April 05, 2020 - 5:37pm EST by
2020 2021
Price: 3.31 EPS .33 .43
Shares Out. (in M): 74 P/E 10 7.7
Market Cap (in $M): 244 P/FCF NA NA
Net Debt (in $M): 170 EBIT 0 0

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Zix (ZIXI) was last written up in 2016 and more recently in 2019. While the thesis began playing out, the stock has sold off violently in the coronavirus-fueled market selloff. The last write-up gives a decent overview of the business so we’ll only provide a short description. ZIXI currently trades for 9.0x EV/EBITDA, 7.5x LFCF (a ~13% LFCF yield), and 2.0x EV/recurring revenues

Zix is a 100% subscription/SaaS business with recurring revenues providing email encryption, advanced threat protection (ATP), archiving, and productivity solutions (O365 and Secure Hosted Exchange). Gross retention has consistently been 90%+ and net-dollar retention approximates 100%+.

The core legacy Zix business (pre-AppRiver acquisition in January 2019) is mainly enterprise and is all compliance driven with 80% in healthcare, financial services and government. This is a 28-30% EBITDA margin business. In 2020, this will represent roughly ~$80M of the ~210M total consolidated revenues (our estimates). In other words, this business will generate $~$24M of EBITDA in 2020. Zix occupies the dominant market-share in email encryption (>30% marketshare). The moat in the business is the vast directory of users (called the ZixDirectory) that allows two Zix users to seamlessly send and receive encrypted emails without any intermediate steps, creating a network effect as the ZixDirectory of 55M+ user email addresses continues growing . Since Zix was the first mover in the market, they were able to build up a network of thousands of hospitals, banks, and government institutions (such as the SEC) who can all seamlessly send/receive encrypted emails between one another. We’ve done quite a few channel checks to confirm this. The business mainly goes through the direct sales team and VAR channel. The core legacy ZIX business grows organically mid-to-high single digits.

In January 2019, ZIXI acquired AppRiver for $275M. AppRiver is the second largest reseller of Office 365 in North America for Microsoft. AppRiver sells the O365 solution to mainly small and medium sized businesses, with the average customer having 28 users. The AppRiver business has 4300+ MSPs that sell the O365 into the SMBs, and they typically attach the higher margin proprietary encryption, ATP, and archiving solutions on top of it. There are no specific verticals, but roughly half is healthcare, financial, government, and insurance. AppRiver is essentially an arm of Microsoft for small businesses—the customers that AppRiver serves are simply too small for Microsoft to go after. Our channel checks confirmed that customers relied on AppRiver for any Microsoft-related support. This is a $130M revenue business that will do between $23-25M of EBITDA in 2020. This business grows 15%+ organically driven by the continued 25%+ growth in O365. You can track O365 growth in the quarterly MSFT earnings report. Last quarter, Office 365 Commercial Revenue growth was 30% and MSFT guided to a similar growth rate for the upcoming year. More recently in late March 2020, Nadella pointed out that demand for Microsoft 365 (which includes O365) is “increasing significantly” due to the pandemic.  (https://www.axios.com/microsoft-coronavirus-satya-nadella-938dc807-39f9-4246-94ff-9a103303901a.html)  

Before we continue, it might be helpful to look at the capital structure, since this seems to be a point of confusion for investors. The company currently has $170M of net-debt, and a convertible pref that converts into 17.695M shares ($106.527M face value / 6.02 conversion price) today. This will turn into roughly 22M shares in 2023. Zix management has the option of buying out Truewind (the holders of the convertible pref) at about $200M, or outright force a conversion into shares in February 2023. Management has indicated that forcing a conversion of 22M shares is the path they would prefer to take. 


Price                             $3.31

Shares (000)                73,970

Market Cap (000)       244,839

Debt (000)                    183,638

Cash (000)                   13,349

Lease liabilities (000)  13,390

EV (000)                       428,518


ZIXI currently trades for 9.0x EV/EBITDA, 7.5x LFCF (a ~13% LFCF yield), and 2.0x EV/recurring revenues. Note, these are on our depressed 2020 estimates of ~$48M of EBITDA; management guided in late February to 2020E EBITDA of $51-$53M.

Our thesis

·         ZIXI represents an asymmetric opportunity to buy a 100% recurring revenue business with manageable leverage at a valuation that provides a low teens FCF yield with room for significant valuation expansion.

o   The current valuation is discounting a decent chance of bankruptcy and zero equity value. We do not believe that this is the case because of the resiliency and durability of cash flows. After Q120, the company will be at a ~3.6x trailing net-debt to EBITDA ratio, and has an interest coverage ratio of >5x. By the end of 2020, ZIXI will be 2.5x-3x levered, which is manageable given the business quality, recurring revenues and flexible expense structure.   

o   A quick calculation of our estimate of LFCF is:


2020E Adjusted EBITDA               $48M

-2020E Total Capex + SW Dev     $8M

-2020E Interest Expense              $8.5M

-2020E Taxes                                $0M

                                    = 2020E Levered Free Cash Flow $31.5M


o   On a current market cap of $244M, this represents a ~13% LFCF yield. In other words, assuming FCF doesn’t ever grow, you’re earning a 13% real return on a predictable, recurring business with growth opportunities.

·         Our channel checks suggests that AppRiver customers-- even stressed SMB’s-- will not turn off email and email security during this recession, with the exception of those in the travel, leisure and hospitality, who are absolutely churning off. The reason the vast majority of SMB’s will not turn off their email security is because they are using their email more than ever as they work from home and need email security as they work remotely. Email security is low ticket and mission critical, representing a cost of a couple dollars per month. Office365, a portion of AppRiver’s business, is also foundational—again, if you are reading this, have you thought about turning off your O365 subscription during this stressful time? We believe 10% of AppRiver’s revenue or about 6% of the total business is represented by travel, leisure, and hospitality. Even if you assume these businesses all churned off (which they probably will not), management has the ability to cut OPEX to maintain EBITDA margins and cash flows. In short, ZIXI has the ability to flex down selling and R&D expenses to cushion their cash flows. As management has stated in the past, they could run the core legacy Zix business at 40%+ EBITDA margins and the AppRiver business at over 25%+ EBITDA margins and still grow moderately.

o   It’s worth noting how the core legacy Zix and AppRiver exhibited resilience in the Great Recession. Obviously, competition and penetration in email security is higher today than it was 10 years ago, but it’s interesting to look at this nonetheless. Between 2008 and 2010, core legacy Zix grew revenues from $22M to $32M; AppRiver was named among the fastest growing private companies in America during that time period (https://appriver.com/about-appriver/press-releases/inc-magazine-places-appriver-among-fastest-growing-private-companies)

·         We believe that even in a case that the overall businesses grows mid-single digits for the next 5 years, the company will be able to generate between $40-50M of LFCF and still pay off the term loan that expires in 2024. In this case, equity holders receive close to $9/share in the next 5 years (the stock price was here in February 2020) assuming a conservative exit multiple.


·         The current CEO and CFO ran a Thoma Bravo backed company before coming to Zix. We believe they are competent and understand the levers they need to pull.

·         The chairman is an operating partner at Thoma Bravo; the company has been run conservatively and prudently under his leadership

·         There are 2 new PE board members (currently at Truewind, previously from KKR)

·         The others bring a wide range of experiences and have been on the board for multiple years

So what is the downside?

·         What if the total business struggles to generate over $50M of EBITDA in the next few years as the economy plunges into a deep recession and SMBs continually exit and turn off the AppRiver subscriptions? In this case, we believe the company will be forced into a sale (to preserve Truewind’s initial investment) to one the large software buyout shops, such as Thoma Bravo or Vista Equity or a strategic buyer. If the business was sold for 11x EBITDA in a distressed scenario, this would translate into 11 x $50M EBITDA = $550M EV + $13M cash - $183M debt - ($106.527M pref x 1.35 kicker) / 56M shares = $4.22/share. In a distressed buyout, shareholders would get a 27% premium to the current share price today.

o   Barracuda Networks (CUDA), a competitor of Zix, was acquired by Thoma Bravo in November 2017 for ~4x subscription revenue and ~15x EBITDA. The business was under intense competitive pressure from Microsoft at the time.

·         If the business went ex-growth and management expanded EBITDA margins as a result, the business could generate between $55-60M of EBITDA, or close to $44.5-49.5M of levered FCF (using $2M of total capex/cap SW). This represents close to a ~20% FCF yield on today’s market cap. In this case, we believe the stock would trade for at least 8x FCF, or $5.08 per share (a 54% upside from here).


·         In summary, the current share price offers a highly asymmetric risk-reward investment opportunity. While the market views Zix as a highly levered SMB software player that’s vulnerable to mass churn (and thus rapid free cash flow decline) in today’s economic climate, the reality is that half of Zix’s free cash flow is generated from a super stable customer base—the core legacy enterprise customers in healthcare, finance, and government. This alone should protect Zix through a deep, prolonged recession. While you wait, you get paid a 13% FCF yield. For all the reasons above, we think this represents an attractive investment opportunity here.




I do not hold a position with the issuer such as employment, directorship, or consultancy.
I and/or others I advise do not hold a material investment in the issuer's securities.


 -EBITDA growth


-Investor expsoure 

-Doesn't go bankrupt 

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