Friday, November 18, 2011

Acacia Research ( Nasdaq - ACTG ) -- Market Leader Reinforces Position

Acacia Research (ACTG $32.75) appears on track to produce excellent Q4 results.  Acacia is the leading provider of intellectual property monetization services.  The company teams up with inventors and other patent holders to enforce their IP rights against infringing companies.  Outside legal firms are hired on a contingency basis and typically collect 15%-20% of the winnings.  Acacia and its partners divide the remainder.  Each deal is unique but the company normally keeps a little more than half of the balance.  Over the years Acacia has acquired a patent portfolio of its own.  In those situations it retains 100% of the settlement, less what it paid to outside counsel.  Targets generally are large companies that don't have time to conduct extensive patent searches when developing new products.  Before Acacia came along small inventors often were stymied by expensive and time consuming legal maneuvering.  Acacia provided the deep pockets to withstand those delays.  Over the years the company's partner list has expanded to the point where it now licenses more than 200 patent portfolios encompassing hundreds of thousands of individual patents.  That's expanded the number of companies it can sue.  It also has made it possible to sue many companies for multiple infringements, boosting its average award size.

In 2010 Acacia agreed to "structured settlements" with Oracle and Microsoft.  Those deals provided those giants with licenses to all of the patents under Acacia's control, plus all the new ones it would bring in, for a three year period.  Oracle paid $25 million; Microsoft, $40 million.  In Q1 Samsung paid the company $45 million under a similar arrangement.  A portion of that money was paid to the company's partners.  Even so, earnings jumped dramatically in each of the quarters those deals were signed.  Patent values have escalated in 2011, fueled by several major transfers in the smart phone space.  That surge has made it more difficult for Acacia to reach agreements on additional structured settlements.  Infringing companies have been waiting for the dust to settle before committing such large amounts of capital. 

The rise in patent values also has prompted many corporations to figure out ways of monetizing their own patent portfolios.  Acacia is negotiating with several companies, including the three it already made structured deals with, to license large swaths of their patent portfolios.  The arrangement could offset some or all of the money they're paying in infringement cases.  It also will hide the originating company's identity when prosecuting those rights, allowing it to do keep doing business without acrimony.  Judicial pressure might be mitigated, as well.  Acacia probably won't be accused of anti-competitive behavior. 

The lull in signing new structured deals has caused the stock price to retreat over the past few months.  Those transactions provide immediate earnings boosts which investors thrive on.  Income from stand alone settlements has been advancing sharply over the past two quarters, though.  And Q4 comparisons should be positive even if no structured deals are consummated.  Our estimates assume that scenario.  They are unchanged.  Acacia indicates it is continuing to pursue structured transactions.  It also is bringing in rafts of new patents which might take 1-2 years to prepare, but promise to bolster income growth in the future.  The company additionally is looking to buy key patents in partnership with major companies, giving them a license and then suing everyone else.  That might keep the partner off the judicial radar screen.  Earnings could follow a number of paths to sharply higher levels over the next several years.  Our 2-3 year target price is unchanged at $100 a share.

( Click on Table to Enlarge )

Tuesday, November 8, 2011

Amerigon ( Nasdaq - ARGN ) -- Achtung Baby !

Amerigon (ARGN $15.00) reported excellent on target Q3 results.  Performance was slightly ahead of our estimate due to good European sales by the recently acquired W.E.T. business, and a somewhat lower tax rate.  That stemmed from Amerigon's entry into the European market, as well.  Amerigon is the leading provider of automobile seats that can be both heated and cooled.  The company employs a patented technology that allows passengers to dial up whatever seat temperature they want.  Competitors can heat seats as well as Amerigon does.  But nobody else can deliver air conditioned comfort.  Alternative seat cooling systems recycle ambient ("ventilated") air.  Over the past few years Amerigon has extended its technology to cup holders which actively cool or keep drinks warm.  It also has a deal with a bed manufacturer. 

Earlier in 2011 the company commenced a two stage acquisition of a major German manufacturer of heated seats.  That transaction also brought some related product lines, like heated steering wheels.  Amerigon bought 76% of W.E.T.'s shares in the first go around.  It now is going to court in Germany to force the holdouts to sell the rest.  Once the transaction is complete the two companies' operations will be integrated.  That could boost pretax margins by 1%-2% directly.  Product development and cross marketing opportunities could yield additional leverage. 

Q3 performance was solid despite the fact W.E.T. had to be run as a completely separate company.  New auto platforms continued to be added.  Costs were kept under control.  And sales to existing customers remained vibrant in spite of the weakening European economy.  Earnings (excluding stock option and acquisition related costs) advanced 55% to $.17 a share after deducting W.E.T.'s minority ownership's share.  Revenues reached $125.7 million.  Factoring out the acquisition's contribution, Amerigon's sales advanced 15% to $35 million.  (The company redirected $4.5 million of that to W.E.T.'s production facilities.)  Fourth quarter results usually dip sequentially due to seasonal factors.  Still, we are raising our full year sales estimate by $5 million to $360 million.  We also have lifted our earnings estimate by a nickel to $.55 a share.

Margins should widen in 2012 if the remaining W.E.T. shares are bought in.  Earnings also will benefit from a full year of the combined company's sales.  We estimate they'll reach $500 million to provide earnings of $.90 a share.  (See "Accounting Notes.")  Organic revenue growth of 15% appears sustainable over the long haul.  Earnings could rise more rapidly if margins keep widening.  Cash flow probably will be applied to repaying debt incurred to make the acquisition. 

Development of another high potential product is in the pipeline.  Amerigon has been working for years on a system that captures waste heat and recycles it into electricity.  It recently began testing a redesigned system on Ford and BMW vehicles in conjunction with the U.S. Department of Energy.  The previous generation produced 700 watts of output.  The new less cumbersome version delivers similar power but is being streamlined to fit into standard engine blocks.  Fuel efficiency could improve by 2-3 mpg.  If the project succeeds gigantic sales could develop in the auto industry directly.  The technology also offers huge potential in a range of other industrial applications.

( Click on Table to Enlarge )

Sunday, November 6, 2011

Ansys ( Nasdaq - ANSS ) -- Gains Momentum in Q3

Ansys (ANSS $58.00) reported excellent on target Q3 results.  Non-GAAP earnings (excluding non cash stock option and acquired intangible expenses) advanced 29% to $.66 a share.  Revenues climbed 27% to $177.9 million.  Ansys completed its purchase of Apache in August.  That unit was consolidated for two months.  Excluding that contribution organic growth was 20% year to year.  Apache is a leading provider of engineering silulation software for power management applications, like smart phones and tablet computers.  Its revenues are virtually all derived from annual subscription licenses.  That pricing scheme has become more popular among Ansys's other product lines, too.  Recurring revenues amounted to 70% of the total in Q3.  The renewal rate topped 95%.  A substantial though undisclosed amount of revenue was generated by existing customers that expanded their relationship with the company.  Ansys already has penetrated most of the Fortune 100.  But it still has plenty of opportunity to expand by selling its software to additional business units.

Ansys said backlog remained robust despite the questionable economy.  Fourth quarter performance is likely to be excellent, fueled by the Apache transaction and a growing proportion of recurring revenues.  Demand is continuing to rise in huge industries including automobile manufacturing, electronics, and energy production.  Geographic strength is stable, as well.  Demand for engineering simulation technology is poised to keep growing well into the decade.  Competition is compelling companies to invent products with original features, lower costs, and greater reliability.  It also is exerting pressure on turnaround time.  The software itself is improving with the help of academic research and internal efforts.  A bigger factor, though, is the ongoing improvement in parallel processing.  Strings of high power computers now work together on extremely complex problems, sharing intermediate solutions as they go along, and also updating common databases.  Instead of working through problems in a linear manner it's become increasingly feasible to break them down into separate parts and arrive at "go -no go" decision points more rapidly.  Ansys also has improved user interfaces so problems can be set up quicker and more accurately. 

The trend away from physical testing to computer simulation is likely to continue.  Ansys faces competition in several niche markets.  But the company is unrivaled in its overall breadth.  Small users may select a competitor for particular applications.  Large companies with more extensive requirements probably will continue to standardize on Ansys.

Solid gains are likely in 2012.  We estimate sales will increase 19% to $825 million.  Earnings could rise 14% to $2.90 a share.  Our outlook assumes a relatively dismal economic scenario.  Margins probably will finish higher if the environment is livelier.  Order growth could moderate if conditions weaken.  But a solid performance is anticipated nonetheless.  Ansys's customer base is likely to emphasize simulation if their own businesses soften, as a tool for enhancing profitability and market share.  They also will have the money to pay.  Longer term, internally generated growth of 10%-20% appears sustainable.  Ansys throws off substantial amounts of cash flow which should enable it to make further acquisitions without dilution.

( Click on Table to Enlarge )

Pros Holdings ( NYSE - PRO ) -- Pricing Software Leader Accelerates Growth

Pros Holdings (PRO $16.25) reported excellent on target Q3 results.  Earnings (excluding non cash stock option expense) advanced 83% to $.11 a share.  Sales climbed 34% to $25.2 million.  The company still sells its software exclusively on a perpetual license basis.  The target market at this point remains large Fortune 500 type customers, with a particular emphasis on international airlines and other customers with a high number of variable pricing transactions.  Most U.S. airlines operate their own internally developed pricing schemes.  Initial selling prices approach $1.0 million and sometimes expand from there as customers extend the technology to additional business units.  Maintenance contracts, which provide the latest software updates when they become available, are 15%-20% of the current selling price.  In the September period more than 95% of the maintenance contracts that came up for renewal were continued.  Incoming orders demonstrated greater end market diversification.  More industries are adopting pricing (revenue management) software to enhance profitability in a slow growth environment.  Pros already is the industry leader and appears to be lenghtening its advantage by boosting R&D and marketing.  The company is developing specialized applications for niche markets.  It also has boosted the sales force by 50% this year.

Momentum is likely to continue in Q4.  We estimate full year earnings will rise 40% to $.35 a share.  Revenues appear headed for the $96 million mark (+29%).  Pros is rolling the dice a bit with respect to 2012.  The company does have several large companies nipping at its heels in the pricing space, including Oracle and Accenture.  Those behemoths are validating the technology among a far greater customer base than Pros addressed in the past.  So the company plans to keep spending at an elevated level next year to retain its competitive lead and capture a lot of new business.  All that spending is likely to prevent margins from expanding, however.  Pros also is launching a cloud based computing service aimed at smaller mid-market customers in 2012.  That initiative is likely to crimp profitability further.  Gross margins on incremental sales remain unusually high, so Pros will have plenty of latitude to work with.  Despite the escalated spending plan our estimates reflect a modest improvement in 2012 pretax margins.  If economic conditions contract in any serious manner, though, the leverage process could shift into reverse.  With the P/E multiple already at a steep valuation the stock could be a volatile performer if economic conditions deteriorate.

We estimate 2012 sales will improve 20%-30% to $115-$125 million.  Earnings could end up in the $.40-$.50 a share range.  The long term outlook remains bright.  Economic growth in Japan, the United States, and Europe is likely to remain muted for several years.  But corporate income promises to stay robust.  So companies will have an incentive to apply pricing technology to their relatively slow growing operations.  And they'll have the cash to pay for it.  Penetration of the mid-market segment promises additional leverage.  Sales to emerging markets promise to reinforce the long term trend.

( Click on Table to Enlarge )

Thursday, November 3, 2011

Convio ( Nasdaq - CNVO ) -- Adoption Rate Grows Among Non-Profits

Convio (CNVO $9.25) reported excellent on target Q3 results.  Earnings (fully taxed) were flat year to year at $.08 a share.  Revenues improved 18% to $21.0 million.  Margins were affected by the cost associated with rolling out the high potential Luminate product line.  Efforts to move mid-size customers to a cloud computing format also impacted short term profitability.  Both of those programs are likely to bolster margins in future periods as recurring revenue expands.  Convio's computer based donation management technology is gaining market share among non-profit organizations.  The system coordinates all activities so donor activity can be monitored more efficiently.  Historically, charities have maintained separate databases for mailings, telemarketing, events, and other activities; making it difficult to quickly assemble a complete picture of each donor's involvement.  The better analytics also help non-profits target new solicitations more effectively.

Performance is being impacted by the weak economy.  Convio earns a piece of the donations it raises in addition to the money it makes on software sales and service.  The company is gaining a larger portion of its existing customers' money raising activities.  It's also adding more clients.  But overall donation volume is stalled due to economic factors.  Still, organic growth of 10%-15% appears sustainable in the current climate.  Two small acquisitions completed earlier in the year are providing an additional 5% revenue boost.  Changes to the tax code by the "Super Committee" theoretically could impact giving over the long haul.  Liberal members have proposed deductibility limits to divert money from non profits to government welfare agencies.  President Obama is believed to favor that approach.  Change seems unlikely but if the current policy was altered investment risk would elevate.

We estimate 2012 income (fully taxed) will advance 60% to $.40 a share.  Revenues are poised to expand 15%-20% to $92-$96 million.  Our estimate assumes the low end of the range.  International expansion promises to reinforce growth over the long haul.  A rebound in the U.S. economy could reinvigorate donation volume, providing further leverage.  In 2-3 years sales could reach $150 million to provide earnings of $1.00 a share.  Applying a P/E multiple of 20x suggests a target price of $20 a share, potential appreciation of 115% from the current quote.

( Click on Table to Enlarge )

Wednesday, November 2, 2011

Ellie Mae ( Nasdaq - ELLI ) -- Let's Rewrite Those Mortgages

Ellie Mae (ELLI $5.25) reported excellent on target Q3 results.  Performance was affected by the acquisition of the company's largest competitor during the quarter.  Ellie Mae had to foot the bill for the new company's operating expenses.  But FASB accounting rules prevented it from recognizing the subscription income the company brought to the table.  The official accounting rules viewed that as a reduction in the selling price.  So revenues associated with the new business essentially were zero in Q3 while the corresponding expense came in at $1.2 million.  Earnings were understated by $.04 a share as a result.  Ellie Mae netted $.05 a share (fully taxed) in the period, nonetheless.  That was achieved despite the fact U.S. mortgage originations declined 20% year to year to a generational low.  Revenues from the company's pre-merger business advanced 23% to $14.7 million.  That figure was diminished, too, by Ellie Mae's ongoing program to convert customers from perpetual software licenses to a per-mortgage fee structure.  Upfront revenue is substantially higher on license sales.  That makes the deal attractive to banks in the current climate.  But income potential to Ellie Mae is greater over the long haul as the recurring revenue stream builds up.  An even greater windfall could develop if the mortgage market returns to a normal level of activity.

The HARP program could provide a lift in 2012.  That's the scheme the Obama Administration recently unveiled to help underwater borrowers refinance at today's lower rates.  Industry experts predict the new rules could generate 1.0 million successful mortgage refinancings over the next two years.  Currently, 50% of the market is controlled by approximately 20 giant banks.  Ellie Mae doesn't participate in that segment.  Those institutions use their own automation software.  With its recent acquisition the company has taken over about 60% of the remainder, though.  So an extra 300,000 deals could go the company's way between now and the end of 2013.  In theory, that could amplify revenues by $20-$30 million a year.

Assuming flat mortgage origination activity, we estimate 2012 revenues will advance nearly 40% to $70 million.  Approximately two-thirds of that is expected to be generated by the recently acquisition.  The balance could come from greater use by existing customers, and the addition of more revenue generating services per mortgage.  Margins are nearly certain to improve as the revenue from the acquired company starts to be reported, not just the expenses.  Some genuine operating leverage is possible, as well.  We estimate fully taxed earnings will advance more than 100% to $.25 a share.  A stronger showing is possible if the HARP program delivers a boost or the overall housing industry picks up.

We think the housing industry will improve in 2012.  Most economists have predicted rebounds in each of the past three years.  They now forecast further malaise.  That is the trend, so they might prove to be correct.  But American households have de-leveraged over the past few years.  Debt to income ratios are down.  There's tremendous pent-up demand to move for personal, business, or retirement reasons.  And the foreclosure overhang is winding down.  House prices probably won't surge.  But real estate activity has the potential to move sharply higher.  Each new mortgage is an opportunity for Ellie Mae.  The company already is well positioned to perform well under depressed conditions.  Income could fly if volume picks up.

In 2-3 years earnings could reach $.75-$1.00 a share.  Applying a P/E multiple of 20x to the low end of the range suggests a target price of $15 a share, potential appreciation of 185% from the current quote.

( Click on Table to Enlarge )