ZIX Corporation Investment Recommendation November 1, 2012
Investment Managers: Anastasia Sutjahjo, Jeewhan Shin, Ting-Ying (Erica) Wu
Company Overview
Zix Corporation (NasdaqGM: ZIXI) was founded in Texas in 1988. The company provides email encryption services which enables secured email delivery not only within the company but also with the external network. The company is selling the product through single year subscription and multiple year subscription contracts which are paid annually at the beginning of each year services. Due to the large switching cost, the retention rate of subscription is 90%. The company has four main distribution channels, which are direct (36% of new subscription sales), web (3%), OEM (25%), and VAR/MSSP (36%). There are three main customers groups that Zix serves, which are Healthcare (53% of revenue), Financials (29%), and Government (8%), which includes US Treasury, SEC, FINRA, 20% US Bank, and 20% of US Hospital. Some business risks that the company might face are potential legal liabilities, rapid technology change, and bad reputation which already mitigated by hiring lobbying firm, allocating high operating cost and retaining significant cash holding. We own 2000 shares purchased @ $2.89 on 4-17-2012.
Macroeconomic, Industry, and Stock Market Overview
Zix Corporation is in the global application software industry, which is anticipated to be growing by 7.8% until 2015 and driving industry’s market value to be $111 B by the end of 2015. Some macroeconomics factors that can impact Zix are U.S. unemployment rate and the GDP growth. The U.S. unemployment rate fell to 7.8% in September, which was the lowest since 2009. The GDP is also expected to grow, slowly recovering from recession. The stock prices from the last 5 years are highly volatile with annual standard deviation of 168.3% and annual average return on stock of 7.26%.
Financial Analysis and Projection
The price of subscription is stable due to the high competition, and thus the company will grow revenue by increasing volume of contracts. The average quarterly revenue growth is 16.74% with gross profit margin above 80%. The company has a huge tax refund of $26 million and $12 million in 2010 and 2011 respectively due to the net loss from previous years. The company has no public debt, and deferred revenue (backlog) accounts for 87% of total liabilities. Approximately 60% of the backlog is to be recognized within the next 12 months. We project that sales are increasing in future years due to the recognized backlog and the increase of contracts sourced from the regulatory drivers and new product initiatives.
Valuation
The discounted cash flow (DCF) valuation gives the share price of $2.94 using a discount rate of 11.55% and terminal growth rate of 3.5%. The comparable analysis gives median price of $3.54. However, comparable analysis is not reliable in this case since the size of those peer companies is really different from Zix Corporation. Besides, the EBITDA, EBIT, and Net Income of those companies are all negative.
Recommendation
We put 100% weight on DCF, since the comparable analysis is not reliable. The final valuation price is $2.94, and we recommend holding the current 2000 shares in the portfolio. Some considerations account to the recommendation are high growth potential, competitive advantage through ZixDirectory, and company’s growing stage industry cycle. However, the company still has negative retained earnings and their size is much smaller compared to diversified competitors.