JDA Software: Outlook Improves as Pipeline Grows

jda-value-jpgJDA Software Group, Inc. (JDAS) reported its first quarter earnings on April 20th.  Particularly notable on the earnings call was management’s renewed confidence in the company’s sales pipeline.  I am keeping my 12-month price target at $18.00, but I have more confidence in this figure now, and believe there is more upside than downside.

This was a much better call than the Q4 call.  On the Q4 call, it seemed that the bulk of the large deal prospects in the sales pipeline had been realized in 2008, and that with a diminished pipeline and the economy in turmoil, management had little visibility into 2009.  Management said they would no longer provide annual guidance – just guidance on the coming quarter – saying they would rather do this “than set potentially unnecessarily pessimistic [full year] expectations, which as a financially conservative company we might otherwise feel inclined to do.”

Management sounded much more confident this time, stating that they have now “rebuilt” their “large deal pipeline.”  In a bit of chest thumping, JDA’s CEO twice made a point of bashing the competition, going so far as to say that they believe the quarter was a “disaster” for a number of their competitors.

Upside Opportunities

The primary opportunities for growth and value creation beyond the forecast figures appear to be:

  • Large deal wins: JDA’s solutions for retailers and CPG companies continue to be recognized as best-in-class.  JDA should win its share of new deals, so there is upside if industry demand picks up more than expected.
  • Recovery of sales momentum in Pacific Asia and EMEA: JDA has been “retooling” regional management for some time and last year was hopeful that these actions would pay off in 2009.  Q1 was still weak in these regions, so it seems there is more work to be done.  The projections do not assume any significant progress, so this remains an opportunity.
  • Increased sales to manufacturing companies: This was supposed to be one of the benefits of the Manugistics acquisition, but JDA has not yet fully leveraged the acquired products and brands.
  • New Managed Services offering: This was barely mentioned on the call, but in its new investor presentation, dated as of today, the company states that it believes that its clients spend over $2 billion per year managing JDA solutions.  JDA now wants to capture a percentage of this services business, leveraging its new CoE infrastructure.  With targeted operating margins of 30%-40%, this could have a significant impact on JDA’s business in the coming years.

Financial Summary and Projections

The forecast below assumes revenue near the low end of management’s guidance in Q2, and modest growth in the second half.  The resulting adjusted EBITDA for Q2 is also at the low end of the guided range.  Forecast cash flow from operations is a rough estimate, factoring in the seasonality of deferred revenue (40% of maintenance fees are generally collected in Q1, contributing to the high cash flow from operations for the quarter).

The resulting $17.41 projected share price is based on year-end results, so an $18 12-month price target still seems conservative.  This target is not materially different from the consensus target of $17 published by analysts Andrey Glukhov of Brean Murray, Brad Reback of Oppenheimer, and Richard Williams of Cross Research.  However, by going through the forecasting process independently, I gained more insight into the likely range for full-year financial results, and into the upside and downside around the price targets.  My sense is that analysts are erring on the conservative side, given that Q1 came in at the low end of prior guidance.  However, management seems to have more data on which to base its guidance this time around, so the conservatism may be unwarranted.

jda-model-jpg3

(Disclosure: The author is long JDAS)

Copyright © 2009 by John G. Appel. All rights reserved. You may link to any Content on this website. You may not republish, upload, post, transmit or distribute any Content without prior written permission. If you are interested in reprinting, republishing or distributing Content, please contact John Appel via the e-mail address shown on this website to obtain written consent. Modification of Content or use of Content for any purpose other than your own personal, noncommercial use is a violation of our copyright and other proprietary rights, and can subject you to legal liability. Disclaimer: This website is provided for informational purposes only. Nothing on this website is intended to provide personally tailored advice concerning the nature, potential, value or suitability of any particular security, portfolio or securities, transaction, investment strategy or other matter. You are solely responsible for any investment decisions that you make. Terms of Use: By using the site, you agree to abide by the Terms of Use, which includes further copyright information and disclaimers.
Advertisements

JDA’s Retrade is Justified

JDA Stock Price vs. Nasdaq-100 Tech Index

JDA Software Group (Nasdaq:JDAS) has had an offer on the table to buy i2 Technologies (Nasdaq:ITWO) for $346 million, or $14.86 per share.  However, JDA recently notified i2 that its financing terms for the current deal are too burdensome, and indicated that it wants to adjust the purchase price downward.

So far, i2 has kept pressure on JDA to close the deal at the current price.  But given the recent drop in i2’s stock price from $14.60 to under $9, investors are clearly betting that the current deal will not go through.

i2 Technologies Stock Price

The market has undergone a seismic shift since August 11th, when JDA and i2 inked the deal.  Since then, JDA’s stock price has continued to track the market tightly, while i2’s was artificially suspended near the merger price.  When JDA announced that it wanted to reprice the deal, i2’s share price quickly adjusted to reflect new market realities.  i2’s board should view i2’s current stock price as an indication of what the company is worth today on a stand-alone basis.

At $8.89 per share (Friday’s close), the market values i2 at 4.6x EBITDA before stock compensation expense.  This is roughly equal to the average of the multiples of its closest public comparables: Manhattan Associates (Nasdaq:MANH), which trades at 5.4x EBITDA, and JDA itself, which trades at 4.1x EBITDA.

The deal that JDA wants to retrade values i2 at over 7.7x LTM EBITDA, a premium of over 65% to its current market value and to the average comparable values. This is too rich of a deal for i2 shareholders.  A more reasonable price for i2 would be about 6x LTM EBITDA before synergies, or approximately $11.50 per share.  This would be a 30% premium to the current market price – a decent win for i2 shareholders – and would be fair to JDA because the price relative to EBITDA after synergies would be about the same as JDA’s current market multiple[1].

Rather than an all-cash deal, I would like to see some of the consideration be in JDA stock – ideally an amount of stock that would bring pro forma net debt to below 1x pro forma EBITDA.  The current deal would leave the combined company with net debt of approximately $350 million, which is well over 2x pro forma combined EBITDA – very high leverage for a technology company. Add to that a minimum EBITDA covenant of $130 million (revised down from $136 million on 9/29/08), and the risks become intolerable. (For comparison, SAP (NYSE: SAP) has no debt and over $2 billion of cash and Oracle (Nasdaq:ORCL) also has about $2 billion of net cash.) Given the economic environment, the risks and challenges associated with post-merger integration, the fierce competitive environment for SCM and enterprise software, and the need to have liquidity for capital investment and small strategic acquisitions, it seems unwise for JDA to take on the amount of debt needed to finance the current i2 deal – no matter what the terms.

The shareholders of i2 would be much better off with a lower price than with a busted deal.  The potential $20MM break-up fee would do little to make up for the loss of an acquisition premium.

I own JDA stock at an average cost of about $12 per share, and I expect it to appreciate substantially with or without an i2 deal.  JDA is known for its supply and demand chain solutions for consumer goods retailers, manufacturers and wholesaler/distributors.  As retailers and manufacturers look to drive earnings through margin improvement in a slowing retail environment, JDA stands to benefit because its solutions deliver real value.  JDA has a strong management team, which has proven its ability to balance growth and cash flow.

On October 20th, JDA announced record revenues and EBITDA for the third quarter, and reiterated its confidence in its full-year revenue and profit guidance.  Using very conservative growth assumptions, discounting management’s optimism and assuming a recessionary environment over the next 18 months, I put a target price on JDA’s stock of $18 per share.  I base this on normal industry multiples as well as discounted cash flow analysis.

If JDA were to proceed with the i2 acquisition on the present terms, I would lower my price target and sell my stock.  The current price for i2 is too high; the resulting net debt is too high, and the minimum EBITDA covenant is too restrictive.  If the price for i2 comes down, and the deal is restructured to reduce pro forma net debt and eliminate (or significantly lower) the minimum EBITDA covenant, I will increase my price target for JDA by $3-$4 per share.  If JDA abandons the deal, I will keep my $18 price target – and my JDA stock.

__________________________

[1] From JDA’s viewpoint, the current acquisition price is about 5.3x LTM EBITDA after synergies, a significant premium over JDA’s 4.1x market multiple.  In its presentation regarding the merger, JDA projected $20 million of cost synergies, offset in the near term by $6 million of “dis-synergies” reflecting integration costs.  At the $14.86 price, JDA would be paying for all of the synergies and handing that value over to i2’s shareholders in cash.  A price of $11.50 per share would result in an enterprise value for i2 of approximately $270 million, or 4.1 times the pro forma LTM EBITDA for i2 with synergies (assuming the same debt and cash figures as used to calculate the enterprise value of $346 million based on the $14.86 price, and ignoring the $6 million of “dis-synergies”).

Copyright © 2008-2009 by John G. Appel. All rights reserved. You may link to any Content on this website. You may not republish, upload, post, transmit or distribute any Content without prior written permission. If you are interested in reprinting, republishing or distributing Content, please contact John Appel via the e-mail address shown on this website to obtain written consent. Modification of Content or use of Content for any purpose other than your own personal, noncommercial use is a violation of our copyright and other proprietary rights, and can subject you to legal liability. Disclaimer: This website is provided for informational purposes only. Nothing on this website is intended to provide personally tailored advice concerning the nature, potential, value or suitability of any particular security, portfolio or securities, transaction, investment strategy or other matter. You are solely responsible for any investment decisions that you make. Terms of Use: By using the site, you agree to abide by the Terms of Use, which includes further copyright information and disclaimers.