Description
SupportSoft (SPRT) : $4.60/share
Who wants to own a profitable well managed company trading near Net-Net with some decent growth prospects, but is suffering from a stall in a product roll out and some quarterly lumpiness?
SupportSoft is a small cap enterprise software company that sells ‘support automation’ software or as they define it “The Technology that Keeps Technology Working”. They have two key customer categories: Enterprise Customers and Digital Service providers such as Cable MSOs and Phone companies offering DSL service.
Enterprise Support Software Business:
I define this vertical as any software that helps a company manage ‘another vendor’s product.’ There is this concept in IT called ‘Total Cost of Ownership’ (TCO) which put simply says that whatever you paid for a piece of software or hardware—surprise! that is not the true cost. Instead, TCO is some multiple of that upfront expenditure. Additional costs include deployment, repairing and maintaining, and lost productivity when the IT doesn’t work out as planned. All software that falls into my ‘enterprise support’ category attempts to reduce TCO.
This category is highly competitive and full of companies that offer a plethora of products which include: virus protection/remediation, network and desktop security, network management tools, diagnostic tools, patch management/deployment, help desk ticket management, etc, etc, as well as an internal solution a company might build to improve IT support.
How SPRT fits in to the Enterprise Market:
The enterprise support side of SPRT’s business is highly competitive and comprises just under half of their revenues. Some big name accounts who use there enterprise support software include Siebel, IBM and P&G.
Although there are many competitors and products, most of them such as network tools try to deal with IT problems that affect the infrastructure (servers) or obvious endpoint needs such as viruses and security. SPRT takes a more myopic view and has carved out a cute little niche they call ‘Techincal Support Automation’ and ‘Endpoint Management.’ In short they are helping the user solve a problem (reactive) for the former and keeping the IT assets in check (proactive) for the latter. Another way to look at it is Compliance and Conflict Resolution.
-Compliance tools ensure that a company’s machines are using appropriate versions of software, as well as managing their patches and updates, and keeping track of licenses and IT assets. Compliance tools help prevent problems from occurring in the first place, by keeping user’s systems in line with approved applications and configurations. For example when an IT manager diagnoses a problem once, he can create a ‘fault condition’ that will monitor user’s machines for the same type of conditions that will cause the problem, and ‘self heal’ the machine if the fault condition develops. As such, the software over time prevents more and more problems that might tie up the help desk, and require desk side visits (Which according to Gartner costs an average of ~$15/incident).
-Conflict resolution tools help users solve problems with online ‘knowledge centers’ that can included automated one click fixes, automated telephone support, and remote access and interaction with techies. The idea is to prevent downtime and desk side visits from techies. And when tech support is needed, to reduce the time spent fixing the problem and catalog the solution or deploy a fix with ‘mass healing.’
Enterprise Support Software Distribution:
The enterprise software can be purchased as a suite or individual pieces, both of which are deployed by SupportSoft’s professional services group. It is generally priced on a ‘per desktop’ basis and pricing ranges from a few dollars a seat (user) for one or two pieces in the suite to $30/seat or so for the entire suite (on a term basis). The company will also sell you the rights to use the software on a ‘perpetual’ basis for roughly 2-3x the annual licensing fee, and take maintenance revenue as it needs reconfiguration and upgrading, which creates a stable (albeit small) professional services revenue stream. (more on this later).
Direct: Most of their selling is direct to Fortune 2000 customers through their ‘quota carrying’ sales reps, who essentially are like the door-to-door salesman for corporations. Deal size averages in the low $100k’s and bigger $1mil+ deals usually involve the CEO and top management.
MSP: Some corporations actually outsource the help desk that employees rely on to keep their machines up. HP, CSC, IBM, Accenture and others all use SPRT’s software in house to support their clients desktops. SupportsSoft receives the poorest amount of revenue on these accounts, but benefits from a nice distribution channel. I think that the MSPs also prove the value proposition in that it is precisely these companies’ business to support corporate desktops in the most cost efficient manner possible.
Competition:
Now while all this enterprise support stuff sounds really cool and innovative, SPRT is up against some real 800 pound gorillas in this market. Companies like Symantec, Altiris, CA and Microsoft all make products that handle many of the needs of ‘end point management.’ What distinguishes SPRT is that they are a niche player who focuses on automating the tech support as well as well as customer service automation.
Selling software door to door as the small guy is tough, but they are definitely a player in this space. Nonetheless, in recent quarters the enterprise business hasn’t been growing measurably and is a disappointment to many including management. Management sites a difficult competitive environment (pricing and long sales cycles), but doesn’t think they are losing business to competitors. Instead with Sarb-ox compliance in full swing, these types of projects tend to get swept under the rug at many organizations. The cost savings of these deployments are a bit hard to quantify, but customers who have a handle on just how much IT support is costing them definitely realize value. Unfortunately, IT support is simply not stressed by top management as a core competency in most organizations. When was the last time you met with a CEO and he told you that one of his companies defendable competitive advantages is a lower IT support cost?
Nonetheless, SPRT management has its attention on this business unit and has been working to fill out the product line an revamp the sales team. However, I think that the more exciting opportunities for SPRT in the near term is in the Digital Service Provider market which they currently dominate.
Digital Service Providers:
Back in 2000 SPRT bought some software assets from the Excite @Home bankruptcy that later became their Broadband Resolution Suite. The product line started out as a way to help new cable modem subscribers self install. Over time the product has grown in functionality and 7 out of 9 of the top North American broadband providers now use SPRT’s broadband resolution suite to support their customers. The product is very valuable to the MSOs because it is estimated to cost them about $100 every time they need send a tech to your house aka a ‘truck roll.’
The next big opportunities for this business unit are Digital Video and VoIP. SPRT has been developing technology, hand in hand with Scientific Atlanta (maker of Digital Cable Boxes) and the MSO’s internal network engineers to build support products for these other 2 legs of the ‘triple play.’
Its not really a question as to if these products will be successful but what the timing of the roll out and the pricing SPRT will realize. SPRT argues that because they are preventing the same costs (truck rolls) that pricing should be similar to Broadband. However right now, VoIP and Digital Cable are still being deployed by many cable operators and SPRT will not book meaningful revenue from these products till end of ’05 beginning of ’06. Towards the end of last year the market and analysts were too aggressive in how fast they would deploy this new line to their customers, and the company did a poor job of managing investor expectations.
Valuation:
Last year, excluding the acquisition of Core Networks, SPRT generated $14 mil of cash-flow and eps of $.22/share. To put that in perspective they have $2.90/share in cash and an NOL and R&D tax credit carryforwards worth almost $.50/share (undiscounted).
Using a 42 million share count the market cap is ~$195 mil. EV adjusting for the 120 mil in cash and 24 mil of tax assets is just $50 million. This, for a company that has been cash flow positive for the last 3 years, will likely earn about $10 mil this year and has meaningful growth opportunities going forward.
On an EV to Sales its trading about 0.7x revenues even though I believe they can sustain at least 15-20% operating margins, and grow sales over time.
Why so cheap:
The company has had a history of beating guidance and all the analysts estimates for the last 3 years. In 3Q04 they disappointed with a big eps miss driven by a few factors:
-Over reliance on perpetual deals. In a perpetual deal the client pays for the software up front and revenue is booked over the course of deployment (which can take place anywhere from 1 to 5 quarters depending on the size of the deployment).
SPRT was in a position where almost 70% of the licensing revenues were coming in as perpetual deals and the market began to believe that they were running out of products to sell, which at the time was somewhat true. Its not really up to SPRT as to whether or not the buyer takes a term or perpetual deal but the high mix of term deals has been making quarters very lumpy and vulnerable to misses like so.
The 3Q problems can be summed up as the enterprise business was flat with few new customers, which as I said earlier is likely due to organizations making this a low priority going into Sarbanes Oxley compliance. And on the DSP side of the business the next generation of support products Digital Video and VoIP were just going into the final phases of development.
The stock used to be owned by a lot of momentum/growth oriented investors but now I believe the shareholder base is turning over and returning to more value oriented investors.
Thesis: Over the next few quarters it will become apparent that SPRT’s DSP opportunities are real and the total size of the opportunity is likely $50 mil+ for the products that are currently coming online (VoIP and DV support). The enterprise business will hopefully stabilize and begin to grow again. At which point investors will see that this company is extremely cheap on an absolute as will as relative basis to similar companies is this space.
Risks:
Failure of their new product initiative in DSP and to a lesser extent Enterprise business not getting any traction long term. I think this very unlikely on the DSP side as they have a near monopoly with domestic cable providers on their Broadband Suite. I think the opportunity is so large here that it will take care of any weakness on the enterprise side.
Management does something stupid with the cash: SPRT did a 490 million follow-on equity offering roughly a year and a half ago at $12/share and told investors they would use the capital to fill out their enterprise product line through acquisition. After taking down the capital they were surprised by just what prices sellers wanted. Scuttlebutt is that SPRT has bid on several potential candidates but were usually out-bid by a large margin. They decided to benchmark any acquisition by the costs of building a competing product in house, and that is the route the company seems to have taken, even deferring acquisitions pushed the new product cycle out a year or more. Too long for the impatient momentum crowd. That leads me to believe that management is disciplined with their capital. In addition, one of the ‘gaps’ they intended to fill in the product line, ‘patch mangement’ was solved by them licensing a solution as opposed to buying some one, further decreasing the risk of a big bad acquisition.
Instead of a big enterprise side acquisition, SPRT recently purchased Core Networks for its technology to troubleshoot and support networks (DSP side) for roughly $17 mil, and generated $14 of FCF in ’04 (ex acquisition).
Shareholder litigation: A new class action lawsuit was filed against management because they sold stock shortly before warning. The law firm is trolling for disgruntled ex-employees to boost their case, and claims that they’ve been receiving information for ex-employees without being specific.
Weak Controls: In the 10-K the company disclosed that they incorrectly calculated 1Q earnings by under expensing sales commissions. The net effect for the year was zero and it resulted in a shift of a penny from one quarter to another. This doesn’t sound like a big deal but may be a bit of evidence of earnings management.
Catalyst
Catalysts:
The company reports 1Q earnings today after the bell. I think the quarter will be okay because the company would have pre-announced if things were getting worse. The key will be how they are coming along with the roll out of next generation DSP products, how efforts to beef up the sales force in Europe and Japan are coming along, and their guidance and visibility in general.
Stock Buyback: I’ve pressed management to do a stock buyback, but even though the CFO seems to agree with me we haven’t seen a buyback. This is disappointing.
Wait and see: A steady improvement in fundamentals accompanied by a new class of shareholders discovering the name. SPRT has announced that they will be in NY on the 29th.
Take Out- Its hard to put your finger on who would buy them because they are really the only company with enterprise support and dsp under one roof. These guys basically invented the category of ‘support automation’ as a stand alone niche. The #2 competitor on the broadband side, Motive Communications who recently IPO’d could be a possibility, but they don’t have the balance sheet or stock price to reasonably do so and the culture clash would be a disaster.