Is Ebix a successful Roll-up or not?

Here’s a company that has been growing revenue at about 30% for the past 3 years and has translated about 40% of revenue into operating cash flow each year. What’s not to love if the company’s stock is trading at about 9 times earnings? Well, someone out there, and probably several someones, have got it in their head that what looks too good to be true really IS too good to be true; there’s a short thesis that says EBIX’s revenue growth is being achieved through financial shenanigans, or, at best, through its strategy of serial acquisition. To put it simply, EBIX’s base business is not really growing at all; growth is coming solely from acquisitions, and revenues will level off the moment the acquisition strategy is played out.

I guess the fact that I bought shares in EBIX well after the short thesis was put into the public domain should tell you what I think of the short thesis. Don’t get me wrong. I value the role short sellers play in the stock market. But just as there are long theses that are wrong, so too are there short theses. The biggest problem I have with the short thesis on EBIX is not the thesis itself, that will prove itself out in the long run, or not as the case may be, but the tactics that have been employed by the shorts. To my mind its alright to come out and give your short thesis about a company’s stock in as public a forum as you can find. No, not just alright, I think it should be commended. Investors can get far too optimistic about things. Shorts are important in damping mass hysteria (though one might ask where they all were when we needed them in 1999?), and they are even more important in ferreting out financial shenanigans a la Enron. I’m all for shorts and the role they play. However, I really think it hurts one’s credibility when one has to resort to ‘anonymous’ negative statements about a company. Just look at the recent episode related to EBIX; in early November Bloomberg published an article titled “Ebix Accounting Practices Said to Be Probed by SEC” which stated that EBIX “is being investigated by the U.S. Securities and Exchange Commission for its accounting practices, four people with direct knowledge of the probe said.”  Pretty mysterious, no? It sounds like a scoop! But wait a minute, who were the four people (and why four, wouldn’t one or two have been enough)? Were they from the SEC or EBIX? If they were, aren’t they prohibited from talking about an investigation until it is made public? If not, how could they have ‘direct knowledge’ that an investigation was underway? I don’t think we’ll ever know the answer to these and other related questions.

Though EBIX and CEO Raina did whatever they could to dispel the ‘rumor’ (a public statement that they were unaware of any investigation), the stigma seems to have lingered and shares are down some 30% since. There is, of course and not to be discounted, the matter of compressed margins in the 3rd quarter which, I’m sure, hasn’t helped the share price either.

But let’s get to the matter at hand. EBIX is not my usual kind of investment. It has a low tangible book value relative to market cap, meaning the balance sheet has a lot of goodwill/intangibles. I’m usually an asset guy, with earnings secondary. But I AM a ‘glitch’ guy! I first bought in last March (the first ‘glitch’) when there were earlier rumors about fraud swirling around the company. Now I’m upping my stake with the new rumors. If I’m right (and there’s no guarantee of that, let me assure you) this is an opportunity to invest in a true growth business at a reasonable price.

How do we know the shorts aren’t right? The short answer (!) is, we don’t. Theoretically one might look at the original businesses and the acquisitions separately. Are the original businesses producing organic growth? or is all revenue, income and cash flow growth coming from  acquisitions? In reality, of course, we can’t do those calculations as management doesn’t provide this kind of granular information. So instead, lets look at things a little differently.  Let’s take more of a global view. We can see that operating cash flow over the past three years is substantially the same as operating cash flow. That’s a pretty good start; cash in the bank is hard to falsify, unless, perhaps, you’re in China. How much cash has been generated and how has it been used? About $172 million in operating cash flow has been generated since year-end 2009. About $6 of that has been returned to shareholders through dividends (which began this year). The balance was used to make acquisitions and repurchase shares. We’ll also have to consider that debt has increased from about $52 million to $80 million over this time, adding another approx. $30 million in cash which was used. I’m not counting share repurchases as cash returned to shareholders as, you will note, the share count, despite the substantial repurchases, is up slightly. Initially I worried that share repurchases were just keeping pace with the exercising of options, i.e. they were nothing more than disguised management compensation. But this doesn’t look to be the case; I see that there were some convertible notes that were converted during the period in question so the share repurchases were, in effect, just a form of paying down debt. Whether issuing the converts was a good strategy in retrospect is something to go into on your own; we’re concerned here with ‘the big picture’.

So lets say EBIX spent about $195 million (plus the future earn-out liabilities) to get what? Well, let’s make another gross assumption and say that the business that EBIX had at the end of 2009 remained flat (the shorts might think I’m being generous). Thus all incremental Revenue, Net Income and Operating Cash Flows we can attribute to the acquired businesses.  I’ve taken the run rate of the 3rd quarter 2012 and subtracted the average run rate of 2009 to get some incremental numbers. By this measure EBIX has added revenue of about $30 million, net income of $9 million and operating cash flow of $10 million per quarter.  On a cash basis, which is what I’m mostly concerned with, this means we’re getting $40 million in run rate OCF for our $195 million investment. Since I see that EBIX has relatively small Capex requirements (less than $2 million annually, including the acquisitions) we’ll just leave that out of our equation for the moment. So assuming the acquisitions are self-sustaining and have NO GROWTH, we have gotten a return on our $195 million investment of around 20%, leaving aside the earn-out liabilities (which we can’t evaluate due to lack of information). Now if, instead, we assume that EBIX’s base business actually had some organic growth over these three years, our imputed ‘return’ would be lower. But then again, we might also expect the acquired businesses to have some organic growth, don’t you think? (otherwise why did EBIX buy them?) And the impact of these two might cancel themselves out. So, using our back of the envelope approach, it looks to me like we believe 1) the original EBIX businesses were mediocre at best but management is great at acquiring companies with accretive earnings, 2) growth at the original EBIX businesses has been going gangbusters and management is poor at buying and integrating accretive businesses, or 3) somewhere in between; the EBIX base businesses have been growing at least modestly and management has boosted growth with a successful accretive acquisition strategy. I think you know where I come out on this one.

This over-the-top analysis is no proof that the shorts have it wrong, but it illustrates the way I think about the investment. It is just a kick-off point for any potential investor to see whether further in-depth analysis of EBIX is warranted.