PSB Monthly Issue January 2009
January 2009
Once a month I get together with my buddies for a guys night out. We enjoy a meal, have a few drinks, and share a lot of laughs.
Last month we did something unusual. We went to a local Indian Casino to try our luck at the gaming tables. Our favorite game is Texas Hold ‘Em.
The highlight of the night was a head’s up contest with one of my friends.
On the flop, several raises and re-raises knocked everyone else out of the hand. After more raises on the turn and the river my chips were “all in.”
The pot was bigger than any we’d seen that night.
At the showdown, my buddy laid down what he thought was the winning hand. Let me tell you his flush was good… but my full house was better. I walked away the big winner for the night.
Name: GigaMedia Ltd. Ticker Symbol: GIGM Market Cap: $305 Million Recent Price: $5.63 PSB Rating System 4.3 Stars Raging Revenue: (4 Stars) Revenue growth is set to accelerate. The winter months traditionally see an upturn in online gambling. Beautiful Books: (4.5 Stars) Earnings are growing at a steady 20% annual clip. With $100 million in cash and low debt, Giga should safely navigate the global economic slowdown. Stellar Structure: (4 Stars) Management’s 16% stake demonstrates confidence in Giga’s future. Relatively low institutional ownership of 35% means the shares will pop when institutions increase their positions. Valuation Verification: (4.5 Stars) Giga’s shares are priced well below its peers on price to sales, price to book and PEG bases. The stock offers potential returns of 199% or more from current levels. Meaningful Milestones: (4.5 Stars) Giga’s promotion with the World Series of Poker should spur growth in its online gaming software business for years to come. The Asian online games business should see increased growth with the launch of several major new online games over the next year. |
As Paul Newman once said, “Money won is twice as sweet as money earned.”
I enjoy everything about the game of poker. Calculating odds’ reading other players’ making a well timed bluff. Raking in my friends’ chips is just icing on the cake.
I’m not the only one who likes a little action.
Millions of people around the world gamble in casinos, bet on horse racing, and play the lottery every day. What was once considered a social vice is now a hugely profitable industry.
Total gambling revenues worldwide exceeded $345 billion in 2007.
A small but fast growing segment of the industry is internet gambling. More than two million people now gamble online every month.
And, revenues are growing five times faster than land based gambling.
Last year, global revenues from online gambling were more than $10 billion. This figure is expected to grow to $24 billion in 2012.
While the industry’s growing incredibly fast, it would grow faster if it was legal in more countries. Especially the huge markets in China, the U.S., and parts of Europe.
Legalization efforts are gathering steam.
In the U.S., influential Congressmen have sponsored a bill to make online gambling legal. They’re motivated by potential tax revenues of $40 billion over the next decade.
They’re also paying attention to what the voters have to say.
A recent poll shows 68% of Americans believe online gambling should be legal. In fact, they’re already gambling more than $6 billion dollars a year over the internet.
With total gambling revenues of more than $90 billion annually, the U.S. is a huge untapped market.
China is close to legalizing gambling as well (right now it’s only allowed in one area – Macau).
Last November, they began allowing bets on horse racing. Total gambling revenues in China were over $100 billion last year – most of it from illegal gambling operations.
So, how can we get our hands on a share of these billions?
Allow me to introduce GIGAMEDIA LTD (GIGM). Giga is a leading provider of online gambling software and online video games. This exciting microcap is poised to benefit from explosive growth in two fast growing industries.
GIGA’S ONLINE GAMING SOFTWARE BUSINESS
Giga provides software and services to online poker and casino gaming websites. Its main client is Ultra Internet Media (UIM), an online entertainment company. UIM provides online poker and casino gambling through its popular websites – Everest Poker and Everest Casino.
Giga receives a percentage of the gross revenue generated by these sites. This arrangement is highly lucrative for Giga. As revenues rise, Giga stands to earn higher and higher monthly fees.
And these sites are growing rapidly.
Everest Poker is now the #4 online poker website in the world. And, its membership base increased by 28% in just the past few months. It now has 176,000 active customers with real money deposits.
And this growth should continue.
A major marketing promotion is virtually guaranteed to build greater brand awareness. Everest Poker’s logo will be featured on every table in the World Series of Poker.
As the largest poker tournament in the world, this event is televised to more than 300 million households globally. You can’t get much better exposure than this.
GIGA’S ASIAN ONLINE GAMES BUSINESS
Giga also provides online video games to the enormous markets in China as well as Hong Kong, Singapore, Taiwan, and Macau (Greater China). With $1.7 billion in revenue in 2007, these online video game markets are expected to grow to $6 billion by 2012.
Giga owns two of the leading online video game websites in Asia: Funtown and T2CN.
FunTown offers over 40 online multi-player video games to users in Greater China.
It’s the largest online MahJong game site in the world by revenue (MahJong is one of the most popular games in Asia). The site also offers games like Chinese Poker, Chinese Chess, puzzle games, and chance-based games.
FunTown makes money by charging customers hourly or monthly fees to use the site.
It also makes money by selling virtual currency, which customers use to wager on games (MahJong, Chinese Poker, Chinese Chess) or to play chance-based games (bingo, lotto, horse racing, and slots).
The site has over 12 million registered users and more than 107,000 monthly paying users. The size of the user base is critical because every user is a potential ongoing revenue stream.
The opportunity in China is mind-boggling.
China had over 253 million internet users last year, and they’re growing at a 50% annual clip. More than half of these web surfers – about 150 million people – play online games.
T2CN is one of the leading online sports websites in China. It has over 73 million registered users and more than 500,000 paying players.
The site’s most popular game is FreeStyle Basketball. Players can form teams and play against other teams using customized in-game characters.
This game is very popular in China as basketball is the favorite sport of China’s youth.
While T2CN’s games are offered free of charge, customers pay for virtual items. These virtual items improve their online character’s look and feel or enhance their performance.
The Asian Online Games business should benefit from a number of major new game releases in the first half of 2009.
THE NUMBERS BEHIND ONLINE GAMING
Giga’s third quarter revenue jumped 16% year over year (yoy) to $46 million.
Driving the increase was an 18% rise in revenue from the Online Gaming Software business. Revenue from the Asian Online Games business grew 11% due to strong organic growth in China.
Gross Profit Margins held steady at a mind-boggling 81%. Net Income was up a whopping 24% to $12 million.
Giga’s strong balance sheet is good protection against the global economic slowdown.
The company has over $100 million in cash and just under $30 million in total debt. GigaMedia CEO, Arthur Wang recently commented:
“The financial turmoil has created many concerns, many fears… Nevertheless, the fact is we continue to run a high-growth business generating high levels of free cash flow and look to an even better 2009 supported by a strong balance sheet and cash position with no net debt.”
The outlook for 2009 is exciting.
Driving growth in Online Gaming Software is the traditional upturn in online gambling during the fall and winter seasons. Growth in the Asian Online Games business should accelerate strongly in 2009 on major new game releases.
ONLINE GAMING BUSINESS RISKS
Every investment involves risk. One risk for Giga is the global economic slowdown could cause a substantial decrease in player activity.
This is not very likely.
In past recessions, gambling provided psychological relief from personal woes and a chance to strike it rich. Online video games are likely to remain in the budget because they’re a cheap form of entertainment.
Another risk is that extremely fierce competition will hurt Giga’s business.
Giga is too well-positioned in each of its business segments for this to occur. And, the company is not content to rest on its laurels. It’s constantly improving its software, launching new games, and building greater brand awareness.
GIGA’S SHARES ARE MISVALUED
At its current price, GIGM offers tremendous upside. The shares are down more than 70% from their 52-week high just over $20.
Giga’s valuation compares to two other leading online gaming stocks.
Giga’s earnings are expected to grow at a faster rate than both NTES and SNDA. But, Giga’s stock trades at a much lower price relative to its projected earnings growth rate.
With a similar PEG Ratio of 0.80, Giga’s P/E would be 15.5x. Assuming Giga earns $0.81 per share in 2009, a P/E of 15.5x implies a share price of $12.55.
On a price to book basis, Giga’s shares are trading at a 40% discount. Giga’s book value per share is about $4.05. The average of NTES’ and SNDA’s price to book ratios is 4.2x. Using this figure, Giga’s shares are worth $17.01.
A price to sales analysis implies an even higher price for Giga. The average P/S ratio of NTES and SNDA is 5.7x. Giga’s sales per share over the last 12 months is $3.72. Using a P/S of 5.7x, Giga’s shares are worth $21.20.
Based on the above analysis, fair value for Giga’s shares is somewhere between $12.55 and $21.20. The midpoint of this range is $16.87, which is close to the $17.01 implied by our price to book analysis. Using a price target of $16.87, Giga shares offer a potential gain of 199%.
ACTION RECOMMENDATION
BUY GigaMedia (GIGM) up to $7.50, recent price was $5.63.
Stop loss of $2.53 on this position.
Don’t forget your position sizing and stop-loss rules.
Finding mis-valued companies is a specialty of mine. Over the years, I’ve learned to look for things that are out of the ordinary.
Some businesses have value that’s easy to see. But, most of the time, it takes a lot of digging and research to uncover the hidden gems.
This month’s second recommendation is a company with an exceptional business.
They sell software which helps their business customers run more efficiently and save tons of money. And, the company’s management team is great at running the business.
Despite the economic slowdown, the company continues to make money consistently. They’ve been profitable for 31 quarters in a row (that’s more than 7 ½ years for those of you quick on the math).
Best of all they’re sitting on a boat load of cash.
Name: American Software Ticker Symbol: AMSWA Market Cap: $119 Recent Price: $4.70 PSB Rating System 4.2 Stars Raging Revenue: (4 Stars) The company has historically grown revenue at more than 8% per year. It’s not an earth shattering number. The key to this story is recurring revenue. Right now more than $7 million a quarter flows into the company, just for showing up. Beautiful Books: (4.5 Stars) They have $71 million in cash and the stock they own of another public company is worth another $50+ million. To top it off, the business has no debt. Books look great. Stellar Structure: (4 Stars) The company has a variety of large owners and a couple of big institutional holders (the smart money). In addition, the two founders also hold a significant portion of class B stock. That means they have some strong controls over the company… A good sign in my mind. Valuation Verification: (4 Stars) With huge cash levels and part ownership of another company worth $53 million, the assets of the business alone is worth more than the entire market cap of the company. It’s a steal at these levels. Meaningful Milestones: (4.5 Stars) The company just reported its 31st consecutive quarter of profitability. Consistent earnings is a sign of a quality business and sound management. |
But that’s not why I like the company.
Most investors are missing the important part of the story. They’ve overlooked a hidden asset on the company’s books worth millions. As a result, they’re mis-valuing the company in a huge way.
It’s like finding buried treasure in your back yard.
Before I tell you about the hidden treasure, let me tell you a little bit about the company.
THE SUPPLY CHAIN MANAGEMENT BUSINESS
This extraordinary company is American Software (Ticker: AMSWA).
Now before you send me an email saying there’s a typo in the ticker symbol, I’ll point out it correctly has 5 letters.
The extra “A” at the end designates it’s a “Class A” stock. The company holds two classes of stock, both A and B.
Class A shares are what you and I can buy on the stock market. Class B shares are held by Thomas Newberry and James Edenfield. They’re the original founders of the business.
The class B shares have 10 to 1 voting rights and convert to common stock on a 1 to 1 basis.
Enough about that stuff. The important thing about American Software is their product.
American Software develops software for enterprise management and collaborative supply chain solutions. That’s a fancy way of saying they make software to make businesses more efficient.
The software tracks things like inventory. It makes sure there’s not too much or too little. The software can also develop and manage manufacturing flows and order processing.
The software can do a million other things for managing large and small businesses more efficiently.
One of their software products helps companies manage purchase orders.
It allows companies to track when purchase orders were sent out, see how they were approved, and monitor the flow of goods into the manufacturing process. It’s especially useful when you have several locations around the globe.
Another software product manages payables.
PNC bank uses American Software products to monitor and track all of their bills and invoices to ensure on-time payment. The software cuts down on the number of people handling invoices and reduces errors.
If the software sounds complicated, it can be.
Here’s the key. American Software’s products save customers money.
Lots of money.
Now everyone needs to realize, this isn’t off the shelf software. You can’t run down to Best Buy and pick up a couple of copies.
This is a software package that takes time to develop and install. The configuration alone can take weeks.
That’s what makes it so valuable to customers.
The company sells its software all over the world including countries like:
Australia, Canada, China, India, Ireland, Italy, Kenya, the Netherlands, Poland, Sweden, the United Kingdom, and the United States.
The company also has a blue chip list of customers like:
Avery Dennison Corporation, BP (British Petroleum), Home Depot, Hyundai Motor America, McCain Foods, Pernod-Ricard, and Under Armour Performance Apparel.
Best of all, every time the company makes a sale it creates a recurring revenue stream.
Once the software is sold and installed, every customer is signed up for a recurring maintenance agreement. That means every year they fork over more cash for using the software.
In return, they get follow-on support and upgrades.
PROFITS IN SOFTWARE DEVELOPMENT
The business model of American Software is second to none. They sell high end software products, and then capture recurring maintenance revenues.
For the quarter ended October 2008 revenue was $19.8 million. That’s a slight decrease of 16% from the quarter prior. Of that revenue, more than $7 million was recurring (the kind we really like).
Now the recurring revenue doesn’t grow very quickly, but once it’s set up, it’s like money in the bank. And that produces profits.
Despite the revenue decline in the last 6 months, the company generated $20 million in gross profits.
They posted operating profits of $3.2 million and net income of just over $1 million.
And profitability is a major key to the story.
Last quarter the company announced profits of just under half a million dollars. That’s about $0.02 per share. It doesn’t seem like much, but remember many of their competitors are losing money.
American Software’s the exception… they actually make money on a regular basis (imagine that).
Last quarter marked the 31st quarter in a row a profit was recorded. Very few microcaps have 7 ½ straight years of profits.
That’s not all. The company also has no debt and more than $71 million in cash on the books.
I really like the way management uses their profits.
They recently repurchased almost 100,000 shares of stock and paid about $2.3 million in dividends. That’s great for current and future shareholders.
Now, I’m not the only one who likes this amazing company.
Institutional ownership stands at 62% and the top 10 holders own 41% of the company. Two of the top mutual fund holders, Brown Capital Management Small Company Fund, and Perritt MicroCap Opportunities Fund have been buying the stock recently.
It shows the smart money investors are getting behind the stock. As they buy more, we could see stock prices move higher.
RISKS OF INVESTING
There are a few risks. The company is exposed to the economy.
If businesses cut back on software spending, the company will be impacted. However, their products tend to cut costs in the long run. That means better demand throughout the recession.
The company also has close ties to the retail industry.
Many of their customers are either in the retail industry or supply products. Unfortunately the retail industry’s been struggling, and that might hurt near term sales.
The last risk I want to flag for you is a customer concentration issue.
Home Depot accounts for 12% of sales. If they were to change software platforms, the company’s revenue numbers would undoubtedly fall. I don’t see this happening any time soon, but it could be an issue.
WHAT THE NUMBERS SAY
The valuation of American Software is where the treasure trove is hidden.
Now, compared to other firms in the industry, American Software isn’t tremendously undervalued.
You’ll note they have a higher Price to Sales ratio, but are in the middle of the range for Forward P/E ratios. Also, at these levels the company is paying out a robust dividend (more than 8% annually).
It doesn’t seem like it but here’s why the company is so is-valued.
American Software owns 88% of a company called Logility (LGTY). It’s a publicly traded company with a valuation of about $60 million.
That means their piece is worth roughly $53 million. But remember American Software also has $71 million in cash on their balance sheet.
$53 + $71 = $124 million. That’s more than American Software’s entire market cap.
With my back of the envelope math the stock’s trading at a 16% discount just to the company’s assets. And that’s if you value the rest of their business at zero.
In reality, the rest of the business is worth at least $50 to $100 million.
Add this to the company’s market cap and you get a fair value of between $174 and $224 million. You can see how this stock could easily double in value from current levels.
ACTION RECOMMENDATION
Buy American Software (AMSWA) up to $5.88, recent price was $4.70.
Use a stop loss of $2.83 on this position.
Don’t forget your position sizing and stop-loss rules.
Category: PSB Monthly Issues
