Ian, my response to your post:
<<Mike - You classify MIFGY as a Y2K stock. As of May 98, Y2K revenues were 17% of total with an expectation of peaking (at around 20%) in mid fiscal. Does really classify them as a Y2K stock? They have many products inc. Euro, XDB etc. which have good potential post Y2K.>>
I did not classify MIFGY as a Y2K stock. I believe a more objective reader of my past posts would conclude that I view MIFGY as a run-of-the-mill systems integrator, with a few tools, which is well-managed but overly focused on a language that will eventually die and which became over-valued because the development of Y2K and Euro business gave it a temporarily high growth rate. Yes, I suppose this is my somewhat wordy "classification".
How much faster has MIFGY grown, cumulatively, over the past two years, because of Y2K ? I have it on reasonable authority (yours) that this figure might be about 17%. Enough for the market to give it a hefty multiple...at least until it realized the growth rate cant last.
<<The merger deal was struck at around 3-times ISLI revenues. Not cheap. OK you will say that this is academic in an all paper deal - but we don't now know the real worth of an independent ISLI now whereas we did then.>>
Ian, of course we don't really know what an independent ISLI is worth since it is now tied to MIFGY. I believe ISLI is worth a lot more on its own than it is currently trading. Hence I argue for breaking its tie to MIFGY -- which has now been shot by the market over concerns about what the real growth rate of the business would be after we get past Euro and Y2K. But I must say your position seems inconsistent. If you really believe ISLI is not such a great value, why, as an MIFGY holder, would you argue so strongly for the merger ?
<<My philosophy perhaps - but investing in any software company is investing in the management. A merger of MIFGY/ISLI is what the managers of both enterprises want.>>
Yes, management is important. So are a few other factors, don't you think ? I'm not sure I understand your point. I'm sure ISLI mgmt wanted this merger to go through with the price of MIFGY where it was. I'm not sure they want it now. I AM sure MIFGY management still wants it.
<<At the last MIFGY AGM, Martin Waters was asked (by a company founder) to comment on "earnings quality". To which Martin asked "what do you mean". To which the guy could not provide an answer.>>
I once asked a technology company CFO, during a due diligence session, if he would could comment on earnings quality. He also said "what do you mean?". I did not interpret his response as a lack of real knowledge. He knew full-well what I meant. The company had accelerated revenue recognition (by dipping into their deferred revenue liability...and perhaps playing a few games with pending contracts). I was concerned they were also playing games with a couple of other asset categories (not writing them down quickly enough). I would be far more impressed if Mr. Waters had simply answered the question.
<<MIFGY balance sheet bloated - what with cash?? One thing that I have always appreciated about MIFGY is that they put R&D on the P&L and take it "as it should" in the year. No depreciating over years as an asset on the balance sheet. So what is your definition of "earnings quality".>>
You are mistaken. According to the most recent public filings, MIFGY capitalized $9.3MM of its $31.6MM in development costs during fiscal 1998, about 13% more in capitalized costs than the prior year. ISLI capitalized only $2.1MM of its $26.3MM in fiscal 1998 development spending, a dramatic REDUCTION from the $9.5MM capitalized in the prior year, suggesting a quite material improvement in earnings quality, in terms of R&D accounting, relative to MIFGY.
MIFGY now has $18.9MM of capitalized software assets on its balance sheet versus $3.6MM for ISLI. This is some of the bloat I was referring to. A/R for MIFGY is not bloated...the absolute level is quite good for a software company, especially when the deferred revenue liability is netted out (as is appropriate). However, in considering earnings quality during a particular period, the absolute level of turnover is meaningless. You look at the CHANGE in the asset turnover from the beginning of the period to the end of the period. In considering A/R (net of deferred revenue)as a % of revenue, you will notice that A/R turnover (or calculated using days, if you like) has slowed over the past year. You see, MIFGY has been dipping into its deferred revenue liability to boost revenues (to the tune of about nearly $6MM in the past two quarters). I am NOT arguing that this was inappropriate. It may very well be that the accounting was completely appropriate. But a change in deferred revenue still is a critical earnings quality issue for a software company. This change in deferred revenue, of course, falls directly to the bottom line (or at least the pre-tax line). ISLI, on the other hand, has been rapidly growing its deferred revenue liability over the past year (45% LTM growth vs. 14% LTM revenue growth). If you adjust for changes in deferred revenue and adjust to hold A/R turnover constant, ISLI has actually grown faster than MIFGY (being a software industry expert, I'm sure you have looked at these adjustments). Adjustments to normalize both revenues and the rate of R&D capitalization between the two companies would have a dramatic impact on earnings (since adjustments for both flow down at least to the pre-tax line). The pre-tax adjustment to normalize changes in the rate of R&D capitalization during fiscal 1998 would be about $8MM in ISLI's favor. Normalizing the change in the rate of A/R turnover (net of def. rev.) over the last 12 months would be about $12-14MM in ISLI's favor, depending on whether you used quarterly, LTM or annual balance sheet data. These are big numbers considering MIFGY's net income in the latest fiscal year was only $14.6MM.
I am not concluding that MIFGY has inappropriately spiked its income in recent quarters. I am mereley suggesting that ISLI's earnings quality has been much better, RECENTLY, RELATIVE to MIFGY.
In discussing "earnings quality" there are, as you may know, a number of other areas to consider, but these were the two areas of most interest to me. When I asked you whether you had any view of earnings quality, this is what I meant. If you do not, thats fine. I was genuinely interested in your thoughts, however, since you must know MIFGY much better than I do.
<<And, significantly, have you any indications of the level of ISLI acceptances yet. I have asked MIFGY to issue a statement - but no response as yet.>>
No. But as I suggested, institutional investors are not stupid. I expect this merger to be cancelled or restructured. |
