Small Cap Stocks

Introduction
Despite an ongoing accounting investigation and a lack of current financial statements, we think that Motive (MOTV.PK) is an interesting enterprise software stock to keep an eye on. As the company files updated financials in the coming months, investors may begin to feel more comfortable assigning the company a higher valuation, especially considering the recent increased value in MOTV’s chief competitor, SupportSoft (SPRT), and our belief that enterprise software shares will outperform the market in 2007.

Important Note: If you plan to trade in MOTV’s stock, please use limits. We do not recommend purchases above $3 and if you are extremely risk averse, you can wait till the company completes its restatements before considering this issue.

The Business
Motive, like SupportSoft, provides software that enables broadband providers to automatically deploy, maintain and support advanced voice, video and data services. Customers include: RCN, AOL, British Telecom, and many additional telecom and broadband companies. The company was founded in 1997, and went public in June 2004 at $10 per share. Their website is at www.motive.com.

Due to the fact that the company is still undergoing an accounting investigation, there are no updated financial figures for Motive, but based on our estimates the company probably has between $32 million and $60 million in annual sales (Note that the company reported over $90 million in sales in 2004, but this number is definitely going to be restated downward significantly). We believe the company will end 2006 with about $40 million in cash, and no debt. There are close to 28 million shares outstanding on a fully diluted basis.

For some recent PR from the company which gives some indication as to financial results thus far in 2006, please see the link below:

http://www.motive.com/newsevents/pressreleases/pr.asp?id=5902

The Problems: Revenue Recognition Issues and Lumpy Sales from Large Contracts

The following are the two major problems that Motive has faced and may continue to confront:

• Past Accounting Issues Cloud the Core Business
In late 2005 and early 2006, Motive announced that it was investigating its past accounting practices and that it would need to restate its financial statements dating back to 2001. As a result of the expanded restatement, the company has failed to file updated financial reports with the SEC and its stock has been delisted from The Nasdaq National Market.

According to the company the restatements primarily involve software revenue recognition practices. Our feeling, based on our experience with other software accounting shenanigans, is that what probably happened here is that company simply recognized revenue upfront for contracts that were supposed to be delivered over time. In addition, it is possible that the company allocated maintenance revenue to license sales, in effort to prop up the more highly-valued license revenue line. The net result is that Motive’s past financial statements have significantly inflated revenue results. Without past financials, investors do not necessarily have the means to accurately value Motive’s core software business. It is important to note, however, that the revised results will have no effect on the company’s reported cash position, nor are they a reflection on the company’s current business prospects.

• Lumpy Sales
Like other small enterprise software players, including SupportSoft, the principal operational challenge facing Motive, is that quarterly revenue results are very difficult to predict. The company typically derives a significant portion of revenue each quarter from a number of license agreements closed in the last month of a quarter. At the same time, operating expenses are, to a large extent, fixed in the short term. So if revenue falls below expectations in a quarter the company can lose a significant amount of money.

For instance, the company’s cash and short-term investments totaled approximately $59 million as of December 31, 2005, and are expected to be approximately $45 million as of the close of the third quarter. So Motive has burned thru nearly $14 million in cash thus far in 2006. The company, though, has stated that intends to breakeven in the third quarter of 2006.

The basic way the company can prevent losses because of lumpy sales is to increase its reliance on maintenance sales and reduce overhead to ensure breakeven even on disappointing license sales. Motive could also begin to experiment with different subscription business models, much as SupportSoft is doing.

Recent Changes and Their Significance:
New Management and Increased Value for SupportSoft

Despite the above challenges two recent changes augur well for Motive on a go-forward basis:

• An Entirely New Management Team Has Been Installed

Throughout 2006, Motive has completely revamped its entire executive management team. Notably, in February 2006, the company hired Alfred Mockett as the new Chairman and CEO.

Mr. Mockett previously worked at British Telecom (BT), where he served as chief executive of BT Ignite, the company’s $6 billion broadband and Internet services business unit. More recently, Mr. Mockett was the chairman and chief executive officer of American Management Systems (AMSY), the $1 billion revenue IT consulting and professional services company. AMS was acquired in mid-2004 by the CGI Group.

In looking at the share performance of AMSY, it appears that the company was sold at approximately the same price of the stock as when Mr. Mockett took over in late 2001. This of course is somewhat of a negative for MOTV, but we would note that AMSY was a different business than that of MOTV with nearly 40% of the revenue coming from the US Government. In addition, several of AMSY’s large customers were in the telecom industry, which had a major downturn during the time when Mr. Mockett was CEO of AMSY. Finally, it is important to note that AMSY had nearly $1 billion in revenue, as compared to MOTV’s $40 million or so. It is much more difficult to turnaround and grow a $1 billion company than it is to stabilize and grow a company with less than $50 million in sales.

Overall, it would appear that Mr. Mockett managed AMSY well, given the difficult economic backdrop, and in the end shareholders did not lose any money. In our opinion, Mr. Mockett is an executive with enough experience to manage MOTV at this juncture. His background in telecom, particularly with BT, a large customer of MOTV, will surely be of benefit to MOTV. Mr. Mockett was granted 200,000 shares of restricted Motive stock and a non-qualified stock option to purchase up to 750,000 shares of Motive’s common stock at an exercise price of $3.40 per share

In addition to Mr. Mockett, the company recently hired 3 other high level executives, including a new CFO. You can read about these executives by clicking on this link:

http://www.motive.com/newsevents/pressreleases/pr.asp?id=5903

From our perspective, the hiring of a new CFO seems to imply that the company’s restatement is near completion. Mr. Fitzpatrick, the new CFO, was granted a non-qualified stock option to purchase up to 100,000 shares of Motive’s common stock at an exercise price of $2.15 per share.

• Motive’s Main Competitor, SupportSoft, is Gaining Traction on Wall Street

Long time subscribers to our research, have probably already benefited from our astute call on SupportSoft (SPRT) earlier this year. The company has been undergoing an impressive turnaround under its new management team and the stock currently trades at $5.50, sporting an Enterprise Value (EV) to revenue multiple of nearly 2.5. SupportSoft is a direct, and somewhat smaller competitor to Motive. As such, it is our opinion that resurgence of SupportSoft and its renewed Wall Street coverage must at some point filter down to Motive’s shares, especially considering the wide valuation gap between the two companies.

The Price: Risk/Reward – Upside/Downside

Financial Condition is Solid and Business Risk is Limited
Before getting to some basic valuation considerations, it is important to note that there is little financial risk for Motive. The company has nearly $40 million in cash and no debt. In addition, despite the accounting troubles, the company still has a strong base of satisfied customers and generates in our estimation nearly $30 million a year in maintenance revenue. We do not think the company’s financial restatements have had any effect on the company’s ability to maintain the current customer base.

Main Risks
Despite the solid balance sheet, Motive still faces significant risks, chief of which is the company’s reliance on lumpy sales and high fixed costs. Furthermore, if customers do not renew their licenses for the company’s products (licenses usually run for three years) the company may begin to lose money at fast pace. Overall, it is still not entirely clear if Motive will be able to operate its business profitably, following the closure of the company’s accounting restatements. There is also no guarantee that the company will be able to sign new customers and ignite growth, given that the company’s image may have been tarnished by the accounting scandal and given that the company’s main competitor, SupportSoft, is quickly gaining a foothold in key international markets.

Downside Price Risk: $2.50
Notwithstanding the above risks, we think that following MOTV’s financial restatements, the company could become a takeover target. This view is supported by Mr. Mockett’s, Motive’s current CEO, operational steps at his last software company, AMSY. Assuming an M&A transaction, we have calculated that MOTV’s stock is worth at least $2.50 in a worst case scenario. We arrive at that value by assuming a minimum of $30 million in revenue and applying a 1X revenue multiple to that value and then adding back cash of $40 million.

Upside Price Potential: $5.50
In arriving at our upside target, we assume that following the company’s restatements, Motive, like SupportSoft, becomes successful in signing new licenses, growing its customer base, and generating cash. We think that it is definitely conceivable that Motive could do $50 million in annual revenue in such a scenario, as this was the company’s run-rate in the last “true” quarter prior to restatements. Applying a multiple of 2 (lower than SupportSoft’s current EV/R multiple) and adding back cash results in an upside of $5.00.

Conclusion
With at most 10% downside, and the potential for 90% upside, we think Motive is an excellent investment “gamble” at current prices.