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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.

Friday, May 23, 2008

Authentidate (ADAT) Remains Undervalued

Authentidate Holding Corp (nasd:ADAT)- $.43-This is an update to previous notes (1.CF Break-Even 12 months 2. Traction in Germany 3. Attractive Speculative Play). I remain optimistic towards ADAT given management’s forecast of cash-flow break-even in the December or March quarter. ADAT announced this intention earlier this year, and has continued to reiterate its guidance. I truly believe management would not provide this guidance unless they were very confident that it could be accomplished.

ADAT is trading for less than its $.53 cash/share and $.90 book value/share- and it has no debt. Thus, ADAT’s share price reflects the expectation that it will soon burn through its cash and close its doors. Management believes they can reverse the burn rate well before cash dries up. There is little doubt that significant revenue potential exists, rather doubt has been cast on its timing. The key issue facing investors is whether ADAT will run out of cash before revenues amass to a break-even level. In short, Management believes (so do I) that break-even will be achieved with cash to spare. When ADAT becomes cash-flow positive, I think we could easily be looking at a $2-$3 stock.

The business model is promising, but has been slow to gain traction. The introduction of the Inscrybe platform has accelerated adoption and generated impressive revenue growth. Due to the ~70% gross margins and amount of leverage in the model, there is considerable upside potential in profitability. After attaining sufficient revenue volume to cover fixed expenses, a very large portion of incremental revenue falls to the bottom line.

In my opinion, Authentidate is undervalued. Granted, there are significant risks, but the share price doesn’t reflect ADAT’s true value. Authentidate is unknown to many investors, and its low share price and trading volume make it difficult for institutions (and individuals) to invest. On average, 50k shares, or 25k in dollar volume, change hands daily.

Without analyst coverage, investors look to ADAT for company news. Management has been hesitant in providing details on business. Back in 2003-04, ADAT shot up to $20/share, and when expected sales traction failed to occur, the share price plummeted. Of course, this invited every ambulance-chasing law firm on Wall Street to file class action lawsuits. Even though those suits never materialized, it drained Authentidate’s strategic focus and checkbook. I believe this has led management to be more guarded in its statements to investors. The irony is that ADAT is claiming cash flow break-even in CY08. Given ADAT’s history of not providing much guidance, logic suggests that management would not make such a claim unless it was highly certain it will be achieved. The company also hinted that once progress begins to appear in the financial statements, that it will be much more involved with the investing public. In essence, the share price is not a product of broad based opinion, rather transactions of a few, thus ADAT is inefficiently priced.

About Authentidate:
Taken from Authentidate’s Press Release
Authentidate Holding Corp. is a worldwide provider of secure workflow management software and web-based services. The company's automated and trusted workflow solutions enable enterprises and office professionals to employ rules-based electronic forms, intelligent routing and transaction management, electronic signing, content authentication, identity credentialing and verification and web and fax based communication capabilities. Customer benefits from the company's offerings include reduced costs, improved productivity and service levels, automated audit trails, enhanced compliance with regulatory requirements and the reduction of paper-based processes. The company has offices in the United States and Germany. In the United States we offer our patent pending content authentication technology in the form of the United States Postal Service® Electronic Postmark® (EPM). See USPS EPM

ADAT plans to achieve break-even through cost reduction and revenue acceleration.

Revenue Growth:
Authentidate will need a run-rate of 4 million-plus per quarter for cash flow break-even. Revenue in the March quarter was 1.7 million with US segment revenue (Inscrybe) increasing 18% sequentially. Growth Yr/Yr was 33%, thus accelerated in the recent quarter. Most of Authentidate’s customers are still in the initial – intermediate stage of implementation, thus revenues will continue to increase just from roll-out.

My thinking is that the current customer base is likely sufficient to generate the required level of sales for break-even. My theory is this is why ADAT is comfortable with stating its goal of break-even in the coming quarters. If they know a customer’s billing is (x) amount at (y)% implementation, then that ratio should hold as implementation nears 100%.

The major customers are Apria, American Home Patient, Lincare, Liberty Medical, and several others. These healthcare providers’ business models are largely driven on working-capital management. There is a long delay from the time services/products rendered to patients until reimbursement from Medicare/other insurers. Much of this delay stems from extensive paperwork and physician signatures that must be completed and collected before these agencies can be reimbursed. Authentidate’s services aid in drastically reducing days sales outstanding (DSO), hence working capital requirements.

Home medical equipment providers, such as Apria and American Home Patient, benefit significantly from using Inscrybe, in turn, they persuade physicians to sign-up. Some physicians using Inscrybe have then turned to agencies not using Inscrybe, and have recommended that they start using Authentidate’s platform. That illustrates a powerful, viral process in which adoption can easily and rapidly spread. (see MD interview).

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."

Market Potential:
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.

Authentidate is expanding its addressable market. Over $500 billion are spent annually administering healthcare. $10’s of billions are spent handling business and legal documents. Document-intensive industries are stuck in a paper-based world, however, Authentidate provides solutions for migrating to a more efficient, electronic based environment. The following table is from Authentidate’s May 2008 shareholder meeting. It highlights the potential markets and revenue streams available to Authentidate.

Cost Reduction:
Operating expenses have been averaging $5-6 million per quarter, but have been trending down. Costs should continue to fall as ADAT recently cut 20% of its workforce, mostly mid-senior level positions. In addition, severance costs and legal fees will soon go away, further decreasing Authentidate’s expenses. Management is highly focused on cost control, and it should be able to continue to make progress in this area.

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. These 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 rate causing a significant increase in sales growth. Gross margins have historically ranged 60-70%. SGA expenses have been the primary problem, totaling $16.8m fro FY07. For the 3 quarters already reported for FY08, ADAT recored 4.4 million in sales.

Authentidate is on pace to achieve cash flow break-even in the next 6-9 months, and subsequently become profitable on a GAAP basis. The stock trades for less than cash, hence no value is attributed to ADAT business nor as a going concern. The stock is undervalued because very few know about ADAT and its prospects. The scant trading volume confirms this, thus if more investors knew the facts surrounding ADAT, it would be trading higher, in my opinion. As ADAT moves to profitability, we will see increased interest in ADAT shares accompanied with higher prices.

Disclosure: Long ADAT


Anonymous said...

Hi, You have an interesting blog. I have interest in the P/BV - ratio. Do You happen to know any source to find P/B ratio of U.S. stocks for years or decades, what has been an average P/B ratio. I have a blog about investing, but it is in Finnish :-)

reflexivity44 said...

I have been listening to their conference calls for the last year as well trying to figure out the direction of the company. I came to the conclusion as you have except I am unsure about the logistics of the cash flow break even. Management said 4 million quarterly revenue were needed to break even but in terms of milestones to reach this goal I was wondering what you were looking at as an indicator. I was thinking that ADAT needs to report bare minimum $2.1 million next quarter otherwise there is no way they can be on pace to reach CF break even. I am not sure the likelihood of this scenario though. They seem to be pretty vague about their ability to attract new customers. I think this company has a great product but a poor execution. I am long in the company until next quarter when I reevaluate my position.

My Personal Finance Blog said...

i am unsure about the logistics of the cash flow break even..,they have the ability to impress the customers ,but have poor execution...

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