Description

Speed Commerce [Nasdaq: SPDC] is a highly levered and illiquid microcap. At today’s price of $0.75, it has a market cap of $52mn plus $92mn pro forma net debt for an enterprise value of roughly $144mm.  Over the past twelve months, Speed Commerce’s stock price has had a spectacular fall, moving from $4.50 to today’s price of $0.75.  During this period, management sold the original business (Navarre) and rebranded the company as Speed Commerce, which it purchased in 2012.

The plan was and remains to sell the legacy software distribution business (completed mid 2014) and become an end-to-end e-commerce and fulfillment provider.  During this period, the original Speed Commerce founder failed to manage the growth and maturation of its business.  Meanwhile, the CEO of the parent focused on the deals and repositioning of the company – to the neglect of the core operation.  The CEO’s track record is quite strong – particularly in turnaround situations. 

To summarize: without properly protecting the core, the management team took on way too much, admittedly depending on a founder with a strong operational history. This resulted in (a mid summer) minor covenant breach followed by a small capital raise.  In pursuit of a polished management team to fill out his bench, in November, the CEO executed an acquisition that left the company in a highly levered position.  Nevertheless, management was and remains quite confident in its assessment of its mid and long-term business prospects.  For the immediate term, they also were confident yet wrong.

Three weeks ago, the company announced an (expected) management shake-up coupled with significant downside guidance, which implies that they will breach covenants on the just two-month old issued debt.  Yet, on that same conference call, they emphatically stated that they would NOT breach these covenants.  Further conversations have elicited strong QUANTITATIVE reasons to believe them.  Our / your work is to make a qualitative assessment.  As this will take time, the stock continues to move lower.  The SpeedFC founder’s expected sale of his remaining shares may also provide an overhang on the stock.  He has personal reasons for selling.

Though we too are in the middle of our qualitative assessment, below is the math and some general facts and opinions on why there is likely a brighter future for the company and the stock price (particularly as the stock continued to tank into February month end).

Investment Thesis

SPDC is one of a few scale providers of outsourced e-commerce and fulfillment services for consumer brands and retail chains.  SPDC is Oracle’s main middle market e-commerce partner.  It builds and manages front-end e-commerce solutions as well as complete end-to-end solutions (with fulfillment), if a client so desires.  SPDC typically works with retailers and brands in high growth phases.  A primary risk is that as clients hit a certain size or are acquired, they will in-house the SPDC provided services, thus resulting in client attrition.  Great customer service, an extended list of future clients, and three to five year contracts mitigate much of that risk.  Recently, SPDC lost a few big clients all at once.  Going forward, the client diversification is much greater.  Simple math implies that if 25% (on average) rolls over each year and the company only retains 80% (which would be quite low), revenue losses would be 5% (or 20% of 25%). 

At present, there are enormous tailwinds behind the industry and (as mentioned above) very few players of scale.  Per the high caliber salesperson the company hired (six months ago), there is unlimited demand for their services; that is why he left a great job at Oracle to join SPDC.

Since management gave recent guidance, the stock is down roughly 68% and is now down 76% on the year.  The company’s F16 guidance is for $160 to $175mm in revenue and $15 to $17mm in EBITDA.  Gross debt is $99mm and net debt is $92mm.  Fiscal year debt covenant requirements call for $20.9mm in F2016 EBITDA.  As per publicly stated Wall Street guidance, this is unattainable.  As per publicly stated comments about detailed discussions with their lender, they will attain this level.

Therefore, a closer look at the numbers and discussions with management paint a more positive picture.  The CEO and CFO have been clear that they fully intend to meet their future debt covenant requirements.  By the end of F2016 on March 31, 2016, debt must be sub 4x and EBITDA must reach $20.9mm.  As it mimics what management has said (yet not printed), the chart below is instructive:

The base EBITDA guidance also includes roughly $1mm of non-recurring Fifth Gear integration expenses.  Due to a lack of valuable hard assets, we do not believe the lender, Garrison, has an interest in owning these assets.  Therefore, while minor dilution remains a risk, forced bankruptcy or restructuring is unlikely, save for material management missteps, which we believe is unlikely.    

If we assume SPDC can hit their minimum F16 leverage (4x) and EBITDA covenant at $20.9mn of EBITDA the stock is trading at 7x F2016.  For a business with 10-20% organic (existing client) growth, a large pipeline that could push revenue and EBITDA growth up well over 20%, low to mid teen EBITDA margins and over 50% FCF/EBITDA conversion, a higher multiple is likely warranted. As mentioned below these businesses typically receive a 10x multiple which on the minimum covenants, imply a $1.80 stock or more than a double from here.

But not only do we see SPDC hitting these covenants, but meaningfully surpassing them.  With their guidance of $160mn-175mn revenues and $15-17mn in EBITDA, management clearly did a kitchen sink job; in our view, unnecessarily so. The low-end of the company’s verbal guidance implies revenues of roughly $180mm, which produces at least $17 to $18mm of EBITDA.  Cost synergies should provide from $4.5 to $6mm of EBITDA in F2016 alone.  $2.5mm of that has already been signed in a new deal with service provider FedEx.  A Fifth Gear fulfillment center in Pennsylvania has already been closed and 100 people have been let go (in F2015).  Therefore, baseline guidance should be closer to $19 to 21mm (right in the middle of the original guidance).  The “new clients” revenue assumption above ONLY includes the (very conservative) $12mn to $15mm of revenue already signed and presently in development.  The company expects multiple client wins to be signed by the spring for summer/fall launch (thus our $12mn to $25mm range above wherein $12mm assumes zero new client wins since December 2014). Note: once their onboarding process is more refined, new client growth should materially pick up.

If we look out one to two years, the numbers become materially more compelling. If in F2016, the company generates $21 to $23mm in EBITDA, there is reason to believe that F17 estimates should be in the range of $25 to $30mm and well over $30mm in F18 respectively.  Debt would materially decline.

Valuation

eBay bought the number one player GSI Commerce for 14x EBITDA. Sterling Partners acquired Innotrac for 10x. We feel SPDC’s multiple should fall between these two players. Therefore in a few years with normal deleveraging you have material upside to at least $3 to $5 per share.  As per the numbers above, thirteen months from now, the company will likely have $84mm of debt.  At ten to twelve times forward guidance of $25 to $30mn, less debt, the implied stock value equates to $2.69 to $4.21 per share.  [Note: the stock closed 2014 at $3.09 and the company believes it is roughly one year behind in its mission.]  Within two years, with net debt under $70mm and EBITDA in the $30mn to $36mn range, implied equity value could reach a range of $4.42 to $5.52 per share.  With very conservative FCF assumptions we see a minimum of $0.26 of FCF/share which is a roughly 33% FCF yield.

Business Description

The E-Commerce segment provides a vertical set of solutions that include web platform development, hosting, customer service, fulfillment, order management and logistics, and call center services for the company’s clients.  This suite of services allows small to medium sized businesses with little to no e-commerce capabilities to enter the growing market, unlocking revenue streams previously unattainable. To reach the new customers the company offers third party logistics (3PL) through partners such as UPS and FedEx.  Speed Commerce recognizes segment revenues on a net basis charging 8-12% of gross merchandise value (GMV) as a fee.  Speed Commerce charges customers in a pay-as-you-go structure when developing websites, only recognizing revenues when the site is up, and then spread over the life of the contract.

Risks

·        Customer Concentration

·        Key Personnel Leaving

·        Liquidity

·        Delisting may result in forced selling

·        Hostile acquisition at a price near current levels

Catalyst

• Client wins (via upcoming press releases this winter / spring)
• Stabilization of the core business as manifested / disclosed in future conference calls
• A takeover or go private transaction
• Management changes or key hires