September 22, 2011 - 6:19pm EST by
2011 2012
Price: 11.12 EPS $0.00 $0.00
Shares Out. (in M): 3 P/E 0.0x 0.0x
Market Cap (in $M): 33 P/FCF 0.0x 0.0x
Net Debt (in $M): -23 EBIT 0 0
TEV ($): 10 TEV/EBIT 0.0x 0.0x

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I am recommending Versant Corporation as a long.  It is the subject of two prior writeups on VIC which I urge you to read along side this.


Versant Corporation is a small company that provides object-oriented database software.  Object oriented databases have been around for decades, and have the advantage of performing better than the relational databases (provided by Oracle and others) in certain complex applications.  Often, there is a 10x performance advantage over Oracle databases in these applications, along with simpler development tools.  Despite the technology advantage, the verdict of the market is clear: relational databases are clearly far more important to enterprises due to their broader application.  Object oriented technology is simply not necessary for most functions.  As a result, the object oriented market is a tiny fraction of the database software market.  However, what is left in the scraps is a specialized market that is stable and modestly growing.


The beauty of database software is that it is very sticky.  Once it is installed, it rarely comes out.  This can present a challenge to small players like Versant, because they have virtually no hope of displacing a larger database provider.  Aside from technology issues, CIOs choosing to replace Oracle with a small vendor takes substantial career risk.  However, Versant has an advantage in that there is a low chance they themselves can be displaced.  Their software is primarily used for mission critical applications and would be very risky to replace.  For example, almost every US telecom carrier uses Versant databases for network management, and they chose Versant after attempting to use relational databases and not succeeding.  Versant is the leader in the space and competition is usually a technology decision of a relational vs. object oriented database.  Pricing is stable and software life cycles for these products can last more than a decade.  As a result, Versant has high replacement renewals above 90% and high returns on invested capital.   


Under prior management (before 2005) the company made a number of mistakes which almost destroyed the company.  They had expanded the company in many directions through acquisitions which depleted cash balances and led to operating losses.  In order for a small software company to sell a complex solution to a large customer, they need to demonstrate longevity.  A new CEO came on in 2006 insisted the company have a healthy balance sheet and show consistent profits.  So the new management took actions to simplify the business, while at the same time limiting new investment to build up cash on the balance sheet.  This resulted in adding about $25mm of cash to the balance sheet in just a few years through regular operations.  During this period, they also benefited from two other tailwinds: a stronger Euro (as 50-60% of sales are in Europe) and customers had negotiated prepaid certain license fees and premium maintenance contracts.

In the 2008-2010 period, the two tailwinds became headwinds, combined with the economic crisis.  In addition, the company, now stable and healthy, started to reinvest in S&M to restart growth in the business, looking to the same customers in adjacent areas.  Given the long lead time of sales, increased sales expenses takes a year or two to demonstrate results.  As a result of the above issues, the recent results have been poor.  Pro forma EBIT guidance is $1.0-1.7m for the current fiscal year, down substantially from the profits a few years ago and the outlook for next year will likely not improve. 


Finally, the CEO responsible for the transformation, Jochen Witte, recently stepped down.   From what I can infer, Witte was tired of traveling (he is a German native whose family still resides there) and the company wanted a US oriented CEO to drive sales here.  The new CEO, Bernhard Woebker, who has been with the company essentially since 1994, fits the mold of a US based CEO with a sales background.  With that said, I do not believe the company will change course significantly from what they have already been doing.  Woebker has been on the board of Versant since the transition and generally has been pursuing the same initiatives that Witte had.


Investment considerations:

History of solid earnings

Since 2006, the first full year that the new management took over, they averaged roughly $4.9m of EBIT per year (including estimated 2011 results).  There is lots of variability and they did over-earn during the earlier part of this period.  Earnings will be quite low for this year and likely flat to somewhat worse next fiscal year.  The company recognizes that sales expenses are high given the current revenue production and will have to cut back if unsuccessful.  Under modest revenue assumptions and an appropriately sized sales force, the company should be able to earn at least $4-5m of operating income on a normalized basis. 


Tangible downside protection

With $23.1m of cash (mostly in US dollars), roughly $67m of US federal NOLs and no meaningful liabilities on the balance sheet, you are getting the enterprise virtually for free.  If you exclude the present value of the NOL carry-forward, the business trades at about 1.5x EV/core maintenance revenue, well below the amount software companies can be acquired for and milked for their maintenance stream (typically at least 5x EV/maintenance revenue).


Capable and shareholder-oriented management

Since 2005, the management team has generally had a good track record of operating the business and capital allocation.  They have made targeted investments to grow sales, and they have avoided doing any substantial acquisitions.  Also, they have used their cash to repurchase about 20% of the outstanding shares over the past three years after their stock fell substantially. 


Attractive valuation on Earnings

Enterprise valuations are distorted because of the high cash balances.  Versant trades at 0.6x EV/sales, 1.5x EV/maintenance revenue, 7.5x EV/current year EBIT, 2.3x EV/normalized EBIT.  This is cheap for a software company that is not losing money, has capable management, and has tangible downside protection.   



At 10x average EV/EBIT, or 5x EV/Maintenance Revenue, and including the excess cash and present value of the NOL tax benefit, the stock is worth around $25, greater than 100% upside.  



Economy:  There is risk that the economy would get worse, particularly in Europe where they have 50-60% of sales (and proportionally similar costs). This could lead the company to post operating losses in the short-term.  But the company has some levers to reduce costs (as they are making an investment in increased sales & marketing).  Given their past, I think they recognize that posting operating losses hurt their ability to close sales with larger enterprises, so they will do what is necessary to keep operating losses as low as possible.


Wasted cash:  Although there is always risk of a large, transformative acquisition, I don’t think it is likely.  The company says they would not want to do it first of all.  But even more importantly, is important to keep a large amount ($15-20mm) on the balance sheet to ride out the cycles as a tech company.  Even if they did pursue an acquisition, it may not be a terrible investment as they would be able to utilize their NOL.  They have done a couple of small deals in the object-oriented space.  What they will likely do is continue keep a large amount of cash on the balance sheet to fund share repurchases and do some bolt-on deals.



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