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My investing philosophy mostly centers around the Value discipline and GARP- Growth at a Reasonable Price. This blog includes commentary on market conditions as well as fundamental analysis of specific companies. Graduated from Rhodes College with a degree in Business with concentration in Finance & Marketing. Currently working on obtaining the CFA designation. Previously worked in Mortgage Trading for a major bank. Use MS Excel extensively for developing investment models, notably valuation models based on DCF methods.

Thursday, November 15, 2007

Authentidate (ADAT)- Attractive Speculative Play

Authentidate (nasd:ADAT) is an attractive,speculative play offering massive upside potential with little downside risk. ADAT trades @ near cash with a price / book multiple of 0.8x and has zero debt on its balance sheet. Optimistic expectations stemming from the USPS choosing Authentidate as the sole provider of the electronic postmark (EPM), drove ADAT’s shares to nearly $20 in 2004. As customer adoption has been much slower than expected, revenue traction has been soft causing shares to sink to all-time low price of $0.85. The concept of Authentidate’s product/service offerings has always been solid value proposition, yet support for customer implementation has been rather weak.

Authentidate restructured the company and adopted a new strategy resulting in the August release of its Inscrybe™ web-based platform. Inscrybe simplifies the implementation process, which will lead to increasing customer adoption and a dramatic acceleration in revenue growth. The prospects of accelerating revenue growth coupled with high gross margins make ADAT worth considering as a speculative holding given limited risk for further price deterioration.

Company Description: (from ADAT 10-k)
Authentidate Holding Corp. is a worldwide provider of software and web-based services that enable enterprises and individuals to exchange information securely and conduct trusted business transactions. Our offerings are targeted at enterprises and office professionals, and incorporate security technologies such as electronic signing, identity management, and content authentication to electronically facilitate secure and trusted transactions. In the United States, we also offer our proprietary and patent pending content authentication technology as a web-based service in the form of the United States Postal Service® Electronic Postmark. See
USPS EPM.

New Product: Inscrybe Office
Taken from company press release 8/15/2007-
Inscrybe Office is based on Authentidate's proven Inscrybe suite of capabilities serving the document exchange needs of large enterprises today. The new web-based service combines powerful features, such as electronic signatures, content authentication and trusted time stamps using the United States Postal Service® (USPS) Electronic Postmark (EPM) seal, along with a host of other features that simplify the online exchange of critical and time-sensitive documents. Inscrybe Office is available to anyone with web access, via MyInscrybe.com, a new self-serve portal designed to provide individual users personalized access to Authentidate offerings.

Inscrybe Office, is a user-friendly service designed for business or personal use, to securely and conveniently sign, seal and confirm receipt of important documents over the web. In addition to supporting multiple electronic signatures on the same document, the new service offers senders and recipients the benefits of secure and verifiable online document exchange, with optional features such as acknowledgment of receipt, verification of recipient identity, and audit trails. A user may employ any combination of these optional features to legitimize a document transaction.

Inscrybe Office is ideal for legally binding or compliance-dependent transactions such as business or personal contracts, agreements, closing documents, transcripts, offer letters, prescriptions, authorizations and much more. Inscrybe Office has appeal for professionals and enterprises across a diverse range of industries such as education, financial services, healthcare, legal and real estate.

Business Model:
Authentidate provides security solutions for electronic documents so that legally binding contracts can be signed electronically. Authentidate’s technology verifies each party’s identity, timestamps the documents, and archives them at a 3rd-party retention facility. A “paperless” world falls short due to the requirements for signed, original documents, yet Congress passed the E-sign act in 2000 making electronic signatures legally binding given the specific security requirements are fulfilled.

Here is an example of the advantages to Authentidate’s offerings. To execute a contract, a physical signature must be obtained for an original document. This involves the need to print out a paper copy, sign it, and fed-ex the documents ($30 overnight) to the counterparty. The counterparty then receives the documents, goes to have their signature notarized, and then fed-exs the documents back to the originator In total, the transaction probably takes 2-3 days, several labor hours, and around $60 of shipping overhead.

With Inscrybe™, documents are sent and electronically signed online, thus taking only minutes to complete the whole process. Depending on volume discounts, an EPM only costs .10 to .80, providing huge cost savings from traditional signature methods. Evolution towards a truly “paperless” world is encumbered by the need for physically signed documents, yet Authentidate’s solution eliminates the need for paper copies allowing documents to reach a fully “paperless” state.

Operating Performance History:
Authentidate sold its DocStar and DJS marketing group to focus solely on security solutions. Looking at historical financial statements doesn’t represent an accurate picture of Authentidate’s current operations. For example, income statement found on Yahoo Finance shows sales of $17.5m-2005, $16.5m-2006, and $5m-2007. This figures include revenue from discontinued business segments. Revenues from continuing operations only are illustrated below.

2003: 950
2004: 1250
2005: 2822
2006: 3870
2007: 4998

Sales growth for the past 5 years has averaged 56% per annum. Management declined to give specific guidance, but insinuated that Inscrybe (August release) will accelerate customer adoption and usage rates causing a significant increase in sales growth. Gross margins have historically ranged 60-70%. SG&A expenses have been the primary problem, totaling $16.8m fro FY07. Ostensibly, sales would probably have to reach an annual run-rate of $25m for ADAT to attain profitability.

Limited Downside:
In my opinion, shares of ADAT shouldn’t fall much further due to multiple factors that should provide a price floor. Just looking at the balance sheet, shares almost trade at the value of cash items on the books. ADAT is debt free; liabilities only consist of accounts payable and deferred revenue. ADAT’s market value is roughly equal to net-tangible assets and lower than $1.13 BVPS. I feel these factors should place a limit to further price declines. Taking account of intangible assets, such as product technology, patents, and the USPS contract, a case can be made that ADAT should trade at a higher multiple to book value.

I think the important aspect to recognize is that ADAT, if needed, could sell itself to a larger company at a price, at least equal, but likely higher, than present value. Given the high gross margins for revenue streams, ADAT’s business model could be very attractive to a firm with a more efficient overhead cost structure. A market value of $29.3m and cash of $28m suggests the business model (incl. EPM) can be purchased for a little more than $1 million. If ADAT is unable to achieve a desired revenue run-rate accompanied with needed overhead cost-reductions, I am confident that another firm, with greater resources, could deliver successful results.

Thus, I feel that, just from value derived from the assets, ADAT shares should encounter a support level around its current price. If investors fail to see Authentidate’s value, it’s likely a firm in the related space will. It would be much more costly for a firm to “start from scratch” in duplicating Authentidate’s offerings than to just buy Authentidate itself.

1) $0.81 cash per share
2) $0.84 tangible book value per share
3) $1.13 book value per share
4) EPM contract with USPS
5) Authentication patents
6) Inscrybe web-based platform (incl. customer book)

Revenue Potential:
In the past, there was considerable interest for Authentidate’s product offering, yet the delivery and implantation aspect was more difficult for the customer which impeding adoption. Healthcare related firms have been the primary adopters thus far due to the benefits of processing medical claim documents electronically. To receive reimbursements, patient care services must submit certificates of medical necessity signed by a physician to Medicare or insurance provider.

Doug Guy, SVP at American Home Patient commented about incorporating Authentidate’s solution (ADAT PR 4/23/2007) "We are realizing significant operational efficiencies as a result of deploying the Inscrybe eCMN capabilities in our billing centers and branch locations. Over the past 12 months, we have seen a 65% reduction in turnaround time of documents processed by physician offices through Inscrybe, a significant reduction in unbilled dollars, and a marked improvement in internal document processing throughput. Besides a direct impact on our bottom line, it has improved the service experience for our physician and patient communities."

The market potential is massive. Enormous. The state of Indiana has been using Authentidate’s technology for DMV and court-related documents. In Germany, firms are authenticating electronic invoices for VAT tax compliance standards. The legal, financial, real estate, medical, and likely almost every other industry could benefit from using ADAT’s document security solutions.

The core issue is developing a critical mass of users, since adoption spreads virally. Hence, a user wanting to send documents requires the counterparty to use the technology as well. Think of a fax machine. The first fax machine was useless since it requires another fax machine to receive. Yet, as fax usage increased, more and more people purchased fax machines so they could correspond with those already using fax machines. Thus, adoption rates begin at a slow pace but accelerate quickly resulting in exponential growth.

Outlook:
The attractiveness of speculating on ADAT is that revenue traction could explode in a short time period. ADAT doesn’t face any direct competition; it’s real challenge is developing product awareness so that a critical mass can be attained. The degree of the operating leverage inherent in ADAT’s model (high gross margins) translates into more dollars falling to the bottom line as revenues increase.

In my mind the question will not be “IF” but rather “WHEN” regarding revenue traction. Since Authentidate is unprofitable, it needs to see significant revenue growth sooner than later. It should be evident over the coming 2-3 quarters whether ADAT’s revised strategy and Inscrybe platform is highly successful. I estimate the company has enough cash to fund operations for the next 2.5-3 years. It’s very uncertain if Authentidate will be successful in accomplishing this objective, yet at the current share price, it’s worth taking a gamble.


9 comments:

Anonymous said...

How do you figure "Authentidate Holding: Coghill Capital Discloses 9.9% Stake, Pursues Changes" will play out?
http://www.seekingalpha.com/article/40962-authentidate-holding-coghill-capital-discloses-9-9-stake-pursues-changes

john said...

Turley,

You never mentioned the size of the float or that over 100m shares traded in 03-04 at a price above $4-$6.

Since then, the volume has dropped off considerably, Whne the floor at $2 gave way in mid 2006 vlume dried up to about 500,000 per week.

price recovery with the kind of overhead supply ADAT has is going to be extremely challenging as there will always be a willing seller keeping a lid on any price appreciation.

john said...

The electronic signature service ADAT provides is very intriguing if it catches fire.

Seems a stock to watch.

Turley M Muller said...

John,
yeah I agree with the amount of overhead supply pent-up by prospective sellers, obviously that has been impacting the stock for the past couple years driving the price lower and lower. Especially when positive news has come out of the company and,yet, shares continue to sink. I think we are close to reaching the point where the overhead supply dries up and weaker ADAT holders have exited the stock.

I have been following the institutional SEC disclosures, and for Q3 additions roughly equaled reductions, a good sign since previous quarters there was heavy net selling by institutions for some time now.

I believe in the immediate future share price appreciation will be challenged by awaiting sellers. But I feel the real challenge is finding share demand to take the stock higher. Recent daily volume has pretty much evaporated, and there doesn't appear to be any interest in the stock. So, even with major improvements @ ADAT I am worried that investors will turn their nose up.

The CEO did mention on the last CC that they plan to aggressively market ADAT to institutions and money managers after the new year. Pai also inferred that Inst and MM weren't interested in investing until mgmt produces some results. It appears that the CEO feels ADAT will produce significant improvements in the next qtr or two, that will aid in generating interest among investors.

Thanks for commenting.

Turley M Muller said...

With regards to Coghill and the Seeking Alpha article, I am really unsure how that will play out. I did notice that Coghill did not reduce their position last quarter. If Coghill had reduced their stake, that probably would have indicated they were throwing their arms up and backing away. Yet since that didn't happen, it looks like Coghill is still involved.

It's been more than two months since the last batch of news on Coghill's involvement.

My understanding was that Coghill was pushing for ADAT to sell itself to another firm, or at least mutual combination. My opinion on that is Coghill must think ADAT is worth more than its value in the market, and/or with greater resources that another firm may provide would enable ADAT to significantly boost operating performance. So far it's looking like they haven't found any other firms that agree with their terms of opinion.

Maybe ADAT and Coghill want to hold off for a while to see how the release of Inscrybe plays out.It would suck to sell out to private firm and then Inscrybe spreads like wild fire and the realizing that ADAT was sold way too cheap. Who knows.

Maybe ADAT mgmt anf Coghill have been wanting the share price to fall so that the company is more attractive in the eyes of an acquirer. That's far-fetched, but who knows? Anything is pretty much possible these days we'll just have to wait and see.

john said...

The problem with institutional selling on the way down is that they had to find willing buyers.

The institutions may be out, but that leaves the specs holding the bag the institutions dropped in their lap.

Netted out, there is a secondary negative feedback loop that this selling has created.

In short, the earlier success they had driving the stock price up four years ago is now an albatross hanging around the neck of any success they have ramping up significant accelerations of revenues.

I agree that the real challenge will be one of increasing share demand that exceeds the share demand seen in 2003-2006.

Today's average weekly volume needs to triple or quadruple to return to levels seen in recent years.

Moreover, ADAT has yet to bottom and establish a price base from which to establish an increase in volume.

We are at least a quarter or two away from establishing a price there - and the CEO must be right that there will be significant revenue acceleration in the next few quarters.

I have owned companies whose stock experienced significant overhead supply and whose execs go out on dog and pony shows to institutions and mm.

Dog and pony shows in my experience tend to produce only one day high volume buying which is met with considerable overhead selling, and that just pushes the stock price even lower.

Feel free to contact me with new developments in the new year however as I said, the new service may over time overwhelm the supply of sellers on the market.


Huge share volume increase is needed to

john said...

All too often momentum traders seek out stocks whose price breaks out of a base on high volume. And this drives the stock unrealistically high over the near term.

This behavioral tendency is best described by that turn of phrase "Fools rush in where angels fear to tread."

Once all the fools have rushed in, there is little catalyst to push the stock higher over the near term.

The upwards repricing dramatically re-rates the valuations at a much higher level and becomes a much greater risk to these momentum type of trades.

The post announcement drift that causes the upside breakout is rarely so dynamic that there will be no back and fill.

Further there is oftentimes there is no immediate upside follow through as a result. Instead there is a downward post announcement drift and the market begins to back and fill the gap higher.

Three recent examples come immediately to mind MSFT WFR and SIRF.

So, I stand by never buying a stock immediately after a substantial rise.

Newtons first law of motion still requires bullish momentum to catch up to price, therefore, the tendency is for price to back and fill, which is what makes momentum trading breakouts (buying them) so challenging. If it were that easy, all the momentum traders would be rich.

In some ways, momentum traders behave a bit like ambulance chasers.

Got to date to run off to, will answer rest later.

Anonymous said...

I disagree that ADAT does not face competition...check out Surety www.surety.com

Turley M Muller said...

With regards to Surety and competition:

U had wrote that ADAT doesn't face DIRECT competition, hence other companies offering electronic signature verification with USPS e-postmark.

There are several firms, such as Surety, that offer solutions that overlap with ADAT. Yet, the pie is so big, and penetration thus far is miniscule, therefore firms need not compete against each other for customers (as the case would be if market was saturated).

Actually, competition in a sense would be good because it would heighten awareness to the space and would help speed adoption.

Competition is not a issue for ADAT and probably won't be for some time. The challenge is to wane folks off of doing it manually, and major change is often embraced with hesitantcy. But, as a critical mass forms, adoption will accelerate. IMHO.

Thanks for the feedback!

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