Rimini Street: Current Headwinds Are Creating An Attractive Entry Price

Oct. 07, 2019 1:47 PM ETRimini Street, Inc. (RMNI)10 Comments

Summary

  • Rimini is a leading third-party support provider for Oracle and SAP software products and a Salesforce partner.
  • Despite a large total addressable market and an attractive subscription/recurring revenue model its share price has fallen about 20% year-to-date.
  • Reasons include revenue growth slowing in 2019, ongoing Oracle litigation, a high cost of funding and dilution risk.
  • However at a 1.7x 2019E revenue multiple, which includes a sizeable litigation provision, a lot of these risks seem to be priced in.
  • Outside of very unfavorable litigation outcomes, the current headwinds offer an opportunity to pick up an otherwise solid company at an attractive price.

Business overview

Rimini Street (NASDAQ:RMNI) is a provider of independent software support services, in particular for Oracle (ORCL) and SAP (SAP) products. Its basic sales proposition is to offer support at a 50%+ discount to the cost of the software vendors’ support offering and at much higher level of customer satisfaction with Rimini currently rated about 4.8 out of 5.0 with 5.0 being excellent. Licensees often consider software support as a core outlay resulting in recurring and highly profitable revenue streams for enterprise software vendors. Rimini estimates that for fiscal 2018, Oracle’s cloud services and license support margins were nearly 90%. As of June 30, 2019, Rimini had nearly 1,900 active clients, a year-over-year net increase of 17%. Its investment priorities are to drive revenue growth, increase its share of client IT spend and grow the lifetime value of its clients. Long-term goals include strong free cash flow generation and sustained GAAP profitability.

Source: September 2019 investor presentation

Many of Rimini’s key investment attributes are summarized in the slide above including a large market opportunity, clear value proposition, historical high revenue growth and retention rates, potential for healthy cash flow generation as its growth phase matures, a diverse customer base and a strong management team. Rimini sees Oracle and SAP’s efforts to encourage their licensees to upgrade (e.g. ending full support for some software releases by 2025) as creating a strong demand environment for Rimini’s support services. Rimini also has good defensive qualities, not only from a sticky customer base, but also being able to lower costs materially is a big attraction during harder times.

Financials

Source: September 2019 investor presentation

Rimini’s growth story is supported by its historical financials. It recorded a revenue CAGR from 2015 to 2018 of over 29% with near 100% subscription revenue, 90%+ revenue retention rates. As of June 30, 2019 it had a backlog of USD421 million providing good revenue visibility. Rimini benefits from scale as evidenced by the rising gross margins, though management is guiding to a gross margin of 60% for FY2019. Adjusted EBITDA is depressed by elevated sales and marketing expenses which drive revenue growth. Working capital benefits from upfront subscription sale payments and there is also a tax shield in the form of operating losses carried forward.

Rimini is guiding towards 2019E revenue of around USD275 million, up nearly 9% from 2018. Management points to Rimini’s former multi-draw term loan financing agreement to explain the slowing revenue growth profile. That credit facility had restrictive covenants limiting sales and marketing spend through to its termination in July 2018 when the restrictive covenants were lifted. There is normally a lag of several quarters before increased marketing spend feeds through to revenue growth. In addition, Rimini has been facing more aggressive discounting by software vendors. On Rimini’s Q2 2019 earnings call, CEO Ravin mentioned he expected investment returns to become more visible in billings growth in H2 2019, with accelerated revenue growth in 2020.

Key concerns

Concern 1: Lawsuits

In summary, there are two cases:

  1. Rimini I: started in 2010 when Oracle alleged copyright infringement, it went to trial in Sept 2015 and Oracle was awarded USD124 million in damages which Rimini paid in October 2016. In addition, an August 19, 2019 ruling did not vacate an August 2018 injunction entirely and it looks like Rimini may need to continue to incur additional expenses in the range of 1% to 2% of revenue to avoid infringement. Also while an injunction remains in place, Oracle can file contempt proceedings against Rimini at any time to try and enforce its interpretation of the injunction

  2. Rimini II: in 2014, Rimini filed a separate lawsuit seeking a declaratory judgment that Rimini’s revised processes, in use from July 2014, do not infringe certain Oracle copyrights. In February 2015, Oracle in turn filed a counterclaim including similar claims made in Rimini I, but limited to clients not addressed in Rimini I, along with further allegations that even the Rimini’s amended support processes infringe Oracle’s copyrights. There is currently no trial date set and Rimini does not expect one before 2021. As it believes the award for damages is not probable, nor does it believe there is sufficient information to even estimate one, no accrual was made in its Q2 2019 10Q filing.

Though Rimini’s customers and key financial backers (including GP Investments and Adams Street Partners) seem to share its positive take on the eventual outcomes, its share price trajectory implies the wider market is less confident. Even if the current lawsuits are resolved successfully from Rimini’s standpoint, it does not mean the risk of future litigation is completely alleviated especially because it seems to be a core strategy deployed by Oracle to discourage third-party support services providers from undermining its own support efforts.

Oracle even has Rimini Street related articles on its website and its wording is strong e.g. in Oracle’s August 19, 2019 press release it includes, “Rimini - a dishonest, serial infringer - to cease its unlawful conduct.” In any case, if Rimini is eventually required to pay substantial damages the negative repercussions vary from client withdrawals, triggering of Series A Preferred Stock mandatory redemptions, restricted business practices reducing cash flows and an inability of Rimini to pay its obligations (including the damages) which may result in bankruptcy.

Concern 2: Cost of fundingSource: 2018 10K

In July 2018, Rimini raised USD133 million in the form of a Series A Preferred Stock offering with a liquidation value of USD140 million. The proceeds were used to pay off the credit facility that had been place since 2016. Rimini classified the preferred stock offering as mezzanine equity due to the holders' July 2023 redemption rights. Rimini pays a 10% cash dividend plus 3% PIK dividend per annum as set out in the table above.Source: Q3 2018 10Q

In addition, Rimini incurred USD31.8 million in discount and issuance costs split pro rata between preferred stock (USD27.8 million) and common stock (USD4.0 million) in the table above. The USD31.8 million is made up of an original issue discount of USD7 million, direct costs of USD4.6 million and 2.897 million common shares issued for no consideration worth USD20.1 million at the time of issue. Per the effective interest method, this equates to an accretion rate of around 5% per year. Adding this to the 13% cash/PIK dividend implies an annual cost of 18% a year.

Rimini issued an additional USD6.5 million face value of Series-A preferred stock in March 2019 and a further USD3.5 million in June 2019 bringing the total issuance to USD150 million. In addition, until approximately 95% of the Series A Preferred Stock are no longer outstanding, the company is restricted from incurring additional indebtedness (as defined in the preferred sales & purchase agreement). This limits Rimini’s ability to access additional funds particularly on favorable terms. On July 01, 2019, Rimini filed a form S-3 relating to the resale of 1.9 million shares of common stock. This appears to coincide with the latest share price decline from USD5.20 to USD4.15 level.

Concern 3: DilutionSource: September 2019 investor presentation (numbers as at June 30, 2019)

The slide above is fairly self-explanatory. Rimini shareholders face significant dilution risk subject to a rise in its share price within the time thresholds stated in the slide.

Key takeaways

It seems to me that on the litigation front, even if the Rimini I injunction remains in place, an incremental compliance cost of 1% to 2% of revenues does not seem onerous. With Rimini I, there were signs of a clear infringement acknowledged by Rimini when it modified some business processes completed by July 2014. With Rimini II, there does not appear to be any such modifications and management are not even provisioning for a negative outcome. A view that is likely supported by clients and sophisticated financial backers. Even including a possible further litigation outlay of USD100 million, Rimini is still trading below 2x 2019E revenue, which is very low for a growth story with a large total addressable market, recurring revenues and high customer retention rates. Though there are definitely reasons for its depressed share price, I think these are largely reflected in Rimini’s current valuation. I am long Rimini.

Additional disclosure: Opinions expressed herein by the author are not an investment recommendation and are not meant to be relied upon in investment decisions. The author is not acting in an investment advisor capacity. This is not an investment research report. The author's opinions expressed herein address only select aspects of potential investment in securities of the companies mentioned and cannot be a substitute for comprehensive investment analysis. Any analysis presented herein is illustrative in nature, limited in scope, based on an incomplete set of information, and has limitations to its accuracy. The author recommends that potential and existing investors conduct thorough investment research of their own, including a detailed review of the companies' filings, and consult a qualified investment advisor. The information upon which this material is based was obtained from sources believed to be reliable but has not been independently verified. Therefore, the author cannot guarantee its accuracy. Any opinions or estimates constitute the author's best judgment as of the date of publication and are subject to change without notice.

This article was written by

The professionals at Eight Diamonds Advisors have on average more than 20 years of experience working in the financial markets. Their backgrounds cover a broad swath of disciplines including M&A, restructuring, forensic accounting, investment management and research analysis.

Disclosure: I am/we are long RMNI. 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.

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