Corel is a busted IPO, but is now trading at ~7.5x FCF with good prospects to grow profits at a modest rate going forward. Corel was taken private by Vector Capital in late 2003 for barely above cash value and over the next 2 and a half years Vector stripped out the extraneous R&D and overhead that Corel had built up in trying to maintain its status as a large software company that could compete with the big boys. 

 
The IPO was in early May, 6.5mm shares were sold at $16.  The offering price was initially set at $20, but then was lowered down to $18, and then down to $16.  The number of shares to be sold was initially planned to be 8mm, but that number was reduced to 6.5mm.  There are currently 24.4mm shares outstanding, so at $12.30 the market cap is $300mm and the EV is $357mm.  Corel recently announced the acquisition of Intervideo(IVII) for a $196mm purchase price, but IVII has $105mm in cash so the net cost to them is really $91mm.  The acquisition is expected to close in Q4.

 In the first half of 06 CREL did $78.6mm in revenues and $15mm in FCF.  Based on mgmt’s guidance they will do $172mm-$175mm in revenues for the year and ~$35mm in FCF, and half of that is already in the bag.  Note that GAAP EPS doesn’t mean anything as they have a big amortization expense and they have also taken charges relating to retiring debt early.  They report an adjusted income number which is a pretty good proxy for FCF.  Capex is going to be in the $1mm-$2mm range and their tax rate will be 10-20% going forward due to $249mm in Canadian NOLs. 

 I won’t get into much discussion about their current product line or their history as it would take a lot of space and I don’t have any special insight that you can’t get from reading the various information out there.  There is an initiation report from CIBC dated 6/11 that gives a very thorough history of the company and of their current products and strategy.  Required reading for anyone interested.  The very brief synopsis is that CREL was unfocused, was wasting lots of money on unproductive R&D, and was attempting to compete head to head with Office and Photoshop.  When Vector acquired them they refocused the company, cut out all extraneous R&D, eliminated marginal product lines, and positioned their products as the cheap alternative for people who won’t spend a high price on Office or Photoshop.  A good example of how this strategy makes sense for consumers or small businesses is that you can buy a perfectly good PC from Dell now for $500, and it would cost an extra $200-$300 to get Office pre-loaded which would increase the overall price by 40-60%.  You can have the WordPerfect suite pre-loaded for $80 and you would be able to do anything you could do with Office. 

 
Intervideo Acquisition: Earlier this week CREL announced they would be acquiring IVII for $196mm, $91mm net of cash received.  In the past 3 years IVII had FCF of $11mm, $13mm, and $8mm(they also had $9mm of FCF in the first half of 06).  Assuming CREL pays an additional $9mm in interest expense then the acquisition will be accretive to FCF by at least $3mm-$4mm right off the bat.  However, I think ultimately they will realize more than this for a few reasons: 1) There will be cost synergies in G&A, 2) they will have the opportunity to go evaluate IVII in the same way that Vector evaluated CREL and eliminate marginal product lines and wasteful R&D, 3) Both companies will have an extra 2 quarters of FCF until the deal is closed so in reality CREL will take on less than $91mm in add’l debt. 

 
So in 2007 I think $40mm in FCF is a reasonable number for the combined company.  With the market cap at $300mm then the stock is undervalued as long as the business doesn’t begin to decline.  Like I said above, I don’t have any great insight but there are a few things that have made me comfortable.  1)  Wordperfect revenues began to decline in the mid-90’s but bottomed out in 2003.  2) Revenues from their graphics segment have been growing at a modest rate. 3)  The combined company had 4% organic growth last yr 4) They have opportunities to grow which I will discuss below.

 One opportunity for them is their OEM distribution relationships.  They currently have a relationship with Dell where Wordperfect(the Word Processor only) is bundled onto Dell PC’s as the standard, no-extra cost software option.  CREL only receives about $1 for each copy that is bundled onto a Dell PC but the goal is to get people to upgrade to WordPerfect Office, which costs $82 to have bundled.  Dell represents about 12% of pre-IVII revenues.  They have other OEM deals but have recently begun a relationship where Lenovo will bundle trial versions of the Corel suite that will expire after some time period, with the option for users to upgrade to full versions.  They are hoping the Lenovo deal might someday be on the same scale as the deal with Dell.  It may or may not work out that way, but it’s free distribution and can only offer upside. 

 Also, revenues from Asia were up 30% in the first half of 2006(albeit from a $5mm base) and they view this as an opportunity for them to grow in a region where MSFT doesn’t necessarily have 98% market share. 

 
So, in summary I believe that at a $300mm market cap CREL is trading at 7.5x their pro-forma FCF and despite CREL’s history I believe their future prospects look pretty good.  If they realize synergies from IVII and if they can continue to grow the business organically at a modest rate then the stock is undervalued by quite a bit.