Description

Transactions Systems Architects, Inc. (Nasdaq: TSAI) is an attractively priced business trading at 7.5 x un-levered free cash-flow with market leading products.

The company develops and sells software that runs ATM networks and Point of Sale networks (POS). The firm serves 94 of the world’s 500 largest banks. Customers include Natwest, First Union, Kohls, National Australia Bank, etc. Additionally, the company develops software to facilitate digital and online transactions as well as digital payment fraud detection software.

Lets go over the negatives:

1)The company competes in a very competitive landscape against the likes of First Data Corp, internal information technology teams at banks and other companies such as itself. It has been doing so successfully for the last twenty five years.

2)TSAI had to restate its accounts because of accounting concerns for the periods 3 Qs 2002, 2001 and 2000. The problem related to difficulties in accounting for multiyear, multi component software contracts and has some similarities to what happened to Computer Associates in the sense that both CA and TSAI were booking the present value of revenues up front for what may not have been determinable contracts. Essentially, if you are not sure if you are going to get paid on a contract because payment is due in the future, you should not be booking revenues. The problem is, how to determine if you are going to get paid in the future? Because of these restatements a class action lawsuit was started against the company recently.

3)The company pays a very high tax rate. 62% as of 2nd Q 2003. The reason for this is that is has foreign losses on development projects, which it can’t offset against domestic income. The Co. is working to try to resolve this problem, as a small change in this tax rate would generate a significant amount of savings to the Co.

4)The company will have to write down some goodwill.


But there are significant positives.

1)Attractive valuation. 7.5 x TEV / FCF. Equity 270 mln. Net Cash 59 mln. Un-levered FCF 25 mln. Doing a DCF and assuming the following c onservative operating assumptions: 4% revenue growth starting at the end of 2004. Maintenance of current margins and capex and working capital levels a terminal growth rate of 1% and a WACC of 8% gives an implied price per share of $11.20 per share or a 47% premium from current trading levels. A decrease of the tax rate to 50% from the current 62% would add a further 2 dollars and 40 cents to implied share price to $13.60 or 79% premium to current levels.

2)Significant margin improvement. EBIDTA margins ex charges have improved from –5.6% in 2000 vs. 18.4% (average) for the first two fiscal quarters of 2003. This improvement was the result of significant restructuring activities.

3)Attractive business model. TSAI’s contracts are based on a per transaction basis so that as transactions across banking networks increase, contracts generate more revenues. Additionally typical contracts run 3 to 5 years, ½ of the contract value is paid up front and the rest is paid monthly or quarterly. Furthermore, once a system has been implemented its very hard to change. A further 12 to 15% of the original contract price is generated every year from maintenance of existing networks; and additional service revenues are generated from the implementation of systems, etc.

4)More cash than debt. TSAI has a net cash balance of 59 mln (Cash 91 mln Debt 32 mln).

Catalyst

The company is flush with cash and will announce something regarding its use within the next couple of months as stated in the conference call.

At this valuation it could be an attractive acquisition target

The company is adapting its software to multiple platforms in addition to the HP platform it currently operates on. By expanding the platform, the company could tap a significant amount of additional customers and has begun to through its new system.

Although small the Company’s additional product lines could start generating meaningful revenues.