I tried to post this yesterday but it wouldn't work so with a 6% change in the stock price my numbers are off a bit.
Datawatch (NASDAQ:DWCH) develops and markets data preparation, management and analytics software.
Its primary revenue generating product, Monarch, is used to manage unstructured and structured data for preparation for analysis. For example, if you use FactSet and download financial statements in to Excel to manipulate the data to do a DCF you are using Monarch on an OEM basis. Through the acquisition of Swedish company Panopticon, Datawatch also offers data visualization tools with a niche focus on real-time visualization (customers include Reuters, Nasdaq, JP Morgan). This tool essentially converts data in to a graph on a real-time basis to make data more easily understood. While Monarch may sound like an easily replicated software tool, Datawatch has been investing in and improving Monarch software for 20 years. Monarch’s main competitive advantage is the ability to access unstructured and semi-structured documents for data prep. Because of this advantage, Datawatch has OEM and resale agreements with Tableau, Qlik, IBM, Xerox and Dell’s Statistca and many others.
The reason I believe that Datawatch is a good investment is that the current management team had pie-in-the-sky dreams of competing with high growth vendors of data visualization and management software companies like Qlik and Tableau and failed miserably. I have not run a screen but I believe this management team probably has the worst sales growth/ investment growth ratio in the entire public software space. Because of this abject, failure management has done an about face and decided to focus on growing the core/ legacy Monarch business that has been around for over 20 years. While they have switched focus they have not right-sized the financial structure of the business for this focus.
How do I know this? Datawatch has been a public company for over 15 years. Prior to the financial crisis Datawatch generated a fairly stable $20 million in revenue, $2 million in CFO with $100-150,000 in maintenance capex.
Since current management took over, they have burned through $23 million in cash in the last two years on the aforementioned data visualization dream. Even after downsizing the business to focus on the legacy Monarch software, management is still running opex of $8-9 million a quarter versus the prior management team of $4 million. Sales are 50% higher currently but that is all due to Panopticon revenue which was acquired in 2013. In other words, the current management team has burned through $23 million of shareholder’s money to achieve no organic sales growth, has reverted to focus the salesforce on the legacy business and yet is still operating the business with greater than 100% higher opex than the previous management team. This is quite simply inexcusable and the new management team’s failure to grow the company at significant expense to shareholders means one thing, it must be sold. Given management’s failure to grow the business and its reversion to focus on the stable and highly profitable legacy business, the Board has transparency that this is the right thing to do as fiduciaries of the company.
The most sensible purchase candidate would be one of the above resale or OEM partners as they could put Monarch in their salespeople’s “bag” or simply incorporate it as a license feature in their existing software and eliminate significant sales and marketing cost.
A reasonable income statement under this scenario would look like this:
Revenue: $30 Million
CoGS: $7.5 Million
Gross Profit: $22.5 Million (Current gross margins are 80% + vs. 75% est. here)
R & D: $3.5 Million (Under previous management R & D was $2 million)
S, G & A: $6 Million (20% of revenue is realistic under a takeover)
EBIT $13.5 million
Datawatch also has:
Cash: $33 million (current burn rate of $2 million per q)
Net operating loss carryfowards:
U.S. Federal: $41.5 million
U.S. State: $26.2 million
U.K.: $7 million
Australia: $3.2 million
Germany: $2.2 million
Singapore: $3 million
Sweden: $9.6 million
Total NOLs: $92.7 million
I am not going to do a 382 limitation and NPV analysis but I think we can safely say in the hands of a larger, global competitor they would be worth $25 million.
On a sum of the parts basis this adds up to:
8x EBIT = $108 million
Cash= $33 million
NOLs= $25 million
EV= $164 million
With 12 million shares outstanding and a $4.20 share price there is lots of upside versus the current market value of $50.4 million (EV $17 million)
Another way of realizing sum of the parts is:
3 x maintenance revenue (very high margin and recurring) of $16 million= $48 million
1 x license and service revenue of $14 million = $14 million
Cash = $33 million
NOLs = $25 million
EV = $120 million
While some of the bloom is off the data/ big data rose and thus you may feel my estimated valuation seems excessive I believe the likes of IBM, Dell and Xerox need growth, especially from software while Tableau and Qlik would see Datawatch as a “nice to have”. Further confirmation of Datawatch’s value comes from Hitachi’s purchase of Pentaho about this time last year at 13x revenue. Pentaho is similarly positioned to Datawatch in Gartner’s Magic Quadrant for data management software.
Incentive to sell
Vice Chairman David Mahoney 282,983 shares.
Mahoney is the former CEO of Applix, a company that he sold to Cognos which soon thereafter was sold to IBM.
CEO Michael Morrison 186,743 shares
Morrison was the COO of Applix during Mahoney's tenure at Applix.
Christopher Cox Director 711,193 shares or 6.30%
Part of this holding is as a Director/ Trustee of WC Capital. WC Capital is an investment holding company that was run by James Wood, a former director and shareholder of Datawatch. I would note that Chris Cox is a corporate lawyer with practice in both corporate governance and private equity. Since James Wood’s death he also now has oversight of Wood’s widow’s investment in Datawatch as a trustee. Given the recent performance of Datawatch, both as a company and a stock, he should be feeling the pressure as both a fiduciary for Datawatch shareholders and Mrs. Wood’s trustee.
I do not hold a position with the issuer such as employment, directorship, or consultancy. I and/or others I advise do not hold a material investment in the issuer's securities.