Summary
- Strong growth at Autodesk should trickle down to this value added reseller.
- Rand is severely undervalued if management projections turn out to be correct.
- Confusion regarding tender suggests the market for RWWI shares are highly inefficient.
Rand Worldwide (OTCQB:RWWI) is a value-added reseller (or VAR) of Autodesk (NASDAQ:ADSK), the maker of the well-known computer-aided design software AutoCAD. For the past several quarters, Autodesk has been telegraphing a long-term growth story to the Street. Given how interconnected the companies are, the momentum at Autodesk should provide a nice tailwind to Rand.
From the documents provided in the recent tender offer, we can glean that EBITDA is expected to grow at 18.6% CAGR for the next 3 years according to management forecasts. Compared that to the LTM EV/EBITDA multiple of just 6.5x, I believe Rand is severely undervalued for a company with both high growth and strong FCF generation characteristics.
Business Description
A VAR sells software on behalf of a vendor and provides additional services to help customers get the most out of the software. As a Platinum Partner of Autodesk, it means Rand has "demonstrated an ability to deliver the highest level of solution expertise, service, support, and customer satisfaction." In addition, Rand also develops training materials and has obtained the Autodesk Official Training Guide designation.
Autodesk Relationship
To better understand Rand, it's helpful to know more about how Autodesk works with its channel partners. Over 80% of Autodesk's sales come from indirect channels like distributors and resellers. Typically, Autodesk sells directly to large enterprise accounts while having its partners to interact with small businesses. Autodesk could still delegate support services to one of its partners in named accounts that are directly handled by Autodesk. This allows partners with expertise in value-added services, like Rand, to earn additional service fees. Being one of the largest resellers in the United States, Rand is a key partner in the Autodesk sales channel.
Like many software firms, Autodesk is undergoing a transition from selling perpetual licenses to a subscription-based business model. You know the drill: subscriptions will lower upfront revenue initially but bring, hopefully, more value per account over time. So far so good.
Buoyed by momentum in the AEC (architecture, engineering, construction) and manufacturing end markets, Autodesk witnessed strong growth in the latest quarter (ended Oct 31, 2014):
- Billings: +25%
- Revenue: +11%
- Deferred revenue: +31%
For fiscal 2015 (ends Jan 31), Autodesk is guiding for:
- Billings growth: 15 - 17%
- Revenue growth: 9 - 10%
- Net subscription additions: 325,000 - 375,000
Longer term, Autodesk sees itself extending its performance from FY2014 out to FY2018:
- Billings CAGR: 12%
- Value per account: +20%
- Increase in subscriptions: +50%
With Autodesk planning to end the sale of perpetual licenses in the next 12 to 24 months, there is some uncertainty on how that could affect Autodesk's partners. While the transition to subscriptions may hurt revenue growth at Autodesk, that may not necessarily translate to its partners. At its investor day, Autodesk described how it will incentivize its partners to sell subscriptions. Starting in Q4, Autodesk will increase subscription discounts to its resellers while lowering discounts for perpetual licenses:
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Source: Autodesk 2014 Investor Day slide
These discounts are volume rebates to resellers that reduce Rand's cost of sales. So while differences in revenue recognition could affect revenue, the net effect on gross profit is probably not much.
Autodesk has made the pitch that the transition will benefit its partners. Instead of selling a large license to a customer at every product cycle, resellers can now earn a more stable income by selling subscriptions at shorter intervals. As an example, the cost for one of its products, Revit LT, looks like this:
(click to enlarge)
Source: Autodesk online store
Ultimately, as a reseller, Rand should be a beneficiary of any success that Autodesk is enjoying as long as it can continue to capture the same amount of business in the Autodesk sales channel.
Valuation
Key Stats (in millions):
Note on EV: I assumed conversion of all preferred stocks and added back cash from exercise of options (as if they are all exercised immediately).
Taking account of recent divestiture of the money-losing Rand SD division as well as the recent tender offer, the PF income statement for FY2014 looks like:
(click to enlarge)
Source: Rand tender offer (P. 43)
Thanks to tender offer, we also know management's outlook for the next 3 years:
(click to enlarge)
From the document (P. 18 previous source): "The projections provided by management through 2017 have been confirmed by various executive members of the Rand management team and are the best estimate of the future performance of the company."
Mensch and Maschine (M+M)
I think the company's assumptions are reasonable if we look at M+M, essentially the European Rand. M+M gave the following outlook to 2018:
(click to enlarge)
Source: M+M October presentation
Using my ruler, I believe they expect VAR sales to grow from EUR 100 million to EUR 150 million (11% CAGR) and VAR EBITDA from EUR 5.5 million to EUR 12.5 million (23% CAGR). Rand management's projection of 8.5% revenue CAGR and 18.6% EBITDA CAGR seem about right given that Autodesk sales in Europe is growing faster than U.S. (believe it or not). Autodesk experienced double-digit sales growth in both regions in the latest quarter.
M+M trades at EV/EBITDA of 10x based on 2014 guidance, which is at a significant premium to Rand's 6.5x LTM EBITDA. M+M does have a significant high-margin software development business that accounts for 75% of its EBITDA. However, its VAR business is expected to drive most of the growth with VAR's EBITDA contribution rising to 50% in 2018.
Also, keep in mind that M+M sold its distribution business in 2011 to invest in VAR:
(click to enlarge)
(click to enlarge)
Source: M+M October presentation
In effect, it's trying to become more like Rand and seems to validate Rand's attractive business model. Add in the fact that Rand also has a small, internal software development team and that both stocks are very illiquid due to high insider ownership, M+M is probably the best public comp out there for Rand.
Back to Valuation
So if we believe management provided the above estimates in good faith, shares look quite attractive:
Note:
- For net income, I excluded preferred dividends because I assumed full conversion of preferreds.
- For FCF I assumed D&A in excess of capex by $0.7M, i.e. I added that to net income.
Rand will handsomely double if the future unfolds exactly as my spreadsheet:
Note:
- I give credit for the company's future FCF generation in FY2015 and FY2016.
- Net debt is from end of FY2014 so I do not double count FCF generated in Q1 of FY2015.
A 7.5x multiple seems very reasonable given where M+M trades at and allows ample discount for slower growth and absence of significant software business.
Another tidbit in the tender document that suggest shares are undervalued: if we just look at Covington's (the financial advisor that provided the fairness opinion) DCF using the above projections, they had to come up with anabsurd 28.5% WACC in order to justify that the then $1.2/share price was fair. This implies cost of equity well over 30%, which is more applicable to venture capital type investments! Rand is a growing, high FCF business with over 25 years of experience with 360 employees working in 47 offices. Hey, if I can earn over 30% a year in a private business of comparable quality as Rand, sign me up!
Inefficient Pricing
Based on the recent price action around the tender, I believe there is evidence that the market is not pricing Rand shares very efficiently. On Nov 4, there was a huge spike on large volume after the company announced the final results of the tender. The press release contained no information that should surprise any discerning investor. It appears the market was either:
- Expecting that no one would tender their shares, or
- Expecting that Rand would be unable to obtain financing to fund the tender.
But anyone who read the tender document would have known that Ampersand Capital Partners had intended to tender all 25.2 million shares that it owns. That accounts for vast majority of the 25.8 million shares that were ultimately tendered. The company had also waived the financing condition for the offer and had received a commitment letter from JP Morgan. Lastly, given that the tender is motivated by Ampersand looking to exit its investment and 3K (another large shareholder) looking to gain majority control, I'm sure both parties would have worked something out even if financing fell apart (which it did not).
I don't say this very often, but I may have just found a stock that I genuinely have an edge over other market participants.
Catalysts
- Up-listing to NASDAQ
- Being acquired (say someone like Tech Data)
- Re-rating from higher than expected earnings growth
- Deleveraging increases equity value even if EV stays constant
Summary
I don't think the market is pricing in any growth for Rand despite the rosy outlook at Autodesk and M+M. Even if management's projections turn out to be wrong, Rand's multiple already reflects a bearish scenario of zero growth. If Rand can just hit its number shares should re-rate much higher from here.
Editor's Note: This article covers one or more stocks trading at less than $1 per share and/or with less than a $100 million market cap. Please be aware of the risks associated with these stocks.
Source:http://seekingalpha.com/article/2755045-rand-worldwide-growth-by-autodesk
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