A Short Squeeze May Push This Controversial Stock 50% Higher
It's a CEO's worst nightmare. You wake up one morning to find that your company's stock has been targeted by short sellers and millions of dollars have suddenly been shaved from the firm's market value.
On March 23, 2011, it happened to Robin Raina, CEO of Ebix, Inc. (Nasdaq: EBIX). The company, which sells software and e-commerce platforms to the insurance industry, saw its shares plunge from $29 to $22 the next day.
But the damage has been done and Raina has been trying to contain the fallout ever since. Shares now trade for less than half the levels seen before short sellers first appeared. For investors not yet familiar with this company, the forward view is what counts.
By my math, this stock could rebound into the mid-$20's over the next year if Ebix plays its hand well in coming quarters.
Ebix is known as a "roll up" firm because it made a long stretch of acquisitions to boost sales. Such business models are much-loved when they work, but a target for short sellers when it appears that the deal-making yields few bottom-line gains.
Roll up strategies do bring a clear negative: Nearly $350 million in goodwill sits on Ebix's balance sheet, and much of that will likely need to be written down in coming quarters or years. The heavy amortization of goodwill is also dampening earnings per share.
Since short sellers first targeted this stock, Ebix has delivered a mixed financial performance.
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Sales grew at a decent pace in 2011 and 2012, but Ebix likely generated minimal organic growth. In the absence of acquisitions in 2013, sales barely budged. Of equal concern, operating margins have been trending downward although they currently remain extremely robust. The firm's acquisitions should have dampened free cash flow generation, but the figure appears to be holding up well, according to ThomsonReuters. Still, the core business appears to generate decent enough returns.
2007 | 2008 | 2009 | 2010 | 2011 | 2012 | 2013 | |
|---|---|---|---|---|---|---|---|
Sales | $43 | $75 | $98 | $132 | $169 | $199 | $205 |
Sales Growth Rate | 46% | 75% | 31% | 35% | 28% | 18% | 3% |
Operating Profits | $13 | $30 | $38 | $53 | $69 | $77 | $71 |
Operating Margins | 30.0% | 39.1% | 40.1% | 39.7% | 40.7% | 38.6% | 34.5% |
Free Cash Flow | $13 | $26 | $31 | $50 | $66 | $63 | $53 |
To be sure, short sellers continue to have serious doubts about Ebix, as the short interest now tops 16 million shares. Fully 55% of the trading float is held by short sellers, which makes this the fourth most-heavily shorted stock on the Nasdaq. The top three shorted stocks are Corporate Resource Services (Nasdaq: CRSS), Insys Therapeutics (Nasdaq: INSY) and Zuliliy (Nasdaq: ZU).
With all of these concerns in place, this might look like a stock to avoid. But Ebix's business model has clear positives:
It has a high degree of recurring revenue, a rapidly growing sales push outside the United States and it utilizes low-cost software development in India.
Most importantly, Ebix's string of acquisitions is finally developing into a broad and coherent platform, known as EbixEnterprise. The network helps exchange information among insurance carriers, brokers, third-party administrators and claims agencies. The platform is also being tailored to other countries' healthcare regimes. EbixEnterprise went live in March and may hold the key for long-awaited organic growth from this business model.
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An increased focus on the healthcare market complements Ebix's existing focus on the company's life insurance market. It was previously a hodge-podge platform that is now being streamlined.
Still, the company's progress on product development has been obscured by a June 2014 decision to open a $150 million line of credit. Shares plunged anew and have only recently begun to rebound.
That credit line may be tapped for acquisitions -- which investors may not be thrilled about -- and share buybacks.
That latter step could prove to be quite wise because buybacks create havoc for short sellers. This is especially true when a stock is heavily shorted because some short sellers will be forced to cover. The credit line borrowing rate of LIBOR plus 1.75% is quite reasonable. When you consider Ebix's margins and cash flow, the rates of return on low-cost borrowing should be impressive.
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But financial engineering isn't the reason this stock is appealing. Instead, it's the fact that Ebix built a software platform worth $200 million in sales that's growing increasingly more robust. Management is surely under the gun to deliver organic sales growth in coming quarters, but this is already a profitable and undervalued business right now.
Ebix's quarterly operating cash flow of $18 million equates to roughly $70 million on an annualized basis. That means that shares trade for less than eight times the cash flow run rate, quite cheap for a software firm. Shares are also valued at around 2.5 times annual sales, which again is a fraction of the price/sales multiple typically garnered by software firms. Shares trade for less than ten times the lone 2015 EPS estimate of $1.54.
Even a move up to $25 would leave this stock trading at a decent discount to industry multiples. For that to happen, management needs to continue to boost cash flow and invigorate organic sales growth. If that happens, short sellers will run for cover and shares will quickly surge higher.
Risks to Consider: Ebix may look to take a large write-down of past acquisitions, which would bring fresh pressure to the stock.
Action to Take--> This is hardly what can be considered a clean one-line investment thesis. Ebix has built an impressive software platform, but a promotional CEO, heavy reliance on acquisitions, and the taint of a past SEC investigation is grounds enough for investors to be cautious. Now that short seller claims about past misdeeds have been mostly off the mark, it's the view ahead that counts. A few quarters of solid execution is all this stock needs to move back into the $20's.
If Ebix manages to meet these expectations for an increased cash flow, then it could be a candidate for our premium newsletter Alpha Trader. Cash flow is an influential factor in determining a company’s Alpha Score, which has been used to identify 71 stocks right before they jumped 10% in two weeks. And it's tagged 21 stocks right before they jumped 20%. To see how it does it -- and to get the name of a stock flashing "buy" right now -- click here.
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