Description

Investment thesis: ABT is a mis-priced small-cap software stock. The Company has completed a major transformation in its product offering and business model that has gone mostly unrecognized by investors. The Company has re-positioned itself as one of the leaders in a large and fast growing market. ABT has a high RIOC, rich FCF, somewhat sticky business model and a balance sheet with about one-quarter of its market cap in cash and no debt. The combination of accelerating order momentum and stabilized operating expenses is translating into a period of financial leverage, which should continue in the near future. With the shares valued at an EV/EBITDA ratio of about 5.4x my FY 2013 (June) forecast and a 14.5% FCF/EV yield, the shares are attractive on an absolute (no pun intended) basis. Additionally, the stock is attractive when compared with similar well positioned software-as-a-service (SaaS) vendors and private market valuations in the sector.

A major transformation of the Company and its product line: Over the past few years, ABT has made significant investments to transition itself from a single product company focused primarily on the consumer centric theft recovery market to a more diversified vendor of client management tools (CMT) with a broader go-to-market strategy and increased focus on both commercial and international markets. Historically ABT focused almost exclusively on marketing its Computrace thief recovery product (including LoJack for Laptops). These products imbed source code in the BIOS, using the Company’s unique “persistence” technology to remotely locate and/or scrub clean any information stored on a hard disk. To date the Company has successfully recovered over 23,000 devices and currently has no real competition for this product offering. Theft has gained significant traction with commercial accounts, helped build partnerships with most of the major PC OEM’s and gave the Company visibility with enterprise IT managers. Management believes that the market for Computrace is growing 10%-15% per year. ABT’s reported growth for this product over the last few quarters has been negatively impacted by a change in the OEM revenue recognition from a royalty per PC unit shipped to a payment for every user who opts-in. This transition will be completed in Q3 (March), which should result in growth returning to more normalized levels thereafter. 

The Computrace product is a good solution for one of IT’s major needs centered on the issue of theft of notebooks and the security of the information contained on the device. However, many IT managers are looking for a broader solution to manage the proliferation of devices and content within their organization. While ABT offered a relatively plain vanilla set of asset management tools centered on devices, it did not offer a broad enough set of tools to meet the evolving needs of its customers. Aided by the acquisition of LANrev in December 2009, ABT began an effort to expand the Company’s capabilities from devices to include content and broaden its product focus to the broader CMT market. LANrev gave the Company a technology rich, seamless, multiplatform client solution for managing both Windows and Mac OS devices in a single unified console. A LANrev agent resides on all the devices, collects data on hardware and software, and communicates to the system console. The LANrev lifecycle management suite includes functionality such as: asset tracking/inventory, software distribution, license management, patch management, remote configuration, OS migration, power management, theft tracking, application repackaging and remote control. Client verticals include corporate, government, and education.

Over time this product offering, re-labeled Absolute Manage, has been enhanced with new features/functions and expanded to support multiple devices, including employee-owned mobile devices. Today ABT’s product offering stacks up well in the marketplace. Finding technology companies with true sustainable competitive advantages are rare. However, I would submit that the combination of the Company’s embedded “persistence” theft management, OEM relationships with the major PC system vendors and partnerships with numerous law enforcement agencies gives ABT some of these structural charasterics. Notable in February 2011 Gartner Group, for the first time, included ABT in its “Magic Quadrant” as a “visionary” for client management tools. Underscoring the magnitude of the transition in the Company’s product line, management made the following comments on their Q2 (December) conference call:

“not only are we securing devices, but really for the first time in 17 years of building this Company, we're also securing content as well.”

Aided by improvements to the sales force enacted over the last 18-24 months, Absolute Manage has gained significant momentum in new orders as well as deepening relationships with existing customers and opening the door with new customers. This momentum has translated into accelerated growth in sales contracts (the primary metric used to gauge orders) from commercial non-theft recovery products (mostly Absolute Manage). In Q2 (December) sales of these products increased 183% y/y and now account for 33% of overall sales contracts versus only 14% a year earlier. Noteworthy, the Q2 y/y growth compares with y/y growth of 142% in Q1, underscoring the building momentum for the product offering. Management indicates that the order pipeline for the product is strong with significant opportunities with new customers. Noteworthy in this regard are the following management comments from their Q2 (December) conference call:

“the pipeline overall continues to grow. It's growing in all geographies in all segments. I'd say some of the areas that are growing more rapidly than others certainly would be in the non-theft recovery category. As for (Absolute) Manage, the pipe is growing at an accelerated rate. And the international pipe is growing at a rate faster than it is in North America”

Right place at the right time, a solution to the proliferation of mobile devices: The diversification in ABT’s product line is consistent with the changing needs of the market and positions the Company well to provide a solution to the problem that the proliferation of bring-your-own-devices (BYOD) posses for corporate IT managers. One of the dominant trends in the client management tools market is how to deal with the management and security of employee owned mobile devices in the workplace. According to one study by the independent technology and market research firm Forrester Research, more than 50% of firms surveyed said they support employee owned mobile devices and smartphones in the workplace. Other surveys put the figure closer to 70%. These employee-owned devices pose a number of technical, security, compliance and legal challenges for corporate IT managers. According to Forrester these issues include:

-- device theft/loss increases with portability

-- mobility and portability increases threats to data protection

-- employee have yet another way to leak data

-- malware increasingly targets mobile devices

-- organizations could be liable for employee misdeeds

-- local privacy laws limit control of personal devices

-- companies cannot seize the device, even if ordered to do so

Effectively dealing with this trend of BYOD will likely increase in importance in the future. ABT management describes this trend as “a point of pain” for IT managers, which is disrupting their client management strategy. The Absolute Manage suite of products offers an effective solution to address this challenge. Thus, the BYOD trend is effectively creating a demand pull-through scenario from IT managers looking for products that help them manage this issue. Recent estimates from Gartner size this market opportunity at about $2.2 billion. Thus, the size of this market is many times larger than the size of the theft recovery market and represents a significant opportunity for the Company. While there are a number of competitors in the market (i.e. LANDesk, Altris from Symantec and IBM Tivoli being the largest), Absolute Manage is one of richest from a technology perspective and one of the few that offers support for both Mac OS and iOS (iPad and iPhone) as well as other major mobile devices (including Android). In this regard, the Company’s “persistence” embedded technology is a key differentiator in that it increases the reliability of its solutions and enables IT managers to do things that other competitors cannot do unless they have physical control of the device. 

Past investments translating into improved order momentum and significant financial leverage: Beginning about 24 months ago, in concert with the product expansion, management began making major investments in its salesforce and infrastructure to correct internal deficiencies and reposition its go-to-market strategy. Part of this effort has been to add partners and resources to expand the Company’s international presence. These investments resulted in increased operating expenses as well as pressure on operating profitability and cash flow. The good news is that the Company has begun to see benefits from its salesforce restructuring by more deeply penetrating existing accounts and acquiring new customers. Additionally, ABT’s international expansion is beginning to bear fruit. Sales in these regions increased 79% in the six month period and 98% in the last quarter. Management has commented that the new order pipeline in these markets is strong, underscored by the following comments during its Q2 (December) conference call:

“what we're finding now that is that now that our sales team is getting more confident with the product, that they're stepping outside and we're sort of at a bit of a transition period now where probably half of our sales are to existing customers, half are to new customers. And I think we'll start seeing the pendulum swing further as we get more and more confidence with each sale as the sales force is more confident and willing to step a little bit further out of their comfort zone.”

These efforts have translated into an acceleration in order momentum. Noteworthy, ABT has recorded six consecutive quarters of double digit growth in sales contracts, as highlighted in the following table:

For its part, management appears to be excited about the transformation in its product line and its prospects for future growth. Noteworthy are the following comments from its Q2 (December) conference call:

“I think we've reinvented the Company over the last couple of years. It -- certainly we went through some hard yards, but we've got a phenomenal solution portfolio and we're here to conquer. We're here to conquer some ground. So I'm putting everybody on notice right now…we're coming after them all. And we're going to win.”

The increased order momentum is occurring at a time when operating expenses have stabilized, translating into financial leverage and accelerating cash flow. The operating expense ratio began to drop beginning in the June 2010 (Q4 FY 2010), driven by a significant y/y decline in sales & marketing expenses. Notwithstanding this, R&D spending has remained healthy over the period, supporting continued new product development. These trends are illustrated in the table below:

The financial leverage associated with the improvements in order momentum and operating margins has lead to a notable improvement in EBITDA and FCF. The chart below illustrates the improvement in both categories over the last few quarters:

With order momentum re-established and stabilized operating expenses, ABT produces an attractive, high ROIC, rich cash flow business model. Another appealing characteristic of the Company’s business model is the stickiness of its sales. Roughly 80%-85% of sales to existing customers are due to its recurring term license model. ROIC has rebounded to a level of greater than a 20% annualized rate. Given further leverage, I believe that ROIC will expand to 2x-3x the current level. 

The company has a liquid balance sheet with $62 million ($1.44 per share) in cash and no debt. Deferred revenue is roughly $120 million (compared with TTM revenues of about $71 million), which provides a high degree of visibility for future revenues. In the past management has used its cash to repurchase stock (8 million shares in the last three years) and to make acquisitions (i.e. LANrev). I suspect that both activities will continue in the future.

For modeling purposes, I have assumed the following:

-- total sales contract growth of 17% in FY 2012 (June) to roughly $93 million and a conservative 10% growth in FY 2013 to approximately $102 million.

-- further leverage in EBITDA from the growth in sales and the stabilization of operating margins, with expectations of  $19 million in FY2012 and $32 million in FY2013.

--- Growth in FCF to about $22 million in FY 2002 and $25 million in FY2013.

A mis-priced stock, attractively valued on a number of different metrics: I believe the shares are mis-priced and offer value investors an attractive investment opportunity for a number of reasons. First and foremost, investors have not fully understood the significance of the transition that has taken place in moving the Company from basically a single niche product line vendor to a major competitor in the much larger and faster growing client management tools (CMT) market. In addition, the significant decline in the share price resulting from a period of slowing growth and disappointing financial results during its investment period will likely mean some investors will want to take a wait-and-see attitude before investing in the stock. The Company’s small market cap is also a contributing factor.

I believe the shares of ABT are selling below intrinsic value and are attractively priced on an absolute basis, compared with comparable SaaS vendors and relative to recent private market transactions. Given the company’s deferred revenue accounting and the significant non-cash items that flow through its income statement, I believe the two most appropriate financial benchmarks to value the shares on an absolute basis are EBITDA and FCF. On that basis, the stock has an EV/EBITDA ratio of about 9.1x / 5.4x my FY 2012 /2013 (June) estimates. Relative to cash flow, the FCF/EV yield is about 12.8% based on my FY2012 estimate and 14.5% on my FY 2013 forecast. I believe these valuations are attractive on an absolute basis.

Additionally, the shares are also attractive when compared with other business software-as-a-service (SaaS) vendors. The following table highlights the significant valuation gap in the valuation of the shares of ABT compared with other comparable sized SaaS vendors.

As the Company continues to deliver strong financial results, which underscores its transformation, either the market will reward ABT with a more appropriate valuation or it will be recognized in a private market transaction. Given the intense M&A activity in the SaaS sector in the last few years, this is a very realist possibility. According to analyst reports, historically most acquisitions in the sector are valued at an EV/LTM sales ratio of 3x-5x. A recent report by Barrington Research dated1/23/12states the median P/Rev. purchase price for recent SaaS deals was 4.7x. On that metric, ABT is currently trading at about a 2.4x multiple, which makes its valuation attractive. Using the mid-point of the above mentioned range translates into roughly an $8.00 price. However, remember that as the Company is in the process of a financial turnaround, using LTM data may not fully reflect the current order momentum accurately and understate its potential value.

Catalyst

• Increased investor awareness of the company and its transformation.
• New customer wins and growth in the Absolute Manage product.
• Completing the transition in OEM revenue recognition for its Computrace product in the current quarter.
• Continued growth in EBITDA and FCF.
• A potential aqcuisition.