Description

Group 1 Software is a small-cap software company specializing in the sale of marketing and bill-presentment software packages.

Valuation:
Price: $14
Shares+preferred: 7.4mn
Options: 2.2mn @ 8
Diluted Market Cap: $133mn
Net cash: $43mn (estimate as of 3/31/01)
EV Adjustment--cash from option excercise = +$17mn
Revenues: $94mn (estimate)
EBIT '01 (FYE March): $11mn
R&D: 5% of sales
Free cash flow: $11mn
EPS: about $1.20

EV/EBIT: 6.5x
EV/Sales: 77%
P/E: 12x

Financially, there are a few interesting things to note. First, on a market cap of $123mn, the company generates roughly 11-13mn in free cash flow, indicating a free cash flow yield of roughly 10%. Second, recurring maintenance-like revenues are about 50% of total and have a gross margin of 65%. Third, the company has compounded revenues at 15% and EPS 80% annually for the past four years, each year better than the last. (The figures include the effect of acquisitions). So, financially the company has performed quite well, growing intrinsic value on a per-share basis much faster than the average company. Yet the stock languishes in the middle of an 18-month trading range.

The company has no Street coverage to speak of, and net cash (adjusted for options) is equal to a third of fully-diluted market cap.

GSOF's typical customers send millions of bills to their clients and need a package to track the billing process, track addresses and the success of fulfillment issues (eg. do they have a correct zip code given a particular address?, etc), and even calculate taxes for on-line customers. The marketing aspect of their packages becomes relevant when companies send cross-selling material along with bills. For instance, LL Bean may send you a bill, but notice that you've purchased a particular item in the past and send a solicitation for a similar item along with the bill. Cross-selling generally has a much better success rate than mass mailings, so a software that tracks buying habits of a company's customers is a valuable tool.

The package which helps in determining tax payable is very timely, as states increasingly become interested in taxing the huge volume of untaxed on-line sales. GeoTAX uses GSOF's database of addresses to verify tax jurisdiction thus determining the tax owed dependant on, say, a mailing address.

Customers of the group include American Express, Lehman Brothers, JC Penney, LL Bean, MetLife, Ameritech, MCI, IRS, the US Senate, and (gulp) Pacific Gas and Electric, and others.

Competitors currently include Harte-Hanks and other market-data firms. In the future, though, as bill presentment increasingly goes on-line, the competition should expand to include companies such as Broadbase, Siebel, & Epiphany. For now, though, according to IDC, GSOF is the market share leader in the worldwide Marketing Automation Application area.

Apart from the market position, what I like about this apparently boring business is that there are barriers that GSOF has built up to keep them competitive. Among them is an installed base of loyal users who view GSOF software as a value-added tool with rapid payback. These are "real" customers, not a bunch of fly-by-night dot-coms. High renewal rates are a sign that, indeed, these 'real' customers view these products as necessary and not easily substituted. 67% gross margins show that companies are willing to pay a nice sum for the product. Another barrier is GSOF's postal database, which is an integral part of their billing software. This database is updated on a quarterly basis, providing a source for maintenance revenues.

My intrinsic value is 15x EBIT, or 20x P/E. This equates to $27, or roughly double the current price, and is justified by the +100% pre-tax return on capital, good growth prospects, and solid cash generative ability. The company seems to be in a sweet spot for future growth opportunities, and the current low price provides a nice cushion in the event that growth doesn't materialize. A very attractive risk reward.

Management owns about 18% of the shares and 100% of a preferred stock issue that acts as a poison pill, thus mitigating the potential of one catalyst.

Catalyst

Catalysts include: take-up of the company's tax jurisdiction package by states eager to implement taxes on on-line sales. Florida has just undertaken something similar via a new telecom tax. GSOF's GeoTAX is to be used to ensure that taxes are levied and distributed correctly. Another catalyst is an increase in demand caused by the increasing use of electronic bill delivery