Description

Executive Summary - Blom ASA (BLO NO)

• Blom is a geographic information company that performs studies for clients and owns proprietary databases. The business is underpinned by government contracts across the EU, but the company has recently adapted its product offerings to sell into the navigation and location-based services market to generate high-margin incremental growth

• Sell-side analysts foresee the company at 5x 2009 EBITDA and 2.3x 2010 EBITDA based on essentially zero growth estimated for 2009 relative to 2008, and modest 13% revenue growth in 2010 that would be considered 'average' based on Blom's prior earnings history. 2010 estimates could be materially higher

• The current share price implies zero value for the high-growth business segment that has recently won break-through contracts that should boost earnings in 2H 2009. The high-growth segment generates EBITDA margins of 40-45% and has experienced 40%+ revenue growth in each of the past two years

• The stock is severely depressed due to false association with consumer electronics device manufacturers, a prior accounting scandal at another unrelated Norwegian IT company, and the loss of interest by investors when Blom's clients delayed the roll-out of new products that incorporate Blom's products. Those product roll-outs are now on-track for 2H 2009

• Chairman of the Board owns 9% of the company and has a successful history of selling companies to industrial suitors

• Catalysts for the shares include the retention of Jefferies by the Board to sell the company in order to maximize shareholder value, as well as the earnings contribution from a partner's major roll-out of Blom's products in 2H 2009

Introduction & Thesis

Blom ASA (BLO) is one of the largest mapping and geographic information companies in Europe.  In simple terms, BLO has historically focused on creating various types of maps for its customers, which are typically governments, and adds value to its customers by designing and executing the studies to help those clients understand climate change, strengthen national security and defense, model the effects of disasters and potential disasters, as well as model civil engineering projects. 

The company has two business groups run by its 1,200 employees in 13 countries:  Blom Geo-Engineering Services ("BGES") and Blom Information Services ("BIS").  BGES performs most of BLO's work for governments, municipalities, and agencies.  BLO has high visibility within BGES and already has 70% of 2009 expected revenues booked in the backlog.  BIS licenses geographic information to customers who employ the data primarily for location-based service ("LBS") and internet-based applications.  BIS benefits from a proprietary pan-European database that is protected firstly by patents, and secondly by the 3-4 year lead-time to replicate the database absent patent protection.  BLO has seen an ability to expand its previously government-based product offering to the consumer market and complement the offerings of leading map-makers TeleAtlas (acquired by TomTom for $4.1bn) and Navteq (acquired by Nokia for $8.0bn).  For instance, Microsoft, TeleAtlas, and European online directories are the current customers of BIS, which underscores both the value offered by BIS as well as its credibility. 

An example of Microsoft application based on Blom's databases:

• http://tinyurl.com/r2j53c

An example of Eniro's (Yellow pages of Scandivania) application based on Blom's databases:

• http://tinyurl.com/nlatyx

An example of Blom's databases applied to the GPS market:

• http://tinyurl.com/otfdyz

At 6x EBITDA, BGES alone would yield a NOK 12 share price, which therefore implies zero value for BLO's high-growth business.  Absent a Q1 2009 that was weak due to the global economic collapse, the BIS business has been wildly profitable, with 40-45% EBITDA margins.  BIS revenues grew 56% in 2007 and 43% in 2008.  The stock market had been excited about BIS when it had simply represented 'potential'; the share price hit NOK 89 in expectation of these new earnings.  However, the financial crisis and confusion about BLO's differences with consumer electronics companies such as Garmin and TomTom resulted in the shares being forgotten and cast aside.  The key difference from those prior points in time is that BLO has now been awarded the contracts and its customers have introduced BLO's data into the next product cycles.  Uncertainty has been dramatically reduced. 

As highlighted by the recent IPO of DigitalGlobe (DGI), the predictable, high-margin government-based earnings of BLO are attractive in the current environment.  DGI is valued at 21x 2009 earnings and 30x 2010 earnings, according to the lone analyst covering the stock, Collins Stewart.  BLO's business is stronger in many respects - first and foremost is that BLO does not depend on finite-lived satellites to generate its products, rather, BLO's government-based business is much more based on experience and intellectual property than on raw access to expensive capital equipment. 

Norwegian investment bank, DnB Nor, places BLO shares at just 2.3x 2010 EBITDA and 5.0x 2009 EBITDA (which largely excludes earnings from BIS).  These estimates are reasonable, and likely conservative with respect to 2010.  For a company that grew revenues 62%, 27%, and 19% in 2006, 2007, and 2008, respectively, this multiple is inappropriate. 

The investment case also benefits from a catalyst in that the shareholder-friendly board has hired Jefferies to assist in a sale of the company to realize this discrepancy in value.  In the event BLO remains a stand-alone company, increased earnings growth visibility and a general improvement in market sentiment should propel the shares to significantly higher levels.

Description of Blom

BLO has a government-focused Geo-Engineering Services ("BGES") business as well as a proprietary database business ("BIS") that targets consumer-oriented clients.  The former CEO, who also owns 9% of the company through his holding company originated and led the current strategy.  Upon seeing initial success, yet appreciating the need for an industry expert in the new BIS segment, he stepped aside from the CEO post to become Chairman.  The BGES business is largely dominated by incumbents where governments parcel out work to those who have built the political inroads to receive such work.  For instance, BLO receives a significant share of Italian and Spanish work and will continue to do so based on long-standing relationships.  The BIS business depends on forging new relationships with hardware manufacturers, telecom operators, and web portal owners. 

BGES - Blom Geo-Engineering Services Segment

BGES encompasses the traditional areas such as aerial photography, laser scanning, 2D vector maps and modeling. In 2008 the company also developed a number of verticals in forestry management, environmental services, defense and security, and engineering services.  BGES is viewed as a very stable business with incredibly good counterparties that are primarily government-related.  Major customers include the U.S. Army Corp of Engineers, the armed forces of Norway, Spain, and France, and the governments of Italy and Spain.  The contract flow is marked by many small, yet consistent, contracts.  BGES earns its margins not by simply acquiring the data, but instead by providing the value-added services of performing the data simulations and modeling.  BGES has experienced good demand in 2009, driven by traditional aerial photography products, as well as new products in the laser model markets, and service that help measure the effects of climate change.  BLO has also found success in selling 3D models.  For instance, BLO won a NOK 26MM contract with Telecom Italia SpA to map and model urban areas in Italy to support that company in the planning of base stations for mobile communications.  This business has significant overlap with BIS's activities, and BLO is uniquely situated to lead this product segment due to its patented database that will be described more thoroughly when BIS is discussed. 

Visibility in the business is very strong, with some 70% of 2009 target revenue already booked in the backlog.  Examples of business undertaken just in Q1 2009 by BGES include:

• Swedish government contract to create a national height model
• Dutch government contract to create a new national height model
• Contract to perform laser scanning of Costa Rica
• French Ministry of Defense contract for a bathymetric survey in Indian Ocean
• U.K. Environment Agency contract to make surface and flood maps of England
• Italian government contract to study the coastlines

LTM revenues were NOK 660MM, on which BLO generated NOK 50MM of EBIT and NOK 107MM of EBITDA.  The LTM 16.2% EBITDA margins were in-line with the expected range of 15-20%.  BGES typically grows at 10-15% annually; in 2007, BGES revenues grew 23% and in 2008 revenues grew 17%.  In late 2008, there had been some slow-down in municipal spending due to the shock of the financial crisis, but nothing that has derailed the stable path of BGES.  BGES does not rely on satellites, but instead of a relatively inexpensive fleet of prop planes and 1 jet, along with leased aircraft.  The cameras that BLO owns cost more than the planes.  BLO's CAPEX largely relates to building its databases, as well as investments in processing infrastructure.  In 2008, BLO helped finance a GPS manufacturer ($5MM) to help prove the viability of BLO's applications.  The value of the business lies in the footprint and the long-standing track record and relationships with local governments who rely on BLO to perform scientific studies with the data that BLO acquires. 

BIS - Blom Information Services Segment

BLO has pursued a strategy to extend its products to the navigation, location-based services, and internet markets.  The BIS business revolves around a specific data set, referred to as Pictometry, that BLO has spent the past 4 years developing.  The data can only be collected in the winter on clear days (to avoid leaves and clouds).  Obtaining the requisite fly-over rights is very bureaucratic, especially in Europe.  Imagine obtaining fly-over rights over France's Charles de Gaulle airport when thinking about the difficulties involved; if there are clouds during the 15-minute permitted fly-over, the entire red-taped process restarts.  The database involves oblique images of every major European city. 

With those images, and coupled with data from the BGES segment, BLO is able to provide several Geographic Information System ("GIS") applications.  Markets targeted include the navigation market (GPS), the search market (internet and mobile), emergency services, real estate and property appraisal, and governmental.  BLO provides 3D city models based on this data, as well as mosaic models that allow a program to offer photo-realistic models of cities, which is particularly useful for navigation applications. 

BLO has made significant efforts to drive BIS toward the consumer markets, as this has been viewed by the management as the timeliest opportunity, whereas the more traditional applications of the Pictometry database will remain constant and can be pursued with greater effort in the future.  The consumer markets are increasingly based on 'local' content, where the information and data prepared by BLO has significant ability to differentiate traditional GPS navigation, web search, and internet advertising products and services. 

BLO's creation of BIS was underpinned by an initial contract from Microsoft to support the Microsoft Live platform, while BLO's break-through contract on the consumer-electronic side has been a deal with TeleAtlas.  BLO has a 5-year agreement with TeleAtlas whereby BLO's 3D models and images will be incorporated into TeleAtlas' future map products.  In 2008, TeleAtlas sold 19MM map licenses.  Now that Blom supplies TeleAtlas, its products are poised to become the standard.  Importantly, TeleAtlas has a strong relationship with Google, which is obviously a key potential client for BLO.  BLO has also delivered models to Navteq, which is owned by Nokia.  Previously, BLO had been using small independent OEM's to push the product so that a commercially-available product could be shown at trade-shows to prod the big players to license BLO's products.  The strategy worked.  Industry commentary on recent developments in the consumer markets can be found at the following links:

• http://tinyurl.com/pzudqk

• http://tinyurl.com/qusv7a

BLO's BIS business has its roots in a geo-referenced photography technology called Pictometry.  Pictometry is a geographic information system where angular and vertical photographs are collected and processed by a new and unique method.  BLO entered into an exclusive agreement with Pictometry International that secures the rights to the technology for a total of 23 countries in Europe.  Pictometry International developed the technology (executives are formerly of Kodak) and has built a business around the North American market.  The European library will be owned by BLO.  Pictometry receives 22% on a portion of the gross revenues that relate to the pictures, but not the entire revenues where the sales entail an application developed by BLO - such as the applications being sold to TeleAtlas which involves significant software that enables the databases to run in an efficient and usable manner on handheld devices. 

Pictometry went to BLO for the European expansion because Pictometry would have been unable to circumvent the political barriers to starting an aerial photography operation in Western Europe.  BLO was already established in the European markets and was already trusted; Pictometry would not be able to enter the market by itself.  The issue of experience is important. 

Pictometry International says that it is able to resell databases up to five times.  As such, this is the bogey for BLO, given both companies have the same basic product, but serve the two different continents.  If anything, the European market is larger because the municipalities are much smaller and fragmented.  Pictometry had rich revenue streams due to the fact that beyond counties, states, and federal clients, Pictometry was able to resell information to real estate agents, roofers, banks, title companies, mortgage companies, appraisers, universities, hotels, and various other businesses.  Each sale is essentially all incremental revenue since the database does not need to be re-shot for each customer.   Pictometry's business is recurring due to the fact that clients request updated information.  For instance, most counties renew the images every 1 - 2 years. The margins on the renewals, when Pictometry re-shoots an area, are similar to the initial shoot, yet that database is again resold multiple times.  Pictometry had a 99% renewal rate.   All sales of BLO's Pictometry database fall into the BIS segment for revenue reporting, in addition to the sales of products that are based on the underlying dataset, such as BLO's 3D models and GPS applications. 

The previous links highlighted Microsoft's use of Blom's products, and Blom's GPS application.  The brochure below helps to highlight the governmental and commercial applications of the database:  

• http://www.blompictometry.com/pdfs/English_reduced.pdf

The gem at BLO is the ability to create 3D models at an unprecedented rate because of the ability to leverage its proprietary Pictometry database.  BLO is able to pair its geographic information on cities to peg heights and building locations, and then effectively 'drape' its oblique images on top of those grids, thereby creating models at a fraction of the cost of competitors.  Again, this point is proven by the fact that map-maker TeleAtlas had to sign a deal with BLO to get access to these capabilities, which will play an integral part of future TeleAtlas maps.  The May 20, 2009 press release from TeleAtlas read as follows:

Gent, Belgium, 20 May 2009-Tele Atlas, a leading global provider of digital maps and dynamic content for navigation and location based solutions, announced today the availability of 3D, photorealistic Advanced City Models. Designed for use in navigation systems and location-based applications, Advanced City Models are three-dimensional representations of major city centers that dramatically raise the clarity and reality of screen images within in-car and portable navigation systems and mobile devices. With Advanced City Models, displays more closely match what users actually see in their surroundings, helping them more easily find locations and services.

The release of Advanced City Models builds on the company's suite of enhancement products, which include Urban Maps, Points of Interest (POIs), Voice Maps, Speed Profiles and dynamic content. Tele Atlas has been delivering industry leading 3D products since 2006, used today in Mio, Pioneer and Sony PSP navigation solutions. The company accelerated the development of more advanced 3D images through its partnership with BLOM.

"With the release of Advanced City Models, we are quickly delivering increasingly rich, powerful content to our customers that enhances their products and applications," said Tele Atlas CEO Bill Henry. "Our partnership with BLOM and our new advanced production capabilities allow us to deliver incredibly detailed, realistic 3D maps to the industry and provide a superior experience for the end user in more cities than ever before."

The BIS business provides a complimentary pairing with the BGES business.  Importantly, BIS presents the ability to generate significant incremental margins due to the "multi-client" nature of the business.  Furthermore, as the uptake of smartphones, web-based search that is location-aware, and GPS navigation increasingly takes hold - and all markets begin to offer premium services beyond abstract and 2D mapping, BLO is poised to take significant market share due to the fact that it already possesses the dataset and has the ability to delivery the data through its proprietary servers. 

Why the investment exists

The opportunity to invest in BLO at these prices exists for three principal reasons. 

The first is obvious:  small cap stocks in Scandinavia have suffered immensely in the market down turn, regardless of company or industry. 

Aside from the broader macro issues, the investment community had generated a near paranoia toward BLO's working capital situation, where receivables and inventories increased significantly in 2008.  The arguably undo attention to BLO's working capital requires some knowledge of Norwegian IT company-specific history.  A company called, Fast Search & Transfer, which was ultimately acquired by Microsoft, was known as the "Enron of Norway" due to its aggressive accounting.  The company had booked free software trials as revenue, which obviously served to bloat both revenues and receivables, while failing to generate cash.  The scandal related to this accounting, and the subsequent destruction of the share price, has caused all Norwegian IT analysts and investors to have an immensely skeptical view of local IT companies.  

In 2008, BLO was undertaking rapid growth, especially in its BGES business where significant new business from the Spanish and Italian governments was taking hold.  The governments pay on 180+ day schedules.  Therefore, as revenue growth came from clients with extended payable schedules (not surprisingly, Spain and Italy fit this bill), accounts receivable increased.  Furthermore, 2008 marked a doubled effort by BLO to build its databases (image libraries), which is the crux of its business strategy as it buttresses its BIS segment, which is database driven.  To be fair, the BIS segment did have to aggressively push its initial licenses to small GPS manufacturers to push the product into the market, and reserves have been taken against some of these receivables.  Overall, in 2008, BLO had to invest NOK 150MM in working capital.  While BLO did take some reserves against accounts receivable in Q4 2008 because some of its BIS clients were suffering due to the downturn in the consumer electronics markets, BLO was able to address investor criticisms in Q1 2009 by proving the collectibility of its balances; Q1 2009 saw NOK 45MM of working capital released as those government receivables came due.  Proving BLO's prior explanations, 4 clients (governments) represented 74% of the working capital reduction.  Collections as revenues come due from these same clients will further normalize BLO's working capital position and allay concerns. 

The third issue was an unfortunate association with the actual consumer device manufacturers, Garmin and TomTom, as those players saw their operating margins compress and share prices plummet.  Investors lumped BLO with those companies, ironically, because BLO had spent considerable effort to draw itself into the navigation market as it sought to expand its BIS business.  As the sponsor of navigation conferences and the like, BLO fought hard to become associated with the navigation industry, only to be sold when the sector suffered in late 2008.  Importantly, BLO sells licenses into those OEM manufacturers, but does not manufacture or market consumer electronics.  The same database that can be sold to Microsoft, governments, or real estate appraisers is the same database sold to TeleAtlas.  Thus, BLO's business is robust in surviving a consumer-led downturn whereas the businesses of TomTom and Garmin are not.  Having been falsely associated with the turn of fortune of Garmin and specifically TomTom, BLO shares were hit particularly hard.  The vast majority of BLO's business is entirely unrelated to the navigation market, especially when looking at historical performance.

Valuation

The valuation of BLO is most logically split into an evaluation of the BGES segment and then understanding the possible outcomes for the BIS segment. 

At 5-6x EBITDA, BGES alone would yield a NOK 12 share price, which therefore implies zero value for BLO's high-growth business.  DGI is valued at 21x 2009 earnings and 30x 2010 earnings, according to the lone analyst covering the stock, Collins Stewart. 

The BIS segment has significantly more volatility around future estimates, but benefits from revenue attribution from the Pictometry sales - whether those sales occur through sales to governments, Microsoft, TeleAtlas, or online yellow pages services.  As the TeleAtlas contract comes into force, which could generate from NOK100MM - NOK 400MM per year depending on sales volumes, BLO should begin to get significant traction in the BIS segment, in and above what it has already generated.  Thus, the 2008 revenues of NOK 200MM should represent only a precursor to a substantial growth trajectory from 2010 onward. 

Simplistically, BIS revenues are a function of how many times BLO resells its database, as well as how many device licenses the company is able to sell.  BIS has already generated strong revenues, with NOK 200MM generated in 2008. 

Each time the database is resold, BLO should generate NOK 100MM of revenues.  Pictometry International has experienced roughly 5 'turns' per year when selling to internet-portals, governments, and commercial clients. 

Each navigation license for BLO will generate in excess of NOK7.00-14.00 in license fees when sold through the mass market, i.e. through TeleAtlas.  TeleAtlas sold 19MM licenses in 2008.  The impact on BLO company-wide revenues are significant. 

Pictometry earned 50% EBITDA margins on its business, so if 35-40% EBITDA margins are assumed for BLO's incremental revenues, it is possible to develop crude estimates for the BIS segment. 

While 66% growth might seem aggressive for a "low" estimate, BLO's transformational contract with TeleAtlas and its position with other vendors provides significant reasons for BIS to meet or exceed these estimates.  Q1 2009 numbers reflected the reality of the economic shock, which halted almost all budgets of BLO's clients.  Again, these budgets have been placed back on track, as evidenced by the TeleAtlas announcement. 

Thus, company-wide EBITDA estimates for BLO show an attractive risk-return at the current levels. 

Risks to the Investment

The key risks to the investment lies in weak end markets for some of BLO's clients, as well as the lingering concern in the equity markets about BLO's working capital situation and liquidity. 

The risk with BLO's clients has been largely realized in late 2008.  BLO had expected to begin selling its licenses into TeleAtlas in late 2008, but the collapse of consumer spending and significant difficulties at TomTom caused the delay of new products that would feature BLO's databases.  A May 20, 2009 press release by TeleAtlas confirming the launch of Blom-based products allays that risk and de-risks the BIS-segment's future earnings. 

The issues surrounding BLO's working capital and liquidity have improved in Q1 2009 and the company remains focused on reigning in its days-sales-outstanding and driving sales to match its increased inventory levels.  As working capital intensity reverses, BLO's net debt should be reduced.  Due to government receivables, a build-up of database inventory, and a reduction in revenues due to the economic crisis in late 2008 and early 2009, BLO's cash conversion cycle blew out.  As BLO resets its working capital, there should be significant cash released back. 

BLO has un-utilized bank facilities of NOK 167MM and cash of NOK 63MM.  With total debt outstanding of NOK 290MM against 2008 EBITDA of NOK 155MM and consensus 2009 EBITDA of NOK 200MM, the company's balance sheet is fine.  Of the NOK 290MM, NOK 200 represents a loan from SEB Enskilda, which must have NOK 50MM repaid in both 2009 and 2010, with the remaining NOK 100 repaid in 2011. 

Catalyst

• Successful sale of the company, per the mandate given to Jefferies
• Realization of earnings based upon announced actions of Blom's key clients; products to ship in Q3 and Q4 2009