $684M will be raised by issuing and selling new shares in the market.

A high-level snapshot of the gross margins and net margins of the players involved:

(Source: Yahoo Finance and Morningstar)

Xchanging	HY2015	2014	2013	2012
Revenues ($Million)	301	867	1036	1009
Gross profit ($Million)	31	63	103	95
Gross Profit Margin	10.3%	7.3%	9.9%	9.4%
Net Income ($Million)	(101)	44	98	42
Net profit margin	(33.5)%	5.1%	9.5%	4.2%

Click to enlarge

(using 1GBP = 1.51 USD)

Capita	2014	2013	2012
Revenues ($Million)	6611	5883	5062
Gross profit ($Million)	1821	1614	1421
Gross Profit Margin	27.5%	27.4%	28.1%
Net Income ($Million)	362	260	356
Net profit margin	5.5%	4.4%	7%

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(using 1GBP = 1.51 USD)

Computer Sciences	2014	2013	2012
Revenues ($Million)	12173	12998	14195
Gross profit ($Million)	2639	3726	2902
Gross Profit Margin	21.7%	28.7%	20.4%
Net Income ($Million)	36	880	297
Net profit margin	0.3%	6.8%	2.1%

Click to enlarge

EBIX	2014	2013	2012
Revenues ($Million)	214	205	199
Gross profit ($Million)	167	164	161
Gross Profit Margin	78%	80%	81%
Net Income ($Million)	64	59	71
Net profit margin	29.9%	28.8%	35.7%

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As you can see from the above tables, Ebix is the only company that has consistently achieved and maintained high gross and net margins through multiple acquisitions. In terms of gross margin and net margin percentages, none of the other players are even on the same planet. As my friend and fellow Seeking Alpha contributor US Investor elucidates so well in the following article, Ebix has managed to acquire and integrate companies with low or even negative margins into its Threshold (30% - 40%) margin framework. Ebix has done this not once, not twice but 17 times between 2006 and 2011 with RR at the helm. High margin revenue? Keep that. Low-margin or negative-margin revenue? Move back office processing offshore and convert revenues to Threshold margin revenues. Cannot be done? Sell the division or close it down. This is easy to say but very, very difficult to actually do in practice. As you can see from the above tables, the other players cannot even come close to EBIX in this department. They would be foolish to try and counter a bid on RR's offer because a dollar of revenue in his hands is worth far more than a dollar in theirs.

State of affairs at Ebix before the merger:

Annualizing the current quarter revenues and net income, we see that Ebix, before it acquires Xchanging, is a $267M a year business ($66.8M current quarter) producing $81M in net income ($20.2M current quarter). Given Ebix's fully diluted share count of 34.5 million shares, that translates to a forward EPS of $2.34. RR has stated on the latest conference call that his aspirational target is 20% revenue growth for 2016. Ebix has usually delivered on RR's goals. The London PPL exchange is on track to launch in January 2016. Ebix and Willis (NYSE:WSH) recently announced that Willis has rolled out a new global electronic accounting platform developed in partnership with Ebix to speed up cash flow and settle claims more quickly on behalf of clients. These data points suggest that RR's aspirational goals are closer to reality than aspiration. This means that, by the end of 2016, Ebix could be at an annual revenue run rate of $320M and net income of $97 million. Assuming zero shares are repurchased in this period, Ebix would have an EPS of $2.85 without acquiring Xchanging. That alone should take the share price to $42.75 at a P/E of 15. This EPS calculation is probably understated because if Ebix does not acquire Xchanging, in all likelihood, some of that cash generated will be used for share repurchases.

State of affairs four quarters after the merger:

I do not know what Ebix's capital structure will look like after the acquisition. Based on the pro-forma EBITDA of the combined entity and considering the cash on the balance sheets of both firms, banks may be willing to lend the cash needed. In other words, RR could pull off this acquisition entirely with bank debt if he wanted to. However, it's unlikely that it will be 100% debt. RR does not like taking on a lot of debt. RR also does not like to pay a lot of interest on debt. So, in all probability, the acquisition will be a combination of cash on hand, debt and shares issued and converted to cash. Debt could again be a mix of straight debt, convertible debt and other varieties of debt. Since I'm trying to estimate the EPS post-acquisition, the worst case EPS would be to assume all the cash is coming from share issuance. To be very conservative, I'm therefore assuming an additional 18M shares will be issued at $35.5 to finance the acquisition. This gives us 52.5 million shares as the final, fully diluted share count.

Xchanging is a $601 MM a year business. Currently it has a negative net margin. However, most of this drag is coming from the procurement business which generated just 6.5% of net revenue for the first half of 2015 and saw an adjusted operating loss of $10.3M. Its other businesses, the business process services (BPS) and technology divisions, had positive margins. Over the years, the company has always reported poor margins in its procurement business. This is probably the segment that could be quickly sold or shut down. As we have seen in the past 17 acquisitions, RR is likely to move whatever can be moved offshore to meet his Threshold margin standards. Whatever cannot be moved or improved will be sold or shut down. I do not know if specific parts of the procurement business can be salvaged or needs to be salvaged for strategic reasons. I also do not know of RR's plans for the technology and BPS divisions. I assume that whatever business survives RR's filter will end up at the Threshold margin.

The following table looks at various possibilities at the end of 2016:

Percentage of acquired business that is shut down	20%	30%	40%	50%
Remaining Xchanging business ($ Million)	481	421	361	301
EBIX business ($ Million)	320	320	320	320
Combined revenue 4 quarters after the merger	801	741	681	621
Net income @30% margin	240	222	204	186
EPS (@52.5M shares)	4.57	4.23	3.89	3.54
Share price @15P/E	68.6	63.5	58.4	53.1
Share price @20P/E	91.4	84.6	77.8	70.8

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Conclusion:

The table above says it all. Even if RR sells or shuts down HALF of Xchanging, Ebix can substantially increase its industry footprint, revenues and earnings per share. I'm a long-time shareholder and I'm excited about the company's prospects for 2016 with or without Xchanging.

Editor's Note: This article discusses one or more securities that do not trade on a major U.S. exchange. Please be aware of the risks associated with these stocks.

Analyst’s Disclosure: I am/we are long EBIX. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

Comments

[Manoj Madhavan]

Wow! What a ride! When I wrote this article in January 2016, EBIX was at $34 or so. It is up 76% since then!! Even though EBIX is still one my largest holdings, I must admit that I did not expect such a fast rise and booked some profits in the mid 40's, high 40's and low 50's. Interesting year - to say the least. EBIX made two unsuccessful attempts at mega acquisitions - XChanging and Patriot National (PN). London PPL revenue has been coming in. Indian e-Gov revenue has started coming in. 2017 promises to be another exciting year. Good luck to all!

[Exile of the Mainstream]

You sold early...The operating business of EBIX is sound.

[Manoj Madhavan]

Please read my comment. EBIX is STILL one of my largest holdings. I agree that the operating business is sound.

[Manoj Madhavan]

Alfred - thanks for your comments. It seems that EBIX is not planning to raise its bid against CSC. Maybe, RR looked inside the onion and did not find enough high margin layers after peeling off the "bad" low margin outer layers. In any case, I trust RR to what is right for the shareholders - that was the main point of my piece.

[Alfred L. Angelici]

Xchanging says it does NOT expect EBIX to raise its bid against CSC. http://tinyurl.com/zff...

In my opinion, if Ebix was successful with this M&A, it would have been a "winners curse" for Ebix. Xchanging margins are significantly lower than Ebix's and would have dragged down Ebix's future margins. RR told investors last year that he was looking for high margin businesses to acquire, and he should stick to that strategy!

[Manoj Madhavan]

You are welcome. I am not familiar with LSE Takeover Law either :-) Just reporting what is out there. Nothing to do but to wait....

[Manoj Madhavan]

Here is one link (of many) that confirms EBIX is still interested:
http://reut.rs/1TMSP8n

Here is a link that mentions the 53 day rule:
http://bit.ly/1TMSNNF

[Exile of the Mainstream]

Thank you. I wasn't aware of the latter link. Not familiar with London Stock Exchange Takeover law.

[Manoj Madhavan]

Hey Protagonist - have you looked at other companies lately? Lots of companies have had similar (or worse) price swings in the past few weeks. I do not think their stock buy back would have stopped the slide. For that matter, if the only thing that props the stock is a company buy back, then, clearly, this is the wrong stock to be invested in.
Having held EBIX through much worse price swings I find this nothing to be alarmed about. And there may be more downswings (and upswings) to come. As I reckon, we are only in Day 3 or 4 of the 53 day countdown before the Xchanging acquirer is finally known.

[Exile of the Mainstream]

I thought CSC's bid was accepted? Where is the link to your 53 day note?

[Exile of the Mainstream]

EBIX's price action is ridiculous. They have been distracted by this bidding war and stopped buying back stock. 15-20% of market cap evaporated in 2 weeks.

[Manoj Madhavan]

Again - valid points to consider. I appreciate your point of view.

It all boils down to trust in RR's ability to execute at this higher (in terms of revenues) level.

You say he has done only small acquisitions in the past where the punishment for failure is/was small. I say that the past 20+ acquisitions were only trial runs for the BIG ONE. And I think Xchanging is probably not even the BIG ONE. If he pulls this off, he will go after bigger ones.
Just a reminder to folks out there - EBIX had an annual revenue of $12.8M in 2001. They are at $267M now! Revenues greater than Xchanging's annual business have been earned, managed and integrated by EBIX in this time period.

[Brion Morrison]

Manoj, I understand your point and this is likely an agree to disagree situation. My point is that 30% margin on the acquired business is extremely optimistic no matter the percentage of it that is retained.

Assume that EBIX has to pay 5% more than the current offer price to get the deal done and finances it 100% with shares at $35.5 (20.2M shares). The resulting break even margin on the remaining business is 12% if 80% of revenues are retained (ignoring any potential benefit of selling off part). That is double the existing margin, and increases to 16% at 60% revenue retention. That's the challenge for EBIX, and it is significant at a scale where EBIX management have limited/no experience. Not a recipe for success and in my opinion there is a real probability of reduced EPS. That needs to be factored in to any projected share price.

[Manoj Madhavan]

Brion - thanks for your comments. Your concerns are valid. However ...
1) I assumed that the entire purchase was paid with cash raised from share issuance. A much lower level of share based cash and a much higher level (my assumption was $0 debt) of debt based cash is more likely. Keeping all other assumptions unchanged, this alone will result in higher EPS per share.
2) I showed that EPS is going to be substantially higher @30% margin even if RR sheds 50% of the acquired revenue. Take that 30% and drop it down and increase the retained business to be greater than 50% and you will still end at a higher EPS number.
Long story short, I did not want to go crazy with hundreds of permutations and combinations of share issuance and realized blended margin. But you will agree that most of these scenarios end in higher EPS even with lower margins from the acquired business.

[Brion Morrison]

It seems quite a leap of faith to assume that after acquiring a business over twice the size of EBIX that combined margins would be anywhere close to current EBIX margins in the first few years after purchase. On the contrary, the integration is likely to be very challenging and result in an extended period of depressed margins. Looking back at prior acquisitions it seems to me that EBIX/Raina have a history of overpaying and either failing to maintain the revenues of the new business, or using them to cover up a lack of organic growth. It is hard to tell which is the case because the financial statements do not provide the necessary level of detail after purchase, but if you run the numbers it is clear that the purchases have not increased top/bottom line at the advertised rates. If they must pursue acquisitions my preference is that they continue the "small ball" that has a lower risk of value erosion, or in the best case provides incremental cash flows.

I took advantage of the short seller attacks to purchase EBIX at excellent value number of years ago, but if this acquisition goes through I expect to see much of that value torched, at the very least in the near term, and am seriously considering selling my shares.

[Manoj Madhavan]

birdman93 - I am not planning to reduce or trade my position. Can there be another short attack? Sure. Since I do not have a crystal ball, I do not know how low it can go, when I should sell, when I should buy back and so on. If you have done this (sell, wait for a dip and buy back) successfully before in the past 17 years, maybe you can do it again. I have traded in and out of EBIX before. I have sold covered calls in the past. I am not planning to do so this time. This time "feels different" somehow. I may be wrong, but I think EBIX went through a "trial by fire" and emerged as a stronger and more resilient company.

[birdman93]

Thanks for the good article. I am a 17-year holder of EBIX and remain long on the company. I am concerned about the short-term. The 2012-3 troubles happened because of Ebix's acquisitions (disgruntled sellers, lawsuits, etc...) that caused the disturbance in Ebix's force. Ebix is also not your typical stock with a remaining, and apparently hard-core, short position at 32%. If RR sells stock, I am concerned that the activist shorts will pounce on that over the next few months and drive the price down. I will not cash out, but am pondering reducing my position to cash in at the 3-6 month period to catch the bounce. Your thoughts?

[ghutchinson7711]

Maybe Ebix loses the bid but does a side deal with the eventual buyer for a piece of Xchangings insurance services or insurance software division? Smaller dollar amt, less risk, they know the business better, much smaller integration risk, etc. My 2 cents. I don't have any intimate knowledge of Xchangings Ins ops to figure out if that is even an option but whoever is buying it, might appreciate immediately recouping a big percentage of the deal. Who knows (a brief look at Xchanging's presentations shows their main platform for growth is insurance related IT, so likely not possible to break it up?).

[Manoj Madhavan]

Thanks for your comments stofil!

[stofil]

just what we longs needed to read. thoughtful insight on potentially huge deal that can affect a lot of us in EBIX. Appreciate your time and effort. Thanks.

[Wenmoose]

Manoj--thank you for your insightful essay. It's reassuring to know Robin won't overbid for Xchang. If EBIX is high bidder, and issues more shares to cover the purchase, will the additional number of shares result in a decrease in PPS?

[Manoj Madhavan]

Thanks Wenmoose. If you look at the last table in my article, I have PPS estimates ranging from $53 to $91. I do not have a crystal ball. The actual price could be higher than $91 or lower than $53. If you read my article, you will see that I expect the PPS to increase substantially from current over the LONG term.

[Manoj Madhavan]

Thanks TexLong! Appreciate your comments.

[TexLong]

Manoj, thank you for an excellent article with very helpful data points. Great analysis. I've been long on Ebix since 2008, and I can't wait to grab the popcorn and see how 2016 unfolds. Greatly appreciate your expertise and efforts.

[Manoj Madhavan]

Thanks for your comments kiransky. You and I have realized the strong future that lies ahead for EBIX. Let us hope the shorts realize this in short (:-) ) order!