Description
Halogen Software is a Canadian provider of talent management software whose stock is undervalued as a result of a broken IPO, a shareholder overhang, and the company's current unprofitability. After IPOing at $11.50 in mid 2013, HGN disappointed investors due to slightly higher churn rates and the forecast that the company would not be profitable for the foreseeable future, causing the stock to decline from $14 to $8 in the middle of 2014. The stock has also struggled as a result of an overhang from private equity owner JMI as well as a lack of understanding/interest in an unprofitable SAAS company by Canadian investors. As the company invests for the long-term, its multi-year road to profitability is also beyond the timeline for most public market investors. However, HGN has a very strong competitive position and is trading at less than 2x its valuable recurring revenue stream, far below most enterprise software peers (at least 3-5x). This recurring revenue provides significant downside protection near $6.50 as well as the potential for material upside to $15-17.50+ which is an attractive risk-reward near $8.
**** NOTE- trades in CAD but USD functional currency ******
Capitalization and Valuation
HGN has 22.2mln diluted shares for a market cap of CAD 192mln at CAD 8.63 or USD 153mln. At 12/31 the company had net cash of USD 46.8mln. However, HGN is expected to burn ~5mln per year in FY 15 (expects to be cashflow positive in FY 16) suggesting an adjusted cash of 39.25mln (1.77 per share) and an EV of USD 114mln. 2015 sales are expected to be USD 67mln (1.7x) with recurring revenues of USD 58.9mln (1.9x).
Business
Talent management is considered a rapidly growing market in software with various industry analysts such as TechNavio, Bersin and Gartner expecting high-teens to 20%+ revenue CAGRs for the industry. Furthermore, this growth should be especially focused on small to mid-market enterprises where Gartner estimates that talent management software penetration is between 5-10%.
HGN is considered best in class in its niche of mid-market (100-10,000 employees) TM software. The company garnered the highest score in customer service in both IDC, Gartner, Bersin and Forrester and its 100%+ dollar retention rate is far in excess of its mid-market peers.
Highest customer satisfaction score based on 325 reviews from HR professionals- 2014 Grid for HR Management Suite rankings
“Halogen garnered the highest scores in customer service and cost-effectiveness from its clients” IDC, MarketScape Worldwide Integrated Talent Management Vendor Analysis 2012 Vendor Analysis,April 2012
“Halogen continues as a leader in customer service and support; customers view Halogen as a partner.”Forrester,The Forrester Wave: Talent Management, Q1, 2013, March 12, 2013
"A clear leader in every customer satisfaction area measured by- prdouct quality, implementation, service and business partnership." Bersin by Deloitte, Talent Management Systems, 2011 Report - (note how far HGN is away from its peers)
Significant customer diligence has confirmed that Halogen is a market leader among small/mid sized enterprises with excellent customer service. The company is noted for its strength in performance management and excellent customer service. These customers have also noted that TM software is "mission critical" to their HR department and that it is very difficult to remove a TM vendor once they have been installed. This stickiness (as show by >100% dollar retention rates) supports the idea that HGN's recurring revenue should have significant value.
HGN has grown recurring revenue at a 27% CAGR from 2010 to 2015 (est). Strong 20%+ growth (constant currency) is expected to continue in 2015 and going forward as the company continues to grow out its sales force and attack an underpenetrated market in both North America and internationally.
While HGN is currently loss-making, management argues that this current profitability is a result of the company's choice to grow rapidly to gain market share in an underpenetrated industry. The company has made these investments in its sales force (75% of S&M expense for new customers) and in R&D for adjacent products. The CFO argues that the company could easily be profitable at current revenue levels if they made that choice as a result of their 70+% gross margins.
Upside
As the company continues to grow revenue at ~20% annually, their consistent execution should lead to it being revalued closer to SAAS/enterprise software peers (3-5x revs). At 4x 2015/16 recurring revenue, HGN should be worth $15-17.50.
It should also be noted that HGN could be an attractive acquisition due to its strong revenue growth, low churn and high gross profit margins (mid 70% margins) and the fact that an acquirer could cut out most of the company's cost structure.
The company recently announced a normal course issuer bid to attempt to repurchase 5% of the company's float over the next year. For an illiquid, unprofitable company, this buyback is a strong action supporting the idea that management views its stock as undervalued at current levels
Downside
HGN has a net cash balance sheet and a stable recurring stream of revenue. At 1.5x 2014 recurring revenue, HGN would be worth CAD 6.50. 1x 2014 revenues is CAD 5 which is extremely conservative.
I do not hold a position with the issuer such as employment, directorship, or consultancy.
I and/or others I advise hold a material investment in the issuer's securities.
Catalyst
Continued Revenue Growth
Cash flow positive in 2016
Removal of JMI overhang