EBIX - Ebix Inc

[Guest wellmont]

I look at the "complex web" of financial transactions, the multiple auditors, the citing of lack of financial controls by more than one auditor, the investigations, the law suits, the massive ceo compensation, the insular bod, and I come to the conclusion that I can't trust the books. therefore I have no idea if the so called FCF is real. your vision may be clearer than mine is, however. :)

[ragu]

[...]the citing of lack of financial controls by more than one auditor

 

Yet, sandwiched between the opinions of those auditors (who did not last long after those opinions), the company felt qualified to opine that financial controls were adequate. You couldn't make this up if you tried!

 

Best,

Ragu

[ragu]

I would like to see that analysis you mentioned.

 

Edward,

 

It's in the Gotham City Research report (worthwhile reading for anyone that's interested in this situation).

 

The relevant free cash flow numbers are on Pg. 36 of this report. The difference between how you calculate free cash flow and how they do it is that they (correctly) deduct the cash cost of acquisitions in arriving at their numbers. That's because the cost of acquisitions for EBIX is effectively the equivalent of "growth" capex.

 

Looking at EBIX's most recent corporate presentation on their website, they calculate free cash flow ignoring the cost of acquisitions. Deliberately misleading or merely ignorant? Neither bodes well for shareholders.

 

Best,

Ragu

 

 

 

 

 

 

[ItsAValueTrap]

I think that it is Gotham City that is being misleading.

 

Suppose that you have a widget business.  Because your factories are crazy profitable, you spend *all* of your profits on acquiring new factories.  Not only that, you issue stock and raise debt to purchase even more new factories.

According to the Gotham City definition of "free cash flow", the widget company has negative free cash flow.  And therefore it's somehow supposed to be a fraud.

 

That doesn't make sense to me.

 

That's because the cost of acquisitions for EBIX is effectively the equivalent of "growth" capex.

You mean maintenance capex.  And I don't see how Gotham City has proven that all of Ebix's acquisitions should be considered maintenance capex.

 

You could also evaluate Ebix's software over time.  Is their software (old and new acquired software) getting better or worse over time?  If it is getting better, then the acquisitions would be growth capex.  If the old software is getting worse but being propped up with acquired technology, then the acquisitions could be considered maintenance capex.

 

2- This is the software business.  Using acquisitions as "maintenance capex" makes little sense.  If you develop software, you can stop maintaining it completely and it will still make money for you.  To keep pace with competing software, you should probably add new features to the software.  In that vague sense, a software company needs "maintenance" capex.  But you can't really buy this "maintenance" by acquiring other companies.  You will almost certainly acquire new features that will improve your existing product if the two are integrated together.

[ragu]

According to the Gotham City definition of "free cash flow", the widget company has negative free cash flow.

 

They'd be right. Of course, negative free cash flow, in and of itself, isn't suggestive of anything more than (perhaps) injudicious expansion on the part of management.

 

And therefore it's somehow supposed to be a fraud.That doesn't make sense to me.

 

What you said doesn't make sense to me too. That's not what they are saying though when they talk about cumulative negative free cash flow.

 

The case for probable fraud, IMO, is in the report. I'd recommend reading it in its entirety, not just the page I referenced.

 

 

You mean maintenance capex.

 

I don't. I suspect you are talking of Buffett's owner's earnings whilst we are discussing free cash flow (by definition, this includes all capital expenditures).

 

Best,

Ragu 

[Edward]

Edward,

 

It's in the Gotham City Research report (worthwhile reading for anyone that's interested in this situation).

 

The relevant free cash flow numbers are on Pg. 36 of this report. The difference between how you calculate free cash flow and how they do it is that they (correctly) deduct the cash cost of acquisitions in arriving at their numbers. That's because the cost of acquisitions for EBIX is effectively the equivalent of "growth" capex.

 

Looking at EBIX's most recent corporate presentation on their website, they calculate free cash flow ignoring the cost of acquisitions. Deliberately misleading or merely ignorant? Neither bodes well for shareholders.

 

Best,

Ragu

Well....

 

 

1. When one reduces FCF by the cost of acquisitions then proceeds to use the result as a proxy for value, he implicitly suggests that these acquisitions were worthless and are in fact "maintenance capex" at best. 

 

Now, were this assumption the correct one, how on earth did they manage to produce the aforementioned 257M$ in cash to acquire all those "worthless" businesses if the main business is indeed a negative cash flowing scam and the acquired businesses worthless? I think you see the problem there.

 

Of course, if the company was buying lots of businesses by issuing stock and not paying cash, this would be a potentially(if not necessarily) decent argument. However this is not the case here as the acquisitions were done mostly in cash which had to come from somewhere, and no, it did not really come from issuing stock or debt. Santa Claus maybe? :)

 

 

2. The ridiculousness of this whole argument can be demonstrated by inverting. There are many, many businesses that you can calculate to be worthless(or worth a whole lot less than earnings would suggest) by following the same calculation.

 

To illustrate:

 

Berkshire Hathaway produces low FCF because it is constantly burning money to make acquisitions. In fact, they used stock for buying Burlington!

 

Berkshire used around 114B$ net cash for acquisitions in the last 10 years while generating 152B$ from operations. So apparently the company created only 38B$ in FCF during the last 10 years while they reported total earnings of 114B$! And they issued some stock!

 

Why would Buffett report 114B$ in earnings while most of that burned away in acquisitions? SCAM! Or maybe not....

 

 

3. In general about this whole report - which I've read extensively in the past:

 

The author is not making a very good case. He uses strange metrics, makes bold assertions without much evidence to support them, and props it all with colourful language. But if you try and look at the factual evidence he has, it's near zero. The whole report is 99% exaggerated fluff and 1% information.

 

Sure it looks serious if you look at it casually. It has a lot of pages and numbers in it. That has to count for something!

 

 

To sum: Do not believe everything you read on the internet.

 

 

 

 

 

[physdude]

I agree wholeheartedly. FCF never includes acquisitions - see http://financials.morningstar.com/ratios/r.html?t=ebix&region=USA&culture=en-us for eg. The Berkshire comparison is apt as the number of outstanding shares has increased despite buybacks. (I am definitely not comparing BRK and EBIX is any other way - BRK is infinitely safer and is also in a completely different league.)

 

There are now a higher number of shares compared to the past due to high issuance when the price was low (makes sense historically as the company was going through a very bad patch then). We need to remember that the corresponding buybacks occurred at relatively high prices and hence, while a lot was spent on them, the overall number of shares has still increased in the long run as the company became a victim of it's own success. I am aware that this does not look like great capital allocation in retrospect but the firm probably only  survived at the crunch due to the old issuances. It is like Berkshire having issued shares for BNSF and other past acquisitions but only buying back them now at much higher prices.

 

More recently, a significant increase  in the number of shares occurred due to the ADAM acquisition. Most of those shares have been bought back already and this again provides significant evidence of good FCF. Lack of FCF does not worry me with the accounts but lack of internal controls and the tax situation does.

 

However, it should be noted that the M-score of the firm is a very safe looking -2.32 and this gives me some confidence that the accounts are not complete fabrications (the M-score has detected several frauds in the past including Enron).

 

I am still holding my (unfortunately large) position after my merger arbitrage went spectacularly bad and, while 20 might not happen for a very long time, I don't think this is a bad risk/reward at 10. I am convinced that the FCF almost definitely exists but there could be some serious issues in the tax and controls areas.

[ragu]

 

 

 

1. When one reduces FCF by the cost of acquisitions then proceeds to use the result as a proxy for value

 

But that's not what Gotham do!

 

What you are doing though is giving credit to increased cash flow from operations without considering that the increases would not have been possible without the acquisitions in question. Put simply: Your definition of "free cash" is incorrect because EBIX's equity holders couldn't have both received that cash and have the subsequent results be the same.

 

FWIW, I disagree with Gotham that the fact that there has been  -ve cumulative free cash flow since Raina took over means that Raina is wrong re. EBIX's story (they don't say so directly, but the fact that this data follows Raina's comment on EBIX's story is certainly suggestive). They are right, however, that cumulative free cash flow from 1999 through the period they examine has been negative.

 

For the last time: The fact that EBIX has produced -ve free cash cumulatively in the period under examination by Gotham does not mean the financials are suspect. Nor does it mean that the company is worthless.

 

So, can we drop that particular strawman?

 

3. In general about this whole report [...]

 

In general, I don't find it good policy to be dismissive of short reports, especially without being specific about any of the potential issues they raise. To each his own.

 

In my assessment, the odds are that this is not going to end well for EBIX shareholders from these prices.

 

To sum: Do not believe everything you read on the internet.

 

Which reminds me to point you to Prof. Damodaran's chapter on how to determine free cash flow.

 

First, any capital expenditures, defined broadly to include acquisitions, are subtracted from the net income, since they represent cash outflows.

(emphasis supplied)

 

 

Best,

Ragu

[SFValue]

 

 

 

1. When one reduces FCF by the cost of acquisitions then proceeds to use the result as a proxy for value

 

But that's not what Gotham do!

 

What you are doing though is giving credit to increased cash flow from operations without considering that the increases would not have been possible without the acquisitions in question. Put simply: Your definition of "free cash" is incorrect because EBIX's equity holders couldn't have both received that cash and have the subsequent results be the same.

 

FWIW, I disagree with Gotham that the fact that there has been  -ve cumulative free cash flow since Raina took over means that Raina is wrong re. EBIX's story (they don't say so directly, but the fact that this data follows Raina's comment on EBIX's story is certainly suggestive). They are right, however, that cumulative free cash flow from 1999 through the period they examine has been negative.

 

For the last time: The fact that EBIX has produced -ve free cash cumulatively in the period under examination by Gotham does not mean the financials are suspect. Nor does it mean that the company is worthless.

 

So, can we drop that particular strawman?

 

3. In general about this whole report [...]

 

In general, I don't find it good policy to be dismissive of short reports, especially without being specific about any of the potential issues they raise. To each his own.

 

In my assessment, the odds are that this is not going to end well for EBIX shareholders from these prices.

 

To sum: Do not believe everything you read on the internet.

 

Which reminds me to point you to Prof. Damodaran's chapter on how to determine free cash flow.

 

First, any capital expenditures, defined broadly to include acquisitions, are subtracted from the net income, since they represent cash outflows.

(emphasis supplied)

 

 

Best,

Ragu

 

it boils down to the recurring (or not) nature of the current cash flows.

 

Both arguments are right, without previous acquisitions cash flows would not be where they are, but how about moving forward?

 

Gotham says in so many words, cash flow would decrease (no organic growth, etc...) , EBIX says 80% recurring revenue plus a lot of future synergies plus more opportunistic and accretive acquisitions.

 

 

[mankap]

Let us say that Ebix does not do any acquisition for next 2 years.

Can they devote all the cash flow to buyback for next 2 years?

I think the answer is Yes.

They can put 100m to buyback from existing cashflow.

[physdude]

 

If Ebix was trading at less than 16, Whitbox would have lost money.

Ebix borrowed the money to fund the acquisition.What is unusual about that.

Ebix paid $19.0m in cash to Whitebox instead of diluting the shareholders.

They could have chosen to pay whitebox all in shares and diluting the shareholders.They chose not to do it.

 

In accordance with the terms of the Whitebox Note, as had been understood between the Company and the Holder, upon a conversion election by the Holder the Company had to satisfy the related original principal balance in cash and could satisfy the conversion spread (that being the excess of the conversion value over the related original principal component) in either cash or stock at option of the Company. In November 2010 Whitebox VSC, Ltd elected to fully convert all of the then remaining August 26, 2009 Convertible Promissory Note. The Company settled this conversion election by paying $19.0 million in cash with respect to the principal component, paying $2.3 million in cash for a portion of the conversion spread, and issuing 275,900 shares of Ebix common stock for the remainder of the conversion spread.

 

you said whitebox could have lost money. wrong. if ebix stock went down they were short the stock and owned a security with a claim on the assets of ebix (such as they were) that was ahead of the common. that equals marginal profit. Second, ebix had to settle the principal amount in cash. So Whitebox, did not waste any time (less than 2 years) in collecting their bounty from ebix. ebix could not have diluted shareholders for the $19m even if they had wanted to. whitebox did not want to take the risk that after two years the stock would be lower. it sounds to me like whitebox thought that was a real possibility and mitigated it.

 

Aren't you describing a standard option hedge? It is obvious that the option has positive value otherwise the loan would have not been made. The real question is what was the ex-ante value of the call? The answer can be approximated by the Black-Scholes value. My Black-Scholes calculator gives me an interest rate of about 11% p.a. using an implied volatility of 40% - high but quite reasonable at the time of the credit crunch. It is arguable that the equity risk premium at that point was much higher than 11% p.a. so this was, in fact, a pretty decent deal.

 

The early exercise option is IMHO a red herring. The value of an American call is the same as that of the corresponding European call provided no dividends are paid on the stock and EBIX was not paying a dividend at the time (adding a small dividend yield also does not significantly change the implied interest rate).

 

While there may be several things wrong with EBIX and while I agree that management could be more honest and trustworthy, a lot of the shorts' arguments seem to have superficial substance but serious core weaknesses.

[physdude]

 

 

 

1. When one reduces FCF by the cost of acquisitions then proceeds to use the result as a proxy for value

 

But that's not what Gotham do!

 

What you are doing though is giving credit to increased cash flow from operations without considering that the increases would not have been possible without the acquisitions in question. Put simply: Your definition of "free cash" is incorrect because EBIX's equity holders couldn't have both received that cash and have the subsequent results be the same.

 

FWIW, I disagree with Gotham that the fact that there has been  -ve cumulative free cash flow since Raina took over means that Raina is wrong re. EBIX's story (they don't say so directly, but the fact that this data follows Raina's comment on EBIX's story is certainly suggestive). They are right, however, that cumulative free cash flow from 1999 through the period they examine has been negative.

 

For the last time: The fact that EBIX has produced -ve free cash cumulatively in the period under examination by Gotham does not mean the financials are suspect. Nor does it mean that the company is worthless.

 

So, can we drop that particular strawman?

 

3. In general about this whole report [...]

 

In general, I don't find it good policy to be dismissive of short reports, especially without being specific about any of the potential issues they raise. To each his own.

 

In my assessment, the odds are that this is not going to end well for EBIX shareholders from these prices.

 

To sum: Do not believe everything you read on the internet.

 

Which reminds me to point you to Prof. Damodaran's chapter on how to determine free cash flow.

 

First, any capital expenditures, defined broadly to include acquisitions, are subtracted from the net income, since they represent cash outflows.

(emphasis supplied)

 

 

Best,

Ragu

 

I still maintain that Gotham's and your definition of FCF is contrary to GAAP as acquisitions should not be included. The usefulness of the acquisitions can be determined separately by looking at ROIC. While not spectacular, EBIX's ROIC has been varying between 15-25% which is reasonable. However, prudent capital allocation now dictates buybacks at this depressed price instead of acquisitions if the ROIC is only going to be in that range.

 

A much better use of the cash now, though, would be to appoint a big 4 auditor ASAP and improve internal controls. That is the big red flag. If the accounts are not complete fabrications, EBIX is a pretty good deal at this price IMO (thought not at twice the price).

[Edward]

What you are doing though is giving credit to increased cash flow from operations without considering that the increases would not have been possible without the acquisitions in question. Put simply: Your definition of "free cash" is incorrect because EBIX's equity holders couldn't have both received that cash and have the subsequent results be the same.

Of course owners couldn't receive these results without the acquisitions. However reducing the FCF by acquisitions then projecting high growth is not the correct method IMO.

 

What I am doing is trying to separate the core business from the acquisitions, and asking myself - were the business to cease all acquisitions from here on out, what would the growth be, and from that you can calculate probable intrinsic worth as the business as it is now.

 

Of course one can't assume that an investor can get both the growth and the cash flows. I chose to assume slow growth and no acquisitions. Then management can decide what to do with the cash flow - dividends, buybacks, or acquisitions - but I won't try to project that.

 

My apologies if that seemed like a straw man argument, it wasn't intended.

 

 

In general, I don't find it good policy to be dismissive of short reports, especially without being specific about any of the potential issues they raise. To each his own.

I can't really raise any issues with the report as it didn't raise anything too concrete. Just some general "concerns" without much evidence to go on, so I see no point in going on refuting it point by point. Not worth the effort really.

 

As I said, I read it. I didn't dismiss it without understanding the issues it raises. There is a difference.

 

However, feel free to raise any specifics and we can discuss them in depth.

 

 

Which reminds me to point you to Prof. Damodaran's chapter on how to determine free cash flow.

I think there is a misunderstanding there.

 

I use the term FCF to mean "owner's earnings" per Buffett. That is to say - how much has cash/value did the business throw out last year after maintenance capex. Then, these "owner's earnings" can be spent on acquisitions or be returned to shareholders.

 

Damodaran means FCF literally. Cash in, cash out. It is an academic definition, and not very relevant to real life investing. Same as DCF analysis is not very relevant (Damodaran has some great stuff on that too).

 

Hence the mix-up.

 

[constructive]

Saying FCF when you mean owner earnings generally creates confusion.

[Edward]

Saying FCF when you mean owner earnings generally creates confusion.

Yeah, I've noticed. Sorry about that, my bad.

[physdude]

Reading a couple of the reports, it looks to me that the real risk here is that EBIX is likely to find itself owing significant taxes on income claimed in India and Singapore.

 

Of course, if Gotham is right about cash having never left the US (and they make a reasonable case for it based on interest income), it could be a lot worse.

 

Best,

Ragu

 

That depends on how it is structured. For eg., most of Apple's "overseas" cash is invested in the US but still owned by the foreign subsidiaries. Ebix would have to be very dumb not to structure it properly (not saying that they are not).

[Liberty]

That depends on how it is structured. For eg., most of Apple's "overseas" cash is invested in the US but still owned by the foreign subsidiaries. Ebix would have to be very dumb not to structure it properly (not saying that they are not).

 

iirc, they received advice from Ernst & Young and BDO on their tax structure. Doesn't mean there can't be something wrong with it, but it's probably not something too unsophisticated...

[twacowfca]

Marsh has confirmed reports that it has stopped using EBIX's  Qatarlyst platform according to a recent report by the London financial press.  The platform is still being considered, but Marsh reportedly has concerns about the difficulties of the parent company and especially in committing to a platform maintained by a private company that seeks to become a monopoly supplier

[writser]

The Grumpy Accountant taking a critical look at EBIX: http://grumpyoldaccountants.com/blog/2013/7/5/ebix-did-bad-writing-signal-bad-accounting

[stahleyp]

The Grumpy Accountant taking a critical look at EBIX: http://grumpyoldaccountants.com/blog/2013/7/5/ebix-did-bad-writing-signal-bad-accounting

 

http://blogs.smeal.psu.edu/grumpyoldaccountants/archives/569

 

These guys helped me make some decent money last year. ;)

[physdude]

The Grumpy Accountant taking a critical look at EBIX: http://grumpyoldaccountants.com/blog/2013/7/5/ebix-did-bad-writing-signal-bad-accounting

 

http://blogs.smeal.psu.edu/grumpyoldaccountants/archives/569

 

These guys helped me make some decent money last year. ;)

 

Wow, they managed to almost perfectly pick the bottom! Congratulations on your trade!

[stahleyp]

Thanks man. I'll have to give full credit to the board (mostly Sanj) for this one.  :)

[physdude]

http://finance.yahoo.com/news/ebix-announces-agreement-deploy-multi-113000107.html

[blainehodder]

I've been buying a fair amount of EBIX.  I'd offer individual refutations of the fraud claims, but Edward and others have done a fairly thorough job.  I think this is a fantastic opportunity.  Thanks Wellmont for voicing some valid concerns, including the researched bits on the debt issues to Rennes and Whitebox!

 

Personally, I just can't come to the conclusion that these concerns matter at current prices.  This doesnt need to be the greatest company on earth!  I'm convinced it isn't a fraud, and therefore it is way too cheap to ignore! 

 

Good luck to all!

[siddharth18]

I've been buying a fair amount of EBIX.  I'd offer individual refutations of the fraud claims, but Edward and others have done a fairly thorough job.  I think this is a fantastic opportunity.  Thanks Wellmont for voicing some valid concerns, including the researched bits on the debt issues to Rennes and Whitebox!

 

Personally, I just can't come to the conclusion that these concerns matter at current prices.  This doesnt need to be the greatest company on earth!  I'm convinced it isn't a fraud, and therefore it is way too cheap to ignore! 

 

Good luck to all!

 

LEAPs in this situation would've been juicy. Especially 2015 but there are none :(