ActivIdentity (ACTI): Buying More On This Dip
Posted on January 10, 2007
An interesting compensation arrangement with senior executives, an upcoming first ever cash-flow positive quarter, a very low relative valuation to competitors, and a sector teeming with acquisition activity, has us excited more than ever about ActivIdentity (ACTI), and we’re buyers on this recent dip in the stock price.
Compensation Arrangement
First up the recent 8-K filing. In the filing executives were granted a set of restricted stock units based on the price of ACTI stock on January 9, 2007. Interestingly, these shares vest over three years and only if the company’s stock price is at least 130% above the grant date price for at least 60 days. Furthermore, as the filing states:
“The number of shares underlying each award will be increased by 50% if and the Company achieves a specific targeted level of earnings before interest, taxes, depreciation (“EBITDA”) and will be reduced by 25% if the Company’s fiscal 2007 EBITDA is below a specified target.”
If you’re a big follower of executive option grants, like us, the compensation agreement appears to imply a near-term floor on the stock price at near the close on January 9, 2007. The kicker here is the 50% increase in stock awarded if certain EBITDA targets are met, and a reduction in the grant if they are not. Management is obviously very incentivised in the coming year, and clearly must be be forecasting good EBITDA flows going forward to agree to this kind of incentive arrangement.
First Ever Cash-Flow Positive Quarter
And if this doesn’t make you bullish on ACTI, how does the fact that the company will report its first ever cash-flow positive quarter in the coming quarter? How do we know that? At the end of the company’s very impressive fourth quarter 2006 report, management states:
“The company expects first quarter 2007 revenue to be in the range of $13.5 million to $15.0 million with a loss of between $0.08 and $0.11 per basic and diluted share. Cash (including short term investments) are expected to increase to between $128 million and $130 million.“
As you may already know we believe, and think there is solid empirical evidence to support this, that the best time to get into these types turnarounds is when companies start throwing off cash for either the first time ever or the first time in many years of losses. Your odds of investment success, although never gauranteed, are very good under these types of circumstances, especially when the valuation of the company is depressed and there are few Wall Street analysts covering the company.
Valuation is Low
Which brings us to the valuation of ACTI. With $130 million in cash, and no debt, the company’s Enterprise Value is about $95 million. Security software still remains one of the hottest areas in software M&A with takeouts going at very high multiples of TTM revenue. We believe that on average, takeovers in the software industry as a whole are done at 2.5X EV/Sales. With an estimated $60 million in sales in the coming year, that would imply a takeout price for ACTI at a price of at least $6.10 per share or about 25% above the current stock price. This number may prove conservative given that sales estimates may come in well above expectations, as they did last quarter, and given the valuation of key competitor VASCO Data Security International Inc. (VDSI), which currently trades at over 7X EV/TTM Sales. We think that as ACTI begins to deliver consistent cash-flow over the coming quarters it’s share price will rise so as to eliminate this valuation gap.
Our only problem with ACTI: What’s the company doing sitting on all that cash now that the business is cash-flow positive? They need to either give some of that cash back to shareholders via some sort dividend or stock buyback. Another option is to look for some small add-on acquisitions to accelerate growth. Management needs to address the cash position in upcoming conference calls.
Please Note: We first recommended ActivIdentity (ACTI) at $4.37, and still hold a position in the stock.
Special thanks to Toby Shute for contributing content to this post.
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Interesting, but a key issue here is the fact that much of ACTI’s business is coming from government contracts. The question is how much of a discount that business should get vs. the valuation of competitors. You may be right that the discount is too high, but the company will need to show a few quarters of solid cash-flow before the market will be willing to give it a decent multiple. Also, since the IPO this company has always undelivered, so again it may take some time before investors get comfortable with the name again. I do like new management though under CEO Jason Hart. The guy is a proven entrepreneur and he owns alot of shares here. So you are right that he is incentivised to get this turned around.
Good analysis of timing, thanks. But in an “hottest areas in software” how come that they grow at such a poor nominal rate (adding 5 millions quarter on quarter and mainly through old Protocom delivered deals…)
They are still quite concerned about the confort of management (here or leaving) and have not a scrap for the shareholders. They are very very quiet about achievements (sound in view of the perpetual flow of bad or not so good news)
It is also weird that no one get interested in this share or company at that price…
Anyway, I will follow your advice and add to my position
All good points. As evidenced in their last quarterly report the company’s rate of growth is accelerating. Nobody is buying yet, because the company has a terrible track record and it will take time to regain investor confidence. That’s the way it always is in turnarounds. There’s a “huge wall of worry” here.
But despite the negatives, the valuation gap between VDSI (which just hit a new high today) and ACTI is simply too large. If ACTI keeps delivering results like those given in the last quarter, and they achieve profitability as we expect in 2007, the valuation gap will surely narrow. And in the worst case, ACTI has little downside at these prices because it remains a prime takeover candidate with its cash pile and low valuation.
What’s seemingly driving the renewed growth at ACTI is HSPD-12, see this PR:
http://www.actividentity.com/en/newsroom/display_press_release.php?prid=40
The Stanford Group Company* values the HSPD-12 opportunity at approximately $1.3 billion over five years, with the bulk of the revenue flowing in fiscal years 2007-2009, *(Identity Solutions Industry Outlook, July 2006).
Given the size of the opportunity, and ACTI’s already solid government business, I don’t think a “government” discount is at all warranted here.