Tuesday, May 19, 2009

Why Eddie Lampert Likes Acxiom

Conservative Fair Value: $20

Strategy: Sell July strike 10 puts for .55 and/or buy ACXM at $10.50/share or less

Result: approx 5% yield in 2 months via put strategy, potential 100%+ gain on shares within 5 years

Eddie Lampert likes Acxiom for the same reason he invests in any given company: cash flows. Eddie is a notorious cash flow feign/addict, so much so that some have argued that his micro managing in increasing cash flows at Sear's has crippled its long-term merchandising/marketing strategies. Nevertheless, I would say that Acxiom's main order of business is in the "information-technology-marketing-data-processing" field. A business whose most significant customers are in the retail businesses, whether it be clothing, financial services, credit cards, or automobiles. Right off the bat that throws some red flags, since retail isn't exactly the sweet spot in today's macro-environment. Despite the run-up in the retail industry over the past 2 months, consumers are still spread thin between the lack of growth and their over-leveraged pockets. As a result, ACXM revenues have so far fallen about 20%, sub par performance but not completely dismal as the industry it serves.

Despite these concerns - revenues, macro-environment, and a failed buyout, all of which were much more prominent risks at the end of 2008 - hedge fund magnate Eddie Lampert still decided to pick approximately $30+ million stake in the company. Now I'm sure Eddie would've added back the one time charges to his cash flow calculations, but in 2008 if we assumed a 0 in net income, operating cash flows would've still been at about $180 million due to depreciation and amortization. Already that's a great number... look back on Acxiom's discussions on strategy and you will see a shift in an asset heavy company that bought the hardware for customers, to an asset light strategy where they allow their customers to purchase the hardware instead - structuring the company more like an IT consulting type company (think IBM or Accenture). Great, Eddie likes management teams that have the same type of cash flow mindset as his own.

With $180 million in cash flows and an expected $50 million in capital expenditures, free cash flow came in at $130 million. At a price of $8/share, an enterprise value of about $1 billion, the EV/FCF ratio stood at less than 8x. Fantastic, shares look undervalued by about 50% in the worse of scenarios said Eddie to himself..

But it gets better. Recently Acxiom released their 4th Quarter earnings for 2009, and guess what? They're profitable again. With few one time charges on the horizon, it looks like Acxiom should be able to repeat their performance of about $20 million in adjusted earnings throughout fiscal 2010. Furthermore, they signed new customers and now expect revenues to increase!

So lets take that $20 million and annualize it to $80 million (btw if you adjust 2009 earnings, you should get a number in the range of $75-100 million depending how you do this). Let's add our $80 million in income to our free cash flows and we geta total of $210 million. Using a recent share price of $10.5, EV totals about $1.2 billion, giving a EV/FCF ratio of just under 6x. Shares now look like they can be worth at least $20!

Oh but wait, there's more to the story... International growth is where the party is at for consumer spending, read some of their latest 10Q's and press releases in 2008, and you would see that international revenues actually would've grown if it were not for the stronger dollar. On that end, lets factor in some growth. With capex of $50 million (remember the asset light strategy now), I'll assume that most capex is due to new clients and internal expansion needs. Invested Capital totals about $1 billion (see previous articles to see how I calculate this), for a ROIC/CFROI of about 20%. With the same level of capital spending, 20%*$50 million of capex, should yield an additional $10 million in cash flows next year, or growth of 5% of Free Cash Flow (a conservative # by all means). Compound growth of 5% for 5 years and times the result by $210 million and you receive a projection of cash flows close to $270 millon - let's use $260 million to be conservative.

At $260 million in free cash flows, shares look like they can be worth up to $30/share, about 25% return per year. Of course if management sees the ability to make more profitable investments in operations or make better use of their capital now, the $30/share price may also end up being quite conservative.

By the way, one of their other largest shareholders, ValueAct Capital, managed by Jeffrey Ubben, also has the same variation of addiction to cash flows as Eddie Lampert. I wouldn't be surprised for these guys to make another play at the company at around $25/share (LBO it and still make a nice 5x multiple off their original investment if my projections are correct).

Disclosure: Long ACXM


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