Infinium Software is a developer of enterprise resource planning (ERP), customer relationship management (CRM) and supply chain management (SCM) software. The company develops its software exclusively for the IBM AS400 and iSeries mainframe/ server platform.
The company has 1800 customers and sells in to three main vertical markets; small to medium sized manufacturers, hospitals and casinos/ hotels. Infinium’s revenue is split between ERP (financial and human resources management) 75 percent, SCM 20 percent and CRM five percent. The company is about number 30 in the ERP/ CRM/ SCM market space with about 0.8 percent market share. Its main competitors in the market for this software/ IBM hardware combination for small to medium business are JD Edwards and Lawson Software although they would also compete with the likes of SAP in certain cases.
Infinium’s customers characterize their software as very user friendly, with excellent support and service and a very low total cost of ownership (TCO) as compared to other software vendors. Because of this, customer retention runs at greater than 95 percent and customer satisfaction also runs at greater than 95 percent, based on an independent annual survey. They have had a great deal of success in some of their verticals. For example, in Las Vegas they installed their ERP software with Harrah’s in 1991 and now have 95 percent of the hotel/casinos in Las Vegas as customers.
While it is somewhat disconcerting that they do not provide software for other hardware/ software platforms (Windows NT, Sun or HP/ UNIX) it would also expose them to markets with firmly entrenched competitors. In fact, Infinium did develop their ERP software for Windows NT but had little success and discontinued the line in 1999. Going forward, I would guess that in their verticals, most companies who were going to move away from IBM have already done so thus limiting any serious decline in numbers in their potential markets.
In 1998 the company decided to hop on the application service provider (ASP) bandwagon. This was the same management team that had tested the waters for their product in the Windows NT environment. The foray in to the ASP segment met with similar success as the Windows NT experiment; they built it but nobody came. Furthermore, rather than outsourcing this endeavor to a third-party ASP they built it and staffed it themselves incurring significant capital expenditures for the hardware and significant overhead for the people to operate it.
In February 2001, James McGowan was brought in as the new President and CEO and he built an entirely new management team in fiscal 2001, ending September 30th. McGowan brought in a “back to basics” management philosophy leading to investment in projects that met two criteria; is it core and is it profitable. He also discontinued the ASP business, resulting in a “big-bath” write-down in fiscal 2001 and significantly cut operating costs.
The company’s revenue peaked in 1999 at $122 million as they benefited from high demand for ERP licenses and received some service revenue benefit from the Y2K scare. Revenues have declined more than 20% in each of fiscal 2000 and 2001 and stood at $74 million at the end of fiscal 2001. Their all important, high margin license fee revenue declined from $41 million in the ERP boom year 1998 to only $10.3 million in 2001. Service revenues have been more stable, declining from $73.5 million in 1998 to $63.7 million in 2001.
The company has also experienced operating losses going back to fiscal 1997. Infinium was cash rich, with a cash horde of about $40 million, and business was good in the late 1990s so, as previously outlined, the management team looked for growth opportunities. Operating losses grew from $1.6 million in 1998 to $19 million in 2000 in the thick of operations for the ASP business and declined slightly to $13 million in 2001.
The high spending times at Infinium, however, changed in 2001 with the introduction of James McGowan as President and CEO. Not only did McGowan discontinue the unprofitable ASP business he also cut costs in the core business. My estimates for fiscal 2002 operating costs are $54 million compared to operating costs of $87 million in 2001. Because 2001 included some operating expenses for the ASP business, 1997 may be a better benchmark year (pre-ASP business) when operating costs were $82 million. Costs have been stripped out of every nook and cranny of the business; the investor relations manager had his cell-phone taken away for example.
For the first half of 2002, operating margins stand at 18 percent versus a loss in 2001. As I stated earlier, management also took a “big bath” with the write-down of the ASP business. With the write-down the company wrote-off $1.6 million of acquired technology and $2.7 million associated with the change in the company’s estimated useful life of capitalized software. They also moved from a three-year amortization schedule to an eighteen month amortization schedule for software capitalization which is at least a better reflection of economic reality. This doesn’t matter because I don’t like capitalization of software and will expense it in my valuation. All this is to say is that depreciation and amortization expense has gone from a $3.9 million annual rate to a $1.6 million annual rate for 2002 and has goosed earnings in the first two quarters.
The company also has a net operating loss and tax credit carry forwards of approximately $48.4 and $2.3 million respectively that expire at various dates through 2020.
Management has not given revenue guidance for 2002 but has given earnings guidance of $0.90-1 per share for 2002. This seems realistic given that the company made $0.45 in the first half of 2002, including a two-cent gain on an asset sale. Given this guidance total free cash flow for 2002 should be:
Earnings at .90 cents p/s: $12,700,000
Plus depreciation and amortization: $3,200,000 (note this amount includes little capitalized software amortization with last year’s big bath)
Less capitalized software: $1,000,000 (it has only been $80,000 for the first six months but I want to account for potentially higher software capitalization later, now)
Less PP&E capex: $600,000
Total free cash flow $14,300,000 or $1.01 per diluted share.
The company has no debt and $17,500,000 in cash.
Market value equity= $7.10 x 14,147,000 shares = $104,687,800
Less cash = $17,500,000
Enterprise value = $87,187,800
Free cash flow = $14,300,000
EV to fcf = 6.1x
I believe 10x free cash flow is a fair valuation offering a potential short-term return of about 65 percent. I believe this a conservative multiple given the multiples often afforded software companies; a slightly higher multiple, 12x for example, would lead to a double. Lawson (LWSN) and JD Edwards (JDEC), Infinium’s two main competitors, both trade at 20 x EBITDA.
I view this as more of a straight value play than a value and growth play. I would point out that Infinium is suffering from the same economic circumstances as other software vendors and there is a potential for future growth in license fee revenue with a better economic cycle. They have recently introduced a web-based version of their software in March 2002 but have not had an upgrade of their installed based software for 18 months. The upgrade cycle should bring an up-tick in license fee revenue; in fact Q3 ‘02 to Q3 ’01 license revenue will be up 100 percent based on management guidance.
The company has also identified 600-700 potential clients in the manufacturing sector who use their ERP software but not their SCM software as potential new licensees.
Greater recognition of the turnaround that is taking place and INFM's low valuation.