With technology buzzwords like “cloud computing” and “Software-as-a-Service” increasing in popularity right now, it’s easy for small tech companies with truly innovative products to get passed over. But my latest magic formula investing play actually develops next-generation software products – and it does so with the fundamental numbers to back it up. Here’s everything you need to know to invest in this potential buyout target…
Magic Software Enterprises Ltd. (MGIC, Financial) is a business software company based in Israel. The firm’s business revolves around two main products: uniPaaS, a software development platform designed for creating web-delivered business applications; and iBOLT, software that’s used for integrating business data from various enterprise software applications.
Magic earns revenues from new license sales (34%), maintenance and technical support contracts for existing users (23%), and consulting services (43%, but with a much lower margin). The company has a wide range of customers in virtually all geographic locales around the world.
The products themselves are somewhat difficult to understand for those not familiar with software development and business management applications.
uniPaaS is what is known as a “platform-as-a-service” offering. If you think of your laptop computer, it is controlled by an operating system (OS), most likely Microsoft’s (MSFT, Financial) Windows. You run applications off of this OS, such as a web browser or spreadsheet program. These applications are built using “development platforms” that run on top of the operating system. Some examples for Windows would include Microsoft’s .NET platform, and Sun’s JAVA platform. These provide software developers with the tools needed to build applications.
uniPaaS is similar, but is more focused on building web-based applications that execute through a provided browser-like client (an example of a non-browser based client for a web-based application would be Apple’s (NASDAQ: AAPL) iTunes Store). uniPaaS provides developers with logic languages, data storage, and user interface elements to build their application. The result is an app that is accessed through the provided client instead of downloaded onto a computer and run locally.
The advantages of web-delivered applications are several. For one, they are easily deployable. New changes are picked up immediately, instead of users having to download and install updates. There are few requirements for end-user hardware – minimum processor, minimum memory, required operating system, etc. – to run the applications. This “software-as-a-service” (SaaS) paradigm has seen much hype but has not yet been widely deployed. The advantages it offers and relative new-ness of it presents interesting growth potential for Magic Software.
iBOLT is quite a bit simpler to understand. In modern corporate environments, there exist data stores for information like customer records, supplier records, inventories, transactions, and so forth. These are often spread out over numerous systems, and the lack of integration between them means data is duplicated or gets out of date. iBOLT is designed to integrate data from disparate sources for the purpose of a unified view, which can then be used in developing business applications requiring the data.
iBOLT is designed to tie in with a wide variety of popular enterprise software environments, such as SAP (NYSE: SAP), salesforce.com (NYSE: CRM), Oracle JD Edwards (NASDAQ: ORCL), IBM (NYSE: IBM) systems, and others.
So how does Magic Software measure up to our growth, financial health, and competitive positioning yardsticks? Growth is difficult to project. On one hand, cloud computing is clearly a popular buzzword, but it has not seen significant uptake yet for several reasons.
In fact, Magic Software has had slightly negative revenue growth over the past 5 years. Growth really depends on whether SaaS takes off or not. Questions such as security, performance, and reliability have to be addressed sufficiently before that is going to happen. Once they are, most analysts expect rapid growth.
Financial health is fine, so we can cross that off. After a big, one-time $16 million dividend payment back in January, Magic has about $26 million in cash (close to half of market cap) and no meaningful debt. The company’s operating margins have improved recently, but a trailing twelve-month figure of 7.7% is not especially good for a software firm. The company’s return on capital is currently an impressive 131%, way up from sub-10% levels over the past several years. So there is some positive business momentum here, at least from an operating perspective.
Competitive position is a mixed bag. Once they win customers, uniPaaS is sticky, as it takes significant effort to build skills in using it to make and maintain software, and creating and switching to new business apps is a real pain. But Magic is far from the only firm developing “cloudware” development platforms. Even if the overall market does grow, Magic Software with its tiny resource base will have difficulty gaining market share against behemoths such as Microsoft’s Azure technology, or Salesforce’s Force.com.
On the other hand, the company could be a buyout target for a larger software firm looking to expand into PaaS.
Finally, Magic is a bit of a statistical anomaly in “Magic Formula” investing. Calculating MFI statistics using the last reported financial statements, enterprise value comes out to a miniscule $29.6 million, with over $28 million of excess cash on the balance sheet, giving us an earnings yield of 14.4%.
However, this does not account for the previously mentioned dividend, which was paid out in January. Lopping this $16 million out of excess cash, enterprise value becomes closer to $46 million, and earnings yield falls to 9.4%. That’s still pretty cheap, but not the 10%+ we see from most MFI stocks.
It’s too bad we didn’t beat the ex-dividend date, but Magic Software still makes an interesting micro-cap position today, with a cheap stock price, plenty of growth potential, and a strong financial footing.
Sincerely,
Steve Alexander, MagicDiligence.com
for Penny Sleuth
Magic Software Enterprises Ltd. (MGIC, Financial) is a business software company based in Israel. The firm’s business revolves around two main products: uniPaaS, a software development platform designed for creating web-delivered business applications; and iBOLT, software that’s used for integrating business data from various enterprise software applications.
Magic earns revenues from new license sales (34%), maintenance and technical support contracts for existing users (23%), and consulting services (43%, but with a much lower margin). The company has a wide range of customers in virtually all geographic locales around the world.
The products themselves are somewhat difficult to understand for those not familiar with software development and business management applications.
uniPaaS is what is known as a “platform-as-a-service” offering. If you think of your laptop computer, it is controlled by an operating system (OS), most likely Microsoft’s (MSFT, Financial) Windows. You run applications off of this OS, such as a web browser or spreadsheet program. These applications are built using “development platforms” that run on top of the operating system. Some examples for Windows would include Microsoft’s .NET platform, and Sun’s JAVA platform. These provide software developers with the tools needed to build applications.
uniPaaS is similar, but is more focused on building web-based applications that execute through a provided browser-like client (an example of a non-browser based client for a web-based application would be Apple’s (NASDAQ: AAPL) iTunes Store). uniPaaS provides developers with logic languages, data storage, and user interface elements to build their application. The result is an app that is accessed through the provided client instead of downloaded onto a computer and run locally.
The advantages of web-delivered applications are several. For one, they are easily deployable. New changes are picked up immediately, instead of users having to download and install updates. There are few requirements for end-user hardware – minimum processor, minimum memory, required operating system, etc. – to run the applications. This “software-as-a-service” (SaaS) paradigm has seen much hype but has not yet been widely deployed. The advantages it offers and relative new-ness of it presents interesting growth potential for Magic Software.
iBOLT is quite a bit simpler to understand. In modern corporate environments, there exist data stores for information like customer records, supplier records, inventories, transactions, and so forth. These are often spread out over numerous systems, and the lack of integration between them means data is duplicated or gets out of date. iBOLT is designed to integrate data from disparate sources for the purpose of a unified view, which can then be used in developing business applications requiring the data.
iBOLT is designed to tie in with a wide variety of popular enterprise software environments, such as SAP (NYSE: SAP), salesforce.com (NYSE: CRM), Oracle JD Edwards (NASDAQ: ORCL), IBM (NYSE: IBM) systems, and others.
So how does Magic Software measure up to our growth, financial health, and competitive positioning yardsticks? Growth is difficult to project. On one hand, cloud computing is clearly a popular buzzword, but it has not seen significant uptake yet for several reasons.
In fact, Magic Software has had slightly negative revenue growth over the past 5 years. Growth really depends on whether SaaS takes off or not. Questions such as security, performance, and reliability have to be addressed sufficiently before that is going to happen. Once they are, most analysts expect rapid growth.
Financial health is fine, so we can cross that off. After a big, one-time $16 million dividend payment back in January, Magic has about $26 million in cash (close to half of market cap) and no meaningful debt. The company’s operating margins have improved recently, but a trailing twelve-month figure of 7.7% is not especially good for a software firm. The company’s return on capital is currently an impressive 131%, way up from sub-10% levels over the past several years. So there is some positive business momentum here, at least from an operating perspective.
Competitive position is a mixed bag. Once they win customers, uniPaaS is sticky, as it takes significant effort to build skills in using it to make and maintain software, and creating and switching to new business apps is a real pain. But Magic is far from the only firm developing “cloudware” development platforms. Even if the overall market does grow, Magic Software with its tiny resource base will have difficulty gaining market share against behemoths such as Microsoft’s Azure technology, or Salesforce’s Force.com.
On the other hand, the company could be a buyout target for a larger software firm looking to expand into PaaS.
Finally, Magic is a bit of a statistical anomaly in “Magic Formula” investing. Calculating MFI statistics using the last reported financial statements, enterprise value comes out to a miniscule $29.6 million, with over $28 million of excess cash on the balance sheet, giving us an earnings yield of 14.4%.
However, this does not account for the previously mentioned dividend, which was paid out in January. Lopping this $16 million out of excess cash, enterprise value becomes closer to $46 million, and earnings yield falls to 9.4%. That’s still pretty cheap, but not the 10%+ we see from most MFI stocks.
It’s too bad we didn’t beat the ex-dividend date, but Magic Software still makes an interesting micro-cap position today, with a cheap stock price, plenty of growth potential, and a strong financial footing.
Sincerely,
Steve Alexander, MagicDiligence.com
for Penny Sleuth
