Description

SmartPros is a leader in accredited education (continuing education) for Attorney's, CPA’s, Engineers, Insurance Agents, and Stock Brokers. The company is moving more and more online with over 450,000 visitors and 1 million ads served a month with about 34% of the revenue web base today (which is up 60% yr/yr). Margins should continue to expand as the company continues to move more business online combined with the opportunity to buy small competitors with good content libraries to cross sell to SmartPros’ current customer base of 3,000. SmartPros is a high quality business that is cheap and under followed. What makes the business high quality? In 2007 the company generated an ROE of 20% (with 40% of the market cap in cash), 20% Cash Flow margins, and cash conversion cycle of 6 days. SmartPros currently has 27% cash flow yield off 2007 results with 22% top line growth. CEO Allen Greene strikes us as a very shrewd and hard nosed operator with a strong board. Allen will not pay for any coverage or IR, his Audit fees were $59K, he goes so far as saving $250 in PR by doing an 8K first and skipping a newswire press release, employees were granted 40,000 total shares as a bonus pool in 2007, one board member was in 2004 Chairman of the National Association of Corporate Directors (NACD) Blue Ribbon Commission on Board Leadership. These guys are as straight and honest as we can find in the micro cap world. We think the downside is $3.75-4 and the upside over the next year or so is $9-10.

Allen has made a number of excellent acquisitions with very little cash down and made them contingent on earn outs. His most recent acquisition was from SkillSoft (SKIL) called Financial Campus which has "delivered training to more than 1 million professionals and features a catalog of over 250 accredited online courses representing more than 16,000 hours of approved insurance continuing education credits across all states..." We believe PED paid close to -0- for this in cash or stock. This business was neglected inside of SKIL and went from $3-4mn in annual revenue dwindling down to $1mn in annual revenue. SKIL essentially gave the business to SmartPros to invest and grow the business and keep SKIL’s core customers happy with this product. PED only pays $750K to SKIL if revenue exceeds $2mn. These are the type of deals Allen has been cutting and as he says his business could be a heck of a lot bigger and much poorer if we paid up for deals.

Allen Greene Bio: Former COO of Medallion Financial (TAXI) and previously the President and CEO of  Ryan Beck & Co., a 50-year-old full-service securities and investment banking company. Prior to that, he was Chairman, President and CEO of VSB Bancorp and Valley Savings Bank, which were sold to UJB
Bancorp (now Bank of America) in 1994.  Mr. Greene has been a Director of numerous public and private corporations.

Greene Quotes (from early 2007):

“Our goal over the last couple of years was to make acquisitions to grow the business. We can grow internally, generally from 8% to 15%. But the real growth is going to come from acquisitions and being able to get more savings as a result of those acquisitions. We have not been able to find a large acquisition today that meets our criteria of being accretive within one year. But we have made several acquisitions that have been accretive within one year and are very positive to both our top line and our bottom line.”

“We would like to see a larger acquisition, but if people are still back in 1999 with their idea of valuations, we are just going to continue to keep our hoard of cash that we have of over $7 million. (now over $10mn)”

Market Opportunity

There are in excess of 500,000 CPA’s and 2 million accounting professionals in the US. There are 1.5mn engineers in the US. Attorney’s need 10 hours of continuing education per year and a total of 45 hours every three years. If interested, the company does a great job in the annual report breaking this down in far greater detail. The American Society of Training and Development in 2006 estimated that US organizations spend $109bn a year in employee learning and development. Most continuing education is not discretionary but mandatory requirements. In fact SmartPros has 85% renewals with their subscription business.

Products:

http://education.smartpros.com/main1/acccatalog.asp

www.smartprosinteractive.com

www.accounting.smartpros.com

www.financialcampus.com

http://corporate.smartpros.com/index.html

Moat

SmartPros’ advantage is that since it has been around for 25 years, it has extensive high quality libraries of content for multiple vertical markets, and competes mainly against small private competitors. Most competitors lack access to capital or have the depth of content that PED does. In fact, these competitors are acquisition opportunities for PED as it can leverage its sales network (3,000 customers) and online capabilities.

CEO Acquisition Strategy

CEO Allen Greene’s frugality shows in the acquisition strategy: average P/Sales paid for in acquisitions is 0.3x.  It is important to stress that despite buying content at extremely low multiples of sales and cash flow the value to SmartPros is substantial as the company is running at 20% cash flow margins due to their ability to cross sell content to existing customer base. The bar is set high when he does negotiate an earn-out (e.g. Bright Ideas Group didn’t meet its revenue requirements for the $200K earn-out ending January 2008).  PED is glad to pay earn-outs since it means the results will pay for themselves.  Here is a table with all the more recent acquisitions:

Here are more details regarding each acquisition and the earn-outs:

- Skye Multimedia creates customized training materials for a diverse group of companies (pharma, financial, etc.).  In 2006 it contributed $1.7mm of revenue which increased to $2.2mm in 2007.  The earn-out for Skye is based on earnings adjusted for use of capital, will be paid end of 2008 and will not exceed $1.2mm

- The Sage International Group acquisition was an asset purchase; a library of 58 certified online training courses for banking, finance and insurance.  This combined with the Financial Campus purchase kick started PED’s online financial services offerings (2007 revenues of $1.2mm up from pretty much nothing in 2006)

-MGI Management Institute was acquired for its distance education courses in legal and engineering.  MGI contributed $434K of revenue in 2007.

-  Cognistar produces online training and continuing legal education for the law profession.  Cognistar generated ~$600K of revenue in 2007.  The president of Cognistar was issued 10K options at $2.75 strike price.

- The Selbst Group specializes in training programs for the financial services industry.  A couple of key employees were given 6,500 options striking at ~$5.00.

- Bright Ideas Group develops information technology education and training programs and the acquisition came with 300 courses and customer contracts.  The maximum earn-out is $3mm paid towards the end of 2010 based on average 3yr EBIT, it can be paid 50%cash/50%stock.

- The most recent and more interesting acquisition is Financial Campus.  They offer training courses for the financial services/insurance verticals.  Financial Campus used to be owned by Thomson NetG who sold it to SkillSoft who finally sold it to SmartPros.  Due to these transitions and neglect revenue has declined to ~$1mm but we believe SmartPros will be able to restore it to $3mm-$5mm in the coming years.  This asset was bought for pretty much zero with a maximum earn-out of $750K based on revenue above $2mm per year over the next 3 years.

The results of the acquisition strategy can be seen by the substantial top-line growth FY05 $10.4mm, FY06 $12.5mm, FY07 $15.2mm, about 20% growth per year.  Also, considering PED’s acquisition track record (low multiples) and their continuous appetite for attractive assets, the $10mm cash available could buy another $30mm of revenue in the years ahead.  In the current environment Greene will find it easier to find inexpensive targets.

On top of the acquisition strategy, another key value driver is the shift to online offerings.  As online becomes a larger part of revenue, margins creep up: online revenue went from 26% to 34% ‘06 to ’07 and GM% has crept up from 58.5% to 60.8%, as has EBITDA margin from 11.8% to 12.6%.  This should continue as the more recent acquisitions are geared towards online libraries/courses and the industry in general is more accepting of online training. 

We believe that even without any new acquisitions SmartPros should do $18+mm in revenue for 2008 with EBITDA of ~$0.50/sh.  CF’08 will be $0.70+/sh as they keep growing their deferred revenue model through subscription services. For 2008 we see EV/Sales of 0.6x, EV/EBITDA is 4.2x, and EV/CFO is 3.5x.  The difference between EBITDA margins and cash from ops is a very low cash conversion cycle combined with a deferred revenue model. The company has $4.5mm of NOLs which will expire by 2023 so their tax burden will be low in the coming years.

Another opportunity that is not priced in the stock is SmartPros IReflect Training software which was developed with a 50% partner, Education & Training Systems Intl.  This new venture offers software for companies to create their own customized training courses.

Risks: Micro cap, Allen Greene leaves (very unlikely), Screw up an acquisition (again very unlikely with Greene running company)

Disclaimer: This does not constitute a recommendation to buy or sell this stock.  We own shares of the company, and we may buy shares or sell shares at any time without updating the board.

Catalysts:

NASDAQ Listing April 22, 2008 new ticker SPRO

Value: 3.5x EV/CFO, 20%+ top line growth, 40% market cap in net cash

Management is cheap, smart, and straightforward

Continued growth in revenue and cash flow with significant market opportunity over time

Currently the EV is $2.3 and by end of 2008 should be $1.70

Should exceed $1+ per share in CFO for 2009 and Net cash should be over $2.75 by end of 2008

Potential for double over next year and 3-4x over next 24 months.

Catalyst