Description
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.
Upside:
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.
Risks
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.
Catalyst