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EBIX: Improvement in Operating Efficiency with High Return

September 05, 2011 | About:
Business overview

EBIX is a supplier of software and e-commerce solutions to the insurance industry. EBIX provides a series of application software products for the insurance industry ranging from carrier systems, agency systems and exchanges to custom software development for all entities involved in the insurance and financial industries. The majority of EBIX revenue comes from on-demand insurance exchanges. In fiscal 2010, the on-demand exchanges took around 71% of the total sales.

The data exchanges of life insurance, annuities, employee benefits, risk management, workers compensation and P&C insurance. Each of these exchanges connects multiple entities within the insurance markets enabling the participant to efficiently carry and process data from one end to another. Then the insurance companies work with EBIX or third party vendors to interface an exchange with their back-end systems.

The exchange is built based on industry standards. The interface of the exchange can be built by the company or other vendor depending on the client’s preference. If EBIX builds the interfaces, then the company can incur more revenue in the forms of professional services.

EBIX derives its revenues primarily from professional and support services, which includes subscription and transaction fees pertaining to services delivered over the company’s exchanges or from its own ASP platforms, revenue generated from software development projects and associated fees for consulting, implementation, training and project management provided to customers with installed systems, and business process outsourcing revenue.

Historical performance

Comparison of Five-Year Cumulative Total Return

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According to EBIX's fiscal 2010 annual report, its cumulative return compared to NASDAQ computer and NASDAQ has been pleasing investors of EBIX since early in 2005. For the past five years, if the benchmark was $100, at the end of 2010, the stock price stands at $1,076, with an astonishing gain of 60.8% compounded annual return.

How can the stock price of EBIX be that rewarding to investors, and can the trend continue for investors of EBIX in the future? We can have a look further into historical performance and judge the sustainability of the earnings and return on investment.

Operating performance

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As it can be seen from the chart of top line and bottom line for the business, for the last 10 years, and especially the previous five years, the growth is quite breathtaking in terms of revenue, operating income and the net income. The revenue shot up from $20 million to $132 million within just five years, whereas the operating and net income grew more than 10 times, from $5 million to around $50 million.

And the EPS experienced the same growth over the last 10 years. Over the 10-year period, the annual compounded growth rate of EBIX stayed at 65.5%.

2001 2002 2003 2004 2005 2006 2007 2008 2009 2010
EPS (USD) 0.01 0.02 0.08 0.08 0.15 0.21 0.4 0.76 1.03 1.51


Operating margin

% 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010
Gross Margin 66.4 69.2 70.8 72.7 75.5 79.8 83.4 81.1 78.2 77.6
SG&A 49.1 48.9 48.4 39.7 37.2 32.8 29.7 25.5 22.4 23
Operating Margin 1.5 6.28 11.7 12 19.3 22.9 29.9 39.2 40.2 39.7
EBT Margin 1.95 4.66 12.2 11.9 19.2 22.7 30.8 38.4 40.8 45.1


We can clearly see the improvement in the operating performance of EBIX over the years, including gross margin, operating expenses, operating margin and pre-tax margins.

The gross margin is increasing; operating expenses, represented by selling, general and admin, is decreasing at a very rapid rate, now standing just around 23%, compared to approximately 49% in the previous 10 years. The upward trend in gross margin combined with the decreasing operating expenses has led to a higher operating margin over time.

Return on Equity

As recommended by Warren Buffett, a single-year performance does not dictate anything. Rather, he would prefer a five-year rolling period. And the great business is the business which does not have a lot of assets, meaning high return on equity.

2001 2002 2003 2004 2005 2006 2007 2008 2009 2010
Net Margin % 0.92 3.97 11.56 11.21 17.93 20.39 29.57 36.54 39.74 44.65
Asset Turnover 1.52 1.24 1.32 0.92 0.81 0.78 0.55 0.6 0.48 0.47
Financial Leverage 2.68 2.11 1.79 2.32 1.6 1.81 1.8 2.01 1.54 1.31
Return on Equity % 37.4 11.65 29.24 22.18 27.88 27.32 29.36 41.94 32.23 29.36


On the Dupont model, the return on equity is the results of net margin, asset turnover and financial leverage combined. What pleases investors the most is to see the net margin increase at a rapid rate, and they expect the same thing with asset turnover. In the case of EBIX, the net margin keeps increasing and now stands at the very high rate of 44.6%, whereas the asset turnover has been declining due to the rise in sales and can’t catch up with the rise in assets. Nevertheless, the return on equity of EBIX over the last 10 years has been very pleasing, ranging around 20-40%, at first because of high net margin and higher financial leverage. But then later the financial leverage ratio has been controlled down. Over the last 10 years, the average return on equity of EBIX stands at 28.8%.

Financial Health

EBIX has been making a series of strategic acquisitions over the years. During the last three ears, it has made around 11 acquisitions in software and technology solutions to insurance industries. That is why it’s understandable that the largest assets in EBIX is the amount of goodwill. By June 2010, the amount of goodwill has amounted to more than 60% of the company’s total assets.

On the liabilities side, the company has very little debt. Long and short-term debt only takes around 6% of the total assets. It adds up to total liabilities of around 16.6%.

Free cash flow

USD million 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010
Operating cash flow -3 -1 3 3 5 4 14 27 34 53
Capital expenditure 0 -1 -1 0 0 -1 -2 -1 -3 -2
Free cash flow -3 -1 3 2 5 4 13 26 31 51


The free cash flow figure is quite amazing, and it’s trending upward. EBIX business does not have to reinvest into capital expenditures a lot, otherwise it would use the operating cash flow to make the acquisitions of insurance software solutions provider. With a market capitalization of $537 million, it’s trading at 10.5x of free cash flow in 2010.

Comparables

There are several software solutions companies out there which relate to insurance companies including Ebix Inc. (EBIX), Solera Holdings Inc. (SLH), InsWeb (INSW) and Salesforce.com (CRM)

P/B P/E P/CF
EBIX 1.7 8.8 10.5
Salesforce.com 13.2 357.1 37.7
SLH 5.1 25.3 18.7
INSW 2.3 20.8 27.7


Following the comparable valuation, we can see that EBIX is quite undervalued in every matrix: P/B, P/E, and price/cash flows. The discount is quite significant; some is even double, or even nearly triple in terms of valuations.

Management

What I’m typically looking for in the quality of management is that the key executives have big stakes in the company, so that they have the incentive to walk in the investors’ shoes. What I have found somewhat pleasant is the amount that Robin Raina, the chairman, the president and CEO of EBIX holds more than 10.5% in the company. Raina studied engineering in India, joined the company in 1997, and has been the CEO for 11 years, since 1999.

Valuation

DCF

The growth of EBIX has been quite magnificent. From 2003 to 2010, the FCF has been growing from $3 million to $51 million, at the compounded rate of nearly 50% a year. Along with the low rate of Treasury, Benjamin Graham often suggested using the discount rate of 10%, but the Gordon Growth model cannot be applied if the growth rate is more than the discount rate.

Even with that, if we assumed the growth rate for the next five years of FCF only 8%, then stay forever at 2% per year, with the discount rate of 10%, the total value of EBIX businesses would stay at around $2.4 billion, five times the current market value.

2010 2011 2012 2013 2014 2015 Terminal value Present Value
FCF 51 55.1 59.5 64.2 69.4 74.9 3,821.7 2,398.7


And if doing the reversion valuation, the current market price indicates that at the discount rate of 10%, the growth rate would be 1% year on year from 2011 to forever – a very low figure.

Relative Valuation

Seeing the table of comparables, EBIX seems to have a very low valuation. If talking about cash flow, the next highest figure is with Solera Holdings, at 18.7, and the average P/CF ratios for four companies is 23.6. So with the CFO of $53 million, the value of EBIX would stay at the lowest of $991 million, on average of $1.25 billion.

Conclusion

For valuation, even with the wide range between two methods of relative valuation and discounted free cash flow analysis, we come to the conclusion that EBIX market price is quite undervalued. The business of insurance exchange solutions with improving operating efficiency and profitability over time as well as high return on equity is very intriguing. Besides, the chairman and the CEO has a quite meaningful stake in the company of 10.5%. EBIX can be considered a target for any patient value investor in a basket of value positions.

This is the subjective viewpoint of the author, and it is not the recommendation to buy, hold or sell the stocks mentioned in this analysis. Anyone who wishes to buy, hold or sell the stocks has to do his/her own analysis at his/her own risk.

About the author:

Anh Hoang
Money manager into global equities, especially with US and Vietnam markets. CFA level 3 candidate. Lecturer for Stalla - CFA course in Vietnam

Visit Anh Hoang's Website


Rating: 4.2/5 (31 votes)

Comments

FetchXL
FetchXL - 2 years ago
Excellent post. It looks like your free cash flow figures are excluding acquisitions which represents a much larger number than capex historically ($165MM vs. $8MM over the last 5 years). Do you know if the company breaks out how much of their revenue growth over this same period was organic and how much was the result of these acquisitions?
Adib Motiwala
Adib Motiwala - 2 years ago
Any update on the legal overhang ?
Hester1
Hester1 - 2 years ago


This is a very shallow article. Read Copperfield research's articles on EBIX on Seeking Alpha.

The free cash flow and revenue growth has come from acquisitions. There is very little organic growth. Looking at free cash flow growth per share would have been more appropriate. Margins are falling, R&D and sales/marketing expenses are rising, and the company will eventually have to start actually paying taxes. All things will put earnings under pressure, and so current multiples are inflated.

The company also has had an ugly audit history, changing auditors multiple times. There is a lot of accounting discretion for highly acquisitive rollups, so this should worry you. The company is now starting to get sued by former owners of acquired companies.

The issues outlined in the Copperfield piece are whats holding the stock down and making it "cheap." Without addressing them the info in this piece is incredibly shallow.
buynhold
Buynhold - 2 years ago
I took a look at Ebix a couple years ago and passed on it for the same reasons that Hester1 points out. I doubt its acquisitive roll-ups add any value.

As Marty Whitman says, it's not important what the numbers are, but what they mean. I am not sure if Ebix is an accounting fraud, but it sure reminds me of Tyco International during

Dennis Kozlowski's reign.

forexnutca
Forexnutca - 2 years ago
Wow lots of bearish comments....probably a good sign to be picking up shares.
MichaelGR
MichaelGR - 2 years ago
Re: Copperfield:

If you believe these claims about EBIX without fact-checking and without doing your due-diligence, you are a victim of market manipulators. They have been shown to be false by credible and non-anonymous sources. Here's what the fact-checkers found:

1. Cut & paste this in Google: Craig-Hallum Research Report Provides Counterpoint to Copperfield Claims

2. Google: Crystal Equity Research Short-sale Saga EBIX

ken_hoang
Ken_hoang - 2 years ago
@FetchXL: Thanks. It is hard to track the organic growth of over the years as it lumped with the acquisitions, the company has made a lot of acquisitions over the years.

@ Adib: The shareholder lawsuit is uncertain, nobody knows what would expect the company, maybe major sell-offs if the company loses? As the case of Life Partner Holdings, after that the auditors resigned.. so it's very uncertain. It's unknowable.

@Hester, buynhold: That is true that including the acquisition, the "free" cash flow become negative, investor prefer organic growth.. that's reasonable, but the acquisition growth is not the sign of bad thing. By acquisition, the company is actually grow, and it grow fast, along with customer acquisition, technology acquisition and creating synergy for more efficient operation.

@Michael: Thanks for the two well thought article.

@All: It is interesting to see the CEO owns more than 10% of the company, the meaningful stake. And he in June 2011, bought 30,000 shares at the price of more than $17.

EBIX could be one stock in the diversified portfolio basket, Because it is involved in technology sector, and you can well see the value drop more than 50% overnight easily if the competitors invent something new, better etc.
cdubey
Cdubey premium member - 2 years ago
There is something weird going on with the numbers of EBIX. The competitors, CSC, CRM, INSW have a net margin of around 3-6% and the highest one SLH has around 20%. Why does EBIX enjoy such a huge net margin, and how long can it keep it up, is a good question. A decline of net margin to the levels of its competitors (say 9%) will already make the high P/S ratio of 4 look like 20 (sales*net margin = profit, ie., what goes off margin, must be recouped by increased sales to have the same profit) !

Furthermore, if you see in the TTM the sales growth is already slowing, and is at 10%. If one uses this a growth rate of say 30% with a more manageable margin of say 10% then over a 5Y horizon (if the market is willing to pay a P/E of 10 we have)

Sales=132*(1.3)^5=490m

Profit=49m (= sales*net margin)

Current cap=565m

Current #s=1.5 m (has increased 7x since 2006, was 0.21 m then)

5Y Price = 10*(Earning after 5Y) = 490 m

Which is less than what the company is worth at the moment. And this is assuming that the company does not dilute the shares (unlikely, given its acquisitive streak) and maintains a phenomenal growth rate of 30% with 10% net margin. I do not even think that they can keep this growth rate with no acquisitions.
MichaelGR
MichaelGR - 2 years ago
@Cdubey,

EBIX has a model that has many important differences when compared to most of the companies it is usually compared to. That explains the margins quite well. I suggest you dig deeper into the 10K and listen to the various conferences calls and analyst days that are available in audio on the site (they also have transcript, but they sometimes contain errors that make them a bit harder to follow).
cdubey
Cdubey premium member - 2 years ago
I still stand by my analysis, a 40% margin with 4x dilution of shares will still leave the share price at the same point in 5Y period. My main beef is the fact that the current P/S=4, which for a technology company is too high in my opinion, as technology is inherently a very unstable and volatile field.
MichaelGR
MichaelGR - 2 years ago
You are comparing apples and oranges and making strange extrapolations. EBIX is a hard company to understand, but it is understandable if you do your due diligence. You seem to have only looked at a handful of numbers and assumed that EBIX had the same models as others... That's not an insightful analysis and won't serve others well if they listen to you.
cdubey
Cdubey premium member - 2 years ago
Ok, as I have not done the due diligence, I will back out of this discussion. Thank you for pointing it out. I will come back if I decide to look at the company in more detail.
MichaelGR
MichaelGR - 2 years ago
I really respect that. There are a lot more companies that I don't understand than companies that I do understand, but I've spent dozens of hours digging around to understand EBIX and I think I have a good grasp of how they work. I know not everybody will put in the hours, and that's fine, but I can assure you that if you put the time in, you'll find it an interesting model. The Value Investor's Club has 3 writeups that are good places to start, if you are a member.

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