Ebix Inc. (EBIX) is a supplier of software to the insurance industry. Have you ever applied for insurance and the agent asked you about a million questions, some of which seem like they couldn’t possibly have any effect on your premium? Well they’re entering this data into a computer program that compiles all of that data and pops out an insurance rate. That is the type of software that EBIX produces — and does so quite successfully. They actually provide many more services that this simple example, but the point is that they produce a very specialized product for a very specific market.
I discovered EBIX some time ago through a screen using my Predictable Growth Low Debt screener, for which it ranked tier 1 as far as the selection criteria is concerned. Specifically, EBIX has enjoyed phenomenal growth on both the top and bottom lines over the past number of years: a 51% EPS growth rate over the past five years, and a 31% revenue growth rate over the same period. EBIX has extremely low debt (D/E of 0.12) and a steadily increasing book value as well.
Despite this rosy picture, EBIX has been plagued over the past couple of years with some bad press that has severely affected its stock price. In March/11 Copperfield Research wrote an article on Seeking Alpha calling EBIX a House of Cards, and again just recently on Nov. 5/12 Bloomberg published an article claiming that EBIX was to be probed by the SEC for accounting malpractices. In both cases, share prices were decimated. It is widely believed that the 2011 article was nothing more than a short attack on the company however, and despite the supposed imminent SEC probe back in November, there’s been nothing formally announced. A recent post at the Long Term Value Blog shares some interesting thoughts on this matter. In any case every investor needs to form their own opinion, and my personal belief is that EBIX is an excellent company and this bad press is potentially providing an excellent buying opportunity at a greatly reduced price. The remainder of this article will focus on the company’s fundamentals and attempt to determine an intrinsic value for EBIX under this assumption.
I like to conduct a detailed review of companies on my watch list to make sure I have an excellent understanding of their financial position, competition, growth prospects, and risks before I make an investment. To that effect, I have listed the highlights from both the latest annual (2011) and quarterly (Q3/12) reports below. These can both be found on the Ebix corporate website.
Annual Report (2011) Highlights
- 77% of Ebix’s revenues come from on-demand insurance exchanges
- Strategic acquisitions are a key component of the company’s growth strategy. In 2011 EBIX made two strategic acquisitions: HCS for $18m in cash, and “ADAM” in a stock-based transaction.
- Ebix attempts to capitalize on the insurance industry’s move away from paper-based systems, and allow even smaller insurance firms to benefit from the economies of scale associated with an integrated electronic system.
- The company invested $19.2m in 2011 on product development, which represents approximately 11% of its revenue. The company takes advantage of low-cost expertise in India for much of its software development initiatives.
- Ebix faces different competition in each country in which it operates, but has a competitive advantage in that it is the only company to offer products in all four of the following categories: Exchanges, Broker Systems, Business Process Outsourcing (BPO), and Carrier Systems. The report goes into a detailed explanation of what each of these is, so I won’t repeat it here.
- The company’s CEO, Robin Raina, has led the company since 1999. In much of my outside research Robin is regarded as being one of the main reasons the company has been so successful.
- Ebix currently pays a dividend of $.04 per share.
- The company is currently actively engaged in a share repurchase plan and to date has repurchased over 4.4m shares.
- EPS grew nearly 12% YoY from 2010, and revenue grew 25% over the same period.
- Red Flag: The company carries a very high proportion of goodwill on its balance sheet due in part to its strategy of frequent acquisitions. This is one of the primary risks associated with an investment in EBIX, as if the company is required to write down goodwill, this will adversely affect net income. Specifically, as of year end 2011 Ebix carried over $259m in goodwill on its balance sheet, which represented 63% of its assets.
- Red Flag: There is an open class-action lawsuit alleging that the company made false statements in earnings report, press releases, etc. which artificially inflated the stock price. The company believes that the complaints are legally insufficient, so they get a lawyer for this, and other issues as some dui laws they need to analyze.
Latest Quarterly Report (Q3/12) Highlights
- Q3/12 EPS increased to $.49 from $.45 in the 2011 quarter, an increase of nearly 9%. EPS for the first nine months of 2012 remained flat over 2011 at $1.41 / share.
- Revenue fared better – 3rd quarter sales were 26% higher over the year ago quarter, and 16% higher for the first nine months.
- Long term debt of $34m is low compared to the company’s $353m in total equity.
- On June 1 Ebix acquired Planetsoft for $40m and 296k shares of stock.
Based on this review, there are definitely some concerns. My biggest concern is that the class-action lawsuit, which has not yet been resolved. An unfavorable outcome would likely have dire consequences for the company’s stock price. Also troubling are the flat earnings thus far in 2012. This is a far cry from the growth seen in the past few years. I read the Q3/12 earnings call transcript for some clarification. The answer appears to be that the company is expending all of its efforts to increasing revenue. CEO Robin Raina states:
We are focused on our long-term objective of $500 million in revenue by 2017, as also dealing our short-term goal of $100 million in annualized EBITDA.
To achieve this, the Ebix has invested 26% more in sales & marketing in 2012 and 43% more in new product development. The company also realized 34% higher operating costs (due primarily to acquisitions). In 2011 Ebix also recorded a one time non-recurring gain of $1.2m — this is also a major factor why 2012 gains are flat for the year.
So the question becomes whether or not the additional cash Ebix is spending to increase sales and deal with acquisition integration will eventually lead to higher earnings. Let’s assume that it does, and attempt to determine a valuation.
I am going to use EPS growth capitalization to estimate the intrinsic value of Ebix. From there we can apply a margin of safety (MOS) and define a target entry price.
If — and it’s a big “if” based on the analysis above, Ebix can truly grow its revenue and convert those sales to earnings, just what might the growth rate be moving forward? Analysts consensus is 20% EPS growth over the next five years, so let’s use that as a starting point. It compares favorably to the 51% compounded growth rate over the past five years, but not so much compared with the past year. Currently Ebix is trading at a PE ratio of around 9.5. Historically, PE has been in the 12-14 range, so let’s choose 13 for a future PE.
Our inputs into the calculation are therefore as follows:
- Future EPS Growth: 20%
- Future PE Ratio: 13
- Current EPS (ttm): $1.89
- MARR: 15%
- Timeframe: 5 years
Based on a compound growth rate of 20%, the future value calculation results in a predicted EPS of $4.70 in five years time. If Ebix were to trade at a PE ratio of 13, this would equate to a share price of $61.14. To achieve our minimum acceptable rate of return of 15%, the present value of the stock and hence our intrinsic value equates to $30.40 per share. This suggests that Ebix is severely under valued at its current trading price of $16.42.
I would argue that the future growth rate of 20% is highly questionable given the red flags I identified above and the uncertainty about EPS growth in the immediate future. It’s important therefore that a hefty margin of safety be applied, based on our level of uncertainty in the intrinsic value we determined. Let’s run the numbers again with a much lower growth rate of 14%, and the same PE of 13. Even with the much reduced growth, Ebix still appears to be worth $23.52 / share. This represents a 22% MOS over our intrinsic value of $30.40. To add some extra buffer, we can set our desired MOS to 30% which represents a buy price of $21.28
The current price of $16.42 is 46% lower than our calculated intrinsic value and much below my target entry price. Just out of curiosity, let’s calculate what the EPS growth rate would have to slow to for Ebix to be worth only $16.42, assuming the same 13 PE ratio. It turns out that growth would have to slow to 6%.
Based on today’s trading price of $16.42, Ebix appears to be undervalued in accordance with our calculated intrinsic value of $30.40, and is significantly lower than our 30% MOS. There are some red flags and potentially high risks associated with a purchase at this time, but Ebix will be added to the Stockodo watch list and as well as the model portfolio to track how an investment initiated today will perform moving forward.
- Ebix current stock quote
Disclosure: I am long Ebix.