Falling Knives
Cam Commerce Analysis

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By mrchw
September 19, 2007

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You likely have not heard of this company, but it's down $2.80 right now to $34.54. It hit $40 last Friday. It's my largest personal holding, and if the stock keeps falling, I may add to my position... I don't think it's quite cheap enough to buy just yet. Here's a write-up I did on June 1st. A few things have changed since then, the 10% non insider has bought another 40k shares as high as $37, and the CEO finally sold some shares, about 80k, all over $37. And of course the stock is a fair bit higher after reporting another blow-out quarter in August.
Description / History
CAM Commerce (CADA) is an under-followed (no analyst coverage) microcap (110m
market cap) that looks expensive on the surface (the P/E is reported at 35x by most data
providers), but appears much cheaper upon deeper analysis. CADA was founded in 1983
and has been a public company with the same management team for 20 years. The
company has changed product offerings over the years, buying and selling divisions, until
they finally found a product with steady, recurring revenue.

The company has 3 divisions: 1.) Hardware & Software, 2.) Service, and 3.) Payment
Processing. Ten years ago, the company was primarily a hardware/software company that
sold accounting systems and associated products to small retailers (stores with generally
less than 5 locations, including mall kiosks, etc). They developed a niche selling and
servicing affordable products to customers that could not afford large scale software
provided by companies that could not profitably service such a small customer. When
the bubble hit, they expanded into online storefronts, online auction processing,
etc. About 5 years ago they introduced a product innovation that is the driver of their
current growth. Payment processing was incorporated into their software giving their
customers the ability to accept credit cards and have the transaction integrated into their
software. What makes CADA's solution unique is the integration. In many small retail
shops, sales are rung on a register with credit card payments requiring an additional
activity of swiping on a stand alone machine with a manual entry of the amount of the
transaction. It's a manual process that is ripe with inefficiencies, human error, and even
potential for fraud. CADA's payment processing is integrated, automatically reconciles
at the end of the day, and greatly reduces the chance an employee will over-charge a
customer and pocket the extra cash himself.

While this was a nice product that differentiated CADA's accounting software, growth
really started to pick up about 3 years ago when they changed their strategy to include
offering payment processing as a stand alone product. They started marketing it to other
software companies enabling them to integrate it into their products. This is a win-win-
win situation. CADA wins by increasing their sales (they receive about 50bp of every $1
in transactional volume by the merchant) and getting access to a broader distribution area
(they began to process payments for doctor's offices, restaurants, etc which were outside
of their traditional retail market). The resellers win because CADA doesn't charge for
the software (now called X-Charge) and pays the reseller a commission of 30% of the
revenue their accounts generate. The third winner is the small business because 95% of
the time, X-Charge is able to offer them a better rate on credit card fees than they pay
with their previous provider. There primary reason for this is the scale that CADA offers
(they are in the top 5 customers of Global Payments (GPN), and have renegotiated their
contract a few times as they've become more important to GPN), but also the ability to
accept debit cards with lower transactions fees that many customers were unable to
accept with their previous processor.

The Opportunity
X-Charge revenue represents an estimated 50% of Fiscal (SEPT) 2007 revenue. For the
past few years, the hardware/software/support revenue has been in decline. X-Charge
growth has compensated leaving total revenue largely flat. The company is at a point
where hardware/software and service revenue should remain constant around $11m and
$5m, respectively. X-Charge is growing at about $1m per quarter in annualized revenue,
and should be around $15m in 2007. This represents approximately 50% of revenue in
2007 compared with 39% and 26% in 2006 and 2005, respectively. I estimate it will
reach 60%-65% of revenues in 2009.

This revenue mix change is highly significant because X-Charge is high margin (95%
GM, 65% OM), recurring revenue. Once a customer is signed up, they are unlikely to
change providers unless they change their accounting software. New software is a major
purchase for most small businesses, so unless their software provider can no longer
provide required support, they are unlikely to change. The company has some of the
lowest attrition rates in the industry, under 10%, including stores that go out of business.
Therefore, in the next few years, CADA's GM and OM will continue to expand as X-
Charge becomes a higher percentage of revenue.

Accelerating Growth
CADA currently has over 10,000 merchants with over 15,000 retail locations using X-
Charge, comprised of both their own customers and a network of almost 300 resellers'
customers. In the most recent quarter (Fiscal Q2 07), customers were added at a rate of
over 500 per month. The number of new customers each month has been accelerating as
they continue to add more, larger, resellers. The number of new quarterly installs has
grown sequentially every quarter except Q205.

While the exact market size and number of customers they can serve is not easily
estimated, Founder/CEO Geoff Knapp believes they can form relationships with at least
500 resellers. In 3-5 years he would be disappointed if they had not doubled the number
of monthly installs to 1000 per month. So while the company will begin to show
consistent, meaningful revenue growth first the first time in the next few years, it should
actually accelerate in FY08 and FY09.

Valuation Summary
I value CADA under three different Discounted Cash Flow approaches. The first
assumes that the company will continue to add customers at their current rate, growing
transactional volume by about $1B per year. The second assumes that they will continue
to increase the number of new customers per month, eventually reaching 1000 by 2011.
In both cases, I assume a constant $ and GM for hardware/software and services as well
as constant R&D spending. I assume the business could be sold for 12x the free cash
flow in 2012. I do not assume that CADA will be able to demand better terms from
GPN, however that adds some optionality to the valuation. The final version is a worst
case scenario, which is the steady growth version, but with extra attrition of 10% per

                       Steady Growth Accelerating Growth Downside
                   2006      2012           2012            2012
Customers          8500     30100          42700            21385
X-Charge Revenue % 39%        71%           79%             64%
Total Revenue    $27,212  $55,489         $74,971         $44,880
GM %               67%        81%           84%             78%
GM $             $18,247  $44,944         $63,257         $34,971
G&A              $13,393  $22,033         $27,878         $18,850
EBIT $            $3,317  $21,411         $33,879         $14,621
EBIT %            12.2%    38.6%           45.2%           32.6%
Tax Rate          38.2%    38.0%           38.0%           38.0%
NM %               9.7%    25.5%           29.2%           22.0%
NI $              $2,647  $14,130         $21,922          $9,875
NI CAGR                    32.2%           42.2%           24.5%

DCF Summary (Fully Diluted Shares, 11% Discount Rate)
Net Cash                   $5.67           $5.67           $5.67
Operating Leases          $(0.33)         $(0.33)         $(0.33)
Value through 2012         $9.20          $12.14           $7.23
Terminal Value (12x)      $22.68          $35.10          $15.90
Total Value Per Share     $37.22          $52.58          $28.46

All That Cash
While CADA already has a great Balance sheet with over $25m, or almost 25% of the
market cap, in cash (with no debt), they are now generating enormous amounts of free
cash flow. Because their additional expenses are mostly commissions, they require only
a minimal investment in working capital. Further, the majority of capital expenditures
are capitalized software costs for their accounting software. Therefore, depreciation
more than covers these capital uses and free cash flow exceeds net income. The company
does not have a use for all their cash, so as a result, they have initiated a dividend that is
at least 75% of net income. I estimate the next 12 months will have a yield of about 3%
at the current price of $28 per share.

CEO Geoff Knapp has said that they have no plans to do an acquisition, and would not
pursue one just because they had the financial ability to do so. The obvious move would
be to acquire some of their resellers; however doing so could put them in competition
with their current or potential resellers, which would not be a positive situation.
Other potential uses include a share repurchase; however the small float, limited volume,
and buying restrictions make that difficult. A special dividend is a distinct possibility,
and I would not be surprised to see one within a few years

Recent Industry Transactions
There have been a few recent transactions in the payment processing industry. First Data
and Ceridian have agreed to be acquired by private equity firms at forward multiples of
14x EBITDA and 27x earnings. Applying the same valuations to CADA gives
equivalent prices of $28-$34 based on 2007 numbers and $40-$45 on 2008 estimates. A
discount due to the small size of CADA is probably warranted, however their growth
rates are far in excess of First Data or Ceridian.

When asked why the company was public in light of Sarbanes-Oxley CEO Geoff Knapp
agreed there really was no need for them to remain so. However, he did say that
employee ownership in a public company was a motivational factor for his employees. If
he was to take it private, he believes it would be selfish to benefit the few involved at the
expense of all the other shareholders. Interestingly, in recent months the offices of CEO
and CFO have had changes made in their executive compensation packages within the
change in control clauses. They claim this is solely to bring them in line with industry
norms in the event anyone tried a hostile takeover.

Major Holders
Directors own approximately 18% of the outstanding shares. CEO Geoff Knapp owns
13%, and he had been buying on the open market when the stock was under $20. He
exercised expiring options last fall and did not sell a single share, he paid the taxes due
out of his own pocket. I do note that the dividend policy is a way for insiders to get funds
out of the company without selling shares.

The largest single shareholder is an individual named Ken Templeton. I have not spoken
to him, however he is a friend of CEO Geoff Knapp. His most profitable (public)
investment was in Las Vegas Real Estate; he built an assisted living facility for his
mother after finding the existing facilities inadequate. He sold this and is apparently
investing some of the proceeds in CADA's stock, as he was still buying in late May 2007
at almost $28 per share. He owns close to 14% of the outstanding stock.
Bares Capital, a hedge fund from Austin, TX specializing in micro cap stocks owns
almost 10%. According to Pension & Investments magazine, Bares has had one of the
most successful US Equity hedge funds over the past 5 years with average annual returns
of 24.8%.

Summary / Catalysts
CAM Commerce is an undervalued, underfollowed microcap company worth between
33% and 100% more than the current quote. The company is beginning to show revenue
growth which should persist for the foreseeable future. There is no reason for this
company to be public, however the founder/CEO has no desire to sell the company.
Investors are paid an approximate 3% dividend while they wait for the market to
recognize the value in the company.