in search of Value

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.

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[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”).