HGN.CN - Halogen Software

[whistlerbumps]

HGN is a Canadian SaaS provider of Talent Management software used by human resources divisions of small/mid market companies.  The company has stumbled due to sales execution challenges but still has a very sticky (>100% dollar retention) SaaS product in a very underpenetrated market.

 

Revenue growth is expected to slow to mid teens in 2016 from high teens previously due to these sales execution challenges.  New CEO Les Rechan (IBM, Cognos, Oracle) has taken over the sales team and is working to fix the problems with closing that have hampered growth.

 

At 7.50 HGN is trading at 1.4x 2015 recurring revenue which appears to be a very inexpensive valuation for a company that will still be growing sticky revenues mid teens and will be cashflow breakeven in 2016.

 

[netnet]

I don't see the 1.4x revenues.

 

The guidance for this year's recurring is ~60 (59.4), so the price sales is more like 2.9X. If you go on EV then you are still at 2x.

[kab60]

I've been following since Greenhaven Road did a writeup. I think it is very interesting around these levels. They guide 12-13 pct rev growth next year and cashflow positive.

[whistlerbumps]

You have to be careful about USD vs. CAD.  Price is in CAD but financials are USD. 

 

Thus, 7.5 CAD *22.3m diluted shares= 167m CAD Mkt Cap

167/1.35 = 124 USD Market Cap

 

124- 39mln cash= 85mln USD EV

 

85/60=1.4x EV/S.

 

Hope that helps.

 

[Txvestor]

What do you all make of the increasing marketing spend with simultaneous decrease in revenue growth rate?

That seems not a good path for an as yet unprofitable company.

[whistlerbumps]

The marketing spend was a planned investment to significantly grow the customer base and expand internationally.  Losing money in the near term makes a lot of sense for a SaaS business with high recurring revenue due to the significant value of sticky subscription customers. 

 

Here are a couple of quotes from the company on this topic

 

" That aside, when we think about the top line versus the bottom line, it’s really about maximizing the long-term value of the company. And the way to do that is to build the biggest asset of customers and recurring revenue we possibly can, and then harvest that base. "

 

"The key metric, if we want to solidify it down to a single one, would be the recurring revenue. If you go back and look over our financial statements, we show a grid, and you can see the growth in that recurring revenue over time. And recognizing that we do have greater than 100% dollar retention on that recurring revenue, it’s just going to keep going up. That’s the math on our utility type of business model. Then it will be about taking that recurring revenue and, again, harvesting it appropriately."

 

"One is that investors might have the worry that we can’t be a highly profitable company. But we totally can. The background here is, if we want to be focused on profitability, we wouldn’t be expanding internationally the way we are. We wouldn’t have opened an office in Amsterdam, Dubai, Charlotte and San Jose in the last 24 months, we wouldn’t have been expanding our Sydney and U.K. offices. "

<http://www.cantechletter.com/2015/06/halogen-ceo-paul-loucks-talks-to-cantech-letter/>

 

The decrease in the revenue growth rate is the key issue though as growth in recurring revenue is the key metric.  HGN's sales force has underperformed in terms of execution with regards to closing deals in 2015.  As a result of this underperformance, the CEO and VP of sales have left the company to be replaced by Les Rechan, who has a very strong software sales background.

 

For this investment to do very well, Les has to successfully improve the sales force execution and reaccelerate the growth rate back towards the high-teens. 

 

 

[Txvestor]

I agree that a sales and marketing reboot is required. Those are not as easy. On certain metrics the stock certainly appears cheap, but  importantly it is also not yet profitable or cash flow positive which gives you more latitude with execution risk.

They are at a place where they are increasing spending and not seeing the results, infact they are seeing a deceleration. From what i can tell over 30M sales and marketing spend for a 10M annual incremental increase in sales. Ironically earlier in their history they were accomplishing a similar increase in sales(new business) with around half of that spending. They claim to already have a greater than 100% revenue retention rate for recurring revenue. I understand the long lifecycle profitabiloty of the new revenue, but surely the decreased efficiency with which recurring revenue is growing is a significant concern which i have not seen them address to date.

What they say about recurring revenue is accurate and i have no issue with that, but they have to show some improvement in sales performance and revenue growth with new contracts, or alternatively cut down growth ambitions and demonstrate profitability(which they claim they can do) to justify the investment for me. Otherwise we could easily be looking at other shareholder problems like equity raises down the road. Granted their cash cushion makes that unlikely for a year or two.

I beleive they have a strong product offering, and market opportunity, but their execution in 2015 has been abysmal. Surprising given the tenure of their just departed CEO. The new ceo has good pedigree but yet to prove himself.

If on the other hand they get revenue growth back up close to 20% and turn cash flow positive, this is easily a $20 stock.

[whistlerbumps]

I completely agree that the sales and marketing execution is a concern and that's why the stock trades where it does. I also completely agree that turnarounds take time.  I think this is why you are getting this highly valuable sticky SaaS revenue at such a low multiple. But obviously we can have different opinions about what is cheap.

 

I disagree about the risk of an equity raise.  HGN has $40mln of cash and have committed to being cash flow breakeven in 2016 and  even with the poor sales execution and high sales and marketing investment.  They were also cash flow positive in the most recent quarter.  Thus, I don't expect cash to drop much below this 40mln number unless they significantly increase the pace of their buyback so I don't expect any need for an equity raise.

 

 

 

 

[Txvestor]

I completely agree that the sales and marketing execution is a concern and that's why the stock trades where it does. I also completely agree that turnarounds take time.  I think this is why you are getting this highly valuable sticky SaaS revenue at such a low multiple. But obviously we can have different opinions about what is cheap.

 

I disagree about the risk of an equity raise.  HGN has $40mln of cash and have committed to being cash flow breakeven in 2016 and  even with the poor sales execution and high sales and marketing investment.  They were also cash flow positive in the most recent quarter.  Thus, I don't expect cash to drop much below this 40mln number unless they significantly increase the pace of their buyback so I don't expect any need for an equity raise.

 

If certain of positive FCF next year, they should do share buybacks with atleast 1/2 their cash position, which would be a near 15% buyback or about a quarter of the float since insiders own a substantial minority, I don't see that nor have i seen any insider buying.

Like I said if the efficiency of their sales and marketing spend starts trending up, this is an easy buy.

At this point management credibility is less than stellar. A CEO replaced/resigned. A 15B opportunity touted, not profitable, and revenue growth efficiency declining. Talk is more here and results are lacking. The market is appropriately discounting these negatives. One to keep an eye on however.

[netnet]

I stand corrected on the numbers.  So on a price sales it is about 2x. 

 

On the business model, it is expensive to convert SMB to software.  Have they done it successfully for the non-early adopters?

 

To me the key number is the customer acquisition cost versus the lifetime value of that customer in this case the sales and marketing spend versus incremental growth.

[kab60]

I think it's quiet easy to see how they'd do a cashlow yield of 10-15 percent if they wanted. That would slow growth down though, so even though it might trigger a rerate I don't think they should do it. The "issue" I see is that growing gets incrementally harder because they haven't been able to upsell more modules to existing customers.

[Txvestor]

If you look at their revenue numbers however, the issue does not appear to be upselling of modules, it appears more to be with generating new customers and the increasing inefficinecy of the marketing $$ in generating these new customers. Their upsell is fine as evidenced by their over 100% dollar retention rate in the face of an approximately 10% customer cancellations(due to a variety of reasons ie M&A, Business failires, Switch to competitors etc. 

if we see new revenue accelerating upwards, then sales and marketing efficiency would be improving.

As it stands they are incrementally spending more and more for growth, and yet that growth is slower and slower.

[kab60]

I agree. My point was that their customers "only" buy 2.3 modules and I think they have done that for quiet some time.

[kab60]

I agree. My point was that their customers "only" buy 2.3 modules and I think they have done that for quiet some time

 

Update: I just took a new look at the numbers. I think it looks more worrisome than my initial thoughts.

 

FY2012 SG&A was 25m. FY2013 revenue increased 10m y/o/y.

 

FY2014 SG&A was 40m. FY2015 revenue is set to increase 10m y/o/.

 

So SG&A has increased 60 percent while growth in absolute dollars is constant.

 

FY2015 SG&A will probably come in at 43m while they guide for revenue growth of 8m in FY2016.

 

Obviously SG&A increases in absolute dollars with more customers but it doesn't look like there's a lot of operational leverage unless the big change (for the worse) is because the sales force really has started to suck or they've become extremely bloated.

 

You seem like you've taken a good look, what's your take Txvestor?

[Txvestor]

It is definitely cheap, but the concern above has kept me from investing for now.

Since it is a small cap and relatively low volume, if they do demonstrate a

Re-acceleration in revenue growth commensurate with their increased marketing

spending, then i would feel inclined to buy, even if at a price level higher than

what it trades for right now. One tough lesson for me has been buying early expecting

a turn around. Sometimes seeing that turnaround is worth waiting and paying up for.

If the addressable market and runway is what they say it is, and Halogen has competitive

advantages, they will either continue to grow at a decent rate for a very long time or get taken out by one of the larger players at much higher levels.

 

[kab60]

Makes sense. What I'm missing is how much of the SG&A that is required in a steady state situation and how much is for actual growth. I think it looks cheap because small cost reductions probably could get you to a +15% cash yield but their disclosures makes it hard (impossible?) to confirm via their numbers. Minor point but they should start to get some nice currency tailwinds because their old hedges are starting to roll off.

[Txvestor]

True on the currency hedges. However the focus should be on new revenue growth and SG&A spending. Because if they can achieve that, then this would be insanely cheap and a multi-bagger.

To be fair they have opened up a number of field offices in Europe/Aus etc. recently and that can be viewed as a $$ investment with a significantly delayed return. However a look at the numbers trend did not leave me comfortable that this was the only issue as I explained.

[rkluwer]

Halogen out with Q1 numbers:

First Quarter 2016 Financial and Operational Highlights:

 

Recurring revenue increased 13% from Q1 2015 to $16.2 million, representing 92% of total revenue in the quarter.

Total revenue increased 11% from Q1 2015 to $17.7 million.

Deferred revenue rose 13% year-over-year to $36.8 million.

Adjusted EBITDA of $0.91 million compared with $(3.6) million in Q1 2015.

Dollar retention continued to be greater than 100%2.

 

Beat on Ebitda and highten there Ebitda forecast for 2016 to 1.5-2 mio. Seems like the should turn positiv on Ebit to. Keep buying back shares and growth stays around 11-13%. - Gross margins rose 1% to 75%. Hopefully the new CEO have low-balled the guidance and we will see and nice steady uptick doing the year. Nice start tot he new, nothing impressing, but the are delivering. From the conf. call the sound very optimistic about the collaboration with obviate and dell boomi. Also sounds like a good active stand to the international saleforce and that the will strive for a profitable growth or close it down, from what it sounded like, without saying it directly.

 

http://ir.halogensoftware.com/company/investors/investor-news/investor-news-details/2016/Halogen-Announces-First-Quarter-2016-Results/default.aspx

 

[sae85400]

via Greenhaven Q1 letter:

 

Halogen is a Canadian-based software company, trading on a Canadian exchange,

selling talent management software to mid-sized companies, primarily in the U.S. Later in the letter, we

discuss the importance of simple math. In the case of Halogen, part of the simple math relates to currency

conversion. Halogen’s share price is denominated in Canadian dollars; with today’s exchange rates, a

Canadian dollar equates to around 80 U.S. cents. Other than share price, every other number for Halogen

– including cash on the balance sheet and revenues – is valued in U.S. dollars. When converting the

currency properly (not clear that everyone does this basic math correctly), Halogen has just about the

lowest Enterprise Value (Market Cap less Cash)/ Revenue of any company we know of that is not facing

some sort of terminal decline. Specifically, at $7 (CAD) – where we bought a lot of additional shares –

the company had an EV of less than $85M USD and revenue (growing 10%+) of $65M, so it was

effectively at an EV/Rev of 1.3X when SAAS companies will typically trade anywhere from 2X-8X

depending on growth rates, margins and the competitive landscape. We would typically focus on cash

flow, but in the case of a growing SAAS software company with strong unit level economics (positive

lifetime value of a customer), sales and marketing to acquire even more customers is expensed

immediately (not capitalized) and distorts the Price to Earnings and Price to Cash Flow metrics. The

valuation is not demanding. The largest problems with Halogen are that customer acquisition costs have risen and growth has slowed. By my estimates, which I shared with management, Halogen is paying

approximately $55K to acquire each new customer, but the company was only being valued at less than

$40K per existing customer when using the public market enterprise value/# of customers. My argument

to management was that it is cheaper to buy back stock than go and acquire new customers. The

company has since put in place a large buyback for 1.2 million shares (5% of the outstanding shares), and

fortunately, given the large cash balance, Halogen can buy back shares and still acquire new customers.

The new CEO is outstanding and has embraced a partnership model to acquire customers more

efficiently. I think he is making very sound decisions and look forward to the progress the business

makes. The combination of a low multiple and improved marketing efficiency could be a powerful

catalyst for future returns. The HR software space is undergoing consolidation as companies go from

offering piecemeal solutions, such as payroll, benefits management, or talent management, to offering a

complete suite of solutions. Given the current valuation, the corporate overhead that could be stripped out

by an acquirer, and the lowered customer acquisition costs if folded into a larger company with an

existing customer base to sell into, the economics for an acquirer would make sense even at twice today’s

share price.

 

 

 

[Txvestor]

Halogen out with Q1 numbers:

First Quarter 2016 Financial and Operational Highlights:

 

Recurring revenue increased 13% from Q1 2015 to $16.2 million, representing 92% of total revenue in the quarter.

Total revenue increased 11% from Q1 2015 to $17.7 million.

Deferred revenue rose 13% year-over-year to $36.8 million.

Adjusted EBITDA of $0.91 million compared with $(3.6) million in Q1 2015.

Dollar retention continued to be greater than 100%2.

 

Beat on Ebitda and highten there Ebitda forecast for 2016 to 1.5-2 mio. Seems like the should turn positiv on Ebit to. Keep buying back shares and growth stays around 11-13%. - Gross margins rose 1% to 75%. Hopefully the new CEO have low-balled the guidance and we will see and nice steady uptick doing the year. Nice start tot he new, nothing impressing, but the are delivering. From the conf. call the sound very optimistic about the collaboration with obviate and dell boomi. Also sounds like a good active stand to the international saleforce and that the will strive for a profitable growth or close it down, from what it sounded like, without saying it directly.

 

http://ir.halogensoftware.com/company/investors/investor-news/investor-news-details/2016/Halogen-Announces-First-Quarter-2016-Results/default.aspx

 

This quarter essentially confirms my suspicion that revenue growth rates have moderated despite

the increased marketing spend which was my main concern. The growth rate is down from high teens

up to 20% YOY to low teens now. I haven't gone through the quarterly conference call but if it is accurate that they alluded to possibly shutting down some international offices then that will mean

they wasted some $$ on a misguided international expansion effort when clearly buying back shares would have been a better result for shareholders. Thus far overseas revenue growth has been abysmal.

The shares are trading higher on the recently announced buybacks which represent a roughly 5% outstanding shareholding impact. Considering insider holdings and long term holdings, it probably represents a more sizeable impact. Will wait to see exactly how much they buyback.

I would get more constructive on this if I either see cuts in recent marketing ramp up spend without impact on revenues or alternatively an acceleration of revenue growth back towards the high teens.

[iambagman]

The call is definitely worth listening to.  The new CEO/the team have made several smart decisions.  They are deemphasizing international which clearly has not been as successful as they had hoped.  More importantly he is emphasizing partnerships as a way to reduce customer acquisition costs - this is possible because they are integrating much better with other systems through something called Dell Boomi - this is important because it should improve retention rates (people won't leave because they don't want another system to maintain) and win rates - because people can choose Halogen for Talent Management and other vendors for functional areas where Halogen is not as strong they can get best of breed there as well.  The net result is we should see lower international spend, and hopefully modest improvements in win rates / retention.  They are also talking about new products particularly in analytics. The combination of all of these initiatives should be very positive over time.  Again the call is worth a listen - a lot is happening under the covers here.  I am a Les fan. 

[rkluwer]

Sure is a great call to listen to - and seems to me that the are taking in advice from outside investors. This is from Greenheaven road capital Q1 letter, where Scott Miller, the founder, writes about talks he have had with management about the way the do biz. He is very positive about Halogen and from what he writes, its sure to see he expect them to be sold to a bigger player in the future.....

 

Copy from Greenheaven road capital Q1 Letter:

 

Halogen Software: Halogen is a Canadian-based software company, trading on a Canadian exchange, selling talent management software to mid-sized companies, primarily in the U.S. Later in the letter, we discuss the importance of simple math. In the case of Halogen, part of the simple math relates to currency conversion. Halogen’s share price is denominated in Canadian dollars; with today’s exchange rates, a Canadian dollar equates to around 80 U.S. cents. Other than share price, every other number for Halogen – including cash on the balance sheet and revenues – is valued in U.S. dollars. When converting the currency properly (not clear that everyone does this basic math correctly), Halogen has just about the lowest Enterprise Value (Market Cap less Cash)/ Revenue of any company we know of that is not facing some sort of terminal decline. Specifically, at $7 (CAD) – where we bought a lot of additional shares – the company had an EV of less than $85M USD and revenue (growing 10%+) of $65M, so it was effectively at an EV/Rev of 1.3X when SAAS companies will typically trade anywhere from 2X-8X depending on growth rates, margins and the competitive landscape. We would typically focus on cash flow, but in the case of a growing SAAS software company with strong unit level economics (positive lifetime value of a customer), sales and marketing to acquire even more customers is expensed immediately (not capitalized) and distorts the Price to Earnings and Price to Cash Flow metrics. The valuation is not demanding. The largest problems with Halogen are that customer acquisition costs have

April 25, 2016

Greenhaven Road Capital | scott@greenhavenroad.com | www.greenhavenroad.com

  risen and growth has slowed. By my estimates, which I shared with management, Halogen is paying approximately $55K to acquire each new customer, but the company was only being valued at less than $40K per existing customer when using the public market enterprise value/# of customers. My argument to management was that it is cheaper to buy back stock than go and acquire new customers. The company has since put in place a large buyback for 1.2 million shares (5% of the outstanding shares), and fortunately, given the large cash balance, Halogen can buy back shares and still acquire new customers. The new CEO is outstanding and has embraced a partnership model to acquire customers more efficiently. I think he is making very sound decisions and look forward to the progress the business makes. The combination of a low multiple and improved marketing efficiency could be a powerful catalyst for future returns. The HR software space is undergoing consolidation as companies go from offering piecemeal solutions, such as payroll, benefits management, or talent management, to offering a complete suite of solutions. Given the current valuation, the corporate overhead that could be stripped out by an acquirer, and the lowered customer acquisition costs if folded into a larger company with an existing customer base to sell into, the economics for an acquirer would make sense even at twice today’s share price.

 

http://static1.squarespace.com/static/5498841ce4b0311b8ddc012b/t/572d5f90c6fc0829126ac045/1462591377039/Q1+2016+Final.pdf

 

 

[Alex.N.B]

Anyone have a model they would be willing to share by any chance?

[rkluwer]

Q2 out for Halogen. Nice 12%-14% growth. Turning positive and raising Ebitda guidance to 4-5 mio. Expenses falling and the route to a more profit able company seems well underway. as long as R&D expenses and there 0 growth,  ain't gonna effect the innovative development.

 

The only bought back 118.0 shares in Q2 out of 1.2 mio buy-back program. So if the need to fill this, the need to step it up. But due to the low lips and lack of shares trading daily, it seems like a hard mission. buy should create a firm support going fwd. An as the are positive on operating CF, its not hurting there cash balance, thats still very solid at almost 35 mio usd.

 

http://ir.halogensoftware.com/company/investors/investor-news/investor-news-details/2016/Halogen-Announces-Second-Quarter-2016-Results/default.aspx

 

Recurring revenue increased 14% from Q2 2015 to $16.6 million, representing 92% of total revenue in the quarter.

Total revenue increased 12% from Q2 2015 to $18.0 million.

Deferred revenue rose 13% year-over-year to $37.3 million.

Net Income of $283,000 in Q2 2016 compared to a Net Loss of $2.3 million in Q2 2015.

Adjusted EBITDA of $1.91 million compared with $(1.1) million in Q2 2015.

Dollar retention was greater than 100%2.

Completed initial integration between the Halogen TalentSpace™ platform and Jobvite for version 16.1 release.

Named a leader in three IDC MarketScape reports for Integrated Talent Management Suites, Performance Management and Learning Management Systems.

Named one of Canada's Top 100 Small and Medium Employers for 2016.

 

The addition of key customers across all regions and strategic verticals including: Large healthcare organizations like Flagler Health  in North America and Southern Cross Care in Australia; Professional services firms such as FCB Worldwide in North America, Boult Wade in the UK and Calibre Consulting in Australia; Public sector organizations such as Town of Wake Forest, North Carolina and Olmsted County; Financial services firms like First Business Financial in North America and Qatar Financial Centre Authority in the Middle East; as well as the addition of strong global mid-market brands like Kia Canada and Nobu Hospitality.

 

Continued a normal course issuer bid to purchase up to a maximum of 1,249,792 of Halogen common shares through March 13, 2017. In the second quarter of 2016, Halogen purchased and cancelled 118,700 shares for approximately $0.8 million under the current normal course issuer bid.

 

[rkluwer]

Halogen appoints 2 new executives yesterday and continue the way forward to produce better earnings.

 

Seems like people are also paying more attention to whats going on and the potential that Halogen provides. As Scott Miller from Greanheaven says, the most likely outcome of this investment is still a buy-out by a larger payroll player. But in the mean time, its nice to see that the company is going in the rite direction.

 

http://www.cantechletter.com/2016/09/halogen-software-still-undervalued-says-industrial-alliance/