Thinking Big About Small Companies

Zedi Part 7 – The Sum Is Greater than the Stock Price

October 10th, 2013 | Posted by Torin in ZED

There are a number of ways to value Zedi. I’ve already looked at free cash flow. The other conventional valuation method one might use is EV/EBITDA. Zedi looks awfully cheap on this basis too. On trailing figures, ZED shares trade for 4.6x EBITDA. On a forward basis, and including the cash I think could accrue to the balance sheet in the second half, ZED trades for about 4x.

A 4-5x EBITDA multiple for ZED is a noticeable historic outlier. Until 2012, ZED shares almost always traded around or above 10x EBITDA. In the ghastly fourth quarter of 2008, ZED shares fell all the way to…8x trailing EBITDA. That seems like a fair to conservative multiple for the business today given the high business quality and cyclically depressed earnings. If the gas drilling market recovers, I wouldn’t be surprised to see ZED shares regain the ~10x multiple at which they used to trade. 10x 2013 EBITDA would put Zedi shares at about $1.60.

I think book value is also a worthwhile measure of the company’s valuation. ZED currently trades for 1x book value. This multiple is very low for a business of Zedi’s quality. It is also very low by historical standards, and once again represents an extreme historical outlier: in 2009, at the very bottom of the market, ZED traded for 0.9x book.

A sum-of-the-parts approach to valuation, while quite imprecise in the case of Zedi due to the lack of comparables and the number of business lines, nonetheless offers some insight about the value of Zedi as an enterprise.

I’ll start with data fees. Zedi has disclosed that these fees are approximately $22 million annually. They grew 11% in the most recent quarter. As I’ve discussed, the attrition rate for this revenue stream is extraordinarily low, the margins are extraordinarily high, and it is likely that Zedi will be able to effect price increases regularly going forward.

Software businesses such as this one are valued very highly, period. Sanely-valued ERP companies have regularly traded hands for 3-5x “maintenance” revenue (and far, far more in today’s QE-influenced markets). Maintenance revenue is the portion of revenue that is contracted, recurring, and has little or no associated costs. For Zedi, all of the data fee revenue is essentially maintenance revenue.

Applying just a 3x maintenance revenue multiple to Zedi’s data management fee stream alone implies a value of $66 million, almost equal to the current market capitalization. That means the rest of Zedi’s business—$80+ million worth of revenue—is free at today’s share price.

This $80 million includes, among other things, Southern Flow and Silverjack.

What is Southern Flow worth? Zedi paid $15.5 million for it in early 2011. Zedi has had great success cross-selling and up-selling Zedi products to Southern Flow customers, which is the primary reason that Southern Flow’s revenue has grown 50% since Zedi acquired it. Using Zedi’s original $15.5 million purchase price and simply increasing it by 50% to account for that revenue growth implies a value for Southern Flow of $23 million.

Alternately, Southern Flow’s EBITDA has grown by ~90% since Zedi acquired the business. Southern Flow generated $2.2 million of EBITDA in the 10 months prior to the acquisition, putting it at a 12-month run-rate of $2.7 million of EBITDA. This year EBITDA should be about $5 million. If we adjust the purchase price for the EBITDA growth rather than the sales growth, Southern Flow should be worth about $29 million today ($15.5 million increased by 90%), or $0.29 per ZED share. Even using this more ‘aggressive’ valuation method for Southern Flow, the value we arrive at is still just 5.8x EBITDA, which seems fair for a stable, above-average margin business with okay growth prospects.

As for Silverjack, Zedi only paid $1 million for it, but sales are now on pace for as much as $15 million in 2013—1,500% growth since the acquisition just a few years ago. Silverjack earns relatively low margins, but will be Zedi’s biggest growth driver until natural gas drilling recovers. My rough guess is that Silverjack’s gross margins on hardware are somewhere in the 30% range, since this is what a lot of industrial hardware tends to earn. Using about 0.7x sales and/or 3x gross profit, I roughly estimate Silverjack to be worth about $10 million, or $0.10 per ZED share, today.

The Field Operations business has grown revenue significantly since acquisition, but profits haven’t improved much. I value this business at the price Zedi paid for it in 2008: $6.5 million, or $0.06 per share.

That leaves a collection of small business lines, such as the Canadian charts business, the sales of non-Silverjack hardware devices, consulting fees, and a few other things. I assume these businesses in aggregate have a low margin profile, similar to Silverjack’s, so I use the same 0.7x sales/3x gross profit method to value them.

Putting all these pieces together, we get the following:


About $1.10 per share in total. This is by no means a precise method of valuation, but I take solace that the computed intrinsic value estimate is not demanding at all, implying just 7.4x trailing EBITDA and 6.4x forward EBITDA. $1.10 is also in line with the intrinsic value estimates I’ve derived by other means.

The next post will examine how Zedi’s earnings—and intrinsic value—might grow in a natural gas drilling recovery.

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