We went through the exercise of reviewing the 100 micro-cap companies listed in the UK, categorized under the Software and Computer Services sector and over 200 similar companies listed on the NASDAQ in the United States. We are looking for companies that are taking their software to the global stage, so we are really looking for classical growth companies, which have quite strong underlying business models today. We have boiled down the few hundred companies to just five names which have attractive investment characteristics in our opinion. This number is now down to four after Cimatron (NASDAQ: CIMT) received a takeover offer from 3D Systems (NYSE: DDD) at a 50 percent premium to our initial coverage price.
The attractions we look for in these early stage nano-cap and micro-cap companies include lowly Enterprise Value/Sales metrics, high levels of recurring revenue and high levels of investment in software development which indicates management are building sustainable businesses based around intellectual property and know-how. We accept investors are making small leaps of faith and in all likelihood not all these company's will fire.
The ideal companies exhibit quite of a few of the below characteristics in our opinion and there really is no perfect combination, rather we like to see a high concentration of these characteristics.
- Domain knowledge, innovation, decent R and D (% of sales)
- Cashflow positive, or trending positively
- Decent balance sheet, ideally with lazy cash balances, retained earnings, limited dilution
- Revenue growth (higher the better)
- Lucrative industry settings
- High percentage of recurring revenue (subscription, maintenance etc)
- Decent client base, ideally with global focus, recent client wins
- Good amount of executive share ownership with recent buying, some youth on the Board
- Website is busy with client interfacing activities
- Set-backs are explainable
- Open and transparent company
The £37 million capitalised UK company KalibrateTechnologies (LSE: KLBT) trades on an EV/Sales metric of 1.4 times for 2015,
with its most compelling investment metric being its EV/Recurring revenue ratio
of just 2.1 times. The fully taxed 2015
price to earnings ratio at 18 times is pretty ritzy, especially as I perhaps
ambitiously assume profits rise over 30 percent in 2015. The story driving the company’s growth is
pretty compelling with deregulation of fuel pricing in many countries around
the world requiring more sophisticated systems to handle variable pricing
strategies in petrol stations. I also
like the fact the biggest source of competition are in-house developed systems,
which are less likely to keep up with the functionality and compliance
reporting required in today’s fuel market.
I’m forecasting 15% revenue growth in 2015, with top line revenue growth
one of the better facets of this company.
The £36 million Lombard Risk Management (LSE: LRM) sells
risk management and compliance software to a blue chip client base of banks and
financial institutions. Lombard’s most
compelling investment feature has been its top line revenue growth which has
been growing at over 25% per annum (2012-2014).
The biggest detractor has been that free cashflow generation which has
been negative in recent years. The
outflow is largely explained by the combined technology and research and
development spend accounting for a whopping 35% of sales revenue, in each of
the last 3 years. The investment
rationale, is this large technology spend has peaked and can start falling as a
percentage of sales, finally propelling the company into decent free cashflow
generation in 2016. The company trades
on reasonable EV/Revenues ratio of 1.9 times for 2015 and a slightly ritzy
EV/Recurring revenues ratio of 4.1 times.
This name is however not without corporate appeal and historically has
been involved in takeover discussions.
QAD Inc (NASDAQ: QADA) provides enterprise resource planning
software to manufacturers globally. The
most compelling feature for investors is this husband and wife run software
company, trades on an EV/Sales ratio of less than 1 times for 2015. The other compelling investment metric for QAD
is its EV/Recurring revenue sits at just 1.6 times. While these metrics are very attractive for
a software company the price to earnings multiple for the same year at 32.7
times is pretty ritzy. The company is capitalised at around $370 million USD (QADA share price = $20.50, QADA
share price =$18) and is covered by 5 brokers in the US. The investment
rationale here is QAD can raise its EBIT/Sales margins from a miserable
6% (2015) to something approaching 15% in future years. The speed that the company can normalise its
operating margins towards more typical software margins will determine how
quickly shareholders will get rewarded.
The company currently has around $100 million net cash on its balance sheet
post its recent capital raise with an acquisition likely to be additive to
earnings.
The $50 million USD capitalised Top Image Systems (NASDAQ: TISA)
provides document capture software, enabling business to efficiently extract
data from paper documents, email, mobile, and computerise the data, routing it
to the appropriate area within the enterprise.
The company’s mobile imaging technology gives it the ability to sell the
software on a per usage basis in what should be a booming mobile market for
data capture. Top Image Systems tradeson very reasonable EV/Sales metrics of 1.15 times for 2015 which is its most
compelling investment metric. After the
recent acquisition of cloud based documents management company ‘eGistics’ around
half the company’s income is now recurring in nature with its EV/Recurring
revenues a healthy 2.15 times. The
company is profitable with medium term guidance being EBITDA/Sales margins are
heading towards 15%. The investment
rationale is the combination of 10-15% organic revenue growth and a more scalable
business model should result in operating profit margins strengthening and
shareholders rewarded.
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