Note: this is a rather illiquid stock that will be reporting earnings next week so the write up is briefer than normal.

Innodata Isogen (INOD) is a leading provider of content-related business process outsourcing (BPO) services.  The BPO business focuses on knowledge and fabrication services.  Knowledge services include content enhancement, hyperlinking, indexing and general editorial services.  Fabrication services include digitization and data conversion services, content creation and XML services.  INOD is valuable to its clients because it allows them to create, manage, use and distribute information more effectively and economically.  Despite it recurring revenue base (70%), global footprint (US, Europe, Asia), longstanding relationships with blue chip customers (MSFT, Bloombert) and impressive revenue and earnings growth (EPS could grow 100% in 2008), the company remains undiscovered as it has no analyst coverage and historically has done little investor relations (although that will soon change).   Furthermore, the company has significant operating leverage (40% flow thru), large growth opportunities, a healthy balance sheet (15% of market cap is in cash) and significant insider ownership (15%).  The stock is trading at only 14x our estimated 2008E EPS which we believe is far too low considering the company’s many positive attributes.

 

As the following table illustrates, early last year the company swung to profitability and we expect the company to remain profitable for the foreseeable future.  In fact, EPS in 2008 could easily grow by 100% assuming the company can grow revenue by 20% and receive a 40% flow through to pretax profit.  Based on our conversations with management, their strong earnings visibility and their history of underpromising and overdelivering, we believe these estimates are readily achievable.  The Dec Q estimates are our own, but we expect they too are conservative.

 

 

We are optimistic on the company’s prospects for the following reasons:

 

1)      Significant Operating Leverage – Because of the company’s well established infrastructure, the company enjoys significant operating leverage.  Typically, every additional $1 of revenue generates $0.40 of additional pretax profit. 

2)      Significant Recurring Revenue- Approximately 70% of the company’s revenue is recurring.   Furthermore, almost 1/3 of the company’s “non-recurring” revenue is under long term contracts, so the company has significant visibility into its future profitability.

3)      Longstanding, Blue Chip Customers – The company has an impressive list of customers including Microsoft, Bloomberg, LexisNexis, Thomson and Amazon. Many of the company’s largest clients have been clients for over 5 years.

4)      Minimal Cash Taxes – The company’s $17mm net operating loss (NOL) significantly reduces the company’s need to pay cash taxes.  As a result, for 2007 and 2008, the company’s effective cash tax rate is only approximately 10%. 

5)      Significant insider ownership – Insiders own approximately 15% of the company’s fully diluted shares.  As a result, they have a strong incentive to enhance shareholder value and their interests are highly aligned with shareholders’.

6)      Increasing I.R. Efforts – INOD is relatively undiscovered name which currently has no analyst coverage and does limited investor relations.  However, after their earnings release in March, we expect management to be far more proactive with investor relations.  The company has retained an I.R. firm and will be begin meeting with investors.  Management will also be presenting at conferences later this year including one sponsored by Friedman Billing Ramsey. 

7)      Healthy balance sheet – The company has approximately $0.70 per share of net cash on its books, which equates to approximately 15% of its market capitalization.  This gives the company a significant margin of safety and tremendous financial flexibility.  We expect management to utilize some of this cash to make an acquisition and believe they will be very disciplined in selecting only strategic and highly accretive acquisitions.  The company has in the past also used excess cash to repurchase shares.

8)      Growing Sector – The Knowledge Process Outsourcing (KPO) industry (INOD’s primary market) is projected to grow by a 63% CAGR from 2006 to 2014, according to Frost and Sullivan’s 2007 report. 

9)      Global Footprint – For such a small company, INOD has an impressive global footprint with offices in the USA, Europe, Israel, India, China, Sri Lanka and the Philippines.  This allows INOD to service large, global companies and to process the work in the most timely and cost efficient manner.