MCTR upgrade
With recent NEON problems outlined on 10Q taking them by suprise, some analysts have gone back to reading MCTR's 10Q which was released just prior to recent CC with announcements of management changes, stock option repricing and strategic direction. Most of us have already read the 10Q prior to the CC, and have already brought up financial position, credit line revelation, stock option repricing on this board, so FWIW and not to be rankled, some further comments from an analyst at BRG:
INVESTMENT OPINION
We recently upgraded shares of Mercator from SWAP to ACCUMULATE
on the heels of a management shakeout announced on November 16,
and our estimated takeover valuation of $8-9 per share based on
recent comparable transactions. The company also announced a new
geographical segmentation of its sales, marketing and research
and development units. Although any change at the top should be
viewed as a positive long-term development at Mercator, we
believe these changes have better positioned the company as an
acquisition target. We also believe the company's deteriorating
financials (as detailed in this report) will continue to cause
concern for investors and add to difficulties the new management
team faces well into FY01. Despite our apprehensions highlighted
in this report (due to newly revealed data in Mercator's 10-Q
filing as well as numerous trepidations we have mentioned in our
prior comments) we recently raised our rating on Mercator from
SWAP to ACCUMULATE. We continue to believe that Mercator's core
technology, strong partnerships, and impressive customer base are
intact (for now) and, based on comparable transactions, a bottom
for the stock may have been reached.
THE NOT SO IMPRESSIVE 10-Q
Mercator's third quarter 10-Q was particularly important to
investors, especially due to lack of guidance from management,
visibility in revenues, pipeline, and bookings, as well as
detailed breakdowns of some expenses in the quarter and certain
future obligations that extend into middle of FY01.
* In October 2000 Mercator made a cash payment of $1.7 million
to the shareholders of Braid as the final component of contingent
consideration. If you recall, Mercator acquired Braid in March
1999 for $30 million in cash and 1.1 million of then TSI
International (later renamed Mercator Software) stock. This
reduces the company's cash on its balance sheet, further
deteriorating its financial position.
* The implementation of FASB Interpretation No. 44 could
potentially have substantial effect on operating results in
future periods in connection with stock option awards. The FASB
Interpretation No. 44 "Accounting for Certain Transactions
Involving Stock Compensation" (FIN 44) provides guidance for
applying APB No. 25, "Accounting for Stock Issued to Employees."
FIN 44 potentially applies to new stock option awards, exchanges
of awards in a business combination, modification to outstanding
awards, and changes in grantee status on or after July 1, 2000.
Although we can not estimate the exact impact of FIN 44 on
Mercator's financials, we believe the acceleration and re-pricing
of options by the company should have a negative effect in FY01.
* Mercator recently signed a 12-year lease agreement for
57,860 square feet of office space in Wilton, CT. The lease
requires a security deposit of $2.5 million in cash or acceptable
letter of credit. As of 3Q00, Mercator had prepaid $1.24 million
of the deposit using a bank line of credit. Unfortunately, the
company is not in compliance with certain covenants of its credit
facility and is currently negotiating with its bank. Although we
are unsure of the status of negotiations, or whether the bank
will or will not extend the line of credit to Mercator, we
believe in the worst case, the company may be forced to pay the
security deposit using cash, thereby further deteriorating its
balance sheet.
* Mercator reported dramatic improvement in DSOs in 3Q00 to 85
days compared to 108 days at the end of 2Q00. We detailed this
improvement in our October 24 post-earnings note, and attributed
it partially to better collection and lower reported total
revenues. However, the 10-Q states that the another reason for
this decrease was due to change in payment terms from "net 30" to
"due upon receipt." This may not be a cause of concern normally,
but large enterprise software invoices can not be sold on a "due
upon receipt" basis for an extended period of time, and the DSOs
improvement contribution form this factor may not be sustainable
in future quarters.
In our previous notes we have continuously defended and
praised the company's products, partnerships, sales channels,
customer base and strength in R&D, while criticizing the
company's execution. Mercator's 10-Q aptly characterizes what
we would consider to be the greatest risk to Mercator's
survival as an independent software company:
Our future success depends in large part on the support of our key employees,
investors, customers, and vendors who may react adversely to the restatement of
our first quarter earnings and the adjustment to previously disclosed second
quarter results. The restatement of our first quarter earnings and the
adjustment to previously disclosed second quarter results has resulted in
negative publicity about us and we believe that this publicity may have caused
some of our potential customers to defer purchases of our software or to do
business with other vendors. We may not be able to retain key employees and
customers if they lose confidence in us and our vendors may reexamine their
willingness to do business with us. In addition, investors may lose
confidence, which may cause the trading price of our common stock to decrease
further. If we lose the services of our key employees or are unable to
retain and attract our existing and new customers and vendors, our business,
operating results and financial condition could be materially adversely
affected.
Our future success depends on retaining our key personnel and attracting and
retaining additional highly qualified employees.
Our future success depends in large part on the continued service of our key
sales, professional services and research and development personnel, as well
as senior management. Other than the Chairman and the Chief Executive
Officer, all employees are employed at-will and we have no fixed-term
employment agreements with our employees, which prevents them from
terminating their employment at any time. The loss of the services of any
of one or more of our key employees could harm our business.
Our future success also depends on our ability to attract, train and retain
highly qualified sales, research and development, professional services and
managerial personnel, particularly sales, professional services and research
and development personnel with expertise in enterprise resource planning
systems. Competition for these personnel is intense. We may not be able to
attract, assimilate or retain qualified personnel. We have at times
experienced, and we continue to experience, difficulty in recruiting
qualified sales and research and development personnel, and we anticipate
these difficulties will continue in the future. Furthermore, we have in
the past experienced, and in the future we expect to continue to experience,
a significant time lag between the date sales, research and development
and professional services personnel are hired and the date these employees
become fully productive.
Source: Company reports (Mercator's 3Q 10-Q)
NEW CAPTAIN, SAME SHIP.WHERE ARE WE HEADED?
Mercator's new management team has a challenging task ahead.
James Schadt, chairman of the board and the new interim CEO
replaced Constance Galley, while the search for a new CFO lead to
an in-house name: former interim-CFO Richard Applegate will be
the permanent CFO, in what the company described as an exhaustive
search by Spencer Stuart (the firm is currently conducting a
search for a permanent CEO). The company also outlined a new
`decentralized organizational structure', segmenting sales,
services, and R&D efforts along three geographic regions:
Americas, Asia/Pacific, and Europe/Middle East/Africa. Although
Mercator hopes that the new structure will create a more nimble
competitor, we believe an organization of this size (revenue-run-
rate of $129 million) does not need to create separate and
autonomous sales, marketing and R&D groups throughout the world.
We also believe that these changes are more cosmetic than
structural and further validate our inkling that the company is
well-suited as an acquisition candidate. Although we do not wish
to speculate on who the potential acquirers may be, we do believe
that leading EAI vendors and other hardware/software companies
interested in increasing their market share and footprint are
qualifiers.
In an earlier report we highlighted our take-out valuation for
Mercator based on a recent transaction: On November 2, SAGA
Systems (AGS) agreed to be acquired by Software AG of Germany for
$11.50 per share in cash, or $360 million, which is 1.8x SAGA's
TTM revenue of $196 million or 2.1x its revenue run rate of
$174.8 million (based on 3Q00 revenue of $43.7 million). This
transaction is the second major acquisition in the enterprise
application integration universe after webMethods' acquisition of
Active Software in August. Mercator and SAGA software have
encountered somewhat similar difficulties in the past several
quarters, with decelerating revenue growth and slow revenue
migration from traditional mainframe and messaging software to
full-fledged EAI deployments. Based on similar multiples,
Mercator's revenue run rate of $128.8 million and TTM revenue
$130.1 million, we believe Mercator's takeout value would be $8-9
per share. We continue to believe that Mercator's core
technology, strong partnership, and impressive customer base are
stronger and more valuable than that of SAGA Systems, yet we are
hesitant to guess how much more a potential suitor is willing to
pay for such intangibles.
Where is this ship headed? Sailing in un-chartered territory, we
believe Mercator will face strong headwinds trying to compete
with TIBCO, Vitria, or webMethods, and stem its market share
losses. We have been avoiding this stock since our initial
report on May 10, and if we were to base our latest analysis on
fundamentals (deteriorating ones at that!), we would not be
recommending this stock to investors. However, we believe
investors with appetite for investing in a possible acquisition
target should consider Mercator at current price levels. We
believe the risk/reward ratio has substantially tilted in
investors favor, specially after the appointment of the new
management team, and, based on comparable transaction value, we
have raised our rating to ACCUMULATE (technically a Trading BUY)
from SWAP. |
