Investing in small-cap tech companies is all about finding a stock that fits one of two criteria...
Looking for that next great product often requires the work of an army of analysts with years of industry R&D experience. The alternative is to look for companies with a competitive niche product that can stand alone but also fit as an acquisition target for a larger firm.
Analyzing the 500-plus technology companies with market capitalizations of less than $1 billion may seem like an impossible task -- but there is one trick that makes it much easier...
And it just led me to my next investment.
Despite the flood of merger and acquisition activity in the market over the past months, buying or combining with another company can be risky business. That's why many tech companies first collaborate with prospective targets before they consider an acquisition.
A partnership provides a test run for how well the product and key personnel might fit with the company's long-term goals but involves few of the usual costs of an acquisition. For the larger firm, this collaboration gives a glimpse of the potential growth with much less risk; for the smaller firm, it offers the potential payday of an acquisition and strong revenue growth in the near term.
That's why I keep a close eye on the financial news for tech collaborations between very large and very small companies.
Cisco And Enterprise Social Software
Despite the massive growth in social media, making a Facebook (Nasdaq: FB) page almost obligatory for everyone with a pulse, social software for business environments has not caught on like many thought it would.
Cisco (Nasdaq: CSCO) released its Quad product in 2010 as an enterprise collaboration platform to enable connection across a company and its employees. Employees could share ideas, create working groups and videoconference all on a secure platform and in real-time. The product was rebranded as WebEx Social in 2012 and quickly became the world's second-largest public cloud for business collaboration applications.
Yet the product never caught on as Cisco had envisioned. Still, Cisco doubled down on enterprise social software with its acquisition of Collaborate.com late last year. The cloud-based collaboration platform gave it an entry into mobile communications, but it still lacked a great overall offer.
And that brings me to a partnership announced this month and what could be an eventual acquisition.
With its cloud-based platform, Jive Software (Nasdaq: JIVE) is a leader in enterprise solutions for social networking. Since it started reporting its earnings in 2009, Jive's revenue has grown at a compound annual rate of 48%, to $146 million last year.
|Jive's new collaboration with Cisco brings a world-class sales channel and could boost revenue significantly.|
On May 1, Cisco said that it would discontinue sales of WebEx Social immediately and start selling Jive's platform through its customer channel. As part of the collaboration, the two companies will also work together for joint product engineering.
The announcement was a huge deal for Jive and sent shares up more than 10% on the news. While revenue has continued to grow, Jive has not been able to build a reseller channel for its product. The collaboration with Cisco brings a world-class sales channel and could boost revenue significantly.
Ready To Sell
In March Jive hired Silicon Valley investment bank Qatalyst Partners to help find a buyer for the company. Oracle (NYSE: ORCL), SAP (NYSE: SAP) and Workday (NYSE: WDAY) were all reportedly approached, but a deal was never reached.
The collaboration with Cisco might push back Jive's attempt to find a buyer to develop the relationship between the two companies -- but consider Jive has a market cap of just $585 million. That's basically pocket change for Cisco, with a market cap north of $125 billion.
Jive has an enterprise value of $476 million. That is just 2.8 times expected 2014 sales of $174 million, which I expect will be significantly higher on the deal with Cisco. An EV-to-sales multiple of 2.8 is extremely cheap for a company that's still posting sales growth around 20% per year. For that kind of sales growth, the enterprise multiple could easily be 4 times or higher.
An enterprise value of 4 times 2014 expected sales would be $696 million and a market capitalization of $802 million, or $11.40 per share. That is 40% above the current stock price and that is without accounting for the increased sales potential on the Cisco partnership.
I expect Cisco will want to try out the partnership with Jive before exploring an acquisition, pushing any deal into next year. An enterprise value multiple of 4 times expected 2015 sales of $205 million would make the company worth $13.16 a share.
Institutional investors own 93% of the outstanding shares after insiders, with venture capital and private equity firms holding large stakes (Silicon Valley venture capital firm Sequoia Capital owns the largest stake, with 19.3% of the company). These firms are not usually ones to sit around waiting for an investment to pay out -- they like to push for an exit strategy at the highest price possible.
Risks to Consider: Despite its impressive revenue growth, Jive Software has yet to record a profit, and posted a loss of $0.55 a share last year. Higher revenue should eventually lead to positive income, but the share price could fluctuate significantly in the near term.
Action to Take --> Shares of Jive Software have plummeted since the 2011 IPO but are now cheap against high sales growth and a new collaboration agreement with Cisco. The agreement sets up a possible acquisition by the tech giant over the next couple of years and higher sales should support the share price from here. Set a buy-under price of $9 a share and a two-year target of $12 to $13, which represents upside of 40% to 50% from current levels.