This is an idea I sent out to subscribers on in February 2011, since then, in spite of good year end December 2010 results the share price has only increased 6%.
I still like the idea as at under 5.5 times free cash flow I think it’s very undervalued.
Disclosure: As with all investments I recommend, I have a position in Cegid with a 3,9% portfolio weighting. I first bought shares on 28 July 2010 and again on 7 February 2011.
Please do your own research.
I have not fully updated the write-up to incorporate the year end December 2010 results which can be found here:
Cegid Group 2010 results http://www.cegid.com/commun/pdf/ComptesConso_US_030311.pdf
Company description
Cegid, founded in 1983, is a leading French developer of business management software. It offers solutions and services to certified public accountants (CPAs), retail businesses and the industrial sector (fashion, hospitality, services, trade, construction and transport). Cegid’s products include both generic business software and business-specific solutions. It serves 350,000 users in over 60 countries and employs just over 2,000 people internationally. The company has grown organically but it has also made a large number of acquisitions to complement various specialized business areas (the company has acquired over 20 companies since the early 1990s). Cegid was listed on the Paris Stock Exchange in 1986.
Cegid reports sales in the following business areas:
· Licenses and Integration
· Recurring contracts
· Hardware and installation
· Other
The following graph clearly shows that the sale of software is the company’s main business with Licenses, Integration and Recurring Contracts making up close to 90% of total sales over the last five years.
Sales by business line as percentage of total sales (Source: Company Annual Reports)
The large part Recurring Contracts (just under 49% of total sales) make up of total sales is a very attractive feature of the company. This means that the company gets just about half of its sales from existing customers. Positive is that the Recurring Contracts, as part for total sales, have increased from 43,6% in 2005 to 48,7% in 2009.
The company supplies its products to companies in the following sectors:
· CPA/small companies
· General business solutions
· Manufacturing
· Fashion and specialist retailing
· Construction and hospitality
· Public sector
Sales by customer type as percentage of total sales. (Source: Company Annual Reports)
As you can see the company sells mainly CPA/small companies and general business software and solutions, which make up 64% of total sales
Unfortunately, the company does not provide operating or net income level data for the individual business segments.
Really positive is that over the last five years to December 2009 Cegid has managed to increase its gross profit margin from 81,8% to 87,5%. Over the same period Cegid’s operating margin has also grown from 8,7% to 10,7%; however this has decreased from a 2007 high (just before the current recession) of 13,7%. The gross margin growth can be attributed to an increase in the sales of higher margin products such as the hosted applications solutions (also called Software as a Service (SaaS)), but more on that later.
The decrease in the operating margin from 2007 is due to the deteriorating economic conditions, increased depreciation and amortisation, and higher personnel expenses.
Now for more on Software as a Service (SaaS) mentioned above. SaaS, sometimes also referred to as "software on demand," is a model where software is made available over the internet. With SaaS, a provider, in this case Cegid, licenses an application to customers as a service on demand, through a monthly or yearly subscription. The main advantages of SaaS are:
In 2009 the company signed agreements with more new SaaS customers than new normal software licence customers. Cegid is expanding its ability to offer other software products through SaaS to an even larger customer base. As the margins on making SaaS products available are higher than normal software sales this development will have a positive impact on Cegid’s gross margin.
The company has also expanded substantially internationally over the last two years and has strengthened its position in the key markets (Europe, North America and Asia) through both organic growth and acquisitions. Unfortunately no geographic breakdown of sales is given by the company.
Cegid has a multi-channel sales strategy. Even though its own sales force is still responsible for the bulk of new sales (44% in 2009), the indirect/influenced sales channel is growing quickly, increasing by 10% from 2008 to 2009 with almost 40% of new sales now realised through this network of resellers, partners, consultants and solution integrators. Telephone sales have also grown in importance as the graph below illustrates.
Source: Sales strategy 2008 and 2009 – Company presentation
In 2009 the company continued its focus on software development and enterprise solutions hosting; it’s most important business areas. It has rolled out new solutions, which has strengthened its ties with the public sector and CPAs.
Now for more on management ownership.
The board and management do not have a significant direct ownership in the business - less then 1%. However, the chairman of the board, through a company called ICMI indirectly owns 4,6% of the company (8,13% of the voting rights) worth €8,86 million. Additionally, at the end of 2009 the company had a number of key shareholders who have been invested in the company for many years, including Groupama, a mutual bank and insurance company (26%), Apax (private equity fund) (6%), and Tocqueville (fund company) (8%).
The company has a share incentive programme in place, however no options were issued in 2009 or 2008, and there were also no options outstanding at the end of 2009.
The Chairman and CEO were paid €1,2m and €600 000 respectively in 2009. They are employed by ICMI (company mentioned above) and thus received their compensation through ICMI. ICMI provides management services to Cegid. As compensation for services rendered Cegid pays ICMI a fixed and a variable fee equal to 5% of Cegid’s consolidated net income. The fixed fee is tied to the French Syntec index (a salary costs index),
In 2009 Cegid paid a fixed fee of €2,08 million and a variable fee of €0,868 million to ICMI (€2,889 million in 2008). This is an unfortunate management compensation arrangement as it gives the idea that management compensation is not completely on an arm’s length basis. But with other substantial shareholders on board, including a private equity shareholder, it is unlikely that this arrangement will be misused to the detriment of shareholders.
Even though Cegid has an approved share buyback programme to acquire 10% of the outstanding shares in place, up to the end of December 2010 it had not bought back any shares. This is a pity because at the current undervalued share price it would have been a good investment.
Investment Idea
As I have mentioned in past newsletters it is very difficult to say exactly why a company’s share price becomes undervalued.
In Cegid’s case the company is undervalued mainly for the following reasons:
· Low sales growth
· Low earnings
· Limited broker coverage
Low sales growth
From 2005 to 2009 Cegid has, in spite of numerous acquisitions, only managed to grow sales by 3% per year.
If you just look at the sales number you will be disappointed and see Cegid as a no-growth company with a limited share price appreciation potential. But investors that make this assumption are missing a few important points.
Cegid supplies software solutions to a wide range of businesses. While its solutions make life easier for the company to track goods, manage finances and personnel, its products are not critical to the successful operations of its customers’ businesses. This means that Cegid’s sales are dependent on the development of the general economy and this is also the reason for Cegid’s weak sales growth in 2008 and 2009. A really positive development is that the company’s sales did not decrease in the 2008 to 2009 recession; a time when many companies recorded substantial declines in sales. Even though sales growth was helped by acquisitions, that fact that just about 50% of Cegid’s sales are recurring also helped.
Further, in 2008 and 2009 Cegid was active; it was busy expanding its CPA business, increased its presence in the hosted applications business (SaaS) through Cegid Interactive, and expanded internationally to be closer to its customers (especially in the Asia-Pacific region).
Thus on first glance if you only look at sales growth Cegid may look like a stagnating or dying business and this has scared away a lot of investors. But exactly here is your opportunity to buy the company at a very attractive price. With all the measures the company undertook during the recession I expect sales growth to return as the world economy recovers.
I want to return to my point on acquisitions mentioned above. Acquisitions have been an integral part of Cegid’s business model with more than 20 companies acquired over the last 20 years. These have been financed partly by cash, debt and shares. The largest acquisition to date was the acquisition of CCMX in 2004, which doubled Cegid’s revenues and established itself as a leading enterprise software solution company. Even though acquisitions have not helped sales growth from 2005 to 2009, this, along with the restructuring of the company and moving it to higher margin products, has helped Cegid expand its gross margin from 81,8% in 2005 to 87,5% to 2009. This meant that from 2005 and 2009 net income almost doubled to €17,8m, while cash flow from operations increased to €59,7m from €35,7m.
This shows you that just looking only at the sales numbers of a company can give you a completely wrong picture of what is really going on.
Low earnings
The second reason I think Cegid is undervalued is because it generates substantially more cash than profits.
This is because of various non-cash expenses, but mainly because of the software development costs that Cegid writes off over five years. The difference between profits (earnings per share) and cash generated (free cash flow per share) is clearly shown in the graph below.
Source: Company Annual Reports
As you know, the real value of a business is the amount of cash it generates and not its profitability. Only cash can be used to make acquisitions, expand the business and pay dividends. With the market just looking at profits, as shown in earnings per share, they are missing how substantially undervalued Cegid is based on the strong cash flow the company generates.
Limited broker coverage
Although limited broker coverage is not the sole reason a company becomes undervalued (if this is what management tells you, you should sell your investment), a lack of constant research, news and information from analysts can lead to companies being neglected by investors. Because Cegid is a small company (€212 million market value) there is little incentive for large brokers to cover the company. Cegid is currently only covered by four small brokerage companies.
Now for more information on exactly how undervalued Cegid is.
Valuation
At a share price of €23,06 (28 April 2011) Cegid was valued as follows:
Source: Annual report, Bloomberg, Financial Times (www.ft.com) and company website
1 EBIT – Earnings before interest and taxes
2 Enterprise value = Market capitalisation + debt – cash
Looking at the above table you can see that Cegid is undervalued on a number of valuation measures. But the one that stands out the most is price to free cash flow. I have talked about the company’s strong cash flow generation, but at 5,3 times free cash flow, generated in a recession year 2010, makes Cegid extremely undervalued. On average, over the last five years Cegid managed to turn just over 17% of every Euro of sales into free cash flow (23% in 2009), which is a great achievement as generally anything over 10% is outstanding.
What also stands out in the table above is the high returns on assets, as measured by the EBIT to assets. This just shows that software companies have a very attractive business model. They require very little assets to operate and grow, and once they cover their operating expenses and software development costs additional sales are just about pure profit.
In spite of profits being substantially lower than free cash flow, Cegid’s share price is so low that even its price to earnings ratio at just under 11 makes the company attractive.
Also, due to its strong cash generation, Cegid has been paying an attractive dividend for a number of years. In fact, it has doubled its dividend payments since 2001 to €1,05 per share in 2009. The current dividend yield of 4,57% is also very attractive.
Cegid’s balance sheet is also in excellent shape. Despite its numerous acquisitions the company has managed debt levels well. Total debt in 2005 was over €113m and decreased to €71m to 2009, while the net debt to equity ration averaged 46% over the last five years (40% in 2009). When looking at Cegid’s debt levels it is important to consider its strong cash generation ability. For example, total debt at the end of 2009 was only 1,2 times 2009 free cash flow. This means that the company could pay down its debt in less than 1,5 years if required.
Recent developments
To date Cegid has only released sales results for 2010. Full results for 2010 will be released on 2 March 2011. For 2010 Cegid reported sales of €249,6 million, up only 0,4% from 2009. License sales grew by 12%, and sales of SaaS grew faster than the market, increasing more than 23% to €16 million (6,4% of total sales). Recurrent sales of €124 million represented 50% of total sales, the highest annual percentage ever, as SaaS sales increased and the customer support business remained healthy. Internationally, Cegid saw significant growth in its non-recurrent contract sales, which grew 35%, mainly in the retail sector.
For the half year to June 2010, Cegid’s gross margin was 87,5% (88% in 2009) and the company generated net income 45% higher relative to 2009 (€7m vs. €4,8m). Net debt to equity was at 44,9%, down from 52,6% in 2009 H1.
As mentioned earlier, management remains cautious, saying that for the full year 2010 operating profits will be lower than in 2009, but net profit after tax will be slightly higher than 2009 because of lower interest costs and a slightly lower tax rate.
Summary and conclusion
From its high of €47,25 in July 2007 until today, Cegid’s share price has declined just more than 50% due to the financial crisis but also for the reasons mentioned above.
I believe the market is underestimating Cegid’s real value because it is looking only at the lack of sales growth, ignoring the substantial increase in profit margins, but more importantly, the company’s strong cash flow generation.
As the world economy recovers, Cegid’s sales will recover and profitability will increase. This will make the company’s strong cash flow generation more visible, causing a substantial revaluation of the company.
In the meantime, while you are waiting for all this to happen you will be getting a dividend of more than 4,5%.
I still like the idea as at under 5.5 times free cash flow I think it’s very undervalued.
Disclosure: As with all investments I recommend, I have a position in Cegid with a 3,9% portfolio weighting. I first bought shares on 28 July 2010 and again on 7 February 2011.
Please do your own research.
I have not fully updated the write-up to incorporate the year end December 2010 results which can be found here:
Cegid Group 2010 results http://www.cegid.com/commun/pdf/ComptesConso_US_030311.pdf
Company description
Cegid, founded in 1983, is a leading French developer of business management software. It offers solutions and services to certified public accountants (CPAs), retail businesses and the industrial sector (fashion, hospitality, services, trade, construction and transport). Cegid’s products include both generic business software and business-specific solutions. It serves 350,000 users in over 60 countries and employs just over 2,000 people internationally. The company has grown organically but it has also made a large number of acquisitions to complement various specialized business areas (the company has acquired over 20 companies since the early 1990s). Cegid was listed on the Paris Stock Exchange in 1986.
Cegid reports sales in the following business areas:
· Licenses and Integration
· Recurring contracts
· Hardware and installation
· Other
The following graph clearly shows that the sale of software is the company’s main business with Licenses, Integration and Recurring Contracts making up close to 90% of total sales over the last five years.
Sales by business line as percentage of total sales (Source: Company Annual Reports)
The large part Recurring Contracts (just under 49% of total sales) make up of total sales is a very attractive feature of the company. This means that the company gets just about half of its sales from existing customers. Positive is that the Recurring Contracts, as part for total sales, have increased from 43,6% in 2005 to 48,7% in 2009.
The company supplies its products to companies in the following sectors:
· CPA/small companies
· General business solutions
· Manufacturing
· Fashion and specialist retailing
· Construction and hospitality
· Public sector
Sales by customer type as percentage of total sales. (Source: Company Annual Reports)
As you can see the company sells mainly CPA/small companies and general business software and solutions, which make up 64% of total sales
Unfortunately, the company does not provide operating or net income level data for the individual business segments.
Really positive is that over the last five years to December 2009 Cegid has managed to increase its gross profit margin from 81,8% to 87,5%. Over the same period Cegid’s operating margin has also grown from 8,7% to 10,7%; however this has decreased from a 2007 high (just before the current recession) of 13,7%. The gross margin growth can be attributed to an increase in the sales of higher margin products such as the hosted applications solutions (also called Software as a Service (SaaS)), but more on that later.
The decrease in the operating margin from 2007 is due to the deteriorating economic conditions, increased depreciation and amortisation, and higher personnel expenses.
Now for more on Software as a Service (SaaS) mentioned above. SaaS, sometimes also referred to as "software on demand," is a model where software is made available over the internet. With SaaS, a provider, in this case Cegid, licenses an application to customers as a service on demand, through a monthly or yearly subscription. The main advantages of SaaS are:
- Accessible from anywhere with an internet connection.
- No local server installation, thus lower hardware costs.
- Rapid scalability, users can quickly be added.
- System maintenance (backup, updates, security, etc) is often included in the service.
- Lower costs compared with licensed software products.
In 2009 the company signed agreements with more new SaaS customers than new normal software licence customers. Cegid is expanding its ability to offer other software products through SaaS to an even larger customer base. As the margins on making SaaS products available are higher than normal software sales this development will have a positive impact on Cegid’s gross margin.
The company has also expanded substantially internationally over the last two years and has strengthened its position in the key markets (Europe, North America and Asia) through both organic growth and acquisitions. Unfortunately no geographic breakdown of sales is given by the company.
Cegid has a multi-channel sales strategy. Even though its own sales force is still responsible for the bulk of new sales (44% in 2009), the indirect/influenced sales channel is growing quickly, increasing by 10% from 2008 to 2009 with almost 40% of new sales now realised through this network of resellers, partners, consultants and solution integrators. Telephone sales have also grown in importance as the graph below illustrates.
Source: Sales strategy 2008 and 2009 – Company presentation
In 2009 the company continued its focus on software development and enterprise solutions hosting; it’s most important business areas. It has rolled out new solutions, which has strengthened its ties with the public sector and CPAs.
Now for more on management ownership.
The board and management do not have a significant direct ownership in the business - less then 1%. However, the chairman of the board, through a company called ICMI indirectly owns 4,6% of the company (8,13% of the voting rights) worth €8,86 million. Additionally, at the end of 2009 the company had a number of key shareholders who have been invested in the company for many years, including Groupama, a mutual bank and insurance company (26%), Apax (private equity fund) (6%), and Tocqueville (fund company) (8%).
The company has a share incentive programme in place, however no options were issued in 2009 or 2008, and there were also no options outstanding at the end of 2009.
The Chairman and CEO were paid €1,2m and €600 000 respectively in 2009. They are employed by ICMI (company mentioned above) and thus received their compensation through ICMI. ICMI provides management services to Cegid. As compensation for services rendered Cegid pays ICMI a fixed and a variable fee equal to 5% of Cegid’s consolidated net income. The fixed fee is tied to the French Syntec index (a salary costs index),
In 2009 Cegid paid a fixed fee of €2,08 million and a variable fee of €0,868 million to ICMI (€2,889 million in 2008). This is an unfortunate management compensation arrangement as it gives the idea that management compensation is not completely on an arm’s length basis. But with other substantial shareholders on board, including a private equity shareholder, it is unlikely that this arrangement will be misused to the detriment of shareholders.
Even though Cegid has an approved share buyback programme to acquire 10% of the outstanding shares in place, up to the end of December 2010 it had not bought back any shares. This is a pity because at the current undervalued share price it would have been a good investment.
Investment Idea
As I have mentioned in past newsletters it is very difficult to say exactly why a company’s share price becomes undervalued.
In Cegid’s case the company is undervalued mainly for the following reasons:
· Low sales growth
· Low earnings
· Limited broker coverage
Low sales growth
From 2005 to 2009 Cegid has, in spite of numerous acquisitions, only managed to grow sales by 3% per year.
If you just look at the sales number you will be disappointed and see Cegid as a no-growth company with a limited share price appreciation potential. But investors that make this assumption are missing a few important points.
Cegid supplies software solutions to a wide range of businesses. While its solutions make life easier for the company to track goods, manage finances and personnel, its products are not critical to the successful operations of its customers’ businesses. This means that Cegid’s sales are dependent on the development of the general economy and this is also the reason for Cegid’s weak sales growth in 2008 and 2009. A really positive development is that the company’s sales did not decrease in the 2008 to 2009 recession; a time when many companies recorded substantial declines in sales. Even though sales growth was helped by acquisitions, that fact that just about 50% of Cegid’s sales are recurring also helped.
Further, in 2008 and 2009 Cegid was active; it was busy expanding its CPA business, increased its presence in the hosted applications business (SaaS) through Cegid Interactive, and expanded internationally to be closer to its customers (especially in the Asia-Pacific region).
Thus on first glance if you only look at sales growth Cegid may look like a stagnating or dying business and this has scared away a lot of investors. But exactly here is your opportunity to buy the company at a very attractive price. With all the measures the company undertook during the recession I expect sales growth to return as the world economy recovers.
I want to return to my point on acquisitions mentioned above. Acquisitions have been an integral part of Cegid’s business model with more than 20 companies acquired over the last 20 years. These have been financed partly by cash, debt and shares. The largest acquisition to date was the acquisition of CCMX in 2004, which doubled Cegid’s revenues and established itself as a leading enterprise software solution company. Even though acquisitions have not helped sales growth from 2005 to 2009, this, along with the restructuring of the company and moving it to higher margin products, has helped Cegid expand its gross margin from 81,8% in 2005 to 87,5% to 2009. This meant that from 2005 and 2009 net income almost doubled to €17,8m, while cash flow from operations increased to €59,7m from €35,7m.
This shows you that just looking only at the sales numbers of a company can give you a completely wrong picture of what is really going on.
Low earnings
The second reason I think Cegid is undervalued is because it generates substantially more cash than profits.
This is because of various non-cash expenses, but mainly because of the software development costs that Cegid writes off over five years. The difference between profits (earnings per share) and cash generated (free cash flow per share) is clearly shown in the graph below.
Source: Company Annual Reports
As you know, the real value of a business is the amount of cash it generates and not its profitability. Only cash can be used to make acquisitions, expand the business and pay dividends. With the market just looking at profits, as shown in earnings per share, they are missing how substantially undervalued Cegid is based on the strong cash flow the company generates.
Limited broker coverage
Although limited broker coverage is not the sole reason a company becomes undervalued (if this is what management tells you, you should sell your investment), a lack of constant research, news and information from analysts can lead to companies being neglected by investors. Because Cegid is a small company (€212 million market value) there is little incentive for large brokers to cover the company. Cegid is currently only covered by four small brokerage companies.
Now for more information on exactly how undervalued Cegid is.
Valuation
At a share price of €23,06 (28 April 2011) Cegid was valued as follows:
Source: Annual report, Bloomberg, Financial Times (www.ft.com) and company website
1 EBIT – Earnings before interest and taxes
2 Enterprise value = Market capitalisation + debt – cash
Looking at the above table you can see that Cegid is undervalued on a number of valuation measures. But the one that stands out the most is price to free cash flow. I have talked about the company’s strong cash flow generation, but at 5,3 times free cash flow, generated in a recession year 2010, makes Cegid extremely undervalued. On average, over the last five years Cegid managed to turn just over 17% of every Euro of sales into free cash flow (23% in 2009), which is a great achievement as generally anything over 10% is outstanding.
What also stands out in the table above is the high returns on assets, as measured by the EBIT to assets. This just shows that software companies have a very attractive business model. They require very little assets to operate and grow, and once they cover their operating expenses and software development costs additional sales are just about pure profit.
In spite of profits being substantially lower than free cash flow, Cegid’s share price is so low that even its price to earnings ratio at just under 11 makes the company attractive.
Also, due to its strong cash generation, Cegid has been paying an attractive dividend for a number of years. In fact, it has doubled its dividend payments since 2001 to €1,05 per share in 2009. The current dividend yield of 4,57% is also very attractive.
Cegid’s balance sheet is also in excellent shape. Despite its numerous acquisitions the company has managed debt levels well. Total debt in 2005 was over €113m and decreased to €71m to 2009, while the net debt to equity ration averaged 46% over the last five years (40% in 2009). When looking at Cegid’s debt levels it is important to consider its strong cash generation ability. For example, total debt at the end of 2009 was only 1,2 times 2009 free cash flow. This means that the company could pay down its debt in less than 1,5 years if required.
Recent developments
To date Cegid has only released sales results for 2010. Full results for 2010 will be released on 2 March 2011. For 2010 Cegid reported sales of €249,6 million, up only 0,4% from 2009. License sales grew by 12%, and sales of SaaS grew faster than the market, increasing more than 23% to €16 million (6,4% of total sales). Recurrent sales of €124 million represented 50% of total sales, the highest annual percentage ever, as SaaS sales increased and the customer support business remained healthy. Internationally, Cegid saw significant growth in its non-recurrent contract sales, which grew 35%, mainly in the retail sector.
For the half year to June 2010, Cegid’s gross margin was 87,5% (88% in 2009) and the company generated net income 45% higher relative to 2009 (€7m vs. €4,8m). Net debt to equity was at 44,9%, down from 52,6% in 2009 H1.
As mentioned earlier, management remains cautious, saying that for the full year 2010 operating profits will be lower than in 2009, but net profit after tax will be slightly higher than 2009 because of lower interest costs and a slightly lower tax rate.
Summary and conclusion
From its high of €47,25 in July 2007 until today, Cegid’s share price has declined just more than 50% due to the financial crisis but also for the reasons mentioned above.
I believe the market is underestimating Cegid’s real value because it is looking only at the lack of sales growth, ignoring the substantial increase in profit margins, but more importantly, the company’s strong cash flow generation.
As the world economy recovers, Cegid’s sales will recover and profitability will increase. This will make the company’s strong cash flow generation more visible, causing a substantial revaluation of the company.
In the meantime, while you are waiting for all this to happen you will be getting a dividend of more than 4,5%.
