Description

I wrote this before today’s announcement that AGYS will sell its RSG unit for $1.50 per share in cash, closing later this summer.  I have quickly updated the numbers.  I consider today’s announcement to be a catalyst for the stock to move higher, as AGYS should now be much closer to being sold to a larger strategic buyer.  The stock is only up slightly, trading below $12.00 at the time of this posting. 

Agilysys provides technology solutions for the hospitality and retail markets.  Products include property and lodging management, inventory and procurement, point-of-sale (“POS”), document management, mobile, wireless and other types of software which facilitate the relationship between a hotel property or retail outlet and its customer.  The company also provides support, maintenance, resold hardware products and software hosting services.  Customers include retailers, casinos, resorts and restaurants.  A significant portion of revenue is derived from contract support, maintenance agreements and professional services. 

AGYS operates throughout North America, with additional sales and support offices in the UK and Asia.  They report two operating segments: Hospitality Solutions Group (“HSG”) and Retail Solutions Group (“RSG”). 

My investment thesis is simple.  HSG is a terrific business, likely worth AGYS’ current market cap or more.  [I would refer readers to fiftycent501’s recent writeup of MCRS for more/better color on the attractiveness of the industry.]  There would be significant interest from competitors in this valuation range if HSG were put up for sale.  RSG is a decent business, and it is likely worth around $1.75 per share (note: they announced this morning they are selling for net proceeds of $1.50 per share), however it is not interesting to the same buyers, and therefore its presence currently impedes potential buyers of HSG from attempting to purchase AGYS for a fair price.  Finally, pro forma for the sale announced today of RSG, AGYS has $4.90 in cash per share (and no debt). 

AGYS was not always so straightforward.  When MAK Capital took a board seat in 2008, the company was attempting to fix a third division (ITG) which was struggling to compete in the broader IT services sector.  Corporate overhead totaled $47m in FY 2008 (FYE 3/31), consuming 22% of combined HSG/RSG sales, and overwhelming HSG/RSG’s combined $16m in segment-level EBITDA.  Over the past five years, AGYS has reduced corporate overhead to $25m, grown RSG/HSG segment-level EBITDA to that point where the company is profitable, sold the ITG division for cash, replaced senior management and moved the company’s headquarters to save costs.  The company continues to focus on increasing more valuable Support & Maintenance and Professional Services revenues, while de-emphasizing Products revenues.  HSG now generates over two thirds of its revenues in support and services.  AGYS also rejected a bid for the company in 2011 for $11.00 a share, which is disclosed in public filings.  They may have received other bids since then not requiring disclosure, but this is only speculation. 

This year, they became profitable on an operating profit basis, recently increasing guidance to $230-232m in sales and $6.0-$6.5m in Adj EBIT, as well as 24-26c EPS.  Based on the current stock price, the stock appears quite expensive on trailing earnings.  However, this reflects the burden of overhead which an acquirer will largely exclude from their assessment of the ongoing profitability of the HSG unit.  I believe it is more appropriate to use EV/Sales multiples, as well as EV/EBITDA based on segment-level profit, to assess the strategic value of the company’s two business units.  I believe that AGYS is currently prepared to do what it takes to maximize value for shareholders: deploy cash at an attractive rate of return to acquire profitable properties within the HSG sector; dispose of its RSG segment for a reasonable value (done, as announced today); and finally, sell the company to a competitor in the HSG sector (or a larger new entrant) who will be much more motivated to pay a full price once the corporate structure is further simplified and AGYS is put in play.  I also believe that cash may be deployed to acquire additional HSG software properties, and that this is a good thing (and not indicative of the company truly trying to go it alone over the long haul, but rather to get more credit for this cash in an ultimate sale of HSG). 

A sum of the parts analysis yields 13-55% upside from here.  Cash is $4.90 per share, after selling RSG for $34m net to AGYS, which equates to approximately 0.27x LTM Sales and 4x LTM segment-level EBITDA, contributing $1.50 per share.  I value the HSG business at 2-3x Sales, equivalent to 12-18x trailing segment-level EBITDA.  This may seem pricey, but HSG sales and profits are growing, and this is an essential software business with a very loyal customer base (high switching costs and excellent reputation for service/customization = pricing power).  MCRS is the best pure-play comparable, and it currently trades for 2.2x trailing Sales (I believe MCRS is also undervalued).  It has traded in the 2-3x range (and higher) over the past couple of years.  NCR bought competitor Radiant Systems for 3.1x Sales in August 2011.  At 2-3x Sales, HSG is worth $8.70 to $13.05 per share.  Putting it together results in a range of $13.60 to $17.95 for the company, assuming no value is created/destroyed by any cash-funded tuck-in acquisitions.  I would reiterate that given MAK’s 31% stake in this illiquid company, it is highly likely that (a) any deployment of cash is done with shareholders’ best interests in mind, and (b) the company will ultimately be sold or merged in order to gain liquidity for MAK. 

All put another way, the current stock price implies a value of 1.6x LTM Sales for HSG, or 9-10x LTM segment-level EBITDA (growing)…. this is too cheap for this high-quality software business. 

Risks include exposure to the hospitality sector, and the fact that there is little recourse for minority shareholders if they disagree with MAK Capital’s timeline or strategy (although I like what they have done so far). 

Catalyst