Description

ePlus is an under-followed IT service company trading at 6x current earnings power with low downside risk (trading at 1.1x tangible book value).

Founded in 1990, the company offers its Enterprise Cost Management (“eECM”) model, which it calls its “framework for combining IT sales and professional services, leasing and financing services, asset management software and services, procurement software, and electronic catalog content management software and services.” The company derives the majority of its revenues from selling, leasing, financing, and managing IT and other assets.

For FY04 (March), $330 m in sales consisted of: 81% in sales of product and equipment, 15.5% in lease revenues, and 3.4% in fee and other income (including eECM revenues, revenues from adjunct services and management fees). The company’s largest vendor relationships include Tech Data, HP, Dell, Microsoft, Ingram Micro, and IBM.

Through its Web-based software and services offering and its leasing model, the company believes it offers an IT solution with a low total cost of ownership, especially compared to ERP and EDI vendors. It serves mid-sized and large businesses, healthcare companies and government agencies. The company leases computers, computer software, communication related equipment, medical equipment, industrial related machinery, office furniture and transportation equipment. By bundling upfront maintenance, installation, training, software and services with equipment, the company offers a single leased solution.

Over the last five years, the company has grown organically and through some small acquisitions: ProcureNet ($4.9 m plus liabilities in May 2001), SourceOne Computer ($2.8 m in October 2001), Elcom International IT fulfillment and professional services ($2.2 m in cash plus liabilities in March 2002), some assets from Digital Paper ($1.6 m in October 2003), and some assets from Manchester Technologies ($5 m in cash in May 2004).

VALUATION:

What caught our attention is that the company is trading just over tangible book value and at a low multiple of its current earnings power.

The company has tangible book value of $9.8 per share. Historically, the company has realized a premium over its original recorded residual assumption, or the net book value. That would imply that tangible book value is understated. The company has $14.1 m in cash (Sept.).

Because earnings have been quite consistent over the last five years, we can probably estimate the current earnings power of the company. Earnings for FY04 (March) was $1.02 per share. Expensing options would reduce EPS by $0.25 in FY04. The company has a cost of $0.06 a quarter for a lawsuit against Ariba, which goes to trial in early January and should be done by the end of the March quarter. Adding back that cost would add $0.24 to annualized earnings power. In addition, the company has stated that pro forma for the Manchester acquisition (after exiting some business lines and removing duplicative overhead) would have yielded $0.19 to diluted EPS in FY04. Since the deal just closed in May, these cost reductions should start flowing through, which would likely add about $0.19 to earnings power. The company has repurchased 1.7 m shares over the last two years, or about 10% a year. At that rate over the next year, it would add 10% to earnings power per share. If the company’s IT end markets improve that could also add about 10% to earnings power.

Earnings power estimate:

FY04 (March): $1.02
- Expense options ($0.25)
+ Legal costs $0.24
+ Manchester benefits $0.19
+ Share repurchase $0.10
+ Growth in end market $0.10

Current earnings power $1.40
Implies stock is trading at 7.7x current earnings power.

Assuming 90% of cash is excess, then there is $1.4 in cash per share, which implies the stock is trading at 6.3x current earnings power.

An important catalyst is that a significant portion of cash could be used for share repurchase. During the last three fiscal years (FY02 to FY04), the company repurchased 66,100, 1,022,340, and 688,800 shares of common stock. On November 17, 2004, the company announced a potential share repurchase of up to $7,500,000 in stock over the next twelve months.

Importantly, management has a significant interest in the stock, with the CEO Phillip Norton owning about 25% and the Bowen (Exec. VP) owning about 9%.

The stock has been weak over the last two weeks, possibly due to the company finding that one of its customers committed fraud (in the amount of $14 million), as announced on December 20, 2004. The agreements were non-recourse to PLUS, and PLUS is not liable for the repayment of non-recourse loans unless PLUS breaches representations and warranties in the loan agreements. In this case, the company does not believe that it is liable under these agreements. If the company is indeed clean of this event, and if this event does not impact the company’s future debt financing activities (company estimates that there are 40 non-recourse financing sources available), then a resolution of this matter would likely help the stock.

Catalyst

Stock is trading at a low multiple of tangible book value
Stock is trading at a low multiple of current earnings power
End of trial against Ariba boosts earnings in March
Cost cutting after Manchester acquisition boosts earnings
Continued stock repurchases
Pick-up in IT end markets
Resolution of recent customer fraud event