EBIX – Exponential Bargain In Exodus

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Im going to skip right to the chase. Exodus by definition is a “A Mass departure of people.”

Ebix is a leading international supplier of On-Demand software and E-commerce services to the insurance industry. Ebix provides end-to-end solutions ranging from infrastructure exchanges, carrier systems, agency systems and BPO services to custom software development for all entities involved in the insurance industry. Ebix uses a growth by acquisition strategy.

“Our future growth may depend in part on acquiring other businesses in our industry.”

Fortune ranks EBIX 6th fastest growing technology company in America – 2012
Fortune ranks EBIX 4th fastest growing technology company in America & 19th fastest across all industries – 2011
Fortune ranks EBIX 3rd fastest growing company & 3rd best investment in the world – 2010

Some of the more recent acquisitions are outlined below by closing date.
June 1st, 2012 – Closing of acquisition of California-based PlanetSoft Holdings, Inc. for 35M in cash and 296,560 shares valued at 16.86 PPS.
November 15th, 2011 – Merger of Fresno, a California-based Health Connect Solutions for 18M in cash with the right to an additional 4M if revenue targets are achieved over the following two-year period.
February 7th, 2011 – The merger of Atlanta-based ADAM was closed for a fixed exchange ratio of 0.3122 Ebix shares for 1 ADAM share. ADAM is a leading provider of health information and benefits technology in the USA.

During the fiscal year 2012 Ebix continued to actively buyback shares at a rate of 983,818 shares or aggregate purchase price of 18.4M. I would continue to view buybacks as very accretive to shareholders based on a ROIC of 20% vs P/E of under 6.

The dividend is not anywhere near at risk with a payout ratio of 10.6% for 2012 funded from FCF. I continue to believe Ebix will be an amazing dividend grower over the next 5-10 years based on FCF growth and ROIC. If credit facilities become reluctant to continue to lend, or FCF is drastically reduced through lack of revenue growth (roughly 35% of Revs convert to FCF) or a higher effective tax rate, it could lead to problems for Ebix (all of which are unlikely to occur). Capital expenditures are relatively small to maintain current infrastructure with the majority of goodwill coming from past acquisitions, customer accounts and proprietary software.

Financial Health is by all means stable, with a current ratio of 1.56 and a quick ratio of 1.44. The debt to equity ratio is also fairly low at 0.18.

In fiscal year 2012 Ebix earned 1.80 dilutes EPS and is currently trading at 5.28 P/E or 18.93% earnings yield. It is not everyday you find high growth companies with above 20% 5-year avg. ROIC trading at extinction fundamentals.

2012 Revenue (199.37M) was derived from 4 segments, exchanges (159.67M), broker systems (18.61M), business process outsourcing (16.14M), and carrier systems (4.94M).

Running various sets of data, both conservative and aggressive through the DCF model (basic & more advanced) I have come to the same results of over 50% margin of safety and as high as 90%.

I have also used two assumptions when running various calculations, one being 40% tax rate on initial cash flow (competitors highest effective tax rate) and another assumption, shares outstanding diminished to 27M through the active 24 month buyback effective June 30th, 2011(Note 10 of the Annual Report). Also note incorporating an effective tax rate of 40% in the DCF allows for “double taxation” as FCF already accounts for tax, depreciation, change in working capital and CAPEX.

$EBIX – Insurance Software
40 Percent Tax Buy Back
Initial Cash Flow: $70,000,000
$42,000,000 $70,000,000
Growth Rate: 10%
10% 10%
Discount Rate: 15%
15% 15%
Shares Outstanding: 37,170,000
37,170,000 27,000,000
Present Value of All Cash Flows: $1,540,000,000
$924,000,000 $1,540,000,000
Intrinsic Value: $41.43
$24.86 $57.04

Now with the more accurate model I used 3% growth for terminal as well as 15 year growth of cash flow, assumed a cancelled buyback, incorporated all outstanding liabilities as outstanding debt, used a 13% discount rate and still came up with $15.23 IV compared to 9.52 PPS.
If I use more accurate data that is still conservative I arrive at 45.65 IV by making simple changes to share float (reduced to 27M), growth rates 5,10,15 years of 20,10,5 percent respectively & increased the Terminal rate 100BPS. Of the 45.65 IV 36% is attributed to terminal value.

$EBIX – Insurance Software
Initial Cash Flow: $70,000,000
Years: 1-5 6-10 11-15
Growth Rate: 20% 10% 5%
Terminal Growth Rate: 4% Discount Rate: 13%
Shares Outstanding: 27000000 Margin of Safety: 50%
Debt Level: $155,000,000
Year Flows Growth Value
1 84,000,000 20% $74,336,283
2 100,800,000 20% $78,941,186
3 120,960,000 20% $83,831,348
4 145,152,000 20% $89,024,440
5 174,182,400 20% $94,539,228
6 191,600,640 10% $92,029,337
7 210,760,704 10% $89,586,081
8 231,836,774 10% $87,207,689
9 255,020,452 10% $84,892,441
10 280,522,497 10% $82,638,659
11 294,548,622 5% $76,788,134
12 309,276,053 5% $71,351,806
13 324,739,856 5% $66,300,351
14 340,976,848 5% $61,606,521
15 358,025,691 5% $57,244,997
Terminal Year $372,346,718
PV of Year 1-15 Cash Flows: $1,190,318,501
Terminal Value: $661,497,746
Total PV of Cash Flows: $1,851,816,248
Number of Shares: 37,170,000
Intrinsic Value: $45.65
Margin of Safety IV: $22.83
What Percentage of IV comes from Terminal Value: 36%

On a discounted cash flow basis no matter how I slice it I can find 50-60% ROI and as high as 450% through common equity (assuming IV is reached). The pessimistic DCF growth scenario has not much to do with actual company fundamentals and was meant to show an absurd valuation discrepancy.

The prior SEC investigation yielded no accounting irregularities and no wrong doing on disclosure related complaints. Ebix should continue to ignore short sellers with shoddy research, clearly conducting bias and selective studies and bias/selective in presenting the information (obviously motivated by personal incentives). One thing that cannot be faked on the balance sheet is cash, cold hard cash, and Ebix is making plenty of it. Dividend growth, share buybacks and continued acquisitions will lead Ebix from the current irrational market valuation towards a more appropriate valuation.

A great article/response to GCR and explanation of EbixExchange IP asset sale to Ebix Singapore.

The tax implications are widely known that Ebix uses Singapore (As well as Brazil and India) as a tax strategy to reduce expenses through transfer pricing agreements. The Effective 2012 tax rate was 9.6% derived from a statutory rate of 35% decreased by 15.6% (India Tax Holiday through 2015), further decreased by 8.1% (through foreign subsidiaries, primarily Singapore), and finally 3.1% by Sweden permanent passive income exemption.

“The Company also has a relatively low-income tax rate in Singapore in which our operations are taxed at a 10% marginal tax rate as a result of concessions granted by the local Singapore Economic Development Board for the benefit of in- country intellectual property owners. The concessionary 10% income tax rate will expire after 2015,at which time our Singapore operations will be subject to the prevailing corporate tax rate in Singapore, which is currently 17%, unless the Company reaches a subsequent agreement to extend the incentive period and the then applicable concessionary rate.”

The company must pay a MAT (minimum alternative tax) rate in India of 19.94% but using the tax paid under MAT will be carried forward up to seven years against future tax liabilities. More on the tax matters under Note 9 of the 2012 10K. Essentially Ebix is able to utilize such a low global effective tax rate due to the worldwide product development operations and intellectual property being located in Singapore and India as well as having the majority of pre-tax income originate/reside there.

Because of the indefinite nature of investments in business subsidiaries intended to finance on going operations, domestic income tax expenses are not recognized to the full extent. If deferred US tax liabilities were provided because indefinite invested earnings were not indefinite, Ebix would have 71.8M of deferred U.S income taxes. As of December 31st, 2012 the company had domestic non operating losses (NOL) carry forwards of 47M of which 35M attributable to the ADAM acquisition. Portions of the NOL’s are set to expire through 2020-2027.

In regards to tax I believe the company is strategically and fiduciary responsible to minimize taxes for shareholders.

In July 2011 a class action lawsuit was filed based on derivative stock option awards, or so I presume based on the disclosure provided. IF that is all the lawsuits pertains to, I believe it will be likely settled or dismissed during the discovery phase based on 2010 Ebix Equity Incentive Plan approved by shareholders.

YEAR Diluted EPS Free Cash Flow
2002 0.08 2.5
2003 0.08 2.79
2004 0.08 2.44
2005 0.15 5
2006 0.21 3.61
2007 0.4 12.72
2008 0.76 26.21
2009 1.03 30.75
2010 1.51 51.03
2011 1.75 68.46
2012 1.8 70.33
10-Year Avg. YOY % Growth 40.88556306 55.47420128
5-Year Avg. YOY % Growth 38.17588803 45.24284245

 

I believe the hard times will pass and Ebix will continue to grow FCF at impressive clips. I am comfortable buying under $20 (recently @ 8.40 1/3 position) or 12x earnings but am trigger happy when FCF is under 6-10x in a presumable growth industry. I will continue to play with the DCF model adjusting for realized disclosures in future 10-Qs and 10-Ks. Currently I am comfortable assigning an IV of $35 with 50% margin of safety being under $17.50 and estimating 2.00+ EPS @ 13-15x P/E gives $26-30 PPS target.

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