Description

Skillsoft is selling for around 7x next year’s earnings, operates in an industry with good long-term growth prospects but real challenges due to the economy, has no debt with more than $100m in cash on its balance sheet, has a new management team in place (due to Skillsoft taking over its competitor Smartforce in September) and has announced a large share purchase program (8% of the outstanding shares). It is very cheap today and has the potential to double in price just to get to fair value within a reasonably short timeframe (a couple of years is my idea of reasonable, by the way!).

Quick Background
Skillsoft (and Smartforce) are e-learning companies. Obviously what that means is that they create course content for companies to teach employees a particular skill via electronic distribution. Skillsoft (pre-merger with Smartforce) focused primarily on the “soft-skills” like management, leadership, finance, marketing, sales and strategic planning. The old Skillsoft had over 1,200 courses in its library. Its costomer base is made up mostly of large businesses and government. Additionally, a year ago, Skillsoft entered the IT course are by acquiring Books24x7.com that provides about 1,500 IT reference books that are searchable. Smarforce, on the other hand, was much more focused on the IT training arena and because of this has been hit particularly hard by the economic slowdown. Additionally, from speaking with industry observers, it is universally known that its management team was sub-par at best. They sold out because they needed to. With its acquisition by Skillsoft, its combined company management team is significantly better all-around and is making the hard decisions to make a better company.

The big picture in terms of this merger is that it is occurring in the midst of an economic slowdown and it has been especially hit hard due to companies holding back on training or any other discretionary spending for that matter. My view is that, while I have no idea when, this will eventually reverse itself if not stabilize to a more normalized level. Why? Because employers need to continue investing in people to maintain the quality of service that customers demand. More so in a time of downsizing, companies need to give the remaining sales people, client support people and mid-level management people something to gain efficiency, given they now have more on their plates than ever before.

Given this scenario, Skillsoft is the leader in delivering course content electronically, either through CD-ROMS, courseware on internal company servers or via the internet. While not appropriate for all types of training, this is in some cases the most efficient means to get the skills taught to a large number of employees in a consistent manner. The alternative means, i.e. a classroom, instructor-led setting, takes a huge amount of time out of the workday. Through Skillsoft’s offerings, they can take the course anytime and anywhere.

Here are a couple of things affecting the stock price and the reason for the subsequent recent drop from $4.75 per share to its now low level of $2.76.

First, Skillsoft’s management has acquired a somewhat troubled company in Smartforce. A month ago, Skillsoft announced they were restating some of Smartforce’s revenues from 1999 to 2001. They said that some troubling accounting for revenues was discovered back in September when closing the books before the merger. It didn’t look good both from a delay standpoint, and from a PR standpoint. Investors no doubt question Skillsoft’s management in not catching this in the due diligence process. The key thing to know about all of this is that the restatements are non-cash items and they pertain to the old-Smartforce business practices. The new accounting methods employed by Skillsoft’s management team reflects a more conservative revenue recognition method that lines up with the old-Skillsoft’s accounting.

Second, the market was spooked a bit by their announcement that renewal rates were coming in a bit lower than expected…on the Smartforce business, not the old-Skillsoft side. Having lower renewal rates is not a good thing and it further solidified investor’s views that the new management didn’t see something in Smartforce’s business that it should have seen. My feeling is that Skillsoft’s management is better than that and is taking steps to clean things up on the Smartforce side like changing the way salespeople are paid (more in line with Skillsofts system, which will push away some Smartforce sales guys), cutting overhead at the combined firm. They have stated they are cutting costs significantly. This merger does have synergies, like combining delivery platforms for their content, cross selling soft and harder skill courseware to the same customers, etc.

It is fair to say they may have given too much of themselves for Smarforce, and at least in the short term it is easy to say. Skillsoft, prior to the merger, was owned heavily by the current management team. They swapped shares, giving a large portion of the combined company to Smartforce shareholders. They diluted themselves, had a much better company before the merger from a numbers standpoint and did the deal anyway. They saw some potential here and I am sure did it with their eyes wide open.

As it stands today, the estimates for 2003 (ending in Jan 04) revenues are now reduced down to around $190m-$200m and EPS estimates around $0.25 per share. This is in a very tough corporate spending environment and they are likely to hit 13% net margins, nonetheless. This is a profitable business and can be more profitable than this. At $2.76, it is too cheap and most of the bad economic news is factored into at these levels.

Downside: I believe it is limited given its cash pile , its current profitability in a tough economy and its ability to further cut overhead if needed. There is fat in the combined company that SKIL’s “new” management will trim regardless of the environment.

Catalyst

Catalyst:
Too cheap at 7x earnings.
Economic recovery could be a huge boon to results.
Merged company can find cost synergies and management has the discipline to do it.