American Electronics Association
Micro Cap Conference
This was my first time at the Micro Cap Conference. I have previously attended the AEA Classic Conference for medium-sized companies, which is typically held in November. The micro cap conference proved to be as rewarding as any of the classic conferences despite being exclusively for companies capitalised below $200mln or with revenues below $200mln and there being a lower number of delegates. It was an interesting format for presenting companies, matched by an equally interesting range of companies and comments from management teams. A very worthwhile few days.
After attending the conference for the medium sized companies in November we wanted to check-in with their smaller peers as soon as we could. Of the twenty seven meetings with management at the November conference all but two proved to be antagonistic or hostile - a culmination of seven years of attrition and small rewards and a feeling among analysts and investors that companies have failed to deliver. Clearly two diametrically opposing views which led to some awkward meetings! It was therefore important to see if we could gauge any change in investor sentiment given the frustration the companies felt at the seeming ignorance about their prospects.
While the valuations of the companies have not, on the whole, come anywhere near those associated with the valuations in the middle of the last decade, let alone the ones in evidence at the end of the last decade, management were far calmer about their share prices than at the tail end of last year. The momentum and visibility they are seeing in their businesses has allowed them to be far more confident when speaking to the delegates and the body language of a notable number of presenters pointed to a wholehearted resurgence in confidence about the future.
There were a number of interesting themes running through the conference, all associated with a feeling of vindication by the Chief Executives Officers (CEOs) that they had survived the first seven years of the decade and are now in a solid position to move ahead, whether investors wish to pay attention or not. Quotes such as those below were not uncommon: “"it's all about growth momentum”, “this is our growth engine", "we doubled our income but nobody noticed", "we ramped up the sales force last year and will be doing more this year....these guys are getting very costly" and "there is a big pop in the share price to be had."
Most of the companies have enjoyed a good start to the year and there were plenty of admissions by management that when it comes to addressing the value placed upon the company, "we have lots of weapons these days…. If the investors don't look after these companies then we’ll ensure private equity does.” In terms of excess, all these companies are thankfully a long way from capacity constraints and run away salary inflation but they were notably more optimistic than at any time in the last five or six years. Their optimism extended into numerous different areas. Every company was focused on international expansion - what a change. No one mentioned the dollar or the impact recent moves have had. There was just a straightforward acknowledgement that expansion overseas offers huge opportunities.
The conference started with six minute presentations to investors and analysts by forty to fifty companies, divided between two rooms into hardware and software companies. Conference attendees used the six minute presentations to decide which companies they would like to have a more in depth meeting with during the afternoon. I focused mainly on the software companies during the afternoon break out sessions, visiting a number of companies I had seen at the AEA conference in November with a view to finding out how business was progressing. One of the companies that felt most aggrieved when I saw them in November was Keynote Systems (share price $15.70c, mkt cap $274mln, cash $90mln, calendarised hist p/e 2006 n/a and calendarised pros p/e 2007 n/a as at 24 May 2007).
Keynote provides test and measurement systems for mobile telephones and for internet performance. They were clearly annoyed by the valuation of the company in November and subsequently embarked on an aggressive investor relations programme. Although the investor relations push helped to improve the share price it is obvious that they feel it still has a long way to go to reflect what they think is the true worth of the company. On a positive note, the feeling of closure about the period 2000 to 2005 was even more pronounced than six months ago and management concentrated on forward looking plans rather than harping back to the difficult times at the beginning of the decade. Their core service, web-site testing and measurement, has however collapsed in the years since they floated and they have had to work hard to devise other offerings. By venturing into areas such as broadband and mobile phone testing they have sought to offset the decline in their core division.
The company reported a very impressive set of results and a record cash flow performance for the first quarter of 2007, an ongoing trend among many of the companies present. Earnings expectations for 2007 and 2008 continue to rise and the company said that its investor relations team would continue to woo the analysts. Internap (share price $15, mkt cap $781mln, cash $181mln, calendarised hist p/e 2006 n/a and calendarised pros p/e 2007 44x as at 24 May 2007) was another company I also saw in November. An interesting business model providing routing services for corporates to deliver content and video over existing networks. It was one of the few genuine concept stocks at the conference and in the wake of companies such as Youtube, it has attracted a keen following. They have continued to refine their methods of handling traffic so as not to fail on their promise of 100% up-time for customers which has been the main focus of their marketing efforts.
It was a beneficial coincidence that their presentation came just days after the bids for Dow Jones and Reuters. Larger media players are now focussing attention on new video services and methods of delivering their stories/ products to their readers/ clients whether it be a local newspaper using video clips embedded in their website stories or auction sites looking to use better methods of displaying their wares. Internap is forecasting a large growth in demand for its products on the back of this trend. Given the rise in volumes reported by larger peers such as Akami, there is every reason to believe that Internap could form a key part of many companies’ plans for the infrastructure of their web offerings.
Tumbleweed (share price $2.70c, mkt cap $156mln, cash $32mln, calendarised hist p/e 2006 68x and calendarised pros p/e 21x as at 24 May 2007). Tumbleweed sells software which manages and protects incoming and outgoing internet communications, covering emails, files and user identification. They have recently seen two of their largest competitors be acquired, Ironport and Cybertrust, and, understandably, are feeling vulnerable.
With governments and corporates increasingly seeking to protect themselves from inbound and outbound viral attacks and with heavy regulatory burdens relating to the recording of all documentation, Tumbleweed feel that they are in a strong position. They talked about their desire to expand overseas and they sought to entice investors with some very ambitious targets for future growth, notably in terms of new sales recruits in South East Asia.
Rainmaker (share price $8.15c, mkt cap $160mln, cash $22mln, calendarised hist p/e 2006 35xa and calendarised pros p/e 2007 39x as at 24 May 2007) sells software which provides sales and marketing services to corporates. They are benefiting from the increasing level of optimism among buyers as clients increasingly seek to refine and monitor their marketing plans. They were one of many companies to make the comment, “software purchasing was all about outsourcing and cost reduction and tech support - ‘can you help me cut 30c out of a $1 spend’ - now it’s all about how we can take $1 and grow it.” They gave a wholehearted endorsement of their customers’ behaviour and concluded that they were seeing a broad based rise in prospects from both new and existing customers.
They are reporting good turnover growth and they gave an encouraging presentation and account of themselves. The management team gave every reason to believe they have a bright future and were very pleased to announce that Peter Lynch has acquired a holding in the company for one of his Trusts. They were one of the most obvious acquisition targets at the conference and to big players like Oracle I can see the appeal.
As a pure software play, Callidus, (share price $8, mkt cap $238mln, cash $50mln, calendarised hist p/e 2006 n/a and calendarised pros p/e 2007 n/a as at 24 May 2007) is an interesting candidate.
I thought the company was impressive at our meeting in November and they came across even better this time. The business sells software which allows corporates to see who they are paying commissions and incentives to and helps check whether the bonus and commissions are being allocated correctly. The problem of mispayments was first raised by Callidus in November and they have identified, and are selling into, a potentially huge market which has yielded some impressive orders to date.
The rationale for their software is that “fifty per cent of commission payments are wasted; people just aren’t sure which fifty per cent it is.” They had some interesting anecdotes about companies’ allocation and handling of commission payments. They majored on the example of why mobile phone companies are still basing marketing campaigns around “least dropped calls when what really matters is how they incentivise the shop assistants at Best Buy and Circuit City. … they are marketing companies not technology or handset companies.”
(As a welcome aside, and by contrast to our experiences in the middle of this decade, they were the only company to mention Sarbanes Oxley and this was only in the context of auditors fees proving to be more expensive than they imagined.) Management seemed extremely confident about the company’s prospects, “there are lots of options out there for us now….we don’t let investors rule our lives.”
I have seen Captaris previously (share price $5, mkt cap $164mln, cash $62mln, calendarised hist p/e 2006 25x and calendarised pros p/e 2007 14x as at 24 May 2007) and at last the story seems to be being born out in the share price movement. The company provides software which allows businesses to better manage their documentation including archiving and retrieval.
There was a positive change in their body language despite the profits warnings in the intervening period. They seemed refreshed and emboldened having completed a successful acquisition of smaller rival, Castella. Management are working hard to grow their presence in the emerging markets and feel that conditions will be kept buoyant by a number of different factors: “we wish to challenge the notion that paper is going away…the sources it is being derived from are increasing and also the documents are becoming increasingly important.”
Another notable and interesting change was their confidence in gaining leverage from the business given the number of new leads and possible partners available to them: “we are chasing growth…. Companies are beginning to understand that it is important to be disciplined in the filing of all types of paperwork and that, when filed properly, paperwork is very useful and helpful.”
Phoenix Technologies (share price $8.55c, mkt cap $194mln, cash $50mln, calendarised hist p/e 2006 n/a and calendarised pros p/e n/a as at 24 May 2007) epitomised the worst travails of the tech companies but are at last “becoming a turnaround company”. They supply the software which supports operating systems and makes them operate effectively on PCs and other hardware. The previous management team embarked on a number of wayward ventures and drove the company into a parlous state. The new management team were open about the position they believe they inherited and how they believe they have strengthened the company.
The CEO was adamant that while the core division - selling software stabilising systems to the major PC manufacturers and dealing with the likes of Microsoft - contained all the characteristics of an attractive annuity stream, the new ventures “are a proxy on the rollout of new devices and software all over the world.”
By embarking on a rigorous examination of revenue recognition, cash flow and a whole host of other metrics, the management are reviving the company and making it more appealing to investors. They are about to start an investor relations road show and the CEO epitomised the renewed confidence felt by corporates as they seek to overcome the prejudices about the company and new technologies in general.
One of the few companies involved with tech hardware I saw in the break out sessions at the conference was In-Play Technologies (share price $1.40c, mkt cap $12mln, cash $9mln, calendarised hist p/e 2006 n/a and calendarised pros p/e 2007 n/a as at 24 May 2007). In-Play Technologies is an intellectual property company which licences technology to large IT hardware suppliers. They have a number of interesting products including an electronic pen which makes tablet PCs and handheld devices more effective. (A tablet PC has the functionality of a desktop computer but is held in the hand and operated with a digital pen, like a note book.) The company has had a traumatic few years but I wanted to see them because they were adamant in their presentation that the inflection point for their key product is near.
The difficulties suffered in the business were primarily related to problems at their manufacturers in the production of the electronic pen which resulted in one large customer ending the relationship. They pointed to the huge disparity between the number of desktop PCs manufactured in the world and the number of tablet PCs and argued that the point of take off for tablet PCs and durable corporate Personal Digital Assistants (PDAs) is close. Clearly applications for the latter are important and the CEO stated that he believes the release of new applications involved in healthcare, supply chain management and the military are just three areas where In-Play could see large volumes via their large customers.
It was also interesting that despite renewed talk by the media of “bubbles” in the US stockmarket, especially with regard to tech companies, there were very few companies which could genuinely be labelled as expensive on a revenue/market capitalisation basis. Acacia Technologies (share price $14, mkt cap $425mln, cash $53mln, calendarised hist p/e 2006 n/a and calendarised pros p/e 2007 n/a as at 24 May 2007) was the exception to the rule and did look expensive. They help small businesses obtain and protect their patents: “large companies know how to get paid for their patents, and we can help the smaller companies in this area.” With historic revenues for December 2006 of $40mln and prospective revenues for 2007 of $56mln the company’s shares are clearly expecting a great deal of additional progress in terms of turnover and profit growth.
There is clearly a demand for their service and at the same time they are good at retrieving payments. The CEO was proud to announce, “we have doubled revenue every six months for each of the last eight half years.” It is a company with great momentum and it is a good illustration of just how fast the market for patent and licence based revenue is growing: “…worth $15bln a year in 1989, worth $150bln a year in 2000 and worth $500bln in 2008…..driven by the likes of Qualcomm who this year will generate $2bln in patent licence revenue. IBM will generate $1.5bln from licence revenue this year, as opposed to $30mln in 1990.”
The CEO of Acacia gave every impression that the company is perfectly positioned as one of the few operators in this rapidly growing area. By stressing how “low risk” their operations are, the company argues that it is in their customers’ interests to pursue claims for additional revenue as the effort involved is minimal because the hard work is carried out by Acacia with any revenue retrieved then being shared between both parties. By adding patent portfolios, the company is expanding awareness of its name and this helps them win new customers as well as increase their ability to ensure they get paid more quickly. An interesting proposition in an evolving market. Touching briefly on the final few software companies I saw, Pervasive (share price $4.30c, mkt cap $91mln, cash $47mln, calendarised hist p/e 2006 17x and calendarised pros p/e 2007 11x as at 24 May 2007) highlighted the fact they had bought back ten per cent of the company in the last twelve months. Their confidence in the future was impressive: “Vista and Longhorn will breathe new life into the packaged software market for small and medium sized businesses.”
Wave Systems (share price $2.60c, mkt cap $111mln, cash $3mln, calendarised hist p/e 2006 n/a and calendarised pros p/e 2007 n/a as at 24 May 2007) specialise in security systems for PCs and were another company to state confidently that theirs is a “high growth emerging market….the PC will soon know who you are….software and services will soon be deployed that save you from remembering numerous passwords.” They confirmed our belief that business processes will soon be vetted as keenly as other areas of business by compliance teams. Another concept stocks but with $18mln revenue forecast for 2007 the expected surge in growth has attracted investors.
Cam Commerce Solutions (share price $27.50c, mkt cap $109mln, cash $20mln, calendarised hist p/e 2006 40x and calendarised pros p/e 2007 38x as at 24 May 2007) specialises in protecting internet retailers from fraud by installing their own security systems. Of particular interest here was their dividend model which calculates dividends as a percentage (65%) of that year’s earnings. The management noted however that “even with an earnings related dividend plan no one follows us.”
Edgewater Tech (share price $8.30c, mkt cap $109mln, cash $20mln, calendarised hist p/e 2006 40x and calendarised pros p/e 2007 38x as at 24 May 2007) gave a very impressive presentation. While I wasn’t altogether impressed by the company story I was impressed by their confidence for the future: “we’re a high growth company seeing high rates and higher margins….for 2007 we’re pumped and we are ready to grow and acquire.” A real contrast and a fitting conclusion to an interesting conference.
Conclusion
Despite the optimistic narrative about corporate expectations, as the valuations show, the prospective price to earnings ratios for 2007 appear high. There is, however, no doubt that many of these companies are operating at the lower limits of their potential earnings power and are poised for an uplift. The growth forecast is most visible in the projected rate of turnover for 2008, with earnings beginning to rise at a higher rate given the immense amount of operational leverage in many of these businesses. The management teams are well aware of the possible uplift in valuations from current levels particularly as when the cash on the companies’ balance sheets is removed, many of them trade at a multiple of turnover between one and three times putting them on valuations which are fundamentally attractive.
29 May 2007
