Redknee Solutions (OTC:RKNEF) led by ESW Capital had their Business Call to discuss the Strategic Plan on 29th March 2017, followed by the AGM (Annual General Meeting) on the same day. It was encouraging to see Redknee's management and Board of Directors explain some of the details about the business plan. However, the call itself gave little lead time to investors with the announcement made on 28th March 2017 at or around 7:30 PM for the business update call to be held on 29th March 2017, 8:30 AM. It was also unfortunate that despite being in the queue to ask questions at the Business Call, Valsef Capital was unable to get through for Q&A. The reason was that sell-side analysts in the queue were given priority. It could very well have also been a technical issue. Fortunately the AGM (Annual General Meeting) presented itself as an a opportunity to ask ESW Capital and Redknee management all questions un-addressed in the call.
In fact shareholders are obliged to receive the "minutes of the AGM" as per Canada Business Corporations Act (CBCA). It has been over a week since the AGM and a similar duration since we have requested for the "minutes of the meeting ". In the interest of time it is only appropriate that matters discussed at the AGM are known to all shareholders, especially those not present at the AGM. This update to the initial Redknee investment thesis is meant to look candidly at the facts presented at the Business Call and AGM. The update has been split into two sections: "The Negatives/Risks" and "The Positives" to the Redknee business.
ESW Capital and Redknee management have given a thorough explanation of the risks involved. While a summary of those facts is warranted, there is little more that can be added in this matter. Many of these risks were first explained by Valsef Capital on 27 March 2017, nevertheless the main risks as highlighted by ESW at the Business Update Call/AGM can be summarized as follows;
- If $60 million is not raised for the turnaround and the restructuring is delayed, most or all of Redknee's value will accrue to preferred shareholders (ESW Capital). Valsef agrees that it is imperative that the capital raise take place at the earliest and restructuring commence since immediate restructuring was the premise for using preferred shares to replace debt in the first place.
- There are potential conflicts of interest in the ESW Capital playbook - DevFactory, Crossover and possibly others
- Post-restructuring Redknee is looking at $120 million in revenue not $170 million
- Redknee needs to hire 200 personnel to get Customer Success to 100% and all these hires are incremental in nature.
- 2 independent directors Christy Jones and Farhan Thawar have past association with ESW Capital and/or its related companies.
In sum - "Redknee is not in as good a position as ESW Capital initially thought and aggressive action needs to be taken immediately to make the business self-sustainable".
There are a couple of other points that were presented in negative light, but in fact have elements of positive business fundamentals embedded in them. These are discussed below in "The Positives".
ESW Capital is setting low expectations and rightfully so.
- It would be concerning as an investor to see new management come into a turnaround situation and paint a pretty picture. Turnaround situations by design involve uncertainties and ESW Capital setting a low expectation is not out of tune. This shows their experience in dealing with similar situations in the past. It was also encouraging to see that ESW has the confidence to turnaround the company.
- Customer Success at around "50%" is more positive than negative
Redknee built majority of its revenue base from 2 big acquisitions. The client relationships that came along with these acquisitions were not home grown, but transferred as part of the transactions.
Moreover from ESW's own assessment Redknee was not as focused on their core customers as they should be (slides 11, 13, 14 of the Business Update Call presentation). Focus on non-Telecom verticals such as IoT and energy were merely adding fuel to the problem. As a result ESW has decided to close operations outside of Telecom.
Redknee management also confirmed at the AGM that prior to ESW Capital's "Customer Success Program", there was no concrete customer satisfaction program/survey in place; and definitely not to the rigor that ESW does.
ESW Capital also found technology gaps which will need another $100 million over 3 years to turn Redknee's software into "best in industry".
Moreover, enterprise software clients in general are not easily satisfied. They typically have frequent demands ranging from software customizations, need for software updates and patches, additional training, faster turn-around in bug fixes and so on. Clients also show dislike for price increases. These are just a few of the many reasons that may result in clients not being satisfied by their software vendors.
Despite gaps in technology, a lack of focus on core customers and a business under stress/restructuring for 2 years, it is encouraging to know that customers that represent about 50% of the revenue said "Yes" to their satisfaction ("Customer Success") with Redknee Solutions.
- What are the benefits from $60 million in restructuring?
This was addressed at the AGM.
- Danielle Royston said that ESW Capital typically sees $1 in savings for every $1 in restructuring. ( this is a positive)
- That would translate to $60 million in savings for Redknee should it track a typical Redknee turnaround. At 50% of ESW's typical savings, it translates to $30 million in savings. The odds are that cost savings will not be too far from the average given that 50% of clients revenue fall under "Yes" for Customer Success even without a clear focus on those customers.
- More cost savings (Sales, Marketing, G&A, R&D) - Qualitatively Explained
This was also clarified at the AGM
- It was clarified that since Redknee is stopping all business in non-core verticals and with all of the focus on serving existing clients, there will be savings from rationalizing non-core costs.
- However, ESW Capital emphasized that the savings from this cost rationalization and all restructuring will be reinvestment into the business. Why would a capital allocator invest in a business if it does not meet a return threshold?
- Need $100 million in R&D investments
Valsef Capital got the opportunity to speak with Danielle Royston before the shareholder meeting. She gave some color regarding her management methodology at Versata.
Some of the businesses that Versata acquire are in the later stages of the life-cycle and once the restructuring is done those companies don't need extensive work. These businesses run in maintenance mode. Hence Danielle Royston and her core team is able to move onto a new turnaround acquisition.
ESW Capital's intention to reinvest the cost savings from restructuring and cost rationalizations back into Redknee; and not leave the business in maintenance mode shows core business strength.
The statement of reinvestment is also a leading indicator that ESW believes reinvesting in Redknee will meet their internal "return on invested capital threshold".
- Board of Directors and Governance - Keith Graham was elected as Chairperson Audit Committee and Lead Independent Director
Keith Graham was present at the AGM and Valsef Capital had the opportunity to speak with him. He was nominated by Invesco Canada (who owns about 20% of Redknee shares) and has no past association with ESW Capital or their related entities. In addition, his capital market experience, focus of board governance and past involvement in shareholder activism is very relevant experience. This alleviates some concerns around board independence and more importantly governance. A glimpse of his involvement shareholder activism with Sirius XM Canada (OTCMKTS:SIICF) is shown here.
ESW has given a clear picture of the hurdles we face at Redknee, yet they have also shown the commitment to right the ship. There are also leading indicators of positives ranging from (1) a meaningful "Customer Success" level to begin with, (2) meaningful savings from restructuring, (3) a reason to reinvest in a business that shows Redknee has prospects of longevity to (4)the election of Keith Graham as Chairperson of Audit Committee and Lead Independent Director.
Disclosure: I am/we are long RKNEF.
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