After a few years under private equity ownership, financial software business Bravura Solutions looks set to return to the ASX (ASX:ASX).
Up until October 2013, Bravura was a listed business. Then private equity investor Ironbridge Capital acquired it at a valuation of $172m (Ironbridge bought a controlling stake at lower prices in the depths of the financial crisis, so the actual cost was significantly less than $172m.) Now Bravura is worth $430m, at least according to Goldman Sachs and Macquarie Bank (ASX:MQG).
Sound familiar? Like Dick Smith and Spotless (ASX:SPO) before it, an immense amount of 'value' has been created in a very short time. Anchorage Capital may get the private equity gong for whipping $400m out of Dick Smith in two years, but Ironbridge’s effort of $258m in three is no slouch.
Top tier business
So, another float to avoid, right? Not so fast. Bravura is far from the next Dick Smith.
Whether you strolled the aisles or perused the financial accounts, Dick Smith was inferior to its main competitor JB Hi-Fi (ASX:JBH) in almost every respect. As for Bravura, when we could last compare accounts (2013) it was bigger than rival GBST (ASX:GBT). The early release of Sonata, the company’s leading wealth management software, may have extended that lead. This is no second-tier business.
Dick Smith’s weak competitive position also translated into weak financial performance. It was a dud when Woolworths (ASX:WOW) owned it and no better as a listed business, despite the accounting alchemy that to some suggested otherwise. Bravura, on the other hand, has consistently delivered cash, as Table 1 shows. While creative accounting can make a dud business appear profitable in the short term, it’s much harder to fudge the cash flow figures.
The final difference is perhaps the most important. Anchorage made its money selling a dud business at an inflated price. Ironbridge, on the other hand, looks set to sell a very good business at a fair price, or thereabouts. Ironbridge’s oversized profits come not from juicing up appearances but from buying Bravura for an absolute song in the first place.
Equity market investors place too much emphasis on reported profit. The Bravura takeover was a classic example of private equity exploiting this to good effect. Due to intangible impairments and high amortisation, you could drive a bus between Bravura’s reported profit and its cash flow figures. In the five years before the takeover, Bravura accumulated bottom line losses of $26m but generated $89m of cash flow.
|Year to June||2009||2010||2011||2012||2013|
|Net profit ($m)||2||(13)||(21)||5||2|
|Op. cash flow ($m)||13||14||16||21||26|
The cues from the income statement suggested a bleak future, which is why the company’s market value stagnated at around $100m for years. That allowed Ironbridge to mop up the rest of Bravura it didn’t already own at just seven times cash flow. And that’s after paying a 65% premium.
To put this multiple in context, peers such as Iress (ASX:IRE) and GBST currently trade at around 20–25 times cash flow. So while Ironbridge has made a killing, chalk it up to an exceptional purchase rather than exceptional ownership and sale.
This was only possible because the income statement masked economic reality, and equity investors didn’t bother connecting the dots. That’s unlikely to continue, especially as Ironbridge has every incentive to ensure Bravura’s true earnings power is up in lights in the prospectus.
With Bravura’s peers trading around 20 times earnings, each dollar of profit improvement could translate into $20 of market value. Here, Ironbridge might return to the private equity playbook, writing off the historical intangible balance and expensing the development that has occurred since 2013. Reported earnings could therefore be boosted by minimising amortisation.
Of more importance is the extent to which intrinsic value has increased under Ironbrdge’s ownership. Arguably worth around $350m prior to purchase, the growth since then will be a good indicator as to whether the float is a good one or not.
Profit can be rubbery but revenue growth much less so. Bravura generated $125m in 2013. GBST’s 30% growth since then will be an important benchmark.
Generally, we aren’t fans of IPOs. The odds are typically stacked in favour of the seller rather than the buyer. But at the right price Bravura could be worth a look. When the prospectus is made public we’ll be sure to let you know if it is.