ZIXI - Zix Corp

[ericd1]

Here’s an idea for your consideration. Appreciate your comments.

 

ZIX Corp. (ZIXI)  52–wk range $2.38-$3.41 Micro Cap  $170M mkt cap

 

Zix Corporation provides email encryption services to a wide variety of companies in the healthcare, financial services, insurance and government sectors.

 

They are the email encryption industry leader. They have a very high “win” rate (80%+) and a very strong customer retention rate of approximately 95%. Although there are competing services the company’s specialized product offerings provide a wide “moat” within the industry.

 

A recent press release announced the company grew its total number of replacement wins by 80% during 2012. A replacement win is the signing of a new customer that previously used a competing email encryption solution. The increase in replacement wins aligned with a 2012 Ponemon Institute survey that found an estimated 50% of companies using email encryption would be evaluating a switch in solutions by the end of 2014.

 

Revenue growth has been steady over the past five years averaging 15%+ with earnings growing faster ~25% annually. The company has high operating (24%) and net margins (50%+).  Their ROE is ~40% and ROA ~30%. They have no long term debt.

 

The company should earn $0.21+ a share this year and by maintaining or increasing their 20%-25% earnings growth (because of scale) they could earn $0.26 or more in 2014.

 

The company recently agreed to replace two directors with two individuals from Meldrum Asset Management. Meldrum is an activist fund holding over 10% of Zix’ shares. I view this to be positive as Meldrum will have input at the board level and will have the opportunity to drive an increase shareholder value.

 

In summary – the company has superior products providing a wide moat, consistent growth, solid profitability and a growing customer base with extremely high retention rates. The company’s operating results makes it similar to a See’s Candy (a cash cow) and it could easily be a takeover candidate.

 

Anyone else following Zix?

 

I am long Zixi

 

 

 

 

 

[FreeOption]

I follow it, own it, and largely agree.  It is a niche network effect business with secular tailwinds.  It's worth a quick call with management to get a sense for who they compete with and how.  Also, the history of the business and creation of their data network and infrastructure is impressive.  It will give you comfort in their moat.

 

Meldrum's expertise is largely in Macro debt and non-equity strategies, so it's unclear to me if they will add value.  They will certainly be attentive.

 

My main concern is the "exit" - buyout, dividends, share repurchases?  Absent a buyout, at 15x earnings it's tough to see a great IRR (30+%) although they will steadily compound value.

 

My firm, my family, or I may be long, short, or hold derivative positions in ZIXI and may change those positions without notice on this board.   

[Sportgamma]

http://www.cornerofberkshireandfairfax.ca/forum/general-discussion/email-encryption-market-zix-corp-(zixi)/msg91429/#msg91429

[netnet]

Would you care to elaborate on their moat.  If they are getting replacement wins that means to me that the switching costs are not prohibitive. 

 

What is the nature of the moat? Is it shrinking? Increasing? Why?

[FreeOption]

Competitors leaving the market at the same time that Zix's offering is improving and their network is growing.  Competitors legacy systems are coming up for renewal and ZIX is taking their business.  Their moat is expanding.

 

Total market size is maybe $100 million right now (although growing) and it would take $50-100+ million to get competitive.  Doesn't make sense for MSFT, GOOG, SYMC, MFE, etc to compete.

 

Another interesting point is that regulations (HIPAA and others) force potential customers to encrypt email. 

[ericd1]

Sportgamma - Sorry about overlooking your post - I did a search on the site and it didn;t show up. I also sorted the Investment Ideas by ticker and there were not any posts on ZIXI.  I guess we're on the same page!

 

In addition to what has already been said about their moat...Their ZipDirectory is definitely gaining momentum and would be difficult to duplicate...It is similar to Facebook in that it is a social/work network with 34.5M members.  It is the world’s only shared email encryption community. It enables transparent communication and eliminates the complexity of managing encryption keys.

 

From their website -- ZixCorp distinguishes itself through easy-to-use email encryption that embeds security; the strength of its customer base which includes the most influential healthcare, financial and government organizations; and the world’s largest community of shared email encryption users — ZixDirectory.

 

Their system works on virtually any email system including cloud hosted systems and importantly it works on mobile devices.

 

Switching costs aren't high, but as FreeOption mentioned their network is growing and as their user base expands it becomes more difficult for other users to ignore their products and not want to join with the market leader. From a purchasing/switching standpoint, it is a very safe option and perhaps a better option that using other systems.

 

I'm not an expert in this field, but their proven success is pretty compelling.

 

 

 

[Sportgamma]

Sportgamma - Sorry about overlooking your post - I did a search on the site and it didn;t show up. I also sorted the Investment Ideas by ticker and there were not any posts on ZIXI.  I guess we're on the same page!

 

In addition to what has already been said about their moat...Their ZipDirectory is definitely gaining momentum and would be difficult to duplicate...It is similar to Facebook in that it is a social/work network with 34.5M members.  It is the world’s only shared email encryption community. It enables transparent communication and eliminates the complexity of managing encryption keys.

 

From their website -- ZixCorp distinguishes itself through easy-to-use email encryption that embeds security; the strength of its customer base which includes the most influential healthcare, financial and government organizations; and the world’s largest community of shared email encryption users — ZixDirectory.

 

Their system works on virtually any email system including cloud hosted systems and importantly it works on mobile devices.

 

Switching costs aren't high, but as FreeOption mentioned their network is growing and as their user base expands it becomes more difficult for other users to ignore their products and not want to join with the market leader. From a purchasing/switching standpoint, it is a very safe option and perhaps a better option that using other systems.

 

I'm not an expert in this field, but their proven success is pretty compelling.

 

No worries, mate. Mine was more of a general discussion as I don´t really have an "investment idea" around it (yet).

 

So, you would argue that the network effect is more relevant in the context of ZIXI that switching costs?

What other markets besides finance, health and government would you guys think of where encryption would be important?

Are any of you guys users?

 

Here is an interesting study:

 

Abstract:

We consider the social context behind users’ decisions about whether and when to encrypt email, interviewing a sample of users from an organization whose mission requires secrecy. Interview participants varied in their level of technical so- phistication and in their involvement with secrets. We found that users saw universal, routine use of encryption as para- noid. Encryption flagged a message not only as confidential but also as urgent, so users found the encryption of mundane messages annoying. In general, decisions about encryption were driven not just by technical issues such as usability, but also by social factors. We argue that understanding these social factors is necessary to guide the design of encryption technologies that can be more widely adopted.

http://www.cs.princeton.edu/~sgaw/publications/01Feb-Activists-sgaw-CHI2006.pdf

 

[ericd1]

So, you would argue that the network effect is more relevant in the context of ZIXI that switching costs?

What other markets besides finance, health and government would you guys think of where encryption would be important?

Are any of you guys users?

 

Here is an interesting study:

 

Abstract:

We consider the social context behind users’ decisions about whether and when to encrypt email, interviewing a sample of users from an organization whose mission requires secrecy. Interview participants varied in their level of technical so- phistication and in their involvement with secrets. We found that users saw universal, routine use of encryption as para- noid. Encryption flagged a message not only as confidential but also as urgent, so users found the encryption of mundane messages annoying. In general, decisions about encryption were driven not just by technical issues such as usability, but also by social factors. We argue that understanding these social factors is necessary to guide the design of encryption technologies that can be more widely adopted.

http://www.cs.princeton.edu/~sgaw/publications/01Feb-Activists-sgaw-CHI2006.pdf

 

Yes, I think users want to use the proven market leader. It also becomes difficult to stay with a competing system that's losing customers. I believe the company's 'win' momentum is causing a lot of clients to switch to their system.

 

The encryption study applies more to casual users than government, healthcare and corporate users than have a definite need for encryption.  According to a survey published by Forrester Research in January 2012, 33% of companies have implemented email encryption.

 

I see Zix as building a better mousetrap...plus with all the focus on internet security today, some larger tech player/s is/are probably already looking at Zix. Like I mentioned -- looks like a 'See's Candy'...

 

 

 

[Sportgamma]

http://www.rpost.com/downloads/documents/thecouncilemailencryptionbuyersguide2011.pdf

[Sportgamma]

Some reviews:

http://community.spiceworks.com/topic/203896-is-anyone-useing-zixcorp-s-zixmail

 

http://community.spiceworks.com/product/22106-zix-corp

 

Interview with CEO

http://www.dallasnews.com/business/headlines/20110604-making-emails-secure-from-crooks-pays-off-for-zix.ece

 

Interview with vice president

http://www.law.com/jsp/tx/PubArticleTX.jsp?id=1202576959488&Good_Things_Come_in_Threes_James_Brashear_Lands_at_Zix_Corp_for_His_Third_InHouse_Gig&slreturn=20130017200217

 

Report of independent accountants of management assertions

https://cert.webtrust.org/pdfs/soc3_zixcorp.pdf

 

 

[Martian]

Disclosure: No position so far.

 

Zix’s flagship product is ZixGateway. Any email exchange between two email accounts from ZixGateway is encrypted and decrypted transparently without the user having to do anything. The biggest advantage over the competitors is that the user need not enter a password at all. The customers of the the competitors products (Cisco/IronPort, Proofpoint and McAfee/CipherTrust and Sophos) need to create a new id and password.

  Another difference with competitors is that Zix offers SaaS architecture. The customers pay annual service subscription fee.  Their competitors are product-based and the customers need to build and run themselves.

 

  In competitor’s products the identities are not shared among customers. Zix creates a global whitepage of all their customers (ZixDirectory) which is shared, allows transparent secure communication among them with centralized management.

 

In competitor’s products different companies encrypted emails systems are not interoperable. Zix offers interoperability which is necessary in communicating with external networks. It  offers secured pull delivery.

 

Google/Postini is their largest third party reseller. They have relationship with Symantec too. They both contribute around 50% of hosted messaging security market. Their clients include FDIC ,US Treasury, SEC , FINRA,  20% US banks, other 1800 financial institutions and 20% of all hospitals because of HIPAA). The local, state and federal agencies and regulators contribute around 5% of revenue.

 

The ZixDirectory has more than 30 million members i.e around 25% of the number of business email addresses in US.

 

 

The average contract length is 3 years and they have a renewal rate of 95+%. The customers need to pay upfront every year and it is not refundable.

 

The largest customer contributes less than 2% of total revenue.

 

Goodwill is around 3% of total assets.

 

Net Income for 2011 is around 11m (without tax benefit of 11m because of decrease in deferred tax valuation allowance ).  In 2010 it is around 6m (w/o tax benefit of 35m) and in 2009 the net income is 2m.

 

In 2010 the closed their money losing e-Prescribing business and now they are left with profitable email encryption business.

They have a net operating loss carryforward of 276m which expires in 2019.

 

Their largest expenses are research and development.

 

They have no long term debt and as of sep 2012, they have around 57m in backlog orders.

 

Currently Zix offers a better product than their competitors. But if their competitors also switch to SaaS model, it will be easy for the customers to switch to them. Only thing that will stop the customers is the network effect. Unless their competitors give a compelling reason (may be low price) to switch, I don’t think the customers will switch.

[ericd1]

Martian,  thanks for the additional information.

[ericd1]

Zix Corp reported 4Q results today.

 

For the quarter sales were $11.7M, up 18.2% and net earnings of $0.05 per share. They ended the year with a backlog of $57.7M. During the year they generated new first year orders of $9.0M, a 27.0% increase from the prior year. Full-year revenues were $43.4M, up 13.7% yoy. Full year earnings were $0.17 per share.

 

“We are very pleased to report record financial results for 2012 in new first year orders, backlog, revenue and adjusted earnings per share,” said Rick Spurr, ZixCorp’s Chairman and CEO. “During the year, we continued to enhance our email encryption solution, maintaining our industry-leading ease of use and our position as the market leader. We also began investments in two new data protection products and expanded our resources in sales and marketing to extend our reach. These investments, and the recent unveiling of the final omnibus HIPAA rule, position ZixCorp for revenue growth.”

 

 

http://finance.yahoo.com/news/zix-corporation-announces-2012-fourth-211000418.html

 

 

[LC]

Conference call transcript:

http://seekingalpha.com/article/1205141-zix-corporation-ceo-discusses-q4-2012-results-earnings-call-transcript?page=2

 

Rick Spurr

Hospitals, our data says only 60% of the hospitals in the United States have done anything to comply with the law. There are 6,000 hospitals and so 40% or 2,400 hospitals should be compelled to step up and buy something. We currently have 33% at the existing hospital market. So, we hope to get at least our fair share if not a greater share given our dominance in healthcare.

Mike Malouf - Craig-Hallum Capital

And then if I could just expand on that, 2400 hospitals with end of September deadline, I imagine that they’re probably going to be scrambling to try to find a solution. What’s the impact for these hospitals if they do not implement an encryption solution?

 

Rick Spurr

Well, they would have to convince a regulator that they weren’t putting any sensitive information in email which would be, I would think, very, very difficult to do. I would say difficult to impossible to enforce training across all your employees so that they never put anything in email. And they can be subject to audits and obviously large fines and I would say post September, those auditors aren't going to be very forgiving and so not only is it defines but it’s also the reputation risk because these breaches and fines will be reported.

 

Noel Atkinson - LOM

I was wondering, I might have missed this, could you talk a little bit about your pipeline activity within your internal direct sales force?

 

Rick Spurr

We don’t ever comment on the pipeline, no, so you didn’t miss it. Demand is quite strong. We talked about lead flow and inbound increase and all the marketing we’re doing, I can say this. Zix has never been busier in any department of the company certainly sales and marketing and development, so 2013 feels very good to us but that’s all I’ll say about sales guidance.

[Junto]

Anyone catch the reason for the volume and new 52 week highs yesterday?

 

Nice pop.

[ericd1]

New 52-week high yesterday ($3.90) and some older news...

 

This new software product looks very interesting. I don't believe it is anything unique, but it sure fits well with their email encryption.

 

http://www.marketwatch.com/story/zix-corporation-launches-zixdlp-a-new-data-loss-prevention-solution-for-email-2013-02-13

 

I'm long zixi

[LC]

Where do your estimates of IV stand for Zix? I'm trying to figure out what a private owner would be willing to pay and I'm having difficulty...here's my thinking:

 

 

Qualitative

1. As mentioned, Zix's selling point is (I believe) the convenience and security offered by their directory service. Financial/healthcare employees can safely communicate within this directory network and be in compliance without having to enter more passwords and usernames. The convenience factor is key, and the more they add to the network the stronger it becomes. High renewal rates are a very good sign.

 

2. Obviously extremely capital light. No debt. No major assets. It's all cash flow (less R&D and salaries). Now, this also makes it a huge target for competitors. So their moat is their network of customers.

 

3. They are (in my estimate) a huge takeover target as well. Why wouldn't a huge software company (Oracle for example) just buy them up, integrate their own products and cross-sell? Or offer ZixMail along with Oracle's suite of products? Makes sense to me...

 

 

Quantitative

1. $20mm cash. $50mm of DTAs.

2. Adjusted earnings of about $10mm last year.

 

So pull out the cash and haircut the DTAs about 50% and the EV is about $180mm, earnings multiple of 18x. Not cheap, that's for sure.

 

Additionally Zix is guiding 2013 revenue on the lower end of expectations (http://www.reuters.com/finance/stocks/ZIXI.O/key-developments/article/2696585)

 

 

 

I think at these prices you're buying the belief that their network will provide a moat. An EV of $180mm seems like a fair value in a private transaction, I think the downside and upside are both equally evident in this price. There is room to drop if they can't continue acquiring customers or revenues drop, and there is room for the price to move up if they can continue to build their network.

 

Whether I buy it, I'm still undecided!

[ericd1]

LC - Your estimates are similar to mine. I'm looking at continued growth: top line growth 10%+ and more to the bottom line 15%. I also agree with the potential of a buyout, which adds to the upside prospects. It's a small position for me.

 

 

 

 

[Palantir]

Good idea!

 

My question - how is their product different from the encryption feature in MS Outlook? I understand they may have a better product, but to the customer, does it really matter that much?

[ericd1]

It is very important on the enterprise level when security is required and the requirements are going to continue to grow. For example, U.S. HIPPA (medical information) law requires confidentiality. With medical records becoming electronic and likely to be distributed by email Zix  is in a sweet spot.

[ericd1]

Zix reported 1Q results today. Earnings of $600k, or $0.01 per shr on $11.8M in sales. Sales increased  14% over 1Q12. Increased backlog to $60M. Healthcare revenues up 48% and finance 28%. Two new products look interesting, but will not contribute until next year.

 

Call transcript with details on new products available here

 

http://seekingalpha.com/article/1364321-zix-s-ceo-discusses-q1-2013-results-earnings-call-transcript?part=single

 

IBM  or somebody should buy this company. 

[ericd1]

Another good quarter - Record revenue, total orders and high backlog. New first year orders were $2.4 million, up 17% from 1Q

 

FRom Press release - two new products that more than triple the size of our addressable market and that we believe will lead us to even higher growth rates in 2014. ZixDLP, which addresses an enterprise’s number one data leakage problem, was launched in March. Our second new product is ZixOne, our innovative approach to BYOD. ZixOne is in beta with nearly 30 customers and receiving very positive feedback. ZixOne literally takes 30 minutes or less to connect to a company’s email Exchange server, and then individual employees can download and implement the app in less than a minute. ZixOne can solve the BYOD security issue surrounding corporate email that is a top concern of nearly every CIO and CTO in the corporate world. We remain on track to meet our September 3 general availability date and look forward to delivering this disruptive product to the marketplace.”

 

Still think someone is going to buy this $270M company...

 

Earnings Press Release

http://finance.yahoo.com/news/zix-corporation-achieves-18th-consecutive-200500832.html

 

Conference Call

http://seekingalpha.com/article/1566342-zix-corporation-zixi-ceo-discusses-q2-2013-results-earnings-call-transcript?source=email_rt_article_title

 

I'm long Zixi