Description

Summary: Agilysys provides software and hardware products to the hospitality industry. After heavy investments in new product development and sales for a couple of years, the company has finally hit an inflection point of revenue acceleration, including 18% revenue growth last three quarters (27% in the most recent Q) and 60% increase in deferred revenue. AGYS has been taking market share from competitors and is poised for double digit revenue growth for years to come. Yet, the stock is trading at the lowest level in years and a significant discount to numerous recent industry transactions. I believe the company was being prepared for an eventual sale by its control shareholder, who had owned the stock for 7+ years. This is a rare instance of a company with positive fundamentals, motivated control shareholder looking to cash out at the right multiple and eager strategic buyers. I think a likely scenario is a sale at 50%+ premium within the next 12-18 months.

For background of the industry, please read the excellent write-ups by banjo on AGYS in Jun 2013 and by fiftycent501 on MCRS (a close competitor of AGYS) in Apr 2013.

The story on AGYS is pretty straight forward, although the journey had taken far longer than shareholders expected. MAK Capital (owns 30% shares) first took a board seat in 2008, installed a new mgmt team, sold non-core businesses and kept the gem hospitality solutions business. My best guess is that the company could have been sold in 2013, but the new mgmt team saw that the product suite at AGYS and competitors are becoming out-dated, and there is an opportunity for the company to develop next generation/SAAS version of the core products and take share, like many other software verticals.

Long story short, after spending close to $40m of cash on R&D/sales for 2+ years, and looking bleak for a few quarters, the company has turned the corner with new products starting two quarters ago. In the mean time, Micros and Radiant under their new ownership have likely stopped investing and/or been distracted and less focused as part of a bigger company. As a result, AGYS has been gradually winning market share and displacing incumbents. In Q1/Q2 FY ’16, AGYS grew revenue by 15%, and Q3 (reported today) continued the trajectory with topline growth of 28%. Mgmt increasingly sounded optimistic on the product roadmap/pipeline, and business momentum is evident in new logos, average transaction size, and 60%+ increase in deferred revenue in the latest Q.

The only missing ingredient is profitability. Note the recent topline growth may be overstating the growth of the underlying business a bit, as a large chunk of product revenue is hardware. The recurring revenue (maintenance and subscription) is growing at a more modest though still solid 10% pace. Similar to other software companies going through transition from on-premise to SAAS based models, AGYS is taking a short-term margin hit while building a profitable subscription revenue stream. Mgmt is now confident enough in the underlying business that they have offered preliminary revenue growth of 8-12% for the next FY -- they have beat and raised 2 Q’s in a row so that guidance may prove conservative. Again, the jump in deferred revenue is a very good sign.

We can debate whether this investment/transformation has been really worth it, esp. considering time value. But that is a moot point now, and I suspect buyer fatigue is partially why the stock had been treading water despite showing concrete signs of positive inflection last 3 Q’s, and I believe this is where the opportunity lies.

I don’t know anyone at MAK Capital, but a couple of friends have had nice things to say about the PM. All I know is that AGYS had been a big chunk of their AUM and done very little over their holding period. At some point, they have to be looking at cashing out, and now seems as good an opportunity as ever with demonstration of successful product suite and robust revenue growth (key to a strategic buyer). In addition, Discovery, an activist fund, had accumulated 10% of shares in 2014/2015 at prices above current levels. So we know there are motivated sellers at control.

On the flip side, there are motivated buyers, judging by numerous transactions outlined below at very healthy multiples. Both Sabre and Amadeus are actively diversifying away from their core GDS business and expressed desire to further bolster their hospitality solutions offerings. Compared to other verticals, hospitality space is characterized by a long tail of players in different segments, which makes it more compelling to buy rather than build.

By my numbers, AGYS is trading at 1.3x 2016 EV/sales, 2.5x maintenance sales. The multiple is even lower after adjusting for $175m NOL. Even at 2x EV/sales, well below the multiples listed above, AGYS would be sold for $15. With natural operating leverage, standard cost synergy (G&A, sales), a strategic could easily get 20% EBITDA margin on the acquired business and essentially pay 10x EBITDA, which is pretty attractive for a sticky business growing at double digit. I suspect MAK and mgmt team may be looking for a higher price. With $60m of cash, accelerating topline growth and positive FCF, AGYS is no longer a value trap, and time is on investors’ side. 

Catalyst

1) sale

2) continued ramp up in revenue.