Description
SoftBrands (the “Company” or SFBD) is a Software Company in the Enterprise Resource Planning (ERP) area. SFBD is an orphan which came out of the highly publicized AremisSoft (AREM) fraud/bankruptcy – it is the cleaned off remnants of AREM. SFBD shares were distributed on or about March, 19 2004 to old AREM shareholders and class action claimants. We believe they are being sold indiscriminately for several reasons: 1) it is found money as the shares have been restricted for 1 ½ years. 2) based on AREM’s closing price of $.15, SFBD at $1.25 is a big increase 3) Shares are on the Pinksheets 4) nobody cares and the Company is not promoting their story.
Business Description
SoftBrands operates in two business segments: Manufacturing and Hospitality. The Manufacturing segment (70% of Sales) develops and sells manufacturing resource planning software under Fourth Shift, DemandStream and Evolution. In essence, this software helps plan accounting, purchasing, manufacturing as well as the sales & marketing functions all in one.
The Hospitality segment (30% of Sales) currently develops and sells ERP software under the Portfolio brand. This software solution provides property management, leisure management and central reservations software that serve hotels and hotel groups of all sizes as well as the resort and spa markets.
Fundamentals in ($000’s)
Year CY 2004E CY 2005E CY 2006E
Revenue $75,000 $88,500 $115,000
Gross Margin % 53.24% 53.24% 54.84%
Gross Margin $39,932 $ 47,146 $ 63,066
EBITDA% 12.8% 15.24% 16.84%
EBITDA $9,580 $13,497 $ 19,366
Cap Ex $2,625 $ 3,099 $ 4,025
Int. Expense $3,331 $ 3,176 $ 3,094
Rest. Charges $500 $ 500 $ 500
FCF $3,955 $ 5,703 $ 9,021
Assumptions:
• Revenue: My estimate is based on capacity and macroeconomic trends. Management has offered revenue guidance for this fiscal year and hopefully will offer more clarity as the story plays out.
• Gross Margin%: CY 2004 based on Q1 2004 gross margin remaining constant
• EBITDA%: CY 2004 based on SGA improvements from restructuring. Leverage of 2.5% for every $25 million in revenue.
• The company has NOL’s of approximately $20 million, the exact nature and amount of which have yet to be determined given SFBD’s emergence from bankruptcy.
• Fully diluted shares approximate 57 million which includes a put warrant (see below) million shares and the balance of options with strike prices ranging from $1.50 and above.
• CRP Mandatory Redeemable Put Warrant: The Company issued to its lenders a warrant to purchase 6.957 million shares at $.40. This provides CRP with a right to put the shares of common stock it acquires on exercise to the company at fair market value at any time after a change in control of December 2009. The put expires if there is an IPO or when the common stock has been traded on the NASDAQ or NYSE.
Enterprise Value:
Market Cap $56,101
Debt $18,559
Cash $11,671
EV $62,989
Valuation:
EV/CY 2004E EBITDA 6.6x EV/CY 2004E Sales .8x
EV/CY 2005E EBITDA 4.7x EV/CY 2005E Sales .7x
• ERP software firms trade on multiples of cash flow and revenue. The best public comparables are Epicor Software, QAD, Inc and MICROS Systems. SFBD also competes with Oracle, PeopleSoft and SAP which all trade close valuation with averages of EV/EBITDA and EV/Revenue of 14x and 2.27x respectively.
Relative Valuation:
EPIC EV/EBITDA 28.26x EV/Sales 2.69x
QADI EV/EBITDA 12.19x EV/Sales 1.15x
MCRS EV/EBITDA 11.94x EV/Sales 1.54x
ARBA EV/EBITDA 30.30x EV/Sales 2.06x
MANU EV/EBITDA 13.80x EV/Sales 1.57x
AGIL EV/EBITDA 9.65x EV/Sales 1.71x
Average* EV/EBITDA 15.39x EV/Sales 1.78x
EBITDA Multiple Valuation ----11x 2004E EBITDA of $9.58 million = EV of $105.4 million.
Less net debt of $2 million = $100.3 million Mkt Cap. with 48 million shares = Valuation of $2.15 Per Share.
Revenue Multiple Valuation ---- 1.5x 2004E Sales of $75 million = EV of $112.5 million
Less net debt of $2 million = $107.4 million Mkt. Cap. with 48 million shares = Valuation of $2.29 Per Share.
o Our model highlights the optionality on revenue due to the small size of the company entering a large, empty market.
Highlights:
1) Internal Customer Base: Over the past several years SFBD has restructured its manufacturing and hospitality segments. While the manufacturing division has gotten its footing back the Hospitality division has been a drag on results. Its poor results reflect an industry wide downturn due to the effects of 9/11. The hospitality segment concluded restructuring during the quarter ending December 31, 2004. Management has indicated that there is a large pent up demand in the Hospitality segment and Portfolio is in a good competitive position due its international presence and property management capabilities. All of the restructuring costs have been incurred and both divisions are operating with a solid base to grow from. The company wanted to ensure their business is strong enough to capitalize on it once the industry turns around. This stable revenue base is evident by 60%+ of the Company’s revenue is from maintenance/support from existing customers.
2) SAP’s integration of SoftBrands Fourth Shift: SAP opened National Manufacturing Week with an announcement of a global strategic alliance that integrates SoftBrands Fourth Shift with SAP’s Business One suite. Business One has had a strong introduction and a viable product will be available after September 30, 2004. There a numerous benefits to this collaboration. First, this announcement provides an immediate validation and boost in market visibility for SFBD. Second, SFBD will be able to capitalize on SAP’s large selling and distribution channel as well as their brand recognition. SAP and SFBD will co-sell this product and it will allow them to capitalize on SAP’s dominant presence in the manufacturing industry. Third, this will give SFBD customers an interesting upgrade and should prevent any erosion of its current installed base and also open the possibility of expanding into additional sites and divisions. Fourth, due to SAP’s extensive customer base, their willingness to protect its major accounts from competition and the affordability of the product should result in significant licensing revenues for SFBD. SoftBrands has indicated that this is a hundred/s million dollar market. On May 18, 2004 SoftBrands announced its first sale of the Fourth Shift for Business One. This pre release sale along with others is a good indication of the interest in the SAP/SFBD collaboration.
3) DemandStream:
a. Industry Background: This product is capitalizing on the importance of domestic and worldwide manufactures converting to Lean Manufacturing a/k/a Just In Time (JIT). The U.S. manufacturing environment has changed dramatically during the past decade. No longer can U.S. manufacturers compete with the eastern world in terms of cost/price. American manufacturers will need to be able to engineer their operations based on product orders as opposed to having goods shipped from abroad. In order for U.S. manufacturers to survive they will need to manufacture products quicker with customization capabilities. There are thousands of manufacturing facilities in the in the United States that represent a billion dollar market between software, consulting and training. At the present time less than 5% of U.S. manufacturers are lean manufacturers. There has been a shift to lean by several large manufacturing companies such as John Deere and Cooper Industries among others. There are several factors why manufacturers will move to lean manufacturing. First, is due to cost savings and more efficient production. Second, customers and suppliers will mandate it. Third, competitors will switch which will then produce a domino effect throughout the industry. An example of this is the automotive industry. The Big Three auto makers demand their suppliers to be lean. The mandate runs through the whole supply chain and they will have to convert to lean or run the risk of losing big accounts. According to an industry consultant, it is inevitable that all companies, especially American, move to lean manufacturing.
b. Product Specific: SFBD is the only company taking an approach to material flow, supply chain and factory management on the execution side. They use pure Lean principles and do not manipulate a Push ERP system by faking it out like their competition does. They have two small competitors but they lack the most important aspect of the software system which is the global support. The big software suppliers such as Oracle, PeopleSoft and JD Edwards do not have a viable Lean only product at this time. The Lean Enterprise Automation division was announced on September 30, 2003. Since that time the company has announced five new contracts in the December quarter including a significant contract at a Visteon plant in China. According to AMR Research: “Companies want to roll out corporate-wide lean initiatives on a region-by-region and plant-by-plant basis…One vendor worth mentioning with extensive experience in Asia is DemandStream. SoftBrands recent reorganization put a stronger emphasis on the capabilities supporting lean. The company has significant experience in manufacturing plants and has global coverage, including a significant presence in Asia.”
4) Management Team: Since emerging from bankruptcy around September 2002 the company has implemented a plan to position their business for long term sustainable growth and profitability. One thing worth mentioning is the company’s proven CEO George Ellis. George was previously the head of Sterling Software, where he orchestrated 25 acquisitions over 10 years that expanded the business from $30 million to over $500 million in sales before it was acquired by Computer Associates.
5) Liquidating Trust: In accordance with the plan of reorganization of the former parent, AremisSoft entered into a liquidating trust agreement which is entitled to any and all of the proceeds from AremisSoft litigation claims and sale of certain other assets of AremisSoft. SoftBrands is entitled to 10% of the net distributions from the trust. The company has received $2.9 million from a small settlement with other directors of the company. The litigation is trying to recover “hundreds of millions” of dollars of which the founders stole from the company/shareholders. Prosecutors are still working on a money trail but have identified and frozen close to $240 million associated with the founders in the Isle of Mann. They are working on getting this money repatriated.
6) Global Presence: SFBD operates in the Americas, the Asia Pacific (AP) region and Europe, the Middle East & Africa (EMEA). Americas account for approximately 60% of revenue and AP and EMEA account for approximately 24% and 16% respectively. SFBD considers their international presence a large strategic asset. For example, SFBD Fourth Shift was one of the first modern business systems ever sold in China with operations there for over 15 years. Industry experts as well as SFBD believe that their will be a continued movement of western world manufacturers to China and India. The Company also has offshore product development in China and India. These locations allow them to take advantage of cost savings that result in approximately two times the value of R&D as if it were done in the U.S. SFBD has outsourced its global support operations as well. The Company moved support for all Asian countries except China into India. They plan to gradually outsource the support activities for all its customers in English speaking countries to India. Their global support migration to India will result in additional cost savings while they provide higher skilled assistance to customers.
Conclusion
This situation offers significant upside potential due to its considerable licensing revenue opportunities from its alliance with SAP and its recent product introduction of DemandStream, a reasonably successful restructuring of its Hospitality division and the evaporation of the share overhang. Additionally, the company trades at a ‘05 cash flow multiple of 4.7x vs. a peer average of 8x and ’05 revenue multiple of .7x vs. a peer average of 1.7x. Our analysis does not include upside revenue potential or cash flow optionality or liquidating trust proceeds. We look for SFBD to trade north of $2/share and on NASDAQ by CYQ2 2005.
* Disclaimer: We are one of SFBD largest holders and we may add or subtract from our position.
Catalyst
• 2nd Quarter Financial Results due on June 17. The company is not an SEC filer but updates shareholders through quarterly conference calls and shareholder letters. A conference call will be held at 4:30 p.m. Eastern Time on Thursday, June 17. The conference call can be accessed at (877) 501-2102 #2429021. More information is available at www.softbrands.com.
• Increased licensing revenue from DemandStream and pre-orders of SAP Business One with Fourth Shift.
• Pick up in licensing revenue from Hospitality division.
• Form 10 Filing – After their Sept. 30, 2004 audit is complete they plan to make application to the SEC. With than in mind they would file a Form 10 within 120 days of September 30, 2004 and hope to be listed on NASDAQ in January 2005.
• Reduction of Share Overhang
• Liquidating Trust Proceeds.