Description

Have listed the business description below from the AR, and you can also find the Annual Information form for this company on Sedar.  All figures are CAD

Sales                      Adj EBITDA

·         2021       467177                  168509

·         2020       503778                  176816

·         2019       385853                  115580

·         2018       342845                  106046

·         2017       325368                  93999

I wrote up Enghouse Systems about 12 years ago (after being introduced to it by a VIC writeup by andrew152) and have maintained a position ever since.  While the investment is up about 9x since then, the stock has been beaten down lately and currently trades right near the 52 week low ($34.21-64.42).   Here is why I like the business:

*company has a cash-heavy BS.   As of last Q cash currently equals $215m and is typically growing roughly $25m a quarter (sans working capital and after 40+m dividends)

*attractive FCF yield.  Based on CFFO, the FCF yield is 7% based on FCF/EV, but a NI+Da adjustment puts the figure over 8%.  Those same working capital adjustments would also add cash to the BS. 

*pays a growing dividend (74c) typically raised by 10% or more each year (special dividend paid a year ago)

*minimal CapEx requirements for the business, with $3m typically over the last many years

*minimal RSU corruption, with RSU expense typically at less than 2% of cash flow each year

*significant insider ownership, with the CEO and Chairman at 23% ownership

*long and successful history of acquisition related activity and smart capital allocation.  This is just my opinion, but having watched Mr. Sadler operate for many years and reading his comments in the calls I believe he is a top-flight money manager/CEO with superior capital allocation skills.  He does not buy shares, believing that the opportunities he is exposed to offer greater value building opportunities, but is very adept at allocating money and I don’t worry about him like I do 95% of other CEOs.   Here is a chart of the cash flow, acquisitions, etc. for the past 6 years for this company:

Negatives are pretty much the same as they were a decade ago, with one specific to right now:

*recent sales comparisons have been negative year-over-year.   This is primarily due to a huge growth in the Vidyo division (a 'lucky' buy the previous year bot for 40m when it had 60m in sales pre-Covid; sadler mentioned they got a one year payback on this investment) during the pandemic that has tailed down every since, but some is also likely due to the pandemic in general, a growing cloud trend in the contact software division, and Covid related restrictions that have curtailed acquisition activity (my surmise).   Most of the tough comparisons have now tailed off, but in valuation terms Enghouse was seen as a fast grower when revenue spiked with a higher stock price with the valuation now getting clocked and reflecting a slow grower business.

*acquisitions have tailed off.  As can be seen from the above chart, the company’s acquisition activity has tailed off since 2019 with little news in the last nine+ months.   This is not due to lack of trying – Mr. Sadler has mentioned several times his desire for good acquisitions but stated until recently that valuations were more than he wanted to pay.   However, this seems to be changing with the latest geopolitical news and hopefully fewer CAD related Covid restrictions will get this part of Enghouse’s growth engine going again.   

*reliance on Mr. Salder.   It is hard to tell but from following Constellation Software and this one this business seems much more reliant on Mr. Salder’s skillset and ability.  I’m ok with that, but believe this does represent a key man risk.

*it is hard to tell what organic growth here might be.   I have struggled with many years to figure this out but the business is hard to peg, but my guess is that organic growth tends to be flat to down slightly.  However, with previous acquisitions, a shift to cloud, and fx fluctuations, I am not entirely sure.  Some growth challenges seem to be due to the willingness of competitors to sign uneconomic deals that Sadler believes could eventually straighten out as those business models either run out of money or sell out but timing is uncertain 

*for me personally, I don’t have a "true" appreciation as to what they do and more importantly how they stand in relation to competition (contact center and transit related software is for me an obscure business, and I don't see many avenues in building a true edge), but that has been true throughout my entire ownership and I’m ok with this gap in my knowledge.  I know for some of VIC that would be a stop sign but it doesn’t bother me overly much, being overly dense and stupid about much of what I buy but FCF tends to be an equalizer, especially if you trust the person running the business and pay attention to what the market thinks externally.

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In the end, I trust in this CEO, and believe most of the toughest compares are beyond them, especially since the stock was decked double digits on Friday on a blah but ok report (IMO).   What this stock needs is a happier tape and what the business needs is for acquisition activity to ramp up again.  He certainly has plenty of cash and is ready to go.   Course, as anyone knows the stock, especially an otherwise obscure Canadian one, can get cut in half again too but I would be adding all the way down.  

On the estimates, I don’t tend to derive them other than looking at the past figures.   If it matters, TD Newcrest has a 160 and 179m EBITDA estimate for 22 and 23.  Price target is $50 with expectation of accelerated M*A, cloud migrating gaining traction (not sure this is true), and expectation of continued strong margins.  Estimate is based on 13.5-14.5 valuation multiples vs 16.7% historical average.  I am not familiar with this particular analyst.

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From the AR:  Enghouse is a Canadian publicly traded company (TSX:ENGH) that provides enterprise software solutions focusing on contact centers, video communications, remote work, communications for next generation software defined networks, public safety and the transit market. The Company’s two-pronged growth strategy focuses on internal growth and acquisitions, which, to date, have been funded through operating cash flows. The Company has no debt financing and is organized around two business segments: the Interactive Management Group (“IMG”) and the Asset Management Group (“AMG”). IMG specializes in contact center and interaction software and services designed to facilitate remote work, enhance customer service, increase efficiency and manage customer communications across multiple types of interactions including voice, email, web chats, text and video. Core technologies include contact center, video collaboration, interactive voice response, artificial intelligence, outbound dialers, attendant console, agent performance optimization, customer survey, business intelligence and analytics that may be deployed in private cloud, multi-tenant cloud or on-premise environments. IMG’s customers are varied and include financial services companies, telecoms, business process service providers, as well as technology and health care providers. AMG provides a portfolio of software and services solutions to a number of verticals such as cable operators, network telecommunication providers, media, transit, defence and public safety companies. Its products include network infrastructure, Operations Support Systems (“OSS”), Business Support Systems (“BSS”), and revenue generation solutions such as video and Cloud TV solutions. fleet routing, dispatch, scheduling, transit e-ticketing and automated fare collection, communications and emergency control center solutions for the transportation, government, first responders, distribution and security sectors. Enghouse continues to focus on building a consistently profitable enterprise software company with a diversified product suite and global market presence. The Company remains focused on generating positive operating cash flows and having a strong balance sheet. Deploying capital on acquisitions and replacing it through operating cash flows is pivotal to our acquisition strategy and allows Enghouse to pursue further acquisitions. The Company emphasizes the importance of recurring revenue streams to increase shareholder value and the predictability of its operating results. While Enghouse continues to develop and enhance its existing product portfolio to grow organically, including expanding our hosted solution offerings, it is also important to augment and expedite this strategy with new and complementary technology, products and services obtained through acquisition. This dual-faceted approach will enable us to provide a broader spectrum of products and services to our customer base more quickly than through organic means alone.

Catalyst

resumption of acquisition activity and happier tape