Reckon and the power of equity incentive
Software group Reckon (RKN) demonstrated with the recent $180 million agreement to sell its Accounting Practice Management (APM) business how managers and directors who own significant equity are more likely to relentlessly pursue shareholder value. RKN is a stock the Equitable Investors Dragonfly Fund continues to own as we don't think the share price yet reflects the full value of the "sum of the parts" nor the franking credits that may be attached to a special dividend.
Part of the investment thesis for buying RKN was the equity incentive. There is research to back up the view that equity alignment is important - an academic paper published earlier this year concluded that performance reached a maximum level at a managerial ownership level of 21.4% in the US.
With CEO Clive Rabie holding 9.9% of the company and chairman Greg Wilkinson holding 7.1%, they clearly want to maximise value as much as anyone.
Long term commitment
RKN has been listed for a few months longer than this author has been in the finance industry. Both RKN and this author's first employer, InvestorWeb (which became IWL Limited), listed on the ASX amid the original tech bubble of 1999. RKN recorded a 167% premium to its issue price.
Greg Wilkinson was a founder and was the CEO back then. Current CEO Clive Rabie has been there for most of the journey, having been COO from 2001 until he stepped up to his current role in 2006.
Post the "Tech Wreck", RKN bottomed at 6.5c in 2001, recovering to a peak of $2.74 in 2011, having made the strategic acquisition of the APM business along the way.
There have been some trials for RKN to endure since then. The accounting software industry became more competitive. In 2012 RKN surrendered its rights to the QuickBooks and Quicken brands (owned by US accounting software giant Intuit, which is now competing in RKN's market with the QuickBooks brand) and focused on rebranding products under the Reckon banner. And RKN has had to take the fight up to cloud-based software-as-a-service providers, led by Xero.
But the RKN team persisted and sought to maximise value. A few months ago RKN spun out a UK-focused document management business, GetBusy, allowing it to be valued separately. Now, following the announcement of the APM sale, it is very clear what the value of each of RKN's parts are:
- There's the $180m MYOB has agreed to pay for the APM business;
- We can assume a capital gains tax bill - analysts have pencilled in a ~$29m impost;
- Offsetting the capital gains tax bill should be some franking credits;
- There's the remaining businesses delivering $15m EBITDA, including corporate overheads; and
- There's current net debt of ~$50m.
We know shareholders will get the benefit of the franking credits as RKN intends to distribute excess cash to shareholders via a special dividend - that could be somewhere between $0.85 and $1.09 per share, based on various analysts' estimates. Wilsons Equity Research is assuming a distribution of $1.09 a share and crediting $0.12 a share of additional value from franking credits.
The key question left for an investor is how to value the remaining businesses?
The remaining businesses, the Business Group (accounting software for small and medium enterprises with over 100,000 customers) and the Legal Group (the nQueue Billback business), are generating $15m EBITDA, based on calendar year 2017 guidance. But RKN has flagged that it will also spend ~$8m on development in 2017.
If we want to see what the market is currently factoring in, Macquarie has used a post-development spend earnings figure of $7m and applied a multiple of just over 10x for a $72.2m valuation. On that basis, Macquarie's sum-of-the-parts is $178m, about 4% higher than the market. This is before considering the value of franking credits from a special dividend.
As RKN demonstrated with the APM sale, we should expect it to seek to maximise value. Ultimately RKN's revenue and customers may have more value to industry players who trade on higher multiples. We'll wait and see with interest.
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Martin established Equitable Investors and the Dragonfly Fund in 2017 after serving as an investment manager with Thorney Investment Group. Equitable seeks out unique opportunities with intensive research and constructive corporate engagement