Description

Investment Thesis

QAD, Inc (QADI) is a global provider of enterprise software applications, professional services and application support for manufacturing companies.  With revenues of approximately $200m/year, the company has forged a niche in cyclical industries, which has masked QADI's true earnings power in a normalized environment.  The company doesn't screen particularly well on a valuation basis, given traditional metrics of P/E, etc as manifested in the required entries of VIC, but provides a good value at these levels as demonstrated below.   

At less than 5x EBITDA (including hidden assets), < 1x maintenance revenue, and a significant NOL, the company trades at an attractive valuation.  Despite the recent recap plan that established a class of super voting shares, the company may still be an attractive takeover candidate - prospective buyers could be Lawson, Epicor or JDA Software, among others.

Even without a takeout, the downside protection is robust, given the balance sheet and recurring nature of the company's revenues.  Recent steps taken by the management team to rationalize the cost structure (something that was formerly anathema to the company) along with a bounceback in some of the company's end markets (both industry and geography-specific) provide upside from an operating perspective.

Business & Industry Description

QADI was founded by Karl and Pamelo Lopker (who own over 50% of the shares o/s) over 30 years ago.   The company's software is used at approximately 6,000 sites by over 2,500 manufacturing companies that operate mainly in six industries: automotive, consumer products, food and beverage, high technology, industrial products, and life sciences.  QADI has a global presence, with offices in 90 countries.  For the three months ending July 31, 2010 (fiscal Q2 2011), revenues were $51.3m, flat y-o-y, with license revenue of $6.5m and maintenance/other of $32m.  Gross margin was 58%, and the company announced 13 new orders.  QADI's revenues were derived from: 

North America: $22.2

EMEA: $15.7m

Asia-Pacific: $9.7m

LatAm: $3.7m

Notably, the company lost money or barely broke even (from operating profit) in EMEA, Asia-Pacific, and Lat Am - this should change as the company achieves scale in those markets.

QADI's business model is based on a traditional enterprise software license-maintenance model whereby the company sells a license for $x and then receives a % of $x for maintenance fees for several years thereafter.  This recurring revenue model insulates such companies from volatility and provides a nice cash flow stream to support operations during economic or end-market downturns.  Of QADI's runrate $200m of revenues, over 60% is maintenance/recurring.

As part of this traditional enterprise software model, the company also offers a broad range of consulting services to help customers support and improve their global operations, with over 300 consultants in 20 countries

In response to the difficult economic environment, the Company had undertaken steps to reduce its headcount and lower expenses beginning in the fourth quarter of fiscal 2009 and again in the second and third quarters of fiscal 2010.  Related to those restructuring initiatives, the Company reduced its headcount by 260 full-time positions, or approximately 15% of the workforce.  Still, a comparison of QADI's operational metrics (e.g., Rev/E'ee, etc) suggests that there is further upside from restructuring initiatives.

In recent years, industry consolidation has been a primary factor shaping the enterprise software marketplace, given the scalability of the underlying business model.   Ultimately, the maintenance revenue would be attractive to a strategic buyer who could either runoff the revenues while monetizing balance sheet assets, or use it as an entry point to QADI's end markets.

Valuation

At the end of the fiscal second quarter (ending July 31^st), the company had net cash of $40m, an NOL worth approximately $15m, and beachfront property worth anywhere from $25-$50m (book value of $30m).  Using the low end of the real estate estimate, this would create the stock at around 4-5x normalized EBITDA and a free cash flow yield in the double digits.

With a market cap of approximately $150m, and a significant amount of shares controlled by the co-founders, the stock is not particularly liquid.  However, given the downside protection from the balance sheet and recurring maintenance revenue model, the stock is ultimately a call option on an acquisition or continued operating improvements.

Catalyst