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.
Comparison of Five-Year Cumulative Total Return
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.
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%.
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.
|Net Margin %||0.92||3.97||11.56||11.21||17.93||20.39||29.57||36.54||39.74||44.65|
|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%.
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
|Operating cash flow||-3||-1||3||3||5||4||14||27||34||53|
|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.
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.
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.
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|
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.
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.
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.
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