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Is This Beleaguered Software Company Trading Too High or Too Low?

Tuesday - 8/27/2013, 6:30am  ET

A stock that has both an incredibly interesting story and an outsized profit potential doesn't come along very often. Yet, Ebix might fit the bill. The problem is that the company, a software provider to the insurance industry, has had such a bizarre last couple of years that it's difficult to determine whether its stock is worth a lot more than currently bid or significantly less. But one thing is likely; when the dust settles, the shares won't end up being where they are now.

A tale of allegations, lawsuits, and a busted deal

Ebix's share price volatility began in 2011 when a negative online report questioned the veracity of the company's financial reporting. Class action complaints asserting that Ebix inflated its stock price soon followed. In May 2013, it looked like the firm was vindicated when it announced a $20 per share go-private agreement with Goldman Sachs. New lawsuits alleging management had not pushed for maximum value were quickly filed.

Then, in June, the U.S Attorney for the Northern District of Georgia opened an investigation into Ebix. This criminal probe put the kibosh on the Goldman Sachs deal, cutting the stock price in half. In the meantime, a lawsuit by Microsoft for alleged copyright infringement, allegations of SEC and IRS probes into possible misuse of subsidiary tax shelters, and even rumors of a Federal investigation into possible ties to money laundering have also surfaced. 

Is Ebix trading too high?

Does the litany of lawsuits and allegations suggest that Ebix might be overvalued? The company does exhibit some controversial signs that might suggest caution on a too aggressive appraisal.

A major red flag is the company's accounting firm history. From mid-2004 through the 2007 engagement, one major auditing firm resigned and another was dismissed and replaced by a smaller local firm. This local firm resigned for the follow-up 2008 audit and was replaced by another local practitioner who has been active since. This type of frequent change in auditors and use of a small local firm for a listed, complex company is exceptional and proposes some extra analysis of the company's numbers might be prudent. 

Another watchful point is Ebix's operating cash flow versus reported net income and depreciation/amortization ("D&A"). In most cases, especially with software firms, reported profits plus D&A usually do not exceed the amount of operating cash provided. While not a significant amount, Ebix's "excess" profits plus D&A came to about $8 million in 2012, $8 million in 2011, and $13 million in 2010. Lending gravity to this issue is the company's penchant for dispensing cash on acquisitions and investments in small firms. Its $98 million spend, or around 50% of generated cash, over many different entities in the last three years might rightfully be questioned. 

Could Ebix be worth more?

While there may be some legitimate concerns, there are also plausible reasons why Ebix shares may be overly discounted.

The company does have a well-accepted and lucrative product called WinFlex, a software that helps insurance carriers offer and administer their products more easily. The company also has a seemingly solid place in the insurance exchange market, which generates about 80% of revenues. Additional opportunities in this business arising out of The Affordable Care Act's reliance on state-run health exchanges could offer significant upside and looks to be something the company is hoping to cash in on.

In addition, given the short position against Ebix, estimated at over 30% of the float, any surprisingly good news or legal exoneration for the company may spike the share price.

What could Ebix be worth?

In its latest quarter, Ebix reported revenue of $51.0 million, an increase of 7% year-over-year, but earnings per share declined over 25% to $0.35. Cash generated from operations fell to $10.6 million, down 50%, moderately affected by legal and extraordinary operational costs. 

Using a cash earnings times a capitalization multiplier valuation and giving Ebix the benefit of the doubt accounting-wise, fair business value looks to around $15 a share at a conservative 14 times multiple. This calculation, with cash earnings around $40 million and a cash profit margin of 20% on sales of $200 million, looks reasonable based on peer comparisons even considering the lackluster quarter.

Quality Systems is not a direct Ebix competitor, but there are parallels. Quality develops software for medical groups and small hospitals. It has also faced some turmoil. Last year, a director agitated for change with an activist hedge fund soon joining in. Quality ended up resolving the dispute by agreeing to let three hedge fund selected directors on the board and creating a five-person committee to evaluate the company's future.

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