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WHILE THE IRON IS HOT: An Acquirer’s View of Kronos, Inc. P. Howard G. Morrill G. Murphy S. Skoog B. Sprows 3 Dec 2006.

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Presentation on theme: "WHILE THE IRON IS HOT: An Acquirer’s View of Kronos, Inc. P. Howard G. Morrill G. Murphy S. Skoog B. Sprows 3 Dec 2006."— Presentation transcript:

1 WHILE THE IRON IS HOT: An Acquirer’s View of Kronos, Inc. P. Howard G. Morrill G. Murphy S. Skoog B. Sprows 3 Dec 2006

2 Abstract and Summary KRONOS (Greek) – The youngest Titan, son of Uranus and Gaea; devoured his own children, fearing their betrayal devoured his own children, fearing their betrayal ► A Young Titan – low-debt, growing, self-created custom niche – largest of up-and-comers, approaching “big boys” – largest of up-and-comers, approaching “big boys” ► A Devourer – 55+ acquisitions in 15 yrs, more (esp. intl) to follow – cost of acq starting to skew ops, margins, practice(s) – cost of acq starting to skew ops, margins, practice(s) ► An Opportunity? – analysis is presented from acquirer’s-eye view; assessment of current and future performance, assessment of current and future performance, numeric regression and non-numeric business numeric regression and non-numeric business observations, survey of competition, ultimate observations, survey of competition, ultimate valuation and overall investor recommendation valuation and overall investor recommendation

3 Kronos – Present Performance THE GOOD ► Fiscal 2006 – $578M tot revenues (up 11% from $519M in 2005) ► Revenue Streams – Software (predominant), Maint, Prof Serv ► Cash Flow – Solvent (historically $70-90M, ~$100M in 2006) ► Profit Margin – historically 8.5% to 10.5% ► Financial Leverage – impressively low (historical flux 1.7 … 1.9) THE, er… QUESTIONABLE ► Acquisition-Heavy? (skews 5-6% organic growth vs. 11% w/acq) ► Too Far Too Fast? (5-6 acq/yr, $80M ops debt incurred in 2006) ► Debt-Averse? (can do more w/only slight boost in fin. leverage) THE UGLY ► Primary-focus revenue stream (prof serv) is lowest margin (~20%) ► Company has missed three consecutive quarterly estimates ► Significant 2006 option-pricing hit (FAS 123), aftershocks to follow

4 Kronos – Assessment of Competitors ► Similar Business, Similar Sectors – ADP, Oracle, SAP ► Speed-Bumps in the Road – CyberShift, InfoTronics, WorkBrain ► Apples-to-Apples Comparison is Difficult, Given Business Direction  Six-way Business Split (Perf/Talent Mgt, HR, Recruit, Workforce, etc.)  This Identity Crisis will Worsen with Unicru and similar acquisition(s)  Kronos is First and Foremost an (Old-Fashioned?) Prod/SW Company  Service-Oriented (SaaS) is the Future [Forrester, 2006]… Old Dog, New Tricks? ► A Three-Sided War? – Open-Source (]Project-Open[, TalentHRMS) KRONADPORCLSAP Historical RoA8% - 10%5% - 6%12% - 21%16% - 17% Historical RoE33% - 41%20% - 21%37% - 54%41% - 53% Revenue (ttm):$578 M$1.5 B$15 B$12 B Net Income (ttm):$41 M$171 M$3.5 B$2.2 B EPS (ttm):1.2851.1680.6661.76

5 Kronos – Accounting Policies ► Onward and Upward – Acquisitions, Goodwill and Intangibles  $380M in 2006 [up from $212M in 2005]  Anticipate recurrence and growth… amortize maximally  Designate “acquisitions reserve fund” (debt-fuelled) ► Revenue Recognition – “Bill-as-You-Go” vs. “Retainer”  Shift from front-loaded (Retainer) to timely payments  Consequence – Deferred Revenues may grow at diminished rate ► Non-GAAP – One-Time Infrastructural Expenses in 2006  Costly (Oracle) ERP Implementation – skews short-term figures, non-perpetual ► Impact of FAS 123(R) Adoption – Option-Pricing Expenses  Black-Scholes model adopted in 2005-2006, carryover impact to 2007  Single greatest numeric influence on Fiscal 2006 earnings

6 Kronos – Future Performance (1 of 2) Projections – Aggressive (12%) vs. Conservative (5%, w/o acq)

7 Kronos – Future Performance (2 of 2) ► Assumption – Kronos owes much of its present prosperity to acquisitions ► Assumption – Kronos will halve growth (or worse) w/o acquisitions ► Assumption – Expenses (CoGS, R&D, SG&A) relatively constant over 5 yrs ► Projections – Aggressive (12%) vs. Conservative (5%), see prev. chart ► Total Revenue (2007) ~ $607M to $649M ► Net Income (2007) ~ $41M to $43M ► Per-Share Net Income (2007) ~ $1.21 to $1.22 per share ► Total Revenue (2011) ~ $738M to $1,030M ► Net Income (2011) ~ $66M to $85M ► Per-Share Net Income (2011) ~ $1.83 to $2.37 per share ► Outcome – Continued acquisitions require “acq reserve fund” (~75M/yr) ► Outcome – Continued acquisitions require ongoing l-t debt (addl ~45M/yr)

8 Kronos – Intrinsic Valuation ** includes end-of-five-year terminal value (built from terminal cashflow) ► Uses 10.3% discount rate (calculated from weighted avg cost-of-capital) ► Uses 16.21% req. return on equity (Re), derived from 5-yr  ~ 1.9 ► …at these projected values, $1.43 B ÷ 36 M future shares ~ $39.59/sh ► …sanity-check calculation via (Proj Ent Value) ÷ (Equity) ~ $35-$38/sh 20072008200920102011 Operating Cash (aggr)$105 M$137 M$159 M$184 M$1.59 B ** 5-yr NPV (disc 10.3%) $1.43 B = Per-Share Value$39.59 Operating Cash (cons)$68 M$86 M$92 M$97 M$972 M ** 5-yr NPV (disc 10.3%) $862 M = Per-Share Value$23.95

9 Kronos – Intrinsic Valuation vs. Stock Price ► $39.59 per share (calculated) and $35.33 per share (traded)  Projected Book Value vs. Market Value suggests KRON undervalued  NOTE – an acquirer may *not* realize this full 12% differential  Room for growth… this dip is a premium opportunity for investors

10 Kronos – Conclusions, Recommendations ► The key to future Kronos success is continued sub-acquisitions ► Increased activity with debt/leverage is a key finding STRONG BUY at $35.33/share STRONG BUY at $35.33/share BUY at $37.40/share BUY at $37.40/share ACCUMULATE at $38-$39/share ► Speaking of Acquisitions… ► We recommend KRON itself as a promising target for purchase


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