At first glance, enterprise content management provider Hummingbird
Dig a little deeper and you find that the company has generated large amounts of free cash flow over the past few years despite relatively weak GAAP net income earnings. The reason for this is large amounts of depreciation and amortization being offset by relatively small amounts of capital expenditures.
It's the same story in its fiscal second quarter as it has been for the last couple of years, with the exception that sales came in flat, and gross margin came down a smidgen but is still outstanding at 88%.
On the bottom line, the company turned in earnings per share of $0.07 against last year's $0.12. Of course, the company would rather you pay attention to its adjusted earnings, which basically add back the depreciation and amortization expenses, as well as restructuring costs and the tax effects of the two. If Hummingbird included capital expenditures, I'd be OK with this calculation, as it would essentially be a reasonable form of free cash flow. Sadly, Hummingbird doesn't include the capital expenditures in its calculation of adjusted earnings.
It's at this point that I begin to sour on the company as a long-term investment. I'm all for adding back the depreciation and amortization, but to leave out the capital expenditures in such a calculation is a bit disingenuous -- particularly for Hummingbird, which owes the majority of its depreciation and amortization to acquisitions and technology that it has purchased for sale.
Given that the company has mentioned it is interested in pursuing more acquisitions, this leaves me with two methods that I see as relevant for getting a true valuation on Hummingbird. The first would be to take the average free cash flow going back to at least 1999 and use that as the historical basis before going forward and estimating future free cash flows. The second would be to use the company's GAAP net income earnings, because they reflect the previous acquisition spending that makes up 40% of the assets on the company's balance sheet.
The other item that weighs on my mind as I consider Hummingbird is the competition in the enterprise content management industry. EMC's
In the end, it's not that Hummingbird is a bad company; it's just not as cheap and intriguing as it seems at first glance, and it operates in a highly competitive space.
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Fool contributor Nathan Parmelee has no financial interest in any of the companies mentioned.