Market Overraction on This Insurance Software Solution Company

Anh is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.

Ebix (NASDAQ: EBIX) has fallen off a clip, dropping significantly from nearly $20 per share to only $9.50 per share within just two days. The free fall was mainly due to the termination of Goldman Sachs affiliate, caused by the letter of the U.S. Attorney for the Northern District of Georgia investigating the allegations of intentional misconduct to falsify the company’s financial statements and SEC filings. Should we avoid Ebix, or should we consider the recent huge drop as an investment opportunity? Let’s find out.

Growing via acquisitions

Ebix, founded in 1976, is the international leader in providing software and e-commerce solutions, specifically for the insurance industry, with around 80% of its total revenue, $159.7 million, coming from on-demand insurance exchanges. The Broker Systems and Business Process Outsourcing contributed only $18.6 million and $16.1 million, respectively, in 2012 revenue.

In the past five years, Ebix has managed to consistently grow its revenue and net income. Revenue increased from $75 million in 2008 to $199 million in 2012, while the net income rose from $27 million to $71 million in the same period. The business could be considered a cash cow, with an increasing cash flow. The free cash flow consistently increased from $26 million to $70 million during the past five years. Ebix seems to grow its business mainly from acquisitions--since 2008, Ebix has spent the total amount of $171 million to acquire businesses. Ebix generated only $10 million in free cash flow, including the acquisition amount.

Ebix has quite a conservative capital structure. As of March 2013, it had $377 million in equity, $44 million in cash and only $48 million in both long and short-term debt. However, because of a lot of acquisitions, the goodwill and intangible assets were huge, at $408 million. Consequently, Ebix had negative equity of $(31) million. After the drop, Ebix is trading at $9.52 per share, with a total market cap of $353.8 million. The market values Ebix at only 4.46 times its trailing EBITDA.

Solera has a much weaker balance sheet

Compared to Solera Holdings (NYSE: SLH), Ebix has a much cheaper valuation. Solera is trading at nearly $52.10 per share, with a total market cap of nearly $3.6 billion. The market values Solera at 12.54 times its trailing EBITDA. Recently, Solera has expanded its footprint in the Australian market by acquiring Eziworks Pty, which operates as Car Quote. Solera’s founder, Tony Aquila, felt bullish about this acquisition. He said

The Car Quote solution platform and its strong management team are a great addition to Solera. This acquisition will accelerate our delivery of an end-to-end claims management platform in Australia, driving value to a market that processes more than 1 million annual collision repair claims.

For the full year 2013, Solera expected to generate $832 - $836 million in revenue, with the net income fluctuating in the range of $84 to $87 million. Adjusted EBITDA is estimated to stay in the range of $355 to $359 million. The company had quite an ambitious mission for 2020, generating $2 billion in revenue and achieved a 40% adjusted EBITDA margin.

Solera has a much weaker balance sheet than Ebix. As of March 2013, it had $725 million in equity, $447 million in cash and more than $1.14 billion in long-term debt. Moreover, Solera also booked a huge amount of goodwill and intangible assets on its balance sheet--more than $1.4 billion. Consequently, the tangible book value is negative at $(418) million. Indeed, like Ebix, Solera spent a lot of money on acquisitions, nearly $740 million in the past five years.

Lesson from Hewlett-Packard

What I am worried about with Ebix is not the recent legal issues, but the potential write-off of its huge goodwill on the balance sheet. Investors should learn the lesson from the case of Hewlett-Packard (NYSE: HPQ). Hewlett-Packard spent very little money on internal R&D, pushing the bottom line and cash flow position higher. In the past five years, Hewlett-Packard only spent around 2.35% to nearly 3% of its revenue on R&D. Last year, Hewlett-Packard had to write down as much as $8.8 billion on its $11 billion acquisition of Autonomy. Interestingly, out of those $8.8 billion impairment charges, as much as $5.5 billion was due to “serious accounting improprieties.” Even after those significant charges, Hewlett-Packard’s goodwill and intangible assets are still huge, of as much as $35 billion, which are quite vulnerable for any future write-offs.

My Foolish take

The risk in Ebix investment is not in the legal issue, but the future write-down of its huge goodwill amount on the balance sheet. Consequently, I personally think that the market has overreacted on the company’s recent news. With the consistent cash flow generation, Ebix could be a decent purchase at its current trading price. 

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Anh HOANG has no position in any stocks mentioned. The Motley Fool recommends Ebix. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy. Is this post wrong? Click here. Think you can do better? Join us and write your own!

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