|Shares Out. (in M):||44||P/E||0||0|
|Market Cap (in $M):||295||P/FCF||0||0|
|Net Debt (in $M):||80||EBIT||22||25|
Magic Software is a reasonably priced software and IT company. MGIC is based in Israel and provides software solutions and IT services, with about half of revenue derived from the U.S., and the other half from Europe, Israel, and Japan.
MGIC trades at under 11x EBIT with historical revenue growth around a mid-teens rate. I think the stock has upside of about 30% to $9 over the next year based on 10% growth and a target multiple of 13.5x EBIT. The company has over a quarter of its stock price in cash and has a dividend of yield of 2.4%.
The company provides application development, business process integration, and comprehensive packaged software solutions and related professional services, as well as providing IT professional and outsourcing services. Consulting services represent 58% of revenues and have been growing faster than the higher margin software and maintenance revenues. The company has good financial attributes, with 40% gross margins, 13% operating margins, and a tax rate in the low teens. This produces around a low double digit ROA and healthy free cash flow due to limited capex requirements.
Formula Systems (ticker: FORTY), an Israeli IT services holding company, owns 45%, of Magic’s shares. 46% of FORTY shares are in turn owned by Asseco, a Polish company listed on Warsaw Stock Exchange. MGIC was over $9/sh in February of 2014 but has been in decline since the company raised $55M in a secondary at $8.50/share in March of 2014. The raise took FORTY’s ownership below 50%. The stated purpose was to accelerate the hiring of sales staff and raise money for acquisitions, but this was definitely unnecessary as the company already had $35M of cash before the raise. From CEO comments, it sounds like another purpose of the raise was a misguided attempt at bringing investor interest to the company:
“I can tell you that the -- let's put it this way the idea of raising the money was first to bring some new investors because the company was under the radar and no interest whatsoever so -- in the States you cannot bring new investors unless there is a deal on the table. No bank will work for you unless you have a deal.”
So despite the misstep of the raise I think the stock has good prospects going forward with a reasonable valuation and continued growth prospects. I think the stock should appreciate as the taint of the secondary diminishes over time. The company will continue to pursue acquisitions, which will increase earnings as the company’s excess cash is put to work. The company dividend policy shows that there is some respect for shareholders, with a policy to pay out 50% of net income as dividends. Downside seems fairly limited given the company’s valuation and cash position. 9x EBIT on flat earnings would put the stock at $6, giving the stock around a 3 to 1 risk reward.
Valuation penalty derived from unnecessary secondary fades over time
Continued growth over time