Value Investors Club / Mediware (MEDW)

Description

Mediware is almost a net-net despite being a highly cash generative business with likely catalysts on the horizon to realize value. The company has a market cap of just over $31 mm and it holds around $20 mm in cash and no debt on its balance sheet. So for around $11 mm you can buy a company that generated $10 mm in free cash flow over the past 12 months and has generated positive free cash flow every year since 1995 (almost $90 mm in total), including every quarter since 2000. The company is buying back shares and management has also been buying personally during the past 2 months. In addition, Constellation Software, a serial acquirer of small software companies, recently bought almost 18% of Mediware. While the stock is illiquid, for small accounts I believe it represents an outstanding risk/reward opportunity.

The Company

The company is a provider of software tools and services to the healthcare industry, with a particular focus on complex areas such as blood banks. Mediware’s flagship product is its blood transfusion software, which helps hospitals and medical centers with blood donor recruitment, blood processing, and transfusion activities. It has a handful of other products, including a growing business in the UK (~15% of revenues), and over 1400 healthcare facilities use MEDW’s systems. Clients include the American Red Cross, the Blood Center of Wisconsin (a nationally-respected blood center), Shands Healthcare (one of the Southeast’s premier health systems), and the National Healthcare Group in Singapore.

The company was founded 25 years ago and has steadily grown its presence in the niche of healthcare-related software. Over 70% of Mediware’s revenues now come from its service division, with the remainder coming from new product sales. Like many software companies, it benefits from high gross margins, steady cash flows, and an asset-light business model with cash generation consistently higher than GAAP earnings due to a large portion of its expenses being non-cash.

Despite these steady, growing cash flows, the stock is down -40% this year and trading below where it was 10 years ago. All numbers are in millions:

Fiscal Year ending June 30	Revenue	EBITDA	Free Cash Flow	Net Income	Cash on Balance Sheet	Market Cap at Year-End
1995	$8.1	$0.9	$0.1	$0.1	$0.5	$2.90
1996	$10.4	$1.3	$1.2	($3.5)	$2.5	$18.50
1997	$18.9	$4.0	$1.7	$2.1	$1.9	$26.50
1998	$20.5	$3.7	$3.3	$2.9	$4.7	$41.90
1999	$28.3	$4.7	$4.5	($1.0)	$3.6	$46.50
2000	$26.7	($0.9)	$5.5	($0.9)	$3.6	$46.10
2001	$26.2	$1.4	$2.7	($0.7)	$2.3	$21.60
2002	$30.1	$7.1	$5.7	$2.6	$3.2	$56.30
2003	$33.0	$9.4	$9.0	$4.4	$7.5	$74.40
2004	$36.7	$10.4	$7.2	$3.6	$10.2	$98.00
2005	$36.6	$9.7	$10.3	$2.9	$14.8	$78.50
2006	$37.9	$9.2	$7.4	$2.3	$19.0	$78.00
2007	$41.2	$9.6	$7.4	$2.3	$22.8	$58.70
2008	$39.4	$8.0	$12.0	$0.7	$22.7	$44.60
				Dec 30 2008:	$20.00	$31.07

The past year’s dip in revenue was expected by the company due to the timing of its product cycles. The $20 mm of current cash is an estimate, taking the $22.1 mm it had on 9/30 and adjusting for a $3.5 mm acquisition made in November and adding on a small amount of likely cash generation in the current quarter.

While Mediware will likely see some short to medium term headwinds going forward due to decreased spending on IT by its clients, the company remains relatively well positioned given the defensive sector it is in, the “stickiness” of its products (there are literally lives on the line, in addition to the usual operational headaches if clients try to switch to a competitor), and its iron-clad balance sheet. New CEO Thomas Kelly Mann has also been cutting costs since his arrival a year ago, successfully slashing SG&A by 16% YoY in the most recent quarter. Mann has an impressive background, having previously spent 23 years in various senior roles at 3M’s Health Information Systems Division.

Why Mediware?

While there are plenty of cheap micro-caps out there right now MEDW is particularly interesting because two separate catalysts exist that may unlock its value in the short to medium term.

First, the company has finally begun to buy back its own shares this year after previously resisting pressure from its investor base to do so. The board has authorized a total of $7.3 mm in buybacks, $4.0 mm in February of this year and an additional $3.3 mm in October. Of this it has bought $3.3 mm so has $4.0 mm of dry powder remaining. This represents over 12% of shares outstanding and over a third of the free float, so the buyback could have a significant impact on the stock in addition to being an efficient use of the company’s cash while also boosting EPS. The public float is very thin with the 5 largest holders controlling almost 70% of outstanding shares:

Holder: % of Shares O/S:

Lawrence Auriana: 30.7%
Constellation Software: 17.9%

Cannell Capital: 9.9%

Bares Capital: 6.7%

Stadium Capital: 4.3%

Auriana has been Chairman of the Board of Mediware since 1986 and a director since 1983. He has been a Wall Street analyst, money manager and venture capitalist for over 20 years. He added to his position in MEDW in early 2008, buying over 40,000 additional shares. The management team has also been buying the stock recently, with CEO Mann and 3 other insiders making open market purchases in November at between $4.52-$4.77/share.

Cannell Capital, Bares Capital, and Stadium Capital all appear to be successful, value-oriented, long-term investors that a small investor would like to have on their side (Cannell and Bares have been featured in Value Investor Insight and there are some blurbs on the internet about Stadium). Cannell filed a 13-D in early 2008 encouraging the company to consider a merger or sale. This has obviously not happened and the fund sold over a quarter of its shares in Q3 of this year.

While the existence of a large holder potentially looking to get out of an illiquid position is scary in this market, the presence of Constellation mitigates that risk in my opinion and serves as the second catalyst for the stock.

Constellation is a Canadian software company that is a serial acquirer of smaller groups like Mediware. It has bought 85 companies in the past 13 years and spent $94 mm on acquisitions in the first 3 quarters of 2008 alone. According to its website the company looks for vertical market software companies with an outstanding manager, consistent profitability, and above average growth. It began buying Mediware in February 2008 at $6.25/share and has since accumulated almost 18% of the company. Here is a quick timeline of this year’s events involving Constellation:

Feb 20^th, 2008: Constellation begins buying MEDW at $6.25/share

Nov 3^rd, 2008: Constellation makes last known purchase at $3.92/share, files
that is owns 17.9% of company

Nov 6^th, 2008: Constellation CEO Mark Leonard writes in his quarterly report that

there are great software investments to be had given the market

turmoil, but Constellation will only keep up its rapid pace of

acquisitions if the company raises additional financing

Dec 17^th, 2008: Constellation announces $25 mm increase in its credit facility: “We

continue to remain optimistic about our acquisition prospects after

deploying a record amount of capital in 2008. The amendment to

our credit facility provides us increased capacity to explore further

acquisition opportunities” – John Billowits, Constellation CFO

Clearly there is a chance that Constellation makes a bid for MEDW given their interest and capability in doing so. This potential catalyst, when combined with the company’s buyback program, cash-generative business model, and extremely cheap price makes MEDW a very attractive investment opportunity.

While there are the usual risks of potential regulatory changes in the healthcare landscape, a coming slowdown in IT spending, etc. those are largely mitigated by the extremely cheap price of the stock. My biggest worry is that the company does not act in the best interest of shareholders by continuing the buyback program and potentially considering a sale. The company has made 2 acquisitions in the past year and has only used a portion of its authorized buyback so far, so this is a risk. There is also the risk that “nothing” happens (no buyback, Constellation doesn’t make a bid, other shareholders don’t do anything, etc.) and the company continues to be overlooked because it is so illiquid.

Catalyst

Continued share buybacks
Constellation makes bid for entire company
Continued cash generation

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			2008	2009
Price:	4.05	EPS
Shares Out. (in M):	0	P/E
Market Cap (in $M):	31	P/FCF
Net Debt (in $M):	0	EBIT	0	0
TEV (in $M):	0	TEV/EBIT