Description
Few companies on MagicFormulaInvesting.com’s Top 25 list have rapidly improving fundamentals. BroadVision would be such a rare company if its financials were accurately reflected in the relevant database.
BroadVision has turned the corner on profitability and has started growing license revenue for the first time in years. It has new products slated for 2007, a solid balance sheet with significant net cash, and a trailing EBIT to EV yield of 16%. Why this opportunity? BroadVision is off the radar and requires pro forma adjustments to analyze, as it has just completed a rights offering (not yet reflected in financials) and still trades on the Pink Sheets (probably not for long).
Former Internet Software Leader Has Suffered But Survived
You may remember BroadVision (Pink Sheets: BVSN) as a dot com highflier that fell off the map along with the burst of the bubble. Based in Redwood City, Calif., BroadVision sells software that helps companies run transaction-intensive websites featuring sophisticated personalization and other customer service functionality. It has a blue chip client list, including Ferrari, H-P, Japan Airlines, Renault, Sears, Sony, Standard Chartered Bank, U.S. Air Force, and Xerox. BroadVision, which employs 167 people, has annual revenue of $50+ million and derives it from perpetual software licenses (35% of MRQ revenue; 95%+ GM) and maintenance and consulting services (65% of MRQ revenue; 60%+ GM). Founder Pehong Chen runs the company and owns 38% of shares.
As a major provider of software to run large websites, BroadVision became one of the most prominent Internet infrastructure firms in the late 1990s, reaching a peak market value of more than $25 billion. Then the bottom fell out (demand from dot coms evaporated), and the painful six-year slide began. BroadVision shares fell from a high of $800 to under $1 as the company posted steep revenue declines, took asset write-offs, incurred restructuring charges, worked to eliminate large liabilities such as office leases, and saw shareholders’ equity turn negative.
Where We Are Today: A Major Positive Inflection Point
(note: all figures adjusted for recently completed rights offering)
BroadVision trades at $0.805 per share or a diluted market value of $85 million. Enterprise value is $60 million, assuming that $25 million of $33 million in net cash is considered excess cash.
BroadVision has accomplished a major turnaround:
- Recent rights offering raised $16 million, bringing net cash to $33 million (no debt).
- Operations have turned solidly profitable, with LTM EBIT of $9.6 million (18% margin).
- Company is generating cash, with LTM FCF of $8.7 million.
- License revenue is growing for the first time in years, with Q3 licenses up 31% sequentially and up 52% year-over-year.
- Excessive lease obligations have been eliminated.
Valuation: Low Risk, High Reward
BroadVision trades at multiples that do not reflect its positive fundamental inflection point.
|
|
LTM Rev / EV |
LTM EBIT / EV |
EV / Empl ($000) |
|
Art Technology Group (ARTG) |
42% |
3% |
738 |
|
Vignette Corporation (VIGN) |
64% |
2% |
415 |
|
BEA Systems, Inc. (BEAS) |
31% |
5% |
1,087 |
|
BroadVision (BVSN) |
88% |
16% |
362 |
While the above revenue and EBIT yields show BroadVision versus selected comps on a pre-tax basis, an after-tax comparison would favor BroadVision even more heavily. As of December 31, 2005, BroadVision had NOLs of $726 million and R&D credits of $14 million. A portion of the NOLs may have become unusable as a result of recent changes in ownership (due to debt-for-equity conversion by Pehong Chen and recent rights offering). While it is difficult to estimate how much of the NOL remains available, even a small portion of the total NOL would be significant relative to BroadVision’s current market value and earnings.
Based on comparable multiples of revenue and EBIT, a case can be made that BroadVision is worth multiples of its current enterprise value (2x-8x based on a quick scan of the table above). Of course, due to BroadVision’s large net cash position, equity holders have less upside than the analysis of enterprise value suggests.
While investors may differ on the multiple of current enterprise value that BroadVision is worth, little argument can be made about the strong downside protection. BroadVision’s balance sheet is extremely strong, and book value would overtake current market value if a portion of the NOL and R&D credits were capitalized. The company now has a cost structure that allows it to be profitable at a low level of revenue relative to the likely revenue going forward.
At a trailing EBIT/EV yield of 16% and opportunities for high return-on-capital investments (due to rationale discussed in next section), BroadVision offers a compelling risk-reward tradeoff.
“Explosive” Growth Potential: Why Numbers Don't Tell The Whole Story
Unlike companies that require large working capital investments and capex to grow, a software firm like BroadVision can grow revenue quickly without consuming capital. BroadVision’s software license margins exceed 95%. The software has been developed over many years of heavy investment, and new product introductions are slated for 2007. New investors can benefit without having had to endure the losses that were incurred along the way.
Revenue has declined from more than $400 million in 2000 to just over $50 million in the last twelve months. Meanwhile, the market for software to power websites, after steep declines in 2001/02, has recovered and is growing. BroadVision’s current revenue may severely understate its revenue potential. The company has stated in SEC filings that existing and potential customers have been unwilling to renew or sign up because they had legitimate worries regarding BroadVision’s financial viability. Those worries no longer apply – a look at the balance sheet makes this clear. As a result, BroadVision’s ability to close new licensing deals is likely to increase markedly. It is this dynamic that leads me to conclude that BroadVision is now in a situation that allows it to earn high returns on incremental capital invested in the business.
(It should be noted that BroadVision does not need the cash raised in the recent rights offering. The offering was conducted solely to allow shareholders to maintain their pro rate stake in the company after CEO Pehong Chen had obtained majority control by converting debt into equity.)
If BroadVision executes well, the story for shareholders could unfold similar to MicroStrategy’s (MSTR) comeback since mid-2002. In fact, comparing MicroStrategy’s financial statements from 2002 and 2003 to BroadVision’s recent financials is an enlightening exercise.
Key Risks and Concerns
The following negatives should be weighed when considering an investment in BroadVision:
- Lumpiness of license revenue. The timing of new license deals is highly uncertain. It is quite likely that BroadVision will experience a “hick-up quarter” in which license revenue will disappoint and lead some investors to question the sustainability of the turnaround. In fact, Q4 2006 looks to be a rather weak quarter, as disclosed in an SEC filing on November 15, 2006. Getting comfortable with this concern: BroadVision has reported five quarters of operating profitability in a row and now has a much stronger balance sheet than a year ago. Given the positive effect of financial stability on future deal wins, I consider it highly unlikely that the turnaround fizzles even if the company “misses” a quarter due to the lumpiness of new license revenue.
- Strength of competition. BroadVision competes to varying degrees with Art Technology Group (ARTG), BEA Systems (BEAS), IBM (IBM), Oracle (ORCL), and Vignette (VIGN), each of whom has greater R&D and marketing resources than BroadVision. Getting comfortable with this concern: BroadVision has succeeded in stabilizing its business even as competitors have been able to assert to potential customers that BroadVision may not be around to support them. Now that the issue of financial viability has been addressed, BroadVision appears to have improved its competitive position. The company also plans to introduce new products in 2007, further strengthening its value proposition.
- Credibility of CEO (or lack thereof). Founder and CEO Pehong Chen has seen BroadVision rise and fall. The rapid fall from 2000-2005 destroyed Chen’s credibility with investors. What’s more, Chen favored a “takeunder” of the company by Vector Capital last year (Chen would have retained an equity stake), and he converted debt into equity at a below-market price of $0.45 per share. Getting comfortable with this concern: Chen has regained some credibility by supporting a rights offering that allowed shareholders to maintain their pro rata ownership by buying stock at $0.45 per share. Chen’s compensation is not excessive, there are no questionable insider transactions, and Chen is heavily incentivized as the largest owner. Finally, Chen deserves credit for the significant improvement in BroadVision’s recent operating performance.
Knowledgeable Investors Have Shown Interest In BroadVision
- Vector Capital offered $0.84 per share to buy BroadVision in 2005, a time when the company had not yet turned the corner on profitability and had a much weaker balance sheet. The deal fell through because shareholders did not support it.
- Palo Alto Investors (PAI) doubled its share holding to 7.5 million shares (7% ownership) during/following the recent rights offering. It appears that PAI was not entitled to participate in the rights offering because it was not a shareholder on the December 20, 2005 record date. It, therefore, appears that PAI added to its position at prices significantly higher than the $0.45 rights offering price.
- CEO Pehong Chen paid off BroadVision’s debt with personal funds and converted it into equity at the same price as the recent rights offering.
|
Major Holders |
Shares Owned (mn) |
Pct Owned |
|
Pehong Chen, CEO |
40.4 |
38% |
|
Palo Alto Investors |
7.5 |
7% |
|
Other Shareholders |
58.4 |
55% |
|
Total |
106.2 |
100% |
Why Mispricing By The Market Is Plausible
BroadVision...
- trades on the Pink Sheets.
- is too small for many institutional investors.
- has completed a rights offering that is not yet reflected in its reported financials, adding complexity to the value appraisal process.
- has large NOLs and R&D credits that are not capitalized, making it seem more expensive relative to book value than it is actually.
- has started growing license revenue for the first time in several years, but investors may not have noticed because overall revenue is still declining slightly (service revenue is declining due to past declines in license revenue).
- still has an LTM GAAP loss due to a large charge in Q4 2005, making its strong profit turnaround not yet readily apparent.
- disclosed in a filing on November 15, 2006 that Q4 results would be weak on a sequential and year-over-year basis, potentially leading some investors to remain on the sidelines in hopes of a more favorable “entry point”.
Disclaimer
This is not a solicitation to buy or sell stocks. Please do your own independent analysis before buying or selling BVSN (or any other stock). We have a long position in BVSN at the time of this writeup that can change at any time without notice. There are no plans to provide future updates on our BVSN buying or selling activities.
Catalyst
• Value
• Continued strong execution
• Growth of overall revenue, not just license revenue
• New product and deal win announcements
• Stock repurchase (would be hugely accretive; but would it impair NOL usability?)
• Move to Nasdaq (BroadVision is already fully reporting)
• Future appearance on MagicFormulaInvesting.com (!?)