Analysts: Amey Dargude Cindy Anggraini Jiaqi (Tommy) Jiang Siwei (Lerrisa) Li Xuan (Lucy) Liang...

Analysts:

Amey Dargude Cindy Anggraini Jiaqi (Tommy) Jiang

Siwei (Lerrisa) Li Xuan (Lucy) Liang

University of Illinois at Urbana-Champaign

Applied Portfolio Management

November 19, 2015

ANALYSTS

Amey [email protected]

Cindy [email protected]

Lerrisa [email protected]

Lucy [email protected]

Tommy [email protected]

Company Overview Industry Overview Macroeconomic Overview Financial AnalysisProjection & ValuationTechnical AnalysisRecommendation

AGENDA

• Purchased 2000 shares at $2.89 on 4/17/2012• Weight of portfolio ( Market value): 2.5%• Current price: $5.54• Capital Gain: 88.24%

Current Holding

Company Overview Industry OverviewMacroeconomic OverviewFinancial AnalysisProjection & ValuationTechnical AnalysisRecommendation

• Incorporated in Texas

1989

•Entered into email encryption business

1999 •Acquired PocketSript, LLC, expanded into electronic prescribing business

2003

•Exited electronic prescribing marketplace after 10-year loss

2010 •Expanded business into email data loss prevention and bring-you-own-device solutions 2013

Company Overview

• Company History

• Company Service

Email Encryption

Email Data Loss

Prevention

Bring-Your-Own-Devices

Zix’s Unique Email Encryption Service

Source: ZixCorp Website

ZixGateway and ZixDirectory enable the customers to send encrypted emails transparently, which forms Zix’s competitive advantage in the industry

• Revenue: per user subcription fee• Contract: 2.5-year long in average• Distribution channels:

Company Overview-Business Model

Direct Sales

Telesales

Value-Added

Resellers

Original Equipment Manufactur

e (OEM)

New First Year Orders as per Q315


Distribution Channels (Cont.)

Zix heavily relies on third party distribution channels:Original equipment manufacturing (OEM), resellers, and referral leaders

Company Overview-Industry Focus

Revenue as per Q315New First Year Orders as

per Q315


SWOT Analysis

• Rapid Change in Technology• Industry

Consolidation• Expansion

Limitation by Govt Regulation

• BYOD solution • Strengthening

Govt Regulation• Cloud-based

service

• Heavily rely on Third Party

Distribution Channels

• No Debt• Strong Alliance

S W

TO

• Litigation risk• Fail to retain key empolyees • Infrustrcure Outage • Industry consolidation risk• Heavily relay on third party distribution chaneel • Rapid changing technology

Business Risks

Porter’s Five Analysis

Competitive rivalry:

High

Threats of substitute

s: Medium

Threat of new

entrants: High

Bargaining power

of buyers: Medium

Bargaining power

of suppliers: Very High

Buiness Overview Industry overview Macroeconomic Overview Financial AnalysisProjection & ValuationTechnical AnalysisRecommendation

Industry Overview

Application

Software

Data Security

Email Encryption

Communication

• Email encryption business is a small fraction of the overall software industry

• Large companies provide services across different functions in the industry

• High occurrence in business consolidation

Buiness Overview Industry overview Macroeconomic Overview Financial AnalysisProjection & ValuationTechnical AnalysisRecommendation

• Regulations on Data Security • Number of Email Exchange• Number of Mobile Internet Connection• Number of Broadband Connection• Total Health Expenditure

Macroeconomic Overview

WorldwideEmail Users

Number of Email Sent/Received per day

Source: Statista

Number of Business Email Sent/Received per day

Increase in number email exchange predicts strong demand for email encryption service

Internet Industry Development

Number of Mobile Internet Connections

Number of Broadband Connections

Source: Ibis World

Futures Increase in the number of mobile internet connection predicts a stronger demand for BYOD solution

Healthcare Industry

Total Health ExpenditureIncerasing

growth rate of total health

expenditures perdicts a

growth in the healthcare

industry, which will increase the

demand for email encrytion

serviceSource: Ibis World

Buiness Overview Industry Overview Macroeconomic Overview Financial AnalysisProjection & ValuationTechnical AnalysisRecommendation

• Financial Highlights• Revenue & Cost• Tax benefit impact • Profitability• Liquidity & Capital Structure • Asset Management Efficiency & Greenblatt • Dupont Ratio

Financial Analysis

Financial Highlights

• No Debt• No Dividend Payment• Deferred Tax Assets • By the end of 2014, Zix U.S. Net operating loss carry forward of

$254M which begin to expire in year 2020• Zix realized tax benefit of $1.0M, $1.9M, $11.9M, and $35.5M in

year 2013, 2012, 2011, and 2010 resulted from the decrease in deferred tax assts valuation allowance• Zix did not recognize tax benefit and paid income tax in year

2014 and 2015

Revenue & Costs

Revenues (y/y) Costs (% of Revenue)

Tax Benefit Impact on Net Income

Tax Benefit Impact (% of Revenue)

Profitability

Return on Assets and Equity (exc. Tax Benefit)

Profitability Ratios

Liquidity and Capital Structure Ratio

Current Ratio Equity Ratio (%)

Asset Management Efficiency Greenblatt Ratio

Asset Management Efficiency Ratio Greenblatt Ratio

Dupont Model

Dupont Model

ROE is declining due to the

decreasing profit margin. The high

tax burden in 2010 was

because of the high tax benefit

that was reflected on bottomline

• Projection Assumption• Income Statement Projection• Valuation

• Comparable Valuation• DCF Valuation

Projection & Valuation

• Revenue • Backlog: urealized revenue • Recognized revenue of new ordersRevenue prjected by forecasting the value of total orders based on the historical performance

• Tax The company’s tax benefit realizaion policy is not predicted. We consider two scenarios: • Tax benefit will be realized to offset income tax expense • No tax benefit will not be realized

• R&D/SG&AChang with revenue, no significant expenditure is projected

Projection Assumptions

Income StatementASSUMPTION Unit 2010A 2011A 2012A 2013A 2014A 2015F 2016F 2017F 2018F 2019F 2020FTotal Orders (2) $ million 40.8 42.3 48.2 56.6 55.4 64.3 74.5 86.5 100.3 116.4 135.0

% Growth % 3.7 13.9 17.4 -2.1 16.0 16.0 16.0 16.0 16.0 16.0Backlog (1) $ million 49.9 53.7 57.7 65.7 69.3 77.4 87.7 100.0 115.2 133.3 154.5% of Backlog % 55.0 57.0 57.0 54.0 57.0 57.0 57.0 57.0 57.0 57.0Realized Backlog $ million 27.4 30.6 32.9 35.5 39.5 44.1 50.0 57.0 65.7 76.0Changed Backlog $ million 22.5 23.1 24.8 30.2 29.8 33.3 37.7 43.0 49.5 57.3Increase in Backlog $ million 31.2 34.6 40.9 39.1 47.6 54.4 62.3 72.2 83.8 97.2

% of Total Orders % 73.9 71.8 72.2 70.5 74.0 73.0 72.0 72.0 72.0 72.0New first year order (3) $ million 8.7 7.1 9.0 9.0 8.5 9.1 9.7 10.0 10.2 10.4 10.9

% Growth % -18.3 27.0 0.3 -5.9 7.1 7.1 2.2 2.2 2.5 4.2Revenue (4) $ million 33.1 38.1 43.4 48.1 50.3 59.6 67.8 78.0 89.2 103.0 119.3

% Growth % 15.4 13.7 11.0 4.6 18.4 13.7 15.1 14.5 15.4 15.8Residual from revenue $ million 10.7 12.7 15.2 14.9 20.1 23.7 28.0 32.3 37.3 43.3

% Growth % 19.1 19.6 -2.5 13.0 11.0 7.2 7.2 7.2 7.2Research and development expenses $ Thousands 5,089 5,229 7,419 9,563 9,051 8,566 11,136 12,807 14,087 15,214 15,975

% Growth % 2.8% 41.9% 28.9% -5.4% -5.4% 30.0% 15.0% 10.0% 8.0% 5.0%Selling, general, and administrative expenses $ Thousands 16,363 15,128 19,385 21,646 26,222 27,530 31,634 36,786 41,942 48,259 55,876

% of Revenue % 49.5% 39.7% 44.7% 45.0% 52.1% 46.2% 46.7% 47.2% 47.0% 46.9% 46.9%

Revenue Assumption

INCOME STATEMENT Unit 2010A 2011A 2012A 2013A 2014A 2015F 2016F 2017F 2018F 2019F 2020FRevenues $ thousands 33,066 38,145 43,356 48,138 50,347 59,613 67,766 77,968 89,237 102,997 119,254

% Growth % 15.4 13.7 11.0 4.6 18.4 13.7 15.1 14.5 15.4 15.8Cost of Revenue $ thousands 6,468 7,211 7,609 7,614 8,324 10,535 11,720 13,234 15,044 17,578 20,480

% Growth % 11.5 5.5 0.1 9.3 26.6 11.2 12.9 13.7 16.8 16.5Gross Profit $ thousands 26,598 30,934 35,747 40,524 42,023 49,078 56,045 64,734 74,193 85,419 98,774

Research and development expenses $ thousands 5,089 5,229 7,419 9,563 9,051 8,566 11,136 12,807 14,087 15,214 15,975% Growth % 2.8 41.9 28.9 (5.4) (5.4) 30.0 15.0 10.0 8.0 5.0

Selling, general, and administrative expenses $ thousands 16,363 15,128 19,385 21,646 26,222 27,530 31,634 36,786 41,942 48,259 55,876% Growth % (7.5) 28.1 11.7 21.1 13.3 18.6 16.2 17.3 16.4 17.1

Opearating income $ thousands 5,146 10,577 8,943 9,315 6,750 12,981 13,275 15,141 18,164 21,945 26,922Other income (expenses):

Investment and other income $ thousands 96 95 112 132 183 239 272 313 358 413 478Interest expenses $ thousands (22) (7) (1) 0 0 0 0 0 0 0 0

Total other income $ thousands 74 88 111 132 183 239 272 313 358 413 478Income before income taxes $ thousands 5,220 10,665 9,054 9,447 6,933 13,220 13,547 15,454 18,522 22,358 27,401Income tax (expense) benefit $ thousands 35,500 11,889 1,949 1,006 (2,830) (4,495) (4,606) (5,254) (6,298) (7,602) (9,316)Net income from continuing operations $ thousands 40,720 22,554 11,003 10,453 4,103 8,725 8,941 10,199 12,225 14,756 18,084Income from discontinued operations before income taxes $ thousands 762 0 0 0 0 0 0 0 0 0 0Income tax expense from discontinued opeations $ thousands (269) 0 0 0 0 0 0 0 0 0 0Income from discontinued operations $ thousands 493 0 0 0 0 0 0 0 0 0 0Net income $ thousands 41,213 22,554 11,003 10,453 4,103 8,725 8,941 10,199 12,225 14,756 18,084Special event adjustment

Net income exc. income tax (expense) benefit $ thousands 5,713 10,665 9,054 9,447 6,933 13,220 13,547 15,454 18,522 22,358 27,401

Income Statement Projection

Discount FactorCAPMS.D.s&p 0.01S.D.zixi 0.03Correlation 0.49Beta 1.39

Market Risk Premium 5.75%

Risk Free rate 2.34%

CAPM Expected Cost of Equity 10.33%

Annual Realized ReturnsYear Actual

5 57.83%4 -21.65%3 53.45%2 9.38%1 -33.42%

Arithmetic Annual Return 13.12%Geometric Annual Return 6.68%

Weight

Realised Return 6.68% 40%

Cost Of Equity 8.87%

Cost of Debt 0

8.87%

Weighted Average Cost of Capital

CAPM Expected Cost of Equity 10.33% 60%

Discount rate

Business Premium

WACC

9.87%

1.00%

DCF Valuation (Scenario 1 – exc. Tax Benefit)

1 2 3 4 5

2016E 2017E 2018E 2019E 2020ETerminal

ValueNet Income 13,547 15,454 18,522 22,358 27,401Depreciation 1655.16 1669.46 2083.49 2081.66 2076.62Capital Expenditures (1,718) (1,784) (3,533) (1,852) (1,923)Changes in Net Working Capital (1,508) 1,016 (269) (2,340) 1,492

Less Increases in A/R (1,595) 900.05 (398) (2,498) 1303.83Less Increases in InventoriesPlus Increases in A/P 86.15 115.61 129.14 158.46 188.59

Free Cash Flow 11,976 16,355 16,804 20,248 29,046 471,981Present Value $10,900.37 $13,548.84 $12,670.43 $13,895.60 $18,142.86 $294,807.33

Zix Corporation Discounted Cash Flow Analysis ($ thousands)

Calculation of Implied Share PriceImplied Enterprise value $363,965.44Less Debt 0Implied Market Value $363,965.44Number of shares outstanding 55,860.83 Price $6.52

$6.52 2.50% 3.00% 3.50% 4.00% 4.50% 5.00%8.87% 6.75 7.24 7.83 8.54 9.41 10.509.37% 6.21 6.63 7.12 7.69 8.39 9.249.87% 5.76 6.11 6.52 6.99 7.56 8.24

10.37% 5.36 5.66 6.00 6.40 6.87 7.4310.87% 5.00 5.27 5.56 5.90 6.30 6.76

Discount Rate

Terminal GrowthSensitivity Table

DCF Valuation (Scenario 2 – inc. Tax Benefit)

1 2 3 4 5

2016E 2017E 2018E 2019E 2020ETerminal

ValueNet Income 8,941 10,199 12,225 14,756 18,084Depreciation 1655.16 1669.46 2083.49 2081.66 2076.62Capital Expenditures (1,718) (1,784) (3,533) (1,852) (1,923)Changes in Net Working Capital (1,508) 1,016 (269) (2,340) 1,492

Less Increases in A/R (1,595) 900.05 (398) (2,498) 1303.83Less Increases in InventoriesPlus Increases in A/P 86.15 115.61 129.14 158.46 188.59

Free Cash Flow 7,370 11,101 10,507 12,646 19,730 320,600Present Value $6,708.12 $9,196.15 $7,922.11 $8,678.76 $12,323.80 $200,252.21

Zix Corporation Discounted Cash Flow Analysis ($ thousands)

Calculation of Implied Share PriceImplied Enterprise value $245,081.16Less Debt 0Implied Market Value $245,081.16Number of shares outstanding 55,860 Price $4.39

4.39 2.50% 3.00% 3.50% 4.00% 4.50%8.87% 4.54 4.88 5.28 5.76 6.359.37% 4.18 4.46 4.79 5.19 5.669.87% 3.87 4.11 4.39 4.71 5.10

10.37% 3.60 3.81 4.04 4.31 4.6310.87% 3.36 3.54 3.74 3.97 4.24

Discount Rate

Terminal GrowthSensitivity Table

Comparable Analysis

• Messaging infrastructure protection

• Data loss prevention, encryption

• Enforcement of data governance

• Email encryption• Data loss prevention• BYOD: a mobile email app,

prevent data from being stored on device

BYOD: To enable IT to securely manage mobile devices across mobile operating systems and provide secure corporate email, automatic device configuration, and certificate-based security.

• Product and Service

• Customers by industry

Financial Service

Healthcare Government EducationPharmaceutic

alManufacturi

ngRetail

ZIXI √ √ √

PFPT √ √ √ √ √ √ √

MOBL √ √ √ √ √ √ √

Comparable Ratio

• ZIXI had positive net profit• ZIXI and MOBL did not

have debt• All three companies had a

large number of deferred revenue recorded as liability, causing the large leverage ratio

• MOBL have a negative NI and positive tax expense

Comparable Valuation

Multiple Ticker Price/Book Value Price/Sales

ZIXI 5.31 5.34MOBL 4.2x 2.2xPFPT 37.7x 11.6x

Weight Ticker Price/Book Value Price/SalesMOBL 0.90 0.50PFPT 0.10 0.50

Comparable Statistics MOBL 3.82 1.09PFPT 3.77 5.82

Implied ZIXI Share Price $ 7.33 $ 6.64

Weighted Average Stock Price $ 6.98

Technical Analysis

Source: Yahoo Finance

Buiness Overview Industry Overview Macroeconomic OverviewFinancial AnalysisTechnical AnalysisProjection & ValuationRecommendation

Recommendation

HOLD

External Drivers

• Growing BYOD solution

• Growing email encryption industry

DCF Valuation

• $6.52 per share under scenario 1 (exc. Tax benefit) valuation

• Additional rate of return of 20%

Technical & Comparable

Valuation

• Comparable valuation is still atractive

• Technical analysis, SMA 20 above SMA 200

Acquisition Target

• Zix could be an attractive acquisition target with its unique business and high tax loss carry forward reserve

THANK YOU

Analysts: Amey Dargude Cindy Anggraini Jiaqi (Tommy) Jiang Siwei (Lerrisa) Li Xuan (Lucy) Liang...

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Transcript of Analysts: Amey Dargude Cindy Anggraini Jiaqi (Tommy) Jiang Siwei (Lerrisa) Li Xuan (Lucy) Liang...