Enghouse Systems (OTCPK:EGHSF) is a software company listed on the Toronto Stock Exchange. It comprises of 3 distinct divisions: Enghouse Interactive, Enghouse Networks, and Enghouse Transportation. Each division focuses on a different aspect of the business.
Despite the short term macroeconomic risks, I believe this firm is in a good position for growth. The company has a strong balance sheet to weather the current crisis and its technology has shown to be in demand.
Pre-COVID19: Its Balance Sheet was Strong with Little Debt
In the last 4 years, Enghouse Systems had been maintaining an average current ratio of about 1.5 to 1:
(Source: Enghouse Systems Financials)
Its working capital at the end of Jan 31, 2020 was approximately $85.4 million. This was a sharp drop of $60 million from the prior year but the working capital is still reasonably healthy given it still represents 14.5% of total assets of the company:
(Source: Enghouse Systems Financials)
In looking at its long term debts, its long term liabilities is less than 10% of total assets. This shows immense flexibility if the firm ever needs to take on more debt:
(Source: Enghouse Systems Financials)
Its dividend payout ratio remains fairly healthy. In its most recent quarter, its dividend ratio was about 37.4%, a drop of 2.8% from a quarter ago:
(Source: Enghouse Systems Q1-2020 Financials)
In looking at its F score where it measures the company's financial strength, in 2019, the score came to a 5 where the prior year was a 7:
(Source: Enghouse Systems Financials)
There was a drop in the score mainly because of a slight erosion in the gross margins, an increase in the issuance of new shares, and its current ratio had fallen from the prior year. These are likely a result of the 5 acquisitions it made in the past year (more on this later).
Overall, despite a drop in its F Score, the company had entered the COVID19 crisis in pretty good financial shape.
Enghouse Systems Has Been Acquiring the Right Companies
Enghouse Systems' strategy has always been to grow through acquisition. Its growth platform is laid out in one of its web pages. Growing by acquiring others makes the most economic sense. Building your own platform takes talent, time, and resources with no guarantees of success. Let someone else develop the new product. Once the timing is right and there is a clear fit, Enghouse Systems with its balance sheet can come in to help take the software to the next level.
In 2019, Enghouse Systems bolstered its breadth of products by acquiring the following:
(Source: Crunchbase)
This acquisition strategy works. It was reported Enghouse Systems had purchased Vidyo in May 2019 at a discount for $40 million. It was reported Vidyo was valued at $60 million. Not long after the purchase in March 2020, Enghouse Systems had showcased how Vidyo is playing a big role in supporting the health care industry.
Enghouse Systems has been steadily acquiring its capabilities in video conferencing. Its recent 3 out of 5 acquisitions (Dialogic, Vidyo, Espial Group) are video software related. This is well timed since COVID-19 has forced a lot of people to work from home, and working from home has led to a spike for improved communication technologies. As of April 6 2020, there has been a reported spike in the following software categories:
(Source: TrustRadius)
Web conferencing have grown by 500% and video platforms have increased by 265%. This is just a few of Enghouse Systems products.
Even if people start returning to work, I still think there will be a sustained demand for "work from home" related technologies. Businesses have now set up the technologies to enable workers to work from home, and I anticipate workers will be taking advantage of this. This means as working from home continues to be popular, there is definitely a role for Enghouse Systems to play.
Risk: Its Revenue in the Upcoming Quarter Will Take a Hit
The current economy is in pretty rough shape. Without a doubt, Enghouse System's balance sheet has taken a beating as well. What has not been disclosed yet is how bad the numbers are. The most recent filings show its revenue for Q1-2020 are as follows:
(Source: Enghouse Q1-2020
More than half of its revenue comes from "hosted and maintenance services" which is considered fairly safe since these are hosted solutions and are based on usage. Its maintenance aspect is primarily technical support and is based on its licensing arrangements. Since a lot of people are working from home now, I don't see a big negative impact to these figures.
With social distancing, the following revenue lines will likely take a hit: software licenses, hardware, and professional services revenue. During this time, there are probably very few new clients so these areas will see a drop in revenue.
Overall, I do anticipate any drops in revenue to be short term only. Enghouse Systems is about productivity and finding efficiencies for its clients. In a post-COVID 19 world, a lot of companies will want what Enghouse Systems has to offer.
Risk: Technology is Always Evolving
The problem with investing in software companies is today's technology may be cutting edge, but it doesn't mean it can stay cutting edge tomorrow. Enghouse Systems had increased its R+D budget by over 50% from a year ago:
(Source: Enghouse Systems Q1-2020)
This is quite a substantial increase in R+D spending but it's no guarantee it can stay ahead of the competition. Blackberry and its cell phones is the best example of this.
Investors seriously considering Enghouse Systems should be mindful there is this type of risk.
Short Term Fluctuations But Bullish on the Long Term
At end of April 2020, Enghouse's stock price was trending upwards to $37. Just before COVID19, the stock price was hovering close to $40. The difference is about 8.1%. There is a disconnect here. In general, a lot of businesses out there are bleeding cash and cutting costs. One casualty of this are the number of unemployed. The number of Americans without a job has grown to almost 36 million, this represents 22% of the American labor force. A few months ago, the figure was 3.5%. Indirectly, this impacts Enghouse Systems' business. Yet, the stock price is still trading as if the economy is still operating normally.
I believe a dip in the stock price is coming. The business fundamentals here are great. Given how volatile the current stock market is, I do see the price moving wildly here which is also a good opportunity to buy on a downtrend.
In late April 2020, Enghouse Systems had renewed its normal course issuer bid for its common shares. This is an agreement with the Toronto Stock Exchange permitting Enghouse Systems to repurchase its own shares. If management is watching its own stock price closely to buy on the dip, then investors should surely do the same.
I'm bullish on Enghouse Systems business.
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.
