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WHILE THE IRON IS HOT: An Acquirer’s View of Kronos, Inc.

WHILE THE IRON IS HOT: An Acquirer’s View of Kronos, Inc. P. Howard G. Morrill G. Murphy S. Skoog B. Sprows 3 Dec 2006. Abstract and Summary. KRONOS (Greek) – The youngest Titan, son of Uranus and Gaea; devoured his own children, fearing their betrayal

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WHILE THE IRON IS HOT: An Acquirer’s View of Kronos, Inc.

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  1. WHILE THE IRON IS HOT:An Acquirer’s View of Kronos, Inc. P. Howard G. Morrill G. Murphy S. Skoog B. Sprows 3 Dec 2006

  2. Abstract and Summary KRONOS (Greek) – The youngest Titan, son of Uranus and Gaea; devoured his own children, fearing their betrayal A Young Titan – low-debt, growing, self-created custom niche – largest of up-and-comers, approaching “big boys” A Devourer – 55+ acquisitions in 15 yrs, more (esp. intl) to follow – cost of acq starting to skew ops, margins, practice(s) An Opportunity? – analysis is presented from acquirer’s-eye view; assessment of current and future performance, numeric regression and non-numeric business observations, survey of competition, ultimate valuation and overall investor recommendation

  3. Kronos – Present Performance THE GOOD Fiscal 2006 – $578M tot revenues (up 11% from $519M in 2005) Revenue Streams – Software (predominant), Maint, Prof Serv Cash Flow – Solvent (historically $70-90M, ~$100M in 2006) Profit Margin – historically 8.5% to 10.5% Financial Leverage – impressively low (historical flux 1.7 … 1.9) THE, er… QUESTIONABLE Acquisition-Heavy? (skews 5-6% organic growth vs. 11% w/acq) Too Far Too Fast? (5-6 acq/yr, $80M ops debt incurred in 2006) Debt-Averse? (can do more w/only slight boost in fin. leverage) THE UGLY Primary-focus revenue stream (prof serv) is lowest margin (~20%) Company has missed three consecutive quarterly estimates Significant 2006 option-pricing hit (FAS 123), aftershocks to follow

  4. Kronos – Assessment of Competitors Similar Business, Similar Sectors – ADP, Oracle, SAP Speed-Bumps in the Road – CyberShift, InfoTronics, WorkBrain Apples-to-Apples Comparison is Difficult, Given Business Direction Six-way Business Split (Perf/Talent Mgt, HR, Recruit, Workforce, etc.) This Identity Crisis will Worsen with Unicru and similar acquisition(s) Kronos is First and Foremost an (Old-Fashioned?) Prod/SW Company Service-Oriented (SaaS) is the Future [Forrester, 2006]… Old Dog, New Tricks? A Three-Sided War? – Open-Source (]Project-Open[, TalentHRMS)

  5. Kronos – Accounting Policies Onward and Upward – Acquisitions, Goodwill and Intangibles $380M in 2006 [up from $212M in 2005] Anticipate recurrence and growth… amortize maximally Designate “acquisitions reserve fund” (debt-fuelled) Revenue Recognition – “Bill-as-You-Go” vs. “Retainer” Shift from front-loaded (Retainer) to timely payments Consequence – Deferred Revenues may grow at diminished rate Non-GAAP – One-Time Infrastructural Expenses in 2006 Costly (Oracle) ERP Implementation – skews short-term figures, non-perpetual Impact of FAS 123(R) Adoption – Option-Pricing Expenses Black-Scholes model adopted in 2005-2006, carryover impact to 2007 Single greatest numeric influence on Fiscal 2006 earnings

  6. Kronos – Future Performance (1 of 2) Projections – Aggressive (12%) vs. Conservative (5%, w/o acq)

  7. Kronos – Future Performance (2 of 2) Assumption – Kronos owes much of its present prosperity to acquisitions Assumption – Kronos will halve growth (or worse) w/o acquisitions Assumption – Expenses (CoGS, R&D, SG&A) relatively constant over 5 yrs Projections – Aggressive (12%) vs. Conservative (5%), see prev. chart Total Revenue (2007) ~ $607M to $649M Net Income (2007) ~ $41M to $43M Per-Share Net Income (2007) ~ $1.21 to $1.22 per share Total Revenue (2011) ~ $738M to $1,030M Net Income (2011) ~ $66M to $85M Per-Share Net Income (2011) ~ $1.83 to $2.37 per share Outcome – Continued acquisitions require “acq reserve fund” (~75M/yr) Outcome – Continued acquisitions require ongoing l-t debt (addl ~45M/yr)

  8. Kronos – Intrinsic Valuation ** includes end-of-five-year terminal value (built from terminal cashflow) Uses 10.3% discount rate (calculated from weighted avg cost-of-capital) Uses 16.21% req. return on equity (Re), derived from 5-yr b ~ 1.9 …at these projected values, $1.43 B ÷ 36 M future shares ~ $39.59/sh …sanity-check calculation via (Proj Ent Value) ÷ (Equity) ~ $35-$38/sh

  9. Kronos – Intrinsic Valuation vs. Stock Price $39.59 per share (calculated) and $35.33 per share (traded) Projected Book Value vs. Market Value suggests KRON undervalued NOTE – an acquirer may *not* realize this full 12% differential Room for growth… this dip is a premium opportunity for investors

  10. Kronos – Conclusions, Recommendations The key to future Kronos success is continued sub-acquisitions Increased activity with debt/leverage is a key finding STRONG BUY at $35.33/share BUY at $37.40/share ACCUMULATE at $38-$39/share Speaking of Acquisitions… We recommend KRON itself as a promising target for purchase

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