As young tech companies try to establish themselves in the marketplace, they aren't just looking to book a sale with a new client. They want that client for life.
Case in point: Citrix Systems (Nasdaq: CTXS), which has hit a flat spot in terms of new customer wins but remains a solid cash cow, thanks to its lucrative installed base of repeat business. And the stock price, in relation to that cash flow, has become too appealing to pass up.
Unless you work in an IT department, you might not be familiar with Citrix. The company sells desktop management software to more than 300,000 global clients.
If you've ever worked on a corporate desktop that has no local hard drive and instead gets all of its instructions from a central server, than you have probably used Citrix's software (which has been licensed by Microsoft (Nasdaq: MSFT) and others for roughly two decades). These days, such remote servers form the backbone of cloud computing.
Citrix hit the $1 billion sales mark in 2006, $2 billion in 2011 and nearly $3 billion in 2013. Equally impressive, this company has become a cash-printing machine, as free cash flow has steadily risen from $240 million in 2008 to $750 million in 2013.
But the company's once-steady growth rates have come into question. Though sales have grown at a double-digit pace in nine of the past 10 years, they are set to slow to single-digit growth this year. Of greater concern, profits may slip from the $3 a share earned in 2013, due to a sales mix shift toward lower-margin software.
|If you've ever worked on a corporate desktop that has no local hard drive and instead gets all of its instructions from a central server, than you have probably used Citrix's software.|
Yet investors shouldn't see the sales slowdown as a sign of a mature end market for Citrix's software. Instead, the company is simply in the midst of a product transition that will take a few quarters to play out. For example, Citrix has greatly expanded its suite of products that enable network access from mobile devices. Yet customers have been slow to embrace the new products, leading management to re-orient the sales efforts: "We'll refocus on driving more project-specific items, highlighting key attributes that have made our app and desktop solutions market leaders, areas like data security, compliance, cost savings and secure access," said interim CEO David Henshall on the fourth-quarter call with analysts.
Citrix also stumbled by de-emphasizing its XenApp software, which helps IT managers remotely manage employees' productivity apps on their phones and tablets. Henshall concedes the error: "Based on feedback from customers and partners, we are relaunching XenApp this quarter with the next-gen 7.5 edition."
The move to reinstate XenApp as a stand-alone product should pay off in coming quarters, according to analysts at Drexel Hamilton, who look for "renewed focus on the midmarket by re-engaging the partner community, which has been a key strength in the past." Those analysts recently upgraded their rating from "hold" to "buy," with a $65 price target.
And the lack of EPS (earnings per share) growth can be largely attributed to a decision to boost the sales department by 200 people. In coming quarters, as the new sales hires become more productive, profit margins should strengthen again.
Analysts at Credit Suisse have an $80 price target, representing 45% upside. They figure that management's recent 2014 sales guidance is too conservative, and they're expecting a cycle of revenue forecast upgrades later this year.
Why should investors have confidence that sales growth will resume later this year? Because deferred revenue surged $142 million sequentially in the fourth quarter, to $1.4 billion, thanks to a late-quarter spree of new contract wins. Those contracts are spread over a number of quarters, and as a result, simply fail to move the needle in the very short term.
The recurring revenue should translate into very healthy free cash flow, which is expected to reach $1 billion in 2014 for the first time in company history. The free cash flow yield stands at around 10%, which is quite rare for a high-margin software firm.
That free cash flow is fueling share buybacks as well: The company bought back 7 million shares in 2013, with plans to buy back a similar amount in 2014.
Risks to Consider: Citrix is searching for a new CEO, and new management often looks to establish a new, lower bar when they take the reins. So we may not have seen the end of downward EPS revisions.
Action to Take --> The slump in shares may imply that Citrix has a troubled road ahead, but the surge in deferred revenue suggests otherwise. Management erred on a few product rollout strategies but is now taking steps to right those wrongs. With shares trading at such a high free cash flow multiple, investors have a chance to build positions while the company remains in a "show-me" state.