Description

BakBone Software Inc.
Ticker: BKB.TO / BKBOF
Price: Canadian $2.40 / US $1.75
Market Cap: US $102MM / Market Cap Including Preferred Shares: US $140MM
Cash: US $18MM / Debt: $0

BakBone Software (www.bakbone.com) of San Diego, California is an independent developer of backup, restore and archiving data storage software. What the company possesses in great fundamentals it lacks in investor awareness and sell-side coverage resulting in an extremely compelling proposition for value investors. BakBone is one of the few technology company success stories of recent times, having grown revenues approximately 100% for the last three years (FY 2001 - $5.0MM / FY 2002 - $9.8MM / FY 2003 - $18.2MM) culminating in its Q1 FY 2004 earnings announcement on 7/29/03 of its first profitable quarter in its history. According to Gartner Dataquest’s 5/14/03, report “Backup Vendors Compete for the Enterprise” BakBone Software’s NetVault was the fastest growing product in the Enterprise Backup market in 2002 with 124% growth. The company’s NetVault 7.0 software has attained a strong niche in Linux backup/recovery and has been incorporated in such Fortune 500 companies as AT&T, Barclays Bank, DaimlerChrysler, Deustche Telekom, Fedex, IBM, Shell and Wal-Mart. BakBone also has strong OEM relationsips with NCR Teredata, Network Appliance and Sony.

BakBone’s software NetVault 7.0, is a program that is compatible with devices from all the major storage hardware providers including EMC, Hewlett-Packard, Hitachi, IBM and Network Appliance. Its strength lies in Linux backup/recovery, the fastest growing market within backup and recovery which Shonstrom Research Associates believes BakBone has a 10% market share. NetVault offers a superior backup/recovery system featuring a compelling lower total cost of ownership requiring less human interaction and maintenance. BakBone is likely to gain market share from the disturbance caused at Legato post-closing of its acquisition by EMC. Trading at US $1.75 with a market capitalization of US $140MM, BakBone also represents an attractive acquisition for larger storage companies like VERITAS Software or Network Appliance.

While the company’s business is flourishing, its dual-listing on the Toronto Stock Exchange and OTC Bulletin Board has led US investors to shun the company regardless of its success. Many institutional investors in the US may, in fact, have noted BakBone’s success, but are prevented from buying it until the stock is listed on a major US exchange. BakBone is only covered by independent US technology research firm Shonstrom Research Associates and Canaccord Capital (Canada). The company trades at over a 60% discount to the storage group on a forward year price/sales basis and at over a 70% discount to the forward year P/E valuation at which Legato was acquired by EMC on 7/8/03.

However, recent events will provide a catalyst to drive BakBone’s stock higher. BakBone recently received a US $16MM investment from technology venture capitalists VantagePoint Venture Partners, one of the most well-regarded technology VCs in Silicon Valley. This transaction closed on 7/17/03 with the naming of two partners from VantagePoint to BakBone’s board of directors. As a result of the transaction, VantagePoint received 22MM preferred shares which can’t be exercised until the stock is significantly higher (trading at least at $5 Canadian or nearly $4 US). VantagePoint will do everything within its power to increase sell-side analyst coverage, institutional ownership and to move BakBone from the TSE/OTC BB to the NASDAQ National Market or another major US exchange. BakBone’s advisor on the VantagePoint transaction was Salomon Smith Barney. SSB is currently planning a road show for BakBone to New York and California the week of 8/3/03 to meet with institutional investors about investing in the company. Given the limited institutional ownership in the company outside of VantagePoint’s preferred holdings, these meetings will likely drive interest in the company and the stock price significantly higher.

Acquisition Possibilities:
As BakBone continues to show success and wins competitively vs. bigger players like VERITAS, EMC, IBM and Computer Associates, it is likely to see interest from these companies as an acquisition target because of the strength of NetVault software and growth in the Linux market.

VantagePoint Venture Partners Acquires a 27% Position in BakBone:
On July 17, 2003, BakBone completed a venture investment with Silicon-Valley based VantagePoint Venture Partners (www.vpvp.com) for $16MM US giving VantagePoint 22MM preferred shares. VantagePoint Venture Partners is one of the nation's largest venture capital firms with more than $2.5 billion in committed capital in networking, communications, semiconductor and Internet infrastructure companies. VantagePoint is a full-service venture firm offering a unique blend of technology, venture funding, partnering, marketing, and corporate finance expertise. Entrepreneurs have access to the firm's strategic partnerships as well as its network of more than 60 technology executives who serve as limited partners.

The transaction addressed several concerns regarding BakBone’s long-term strategy. The deal strengthens the balance sheet allowing the company to compete with higher capitalized businesses and ensures partners and future clients that BakBone will be around even in the difficult economy. Adding a significant US investor like VantagePoint also adds more diversification to the Canadian investor base which have been the primary holders of the stock thus far in the company’s history. Finally, VantagePoint adds their business savvy and global technology connections.

VantagePoint’s investment in BakBone presents a pressing incentive for the venture partners/board members Andy Sheehan and Stephan Dolezalek to get BakBone either listed on a major US exchange such as NASDAQ or at least get the stock price up to $5.00 Canadian (US $3.60) to monetize their investment (which would allow many institutional investors to buy a position who are not allowed to trade OTC BB). Under the terms of the deal stated in BakBone’s recent 6-K filing on 8/01/03, VantagePoint Venture Partners purchased 22MM preferred shares at $1.00 Canadian for gross proceeds of $22MM Canadian or $15.7MM US. Page 6 of the 6-K describes the provisions of the preferred shares and in turn describes the compelling rationale VantagePoint has to get the stock price up. The preferred shares themselves are essentially illiquid, so VantagePoint and BakBone have agreed to terms in which the preferred convert to common shares which can be sold in the market. The agreement consists of several possible outcomes allowing the conversion (outside of an acquisition in which case the acquirer would buy both classes of shares) subject to majority voting by the preferred shareholders. The preferred shares covert to common if:

1) BakBone is able to complete an IPO on a recognizable US exchange (NASDAQ National Market, NYSE or American Stock Exchange) at no less than US $2.04 which results in gross proceeds to BakBone of no less than US $25MM.
2) BakBone is listed on a recognizable US exchange (NASDAQ National Market, NYSE or American Stock Exchange) and the shares close in excess of US $3.40 per share for a period of 45 consecutive trading days.
3) BakBone’s Toronto Stock Exchange listed shares trade at Canadian $5.00 per share (or US $3.60 based on 8/1/03 Canadian/US $ exchange rate) for 45 consecutive trading days.

Both Sheehan and Dolezalek have significant and lengthy careers in technology investing with connections to the technology investment banking world. Sheehan previously worked in venture capital at ABS Capital Partners and was a Managing Director at Alex. Brown & Sons, where he was Co-Head of the firm's West Coast Investment Banking and Head of the West Coast Technology Group. Sheehan created and led the Alex. Brown Semiconductor Group. In addition, Sheehan served as a corporate finance advisor to a broad range of companies in the software systems and semiconductor markets. Dolezalek previously was a Business and Technology partner with Brobeck, Phleger & Harrison, LLP acting as managing partner of the firm’s Palo Alto Office, head of their Business and Technology Practice Group and chairman of the firm's Life Science Practices Group.

Having a venture investor such as VantagePoint is crucially important because Bakbone’s weakness is in its investment perception, not in its technology. VantagePoint is highly aware of the weaknesses of the dual TSE/BB listing structure, low-institutional awareness and lack of sell-side coverage. They also are aware of their own ability to influence success in addressing these issues. VantagePoint has a reputation as a top-quality technology venture investor and has allocated IPO business (and more importantly paid millions of dollars in fees) to Silicon Valley and New York investment banks. Their strategy will be to increase investment awareness among Canadian investment banks, target Silicon Valley boutique technology banks to cover BakBone from a research and market-making perspective and to get BakBone listed on NASDAQ. This will attract US investors and drive the stock price higher as the strong fundamental story gets more widely disseminated.

Legato Acquisition by EMC Widens BakBone’s Opportunities:
The agreement announced in July for EMC to acquire Legato now places Legato in a new light with regard to other storage equipment manufacturers. While Legato has slipped in the back-up and restore software segment in recent years, they still represent an estimated 5% or $125.0MM in revenues of a $2.5B market according to Shonstrom Research Associates. This creates an opportunity for a non-aligned backup storage provider like BakBone to become a preferred source by equipment vendors for data storage software included in their system sales. VERITAS has already publicly discussed a program to replace Legato. (Note that VERITAS is considered a competitor by hardware vendors because of an overlap in products offered.) Because of NetVault’s growing recognition in the market for its low total cost of ownership comparisons and its ease of use and interoperability, it is considered by many to be the best software to replace Legato. Boston-based EMC’s large corporate bureaucracy may also come into conflict with Silicon Valley-based Legato’s more innovative, less hands-on managed software engineers. It would not be surprising to see engineers leave post closing of the deal, thus weakening the company’s business. BakBone’s relationship with EMC has not been altered by the acquisition as indicated by President and CEO Keith Rickard who stated on the Q1 04 conference call on 7/29/03 that BakBone engineers were at EMC in late July working on software specifications for EMC’s new product offerings. EMC’s acquisition of Legato will have an incrementally beneficial impact on BakBone’s growth.

BakBone’s Financials and Valuation:
BakBone’s Q1 FY 2004 results were revenues of $7.7MM US up 112.5% from the prior year and EPS of $0.01 versus a loss of $.06 in the prior year. Quarterly results had the benefit of the recognition of $2.1MM from the $3.5MM Sony contract with Wal-Mart announced in January. The balance is to be recognized over the following 12 quarters. 87% of revenues were from product licensing with the remaining 13% from customer support contracts. Revenues in North America for the quarter were $4.6MM (60% of total) and 100 new companies became clients. Asia-Pacific revenues were weaker in the quarter at $1.8MM (23% of total) because of SARS. Sales would have been an estimated $400,000 higher were it not for the SARS scare affecting travel in the company’s Asian markets. BakBone estimates it lost an entire month of sales in the quarter in Asia. BakBone signed OEM deals with several companies in China/India including Fujitsu. Europe/Middle East/Africa revenues were $1.7MM (17%) as BakBone saw expansion in Southern Europe (France). Gross profits were 90% and are expected to remain so for the next several quarters. $1MM of cash was burned in the quarter. BakBone’s cash balance prior to the VantagePoint investment of $15.7MM was $4MM.

BakBone’s guidance for FY 2004 (March) is for revenues of $29-$32MM and EPS of $.04 - $.06. This guidance is pretty conservative suggesting little sequential growth which should enable the company to show upside. Shonstrom Research projects BakBone to make $32MM in revenues and $.04 in FY 2004 (March) and $55MM and $.16 in FY 2005. At this valuation, BakBone is trading at a 43x FY 2004 price/earnings ratio, an 11x FY 2005 price/earnings ratio, a 2.5x FY 2004 price/sales ratio and at a 1.5x FY 2005 price to sales ratio. BakBone’s valuation to other companies within the storage software business is as follows:

Computer Associates - $25: 43.2x 03 P/E / 29x 04 P/E / 4.9x 03 P/S / 4.4x 04 P/S
EMC - $10.70: 66x 03 P/E / 38x 04 P/E / 3.3x 03 P/S / 2.9x 04 P/S
Legato - $9.33: 97x 03 P/E / 44x 04 P/E / 3.1x 03 P/S / 2.8x 04 P/S
Network Appliance - $16.23: 48x 03 P/E / 37x 04 P/E / 6.2x 03 P/S / 5.8x 04 P/S
Oracle - $11.82: 25x 03 P/E / 22x 04 P/E / 5.6x 03 P/S / 5.3 04 P/S
VERITAS - $30.60: 42x 03 P/E / 37x 04 P/E / 7x 03 P/S / 6.4x 04 P/S
Average of the group: 45x 03 P/E / 33x 04 P/E / 5.0x 03 P/S / 4.4x 04 P/S
(Earnings estimates from First Call, Sales estimates from I/B/E/S)

BakBone Discount: 69% Discount to 04 Group P/E, 66% Discount to 04 Group P/S
BakBone Discount including VantagePoint Preferred Shares: 53% Discount to 04 Group P/E, 28% Discount to 04 Group P/S
(BakBone estimates from Shonstron Research Associates report dated 7/31/03)

If BakBone were to trade at a valuation closer to the Price/Sales multiple of Network Appliance/VERITAS or Legato’s P/E, the stock would be worth $4-$6. FalconStor Software (FALC - $5.80) might also be used as a comparable company as they are a small-cap provider of storage management software that has a $221MM enterprise value. No research analysts cover FalconStor, so there are no future projections, but based on trailing sales, since the company is losing money, FalconStor trades at 16x trailing twelve month Price/Sales. At such a valuation, BakBone would be worth $4 - $5 US including VantagePoint’s preferred shares outstanding. Granted a discount needs to be assigned for a non-NASDAQ, small-cap stock, but BakBone clearly is worth much more than $1.75 US.

BakBone Software History:
BakBone’s beginnings lie within its NetVault software developed at AT&T’s Bell Labs in the 1980s. With its first release in 1988, NetVault was arguably equal to or superior to the most advanced software on the market. NetVault was spun out into CommVault Systems within AT&T (currently a private competitor that has been having trouble raising money for 9 months despite $50MM sales run-rate and a Microsoft relationship). CommVault hired the Willow Group Ltd. in the UK to assist in further software development. Willow eventually acquired 50% of the NetVault intellectual property (IP). In 1997, AT&T spun out CommVault and the Willow Group purchased the rest of NetVault’s software IP and renamed the company NetVault, Ltd. NetVault’s software, version 5.0, was sold primarily through NCR’s Teredata Division (formerly part of AT&T) but the majority of the company’s revenues came from a partnership with a Japanese distributor. NetVault avoided the IPO market craze of the late 1990s and completed a reverse merger into a Canadian company listed on the TSE in 2000 and renamed itself BakBone Software.

Strong Management with Storage Software Experience:
Bakbone Software has assembled a management team that mixes the technical and engineering talent that developed NetVault with a group of managers with extensive background in the storage software industry. President and CEO Keith Rickard has been in software technology for 30 years including a long career at Sterling Software prior to its acquisition by Computer Associates. Rickard’s last position at Sterling Software was President of the Storage Management Division, where he grew the business to a $200MM sales run rate and consolidated three acquisitions while overseeing worldwide sales, marketing and business development. Fabrice Helliker, Vice President of Engineering, joined BakBone (NetVault, Ltd.) in 1992 to support the existing backup products and to aid in the development efforts with AT&T Bell Labs for NetVault. CFO John Fitzgerald has been with BakBone since 2001 and was previously with Arthur Andersen. On 6/17/03, BakBone added Karen Silva as Director of Investor Relations to aid in investor awareness and to increase recognition amongst research analysts at US-based investment banks. She previously had the same title at MP3.com prior to its acquisition by Vivendi Universal.

NetVault Described:
The code base for BakBone’s current NetVault Version 7.0 was first released in May 1999 and is designed for ease of use and fast deployment of new Application Plugin Modules (APMs). As a result of its modular design, BakBone has been able to release support for all the major platforms and applications, and also for less-common ones, such as SCO, NCR MP-RAS, multiple versions of Linux, NCR Teradata, MySQL, PostGreSQL and Appleshare. BakBone has also invested in support for the latest NDMP (Network Data Management Protocol) specification and for Network Appliance (NTAP) filers. NDMP is an open standard protocol promoted and supported by a server, backup software and backup device vendors. BakBone and Network Appliance are currently co-chairs of the NDMP standards committee. With the version 7.0 release of NetVault in April 2003, the base NDMP support was expanded to include APMs for snapshot to tape and snapshot management.

NetVault 7.0 has a feature set for larger storage installations. These include better policy management, robust reporting, event notification, user level access and encryption. Currently in the lab are applications under development to improve e-mail archive functionality (increasingly important for compliance especially in financial/technology companies), disaster recovery and support for storage clustering (a growing trend in storage implementations). BakBone is ensuring that NetVault continues it leadership in offering the broadest support for Linux environments. This is clearly a competitive advantage as the Linux operating system is gaining greater market acceptance and is beginning to eat into the market share of Windows NT. In 2002, IDC projected a 50.1% CAGR for Linux data storage software in the 2001-2006 period, at which point Linux server OS would represent 3.8% of the installed base. These numbers are probably conservative considering the growth of Linux outside of the US in Europe and Asia where BakBone has a strong presence. Linux license sales are at nearly 40% of BakBone’s sales and will continue to be a strong growth driver for the company.

BakBone’s relationship with storage hardware leader EMC began in early 2001 when BakBone requested lab space at EMC to certify their software. EMC allowed this for a fee, but upon seeing the software’s capabilities, offered the space for free. By Novermber 2001, BakBone was added to EMC’s E-Infostructure Development Program followed by BakBone’s release of an industry leading application plug-in module (APM) for EMC’s CLARiiON NAS systems.

Strong OEM Partnerships:
BakBone has an indirect selling model, with its products distributed through a worldwide network of approximately 220 OEMs and solution providers. BakBone Software has several agreements with larger OEMs that are currently fueling growth including: NCR Teredata (NCR), Network Appliance (NTAP) and Sony (SNE). The NCR Teredata relationship began as both NCR and BakBone were part of AT&T. NCR Teredata represented 12% of BakBone’s revenues in Q1 FY 2004. Sony became a partner in January of 2003. BakBone provides NetVault management software for Sony's StorStation bundled storage solution to enable customers to share and retrieve files on the network, automatically archive files from disk to tape, backup and restore networked files and centrally manage all functions. This Sony relationship has allowed BakBone NetVault 7.0 to be installed at Wal-Mart, the world’s largest retailer. This gave a boost to quarterly revenues last quarter and will provide further licensing revenues and recurring service fees. Earlier in 2003, NAS (Network Attached Storage) market leader Network Appliance announced that BakBone would integrate its NetVault data recovery software into NTAP’s SnapVault software. SnapVault allows for “snap-shot” or the backup of only the blocks of data that have changed since the last procedure and offers improved data management control with an increase in speed. This has been a feature of NTAP’s disc-to-disc solution in backing up data from their NetApp filers to their NearStor appliance. NTAP needed BakBone’s NetVault when a major customer wanted SnapVault’s functionality to be extended to backing up several third party storage devices (EMC, Network Appliance, etc.). NearStor has been NTAP’s fastest growing product segment in the last year as the ease, simplicity and low cost of ATA disc-to-disc technology has attracted many new users. Network Appliance and BakBone Storage completed one of the largest NAS installations ever in 2002 at Deutsche Telecom. The relationship betweem NTAP and BakBone has progressed well according to BakBone CEO Keith Rickard’s comments on their latest earnings call and is likely to lead to further growth extending beyond NTAP’s SnapVault.

BakBone – Smaller, But Capable of Higher Growth:
The market for backup and recovery is fairly mature and dominated by VERITAS, IBM, EMC, Computer Associates and Legato. The market according to Gartner consists of several companies listed below by vendor, product name and market share:

VERITAS / NetBackup – 27% / BackupExec – 19.4%
IBM Tivoli / IBM Tivoli Storage Manager (TSM) - 16.6%
Computer Associates / BrightStor Enterprise Backup - 8.5%
Legato / Networker - 8.1%
Hewlett-Packard / OpenView Data Protector - 3.1%
CommVault Systems / Galaxy - 2%
EMC / EMC Data Manager (EDM) - 2%
Syncsort / Backup Express - 1.2%
Atempo / Time Navigator - 1.1%
BakBone Software / NetVault - 1%
Others – 10.1%

BakBone’s value proposition is in Linux backup/recovery which represents 40% of their revenues but only 1% of market leader VERITAS. BakBone presents a cheaper total cost of ownership because its software requires less of the expensive human intervention required by competitors to integrate different components. BakBone is an independent, non-hardware specific software provider unlike any of the top competitors like VERITAS, IBM, Legato and EMC which all have numerous hardware components they are trying to sell and preventative software agreements that make their software less capable. Reduced manpower for implementation and maintenance is crucial for clients since IT budgets are constrained in economic downturns. In addition to total lower cost of ownership, BakBone’s NetVault 7.0 provides for improved scalability, adapting easily to future needs with one product line. NetVault 7.0 features increased automation for event notification, policy based management and has advanced user definable reporting tools. Its enhanced administrator productivity functionality allows easy maintenance for large numbers of clients.

In 2002, an independent study of 26 users by INPUT, an IT research firm, found that NetVault offered at least a 30% lower total cost of ownership vs. competitors VERITAS and Legato. NetVault scored a 4.6 out of 5 in user satisfaction vs. VERITAS and Legato. It scored better in virtually all categories of the competition including “administrative personnel per terabyte”, “vendor service visits” and “up time.”

BakBone will certainly have pressure competing against technology powerhouses like VERITAS and IBM and will maintain a small market share of a growing market. However, while BakBone maintains only 1% of the total backup/recovery market, their share of Linux is probably closer to 10% according to Shonstrom Research Associates. As stated above, in 2002, IDC projected a 50.1% CAGR for Linux data storage software in the 2001-2006 period, at which point Linux server OS would represent 3.8% of the installed base. BakBone is clearly strongly positioned in the fastest growing market within backup/recovery which the company will continue to benefit from regardless of SCO Systems (SCOX) pending legal arguments regarding Linux. (Note, the company is small with 90% gross margins. $1-3MM revenue opportunities make the company even cheaper on an EPS basis as profits fall to the bottom line.)

Catalyst

* US roadshow starting week of August 3, 2003 held in Canada, New York and California hosted by Solomon Smith Barney targeting institutional investors in the US.
* Vantage Point’s actions to increase sell-side analyst coverage and listing of BakBone’s shares on a major US exchange such as NASDAQ.
* VantagePoint’s preferred share purchase of 27% of BakBone is not monetizable until the company does an IPO on a recognizable US stock exchange at at least $2.04 US or trades at $3.60 US for at least 45 days. VantagePoint’s ability to cash out provides a strong catalyst for the stock to at least double from US $1.75.
* Possibility of Salomon Smith Barney doing a NASDAQ IPO of BakBone. SSB advised BakBone on their transaction with VantagePoint.
* Continued profitability and meeting of $29-32MM revenue guidance and $.04-$.06 in EPS, making the company very attractive on valuation basis. One larger-sized contract landed through an OEM partner such as the Wal-Mart deal in Q1 could make EPS closer to $.07-$.09.
* Possible acquisition by EMC, IBM, VERITAS, Computer Associates or Network Appliance. Network Appliance with their established relationship with BakBone or VERITAS with an interest in expanding its presence in Linux would make most sense as acquirers.
* Disappearance of Silicon Valley-based Legato into Boston-based EMC’s corporate bureaucracy and subsequent channel relationship disturbances from EMC clients preferring third party backup software will result in opportunities for BakBone.