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Is Ebix a successful Roll-up or not?

December 16, 2012

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.

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13 Comments
  1. wei permalink

    Hi, can you explain what the company does? I don’t understand what an exchange is for the insurance industry. I think the shorts are also questioning what the company actually does…

  2. There is a pretty detailed and well-researched short thesis here (probably by some anonymous hedge fund):
    http://seekingalpha.com/author/copperfield-research/articles

    The CEO is a charlatan in terms of the way he runs his charity- it’s so bizarre that the charity website promotes Raina on the about page. The auditor resignations are bizarre too.

    This would go into the too hard / avoid pile for me.

    • Umm… nevermind I’m sure you’ve read that a long time ago!

      • Regarding SEC investigations… I think that they are largely irrelevant. It’s like being audited by one of the big four audit firms. Passing an audit or SEC investigation doesn’t mean that there isn’t fraud going on. Of course, I’m also of the opinion that Copperfield is making a big fuss over something minor. Of much larger concern are the accusations that Ebix has poor internal controls, as alleged by lawsuits against Ebix. The CFO and controller don’t agree on the numbers?! That’s not right.

  3. I am long EBIX as well, having bought in after the recent decline. I’m in at a cost basis of about $17.35. I agree with many of the points in your article, and I do in fact believe the shorts are wrong. To me this is nothing more than a great buying opportunity. Thanks for the detailed analysis – it’s always nice to get some confirmation for my views.

  4. Not to belabor a point already made, metrics in the chart indicate a strong 2011 performance -ROIC was 20%; FCF was $63.8 million representing a 36% rate of growth, y-o-y.

  5. anon permalink

    Yes all of the numeric metrics are great. By the numbers the company is dirt cheap but I just can’t get over them replacing what 4 auditors in 6 or 7 years. If auditor’s were leaving then how can you be certain that you can even trust the numbers?

  6. Hi LT Value,

    I posted this at Corner of Berkshire and Fairfax and wanted to get your take. Been a reader of your blog for 1.5 years and have really enjoyed it. Look forward to your reply!

    Best,
    PSDFinancier

    Hi all,

    I’ve been following the EBIX saga from afar for the past few months, but finally decided to use the long weekend, coupled with the release of the SEC letters this week, to dig into the situation and try to see if I wanted to get involved.

    The company’s financials look fabulous, and at least mentally, the inherent competitive advantages of the Company make sense to me.

    However, I wanted to give the short sellers (i.e., Copperfield) the benefit of the doubt to make sure that I had thought the situation through thoroughly. From the December Copperfield letter, the one part of it that I haven’t been able to disprove to myself is his/her accusation that Ebix has misrepresented organic growth. To pull the words straight out of the report:

    On its third quarter conference held on November 8, management was asked directly about organic growth in the Q&A segment:

    I was wondering, how much of your revenue growth for the last three months and nine months were due to organic growth and how much was due to acquisitions?

    While this benign question would seem to have a very straightforward answer, Mr. Raina’s response was not only convoluted and circular, it also would appear to be a direct lie based on a specific disclosure in the 10Q. While lying may not necessarily be illegal, we do believe his public response directly contradicted and misrepresented the 10Q disclosures about the critical organic growth metric:

    Well, I think we’ve answered that in the past that the way we run our business, and it’s very different — difficult for us to differentiate between what we get out of acquisition and what we get out internally. Part of it, we integrate these products very tightly, there is no — Ebix, as I was just talking through the STP region, I actually talked about one product. What is going to happen if Ebix will become one product company. So every day, that’s what we are doing. So we don’t really — everything that’s so entangled in each other, that’s so difficult for us to read. Our operations are integrated and that’s — our selling process is integrated, our products are integrated. It’s very difficult for us to disintegrate and start breaking up that kind of revenue in that sum. So it’s almost impractical for us to do it. And one of the reasons for Ebix’s success is precisely this. This is one of the reasons why we produce better efficiency and better margins than anybody else because we integrate extremely tightly, we sell in a very tight manner and so on.

    It is a challenge to understand exactly what Mr. Raina’s answer meant, but his abundant usage of “integrated” (6 times) seems to suggest difficulty tracking and reporting organic growth. However, for the first time, the 10Q unequivocally states the actual organic growth rate. In the MD&A section on page 24 of the 10Q, Ebix states explicitly when discussing organic growth that they experienced “a 1.4% DECREASE in revenues associated with Ebix’s legacy operations8 (emphasis ours). The 10Q was filed less than 30 hours after Mr. Raina stated that is was “difficult” and even “impractical” to calculate organic growth. As such, we believe that he was highly deceitful when answering the question regarding organic growth on the earnings conference call. In the past, the sellside has been quick to provide their own analysis of organic growth to justify silly price targets derived from random organic growth assumption. We believe there is no opportunity to “arrive” at some arbitrary growth number when the 10Q specifically states that organic growth is NEGATIVE.

    What should be more disturbing to existing shareholders than negative growth is that it appears Ebix’s most recent 10Q (Q3’12) implies they misrepresented organic growth in the 10Q’s filed for Q1’12 and Q2’12. In Ebix’s quarterly filings, they report pro-forma revenue disclosures that can be used to calculate organic growth. In our last report, we provided analysis showing why Ebix’s “pro-forma revenue” disclosures were not a reliable proxy for organic growth (pro-forma growth will appear higher if Ebix acquires growing targets). However, until the 10Q for Q3’12 (which included the disclosure that the 3.5% pro-forma revenue growth consisted of NEGATIVE 1.4% organic growth and 4.9% acquired growth from seven acquisitions–ADAM, HealthConnect, BSI, Taimma, PlanetSoft, Fintechnix, and TriSystems–completed in 2011 and 2012), the pro-forma revenue was the only metric Ebix provided that was tangential to organic growth. IT IS OUR OPINION THAT SOMETHING MUST HAVE CHANGED THAT CAUSED EBIX TO FINALLY BEGIN DISCLOSING THE APPROPRIATE, ANEMIC GROWTH NUMBERS. FURTHER THE Q3’12 PRO FORMA DISCLOSURES FROM THE THIRD QUARTER 10Q DO NOT RECONCILE WITH 10Q DISCLOSURES FROM Q1 AND Q2.

    When Ebix filed its original 10Q for Q1’12, we were unable to find pro-forma disclosures. In an odd turn of events, Ebix filed an amended first quarter 10Q on July 6, 2012 that included pro-forma revenue growth of 2.8% (see table below). On 8/9/12, Ebix filed its 10Q for the second quarter, which disclosed an implied pro-forma growth rate of 6.3%.

    However, when Ebix filed its third quarter 10Q, it disclosed 3.5% pro-forma growth for the third quarter and only 1.3% for the first nine months of 2012. This effectively implies flat pro-forma revenue growth for 1H’12 (see table 2 below).12 This implied 1H’12 growth rate does not reconcile with the 6.3% growth that was reported in the second quarter 10Q for the first six months of 2012. Since Ebix only closed one small acquisition between the second quarter and third quarter filings, we believe that the apparent “disappearance” of 600 basis points of pro-forma revenue growth is a massive question that needs to be answered. As can be seen in our table below, Ebix claimed to have grown 6.3% in 1H’12 based upon their 10Q filing for Q2’12 ($98,216 of revenue vs. $92,399). However, using the third quarter 10Q, subtracting the reported pro-forma revenues for Q3’12 and Q3’11 from the nine months reported for 2012 and 2011 results in implied pro-forma revenue growth for the first six months of just 0.2% compared to the 6.3% they reported for that exact same period in the second quarter 10Q (1H’12 = $158,336 (9 mo’s) – $54.197 (Q3’12) = $104,139 vs. $103,899 from 1H’11 using same exercise). This implied first half growth rate does not reconcile with the actual first half growth rate that was reported in the second quarter 10Q.

    I know that there might be some complications with the pro forma numbers that I may be missing since I only just started looking at the situation this weekend and am still not 100% comfortable with the numbers, but does anyone here have a refutation of this point? Seeing declining revenue in the legacy businesses for YTD Q3 2012 vs. YTD Q3 2011 is a problem, no? And why don’t the implied 1H 2012 vs. 1H 2011 growth numbers match up with what was reported in 1H?

    Would appreciate thoughts on this. Clearly, if the shorter is just full of BS, then Ebix is a steal even after this week’s run-up.

    Best,
    PSDFinancier

  7. PSD Financier

    You bring up some interesting points. However, it would have helped your case if you had stated at the beginning of your comments that you are in no way associated with short sellers and you, yourself are not a short seller. The tone and the focus of the comment belies this and gives you less credence. Your comments are a little too pat, a little too focused on the minutia of what management said or didn’t say. I think the key issue is whether there is or is not organic growth, not what management said. I agree that Raina’s comments are vague; that doesn’t make him a bad manager or a liar. AN incompetent communicator, perhaps.

    Perhaps one way for a true value investor to view the problem is to invert. What if there is no organic growth? What is the value of the company if the strategy is simply to take over other companies with similar businesses, offshore the software development and raise the operating margins. This depends on 1) how long the rollups can continue, 2) how much value is added through margin expansion and 3) how excess capital is allocated. It seems to me that the third question is the most important and the one that we have least insight into. Up until now capital has been used primarily for acquisitions and secondarily for stock repurchase and dividends. Returning cash to shareholders through these latter means bodes well but doesn’t a great capital allocator make. When the rollup slows will capital continue to be returned to shareholders in an efficient way? The company certainly generates cash. It trades at about 10 times earnings (which is mostly cf) and maybe under this scenario that’s all it deserves. Or maybe not.

    Unless you believe that the cash balances aren’t real I think the shorts have focused on the wrong thing. They may, in fact, be right that there is little or no organic growth, but that doesn’t mean the company is worthless. You first have to prove that there is negative organic growth for the value to be where it is today.

    Let’s just say the proof is in the pudding and wait for the results to prove it one way or the other.

    • PSD Financier permalink

      Hi jay,

      Haha, apologies. Let’s start my response by saying I currently have no position (long or short) in the stock. I have been following the situation from afar, and decided to take the long weekend to take a look at the Company.

      I’ll be honest, I was a bit lazy, and decided to just copy the Copperfield accusation rather than make it a bit more clear. Like you said, I don’t care as much about what Raina did or didn’t say. I’m more focused on the negative organic growth point, which appears to be accurate for 2012. I took time over the weekend to foot Net Income back to FCF and compare AR and revenue growth, and these seem to clearly suggest that the Company is not a fraud.

      Your comment was the first good one I’ve seen in response to my question. I should have thought of inverting on the issue of organic growth…

      Like you said, I guess what this really comes down to is what you think the ROE/ROIC on incremental investment will be. And Raina clearly has a record of investing well.

      I’m going to do a bit more digging, but I think I’m sold.

      Best,
      PSDFinancier

      • PSD Financier permalink

        And by sold, I mean long, lol

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