Description

Price: $3.05

52 Wk Range: $2.89 - $6.59

Shares Outstanding: 60.72

Market Cap: $185m

Cash at last quarter: $31m

Debt at last quarter: $72m

EV: $226m

Net Operating Loss Carryforwards: US + Foreign $66m

Despite its uniquely scalable global platform and proven free cash flow generation, the stock trades for 30% of its IPO price and half of its 2005 Goldman-led secondary offering price.  The shares change hands at 41% of 2007e sales, and sport a double digit (and growing) free cash flow yield based on my estimates of 2008 and beyond.  On every single matrix, from software company valuations to professional services, to consulting firms, Lionbridge is cheap.  A combination of low market cap, confusion between GAAP and Cash earnings, and a merger integration that took longer than the Street expected, are the cause of its depressed valuation.  Lionbridge shares trade at the same level as in 2003 despite growing sales and EBITDA every year since that time and despite acquiring its largest competitor, Bowne Global Services.  I believe that this company and its shares will emerge as both a turnaround and a growth story as the company realizes operating leverage both from its organic growth programs and from the synergies it will continue to generate from the integration of BGS.  The shares offer upside of at least 25% with very little downside.  Over the next 2 to 3 years, I believe the shares are a double.

The market for Lionbridge’s services is around $10B USD and is driven by global growth in software, mobile usage, electronics, web publishing and consumer and commercial content internationalization.  Note that only one in three Internet users logs on to the Web in English.  The Company’s customers include Adobe, Canon, EMC, Expedia, GE, Google, Honeywell, HP, IBM, Microsoft, Motorola, Nestle, Nokia, Oracle, Pearson, Philips, Porsche, Samsung, Sony and Yahoo.

The Company has three business units, which they label GLC, GDT and IS.  GLC stands for Global Language and Content.  A live GLC example is as follows: Motorola is releasing a new phone in 29 countries and they need the software menus on the phone to feature 29 different languages.  LIOX translates English into the local languages and then manages the content over time for additional changes as required.  This business represents the bulk of LIOX’s revenues. 

LIOX enjoys significant repeat revenues from its customers as the only player in the industry that can offer an end to end translation solution.  Because the business requires little capital to grow, LIOX is enormously cash generative.  This can easily be seen in the balance sheet, despite years of somewhat distorted GAAP earnings reports.  At the time of the BGS acquisition, LIOX had net debt of around $78m.  Eight quarters later, net debt stands at $41m, a reduction of $37m.  Without any of the margin improvement opportunities I will describe later and amidst a hectic integration process which took up a great deal of management’s time, Lionbridge still managed to generate over $4.5m a quarter in free cash flow available for debt paydown, or over $18m annualized.
 
Logoport and Freeway
The LIOX offering contains two very sticky, valuable and growing applications that give the firm a significant competitive advantage.  Logoport is, in the Company’s words, an internet-architected, hosted translation memory application that manages previously translated words, phrases and glossaries in real time and simplifies translation management.  In my words, it is essentially a giant database of previously translated items.  The system contains 2 billion words and grew 200% last year.  According to the Company, Logoport has 10,000 registered users, 1,500 active translators per week and 700 customers.  The system ensures a continued reduction in the cost of translation over time, especially as complex language does not need to be translated over and over again.  Over one third of LIOX’s work passes through Logoport.  In my opinion, the value of this database engine is not adequately reflected on the LIOX balance sheet.

Lionbridge is also adding workflow capabilities and integrating portal and machine translation technology, into a comprehensive language management platform called Freeway.  This comprehensive hosted infrastructure is enabling Lionbridge to provide clients with high quality globalization services and highly efficient centralized language management processes.  Freeway currently hosts 600 projects per month, 1,200 registered users and 210 customers.

It is my supposition that in the not-too-distant future, LIOX will be able to offer customer’s in- house technology departments the use of Logoport and/or Freeway for a fee.  This people and asset-light, almost royalty-type model will be more and more important as these platforms grow and remain a significant source of hidden option value for LIOX as well as important competitive advantage.

Margin Improvement Opportunities
LIOX has a number of different areas where management is focusing on margin improvement opportunities.  On the November 6th Conference Call, new CFO Donald Muir outlined 1. enhancing cash flow, 2. reducing foreign income taxes, 3. better managing foreign currency exchange rate exposure and 4. improving decision support systems and processes.  Muir came in to replace Stephen Lifshatz, the former CFO whose resignation we believe came on the heels of 1. Rory’s desire to take the businesses to the next level now that BGS has been fully integrated and 2. personal / family issues which distracted Lifshatz from the day to day details.  We believe that the LIOX model has tremendous operating leverage and the essential nature of its services does contain pricing power.  The weaker dollar has masked a good deal of BGS synergies and margin improvement to date (many LIOX employees paid in local currency yet sales are in dollars), and Muir needs to find a way to hedge this exposure.  In addition, LIOX has a $66m NOL carry forward (1/3 of the market cap) which Lifshatz did not have high on his priority list in terms of figuring out a way to unlock the value.  Muir clearly says on the last conference call that LIOX is going to bring cost effective tax expertise to the company.  There has to be a way via transfer pricing for example, to match U.S. losses with foreign tax exposure.  As an investor, I am not counting on it, but the upside to free cash flow is indeed significant if they can use even 50% of this NOL.

 
Competitors
LIOX’s main competition consists of Companies who perform language and content development in-house.  LIOX’s more than $400m in revenue is 2x the size of what could be deemed its closest competitor, SDL, a UK based company that does not offer an end to end solution like LIOX.  In essence, LIOX’s biggest competitors are the in-house departments of the Companies they service.  The Company must continue to prove that their solution is better and cheaper than in-house alternatives.  Logoport and Freeway are key tools that help sell the value proposition to LIOX’s customers.
 

Management
My observations of Rory Cowan is that he is honest, hard-working, intelligent, articulate and has vision.  While LIOX shares have not dazzled investors these last few years, Rory has been working behind the scenes to put together what will ultimately be a better Company than could have been possible without BGS and without the technology platform his team has created.  The negative commentary is that Rory has occasionally allowed the long-term vision to interfere with day to day execution and management of a very complex global technology company and the stock has paid the price, thus presenting an opportunity to buy a company at a cheap valuation and at a compelling organizational inflection point.

Valuation
There are no direct comps for a business like Lionbridge so I have tried to use a combination of both software and consulting/professional services organizations.  LIOX’s global reach and customer base contain tremendous value to an acquirer who can also offer other services.  Deals in this space get done at high multiples of EV to Revenue (ex. in April of 2007 Computer Sciences bought Covansys for over 2.5x ev/sales).  While this is not the greatest comp metric in the world by any means, it does provide an introductory snapshot into LIOX’s discount to its peers.  Since each business model is quite different, I chose EV/Sales for more of an apples-to-apples comparison.  As sales and margins grow, LIOX starts to become interesting to players like Accenture or others who have no dedicated practice that is doing what LIOX does.  Again, if somebody wants to pay a premium for the LIOX franchise, great.  If not, shareholders should be rewarded through the Company’s own growth and redeployment of its free cash flows.

 
EV / Sales Comparison
Company / (EV/Sales) most recent yr end
Software/Consulting – Art Technology (4.2x)
Software - Interwoven (content mgmt) (2.1x)
Consulting – iGate (1.31x)
Consulting – Telvent (.82x)
LIONBRIDGE (.53x)

Once again, while these numbers are interesting, it is not the reason why LIOX shares offer a great opportunity.  Like any security, LIOX should be valued based on its free cash flows and return on investment.

LIOX currently has a revenue base of around $440m for FY 2007.  For FY 2008, Rory guided to 6-10% growth.  I assume the company can generate 5% revenue growth, which yields total revenue of ~ $460m.  I do not think it is a stretch to say that LIOX can achieve an 8% EBITDA margin if Muir is doing his job and all the “dirty work” of BGS is now well behind the team.  EBITDA margins were 8% in 2006 on a lower revenue base, and should be approximately 7% in 2007 - hard hit by currency.  I believe that this is a mid-teens EBITDA business over the next three to four years although that is not the current Street expectation.

Some free cash flow numbers are listed below at different EBITDA margin levels.  The difference between EBITDA and FCF is interest expense (about $5.5m currently but ratcheting lower as debt is paid down), taxes (using a 35% rate but buffered by the NOL if they can utilize it) and capital expenditures (around $5m per year in maintenance). 

EBITDA and (FCF) at various EBITDA margins:
@ 7.5% EBITDA margin.. $35m EBITDA & $18.7m FCF
@ 8.0%  $37m EBITDA, $20.2m FCF
@ 8.5%  $39m EBITDA, $21.7m FCF
@ 9.0%  $41m EBITDA, $23.2m FCF

While I believe that LIOX will in the very near term generate $20m+ annual free cash flow, the growth, NOL upside and further margin improvement opportunities can take this number to $25m or $30m as the business grows.  I believe today the stock is worth the following at the range of FCF multiples I provide (using only my base $20m in FCF):

@ 12x:  $3.95
@ 14x : $4.61
@ 16x   $5.27

I consider this range of values to be a base case for what the business has generated in the past and what it should be able to sustain in a steady state.

 
Without margin improvement, debt pay down alone will reduce interest expense and allow the company to achieve greater free cash flows.  Free cash flow of $25m at the same multiple range yields stock prices of:

@ 12x:  $4.94
@ 14x : $5.76
@ 16x   $6.58

It should be noted again that these are base-case scenarios.  My mid-and-long-term thesis is that this company provides a value proposition that, while today must be “sold” to the customer, will very soon be “bought by the customer.  When this company reaches that level, it will be able to achieve pricing power, resulting in significant margin improvements, EBITDA and FCF well-in excess of the base case. 

Risk Factors
The risks to an investment in LIOX include poor execution of a dollar hedging strategy, an inability to fully utilize the NOL, and an inability to take advantage of the operating leverage inherent in the model.  I think that most of these risks are priced into the current depressed share price.  LIOX’s customers must stick to global product release schedules as they are planned years in advance.  Even in a slowing global economy, the firms that LIOX services may scale back on advertising and promotion, but the core essence of the products (usability, instructions, menus etc) must still be developed.

Catalyst