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GLH - Global Health

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Elliot

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Sorry for the newbie question, GLH released an announcement on the 7/3/2013 10:02:01 AM mentioning of a an earning upgrade I am just trying to understand what and how exactly did the share price increase if it was not driven by volume. There Share Price is .090 after the ann they made, before that it was .025

Announcement - http://www.asx.com.au/asxpdf/20130703/pdf/42gv6kfkx702t7.pdf

Thanks in advance
 

Ive watched it for ages and and is just too illiquid to touch. Keep in mind it used to be at this price and only about $500 of stock changed hands for it to fall to 2.5c. So theres nobody out there making a killing on those movements.

Would have been a good one for the stock tipping comp....why oh why did I overlook it for another healthcare stock!
 

Right I see, due to its illiquid state it prices drops and price jumps. How many ordinary shares are unlisted ?, I can't seem to find it in there 2012 Annual Report.
 

Update - Still too illiquid but has been kind to those who have been in it since the last post....

 
I’ve seen Global Health (GLH) mentioned a lot in the last month or two… so thought I’d take a peek at the financials as on current / forward earnings it didn’t look incredibly expensive at first glance.

Global Health is an IT company that develops cloud based and electronic database management software and licenses it to medical professionals and hospitals. The main benefits are increased efficiency in both storing and accessing patient information, as well sending it and receiving it from other medical offices (ie. Referrals, patient medical histories).

GLH charges an upfront licensing fee to new users, and then charges on-going software maintenance fees (for which the user receives on-going product support). GLH claims that 80% of this revenue is recurring. The big advantage is that customers in these industries are “sticky” as there are high switching costs, so to speak, both quantifiable (ie. Paying a new license fee for another software provider’s product) and those below the surface (retraining staff, changing internal systems etc).

Like other software development companies GLH has a fixed cost base, which is a double-edged sword. The risk being that revenue needs to exceed this amount for it to be profitable. There's few levers they can pull if revenue slides below costs than in a variable cost business. The upside being that there is a high amount of operating leverage if they achieve the necessary scale for their revenue to far outstrip their fixed cost base. I note that they have significantly reduced their fixed cost base in recent years to a refocusing of their business model and choosing to exit some areas.

Profitability is chalk and cheese in this company. On-going maintenance revenue provides stable cash flow, but in this and other companies in the same sector, there is no money in it (a look at the revenue split vs fixed cost base confirms this). Its sole purpose is to keep the customer base happy and ensure that they don’t leave due to poor ongoing product satisfaction.

The real cream and where the profitability and much of the risks in this business come from are in the software development cycle. Like all software whether it be Quicken or MS Office, there will be new versions under development and released at regular intervals (say every year or two). The greater the frequency the better, as GLH charges an upfront license fee for each new version of its existing products or each new product it releases.
If you look at the revenue break up in the 2013 annual report, the increase in license fees by 800k over the previous period is where a lot of the profitability growth can be found.

There is also $300k of government grants, which I would not count on GLH receiving forever and would omit from any calculation of their earning power / sustainability of profits.

Together new licensing fees and the government grant accounts for much of the current profitability.

So what are the risks to this business model of reaping license fees from each new leg of the software development cycle?

The main risk is that each development cycle needs to be funded by the bounties extracted from the previous development cycle in a business of this size. They spent around $825k last year on R & D which highlights this point. Only $100k or so was expensed. This is the elephant in the room for me – how much the current profit is actually economic profit and how close is the R & D expense of $125k that they have expensed to the actual R & D requirements of this business? The business model implies that they are reliant on future licensing fees to achieve scale and to increase profitability. I believe that $125k amortization that appears in the P & L is far shy of the underlying economic reality and it obviously has to be expensed at some point in time or another.

The chairman’s address at the 2013 AGM stated that 20% of revenue going forward will be dedicated to R & D. If this is between $900k and $1m in 2014, and if you do not include the $300k grant, then that almost wipes out the current reported profit. It’s not so much that they are investing excess profit as discretionary R & D, it almost functions as a quasi “stay in business” capex, because it is essential to the on-going sustainability of their business model. They don't really have a choice, it's not they choose to not return money to shareholders, it's they cannot return it.

What I’m trying to say is that in a P/E of 8, if earnings are over-stated by capitalizing $500-800k of development costs, then only $1.3-$1.5m of profit this quickly turns into a P/E 16, 20… and so on.

The biggest risk in a company like this is probably not a rapid loss of their client base, but low returns on the money that is continually ploughed into R & D. If the future versions of the software are not that great or they spend too much developing them, then current clients will not purchase them and profitability from licensing fees will diminish (a lot of analysts are arguing that this is currently the main threat at Microsoft). If profitability from a future development cycle is underwhelming, then they may need to find alternate funding for the development cycle after that….

Taking all of this into consideration, I just don’t think this is as “safe” or “cheap” on a risk-adjusted basis that a lot of people are currently assuming.

But, that being said, if GLH does get it right, and achieves scale in their offering, then the operating leverage and “royalty” nature of the revenue stream will make this a very profitable business.

I hate paying for blue sky and hope though. So count me out.
 
Ves said:
I’ve seen Global Health (GLH) mentioned a lot in the last month or two… so thought I’d take a peek at the financials as on current / forward earnings it didn’t look incredibly expensive at first glance.
Click to expand...

Great unbiased and informative post VES. Have read it a couple of times already

I agree with your statement about R&D not being fully expensed, it does create additional pressure for GLH to generate earnings on this additional capital (or else suffer lower return metrics and face expensing a big wack in a write down). However on the flip side, if you have faith in management you will be confident that the reason the company is comfortable capitalising their R&D is due to their expectation of additional earnings as a result of the "capex".

Your post is terrific as it puts this risk out on the table and forces investors to contemplate how they feel with their judgements on the earnings potential of the R&D.
Perhaps this would be a good question to put to management, especially if they don't start delivering over future reporting periods....
 
The more I ponder these kinds of software companies, the more I seem to realise how hard it is to make reasonable assumptions about the future cashflow.

The growth vs maintenance distinction is very blurry because of the nature of the capital in their business. Software by definition is almost always finite in nature and should be valued as such… how many pieces of software have you used in your life that have been able to survive over the long-term version after version like clockwork? I think that’s why Buffett avoided Microsoft and such companies at the time, massive potential, but so many unknowns with plenty of risks… the randomness of life means that so many different scenarios could have played out, but of course only one did. For every Microsoft there are literally thousands upon thousands of examples of the contrary. Throw on top of this that technology and the way we consume it rapidly changes, the cards are stacked to the downside.

This probably tells me two things (if you accept that it’s a hard gig, but want to value GLH and invest in it based upon a set of assumptions):

• P/E ratios and other forms of perpetuity calculations probably aren’t relevant - the cash flows are by the definition of their risks closer to a mine-life / product cycle. Which means that to be good investments they need to generate super profits in the short-term to compensate for their finite life span.

• Most of the capex, even if it is growth, will be used to produce new software / ideas that may not even see the light of day.

Management may have a practical industry view of R & D (ie. new software versions are exclusively for growth), but don’t confuse that with the finite nature of each version and the cash flow it produces when making your own determination!

Good luck, these companies are great learning exercises.
 

I think you'd actually be surprised how much life a company gets out of their corporate, mission critical software. Changes to these software tends to be evoluationary... a patch here, upgrade there, new modules etc.

Believe it or not the major banks still use softwares that have their core from the early 90s. When I opened an account for my company with Westpac last year, the account manager went through no less than 30 screens, re-entering very basic information (like personal particulars) over and over again across multiple systems, with some screen in the old green DOS based interface.

Having said all that, treating R&D spend as expense at all times is no doubt the more conservative way of valuing a company. I think Technology One does that with their spend and is often cited as a well managed company with high quality earnings.
 

Agree. Although I think the most important thing is consistency. Despite being conservative in one way, expensing all R&D is a way for the company to keep a lower amount of invested capital - thus boosting return metrics like ROC. As long as you are consistent in valuations and normalise these figures across companies then it shouldn't be a problem.


I also agree about the major banks. Having worked for one of the big 4 I can tell you that while they are using cutting edge tech for some parts of their business (mostly those that can impress a customer), alot of the back-end stuff is still ancient. The fact that windows 98 is still being used gives you a hint at how much it must cost for these companies to upgrade their entire suite
 
Thanks SKC - in a sense that is exactly what I'm saying, unless GLH is able to build a big premium into the monthly / annual subscription costs and / or get doctors and hospitals to pay this for some indeterminable period when they first sign up, then they will be relying on extracting lumpy cash flow from each new software development cycle to fund the next wave of development and so on to reach long-term profitability. If doctors, like banks, are slow to embrace new technology, but the companies major profitability point is re-inventing its software on a fairly frequent basis (which it appears it is to me), isn't there a conflict in motives that may impact on the long-term sustainability of their business model?

Maybe I'm missing something.
 


I am not sure where you arrive at the above conclusions.

1. One-off signup licence fee and its growth can come from new clients as well as new versions of software.
2. I couldn't find any mention of how new version of software is actually charged. It's not uncommon to offer free upgrades as part of the contract in this kind of software businesses.
3. Most of the fixed costs is simply headcount and from what I've seen it's not possible to attribute this costs to "sale of licences" vs "maintenance contracts".

So I don't know "there is no money in maintenance" is true or not, and I don't know if on-going release of new versions is that important to the generation of "sale of licence" income line.

The stickiness of clients to a particular software is a bit of a two-edge sword. Yes once signed up clients don't tend to move away unless you really screw up, on the other hand, you'd need a clearly superior product to lure existing operating businesses away.

If I was running a software company like this, I probably would live with fairly average returns on my initial licence sales, and I'd focus on right sizing my organisation to earn a decent return on the ongoing maintenance. Put another way, I'd sell the Nespresso machine at a discount, but get a healthy margin on those little coffee capsule thingys. It would be the completely wrong business model to rely on new versions of the Nespresso machine to grow my profits, and I'd be surprised if that's GLH's intent.
 
Hi again SKC,

I may be wrong in my posts - it is also possible that the licence fee is received as part of the monthly / annual contract payment in terms of cash flow. Their website seems to indicate this.... apologies if I've misled anyone.

However, my understanding was based on the accounts where after reading the notes it looks like they include it as revenue upfront in terms of recognition. Which is why there is a big acceleration in 2013 v 2012 because sales picked up, and maintenance revenue has barely moved at all.

I think more than anything it will become much clearer over time.... but then again, the market also benefits from that increased certainty, some may prefer to get in early as they see enough potential.

I agree that new customers also help increase revenue and profitability, and that's why I mentioned scalability of the business model and the tremendous operating leverage in these kinds of companies. Any long-term investment thesis would be based upon this turning into reality because the investor thinks the software being developed has a long-term upgrade & life cycle, where profitability far outweighs R & D & fixed cost commitments.

But this is still based on the software development cycle and the R & D expenditure required.... you're obviously much more likely to buy new edition software than something that is now a few years old (especially if competitors have newer alternatives and your software does not have any real competitive edge). That's what I'm getting at - you cannot just shut down your R & D team - it constantly has to re-invent and optimise the software, it's an ongoing cash outflow, and in most cases it shouldn't be capitalised because without it your current profitability is impacted.

Re maintenance - Nescafe analogy doesn't make sense to me. When you're paying a software company a maintenance cost you're really just outsourcing the IT support for their software to them, rather than doing it yourself. It's their job to make sure they address any issues you have with the ongoing operation of the software and to perhaps provide answers to queries on how best to use it in certain scenarios etc. It's not really a value added product, like buying extra coffee to consume, or extra razors such as the Gillette business model IMO. I realise that that's obviously a matter of opinion.

Obviously... if they charged a yearly fee, and locked customers in for a long period of time and didn't really charge a license fee then that'd be ideal and that is probably what they're doing. Maybe that's what you meant. But as above they still need to develop new software and spend R & D to increase their client base.

I actually have a close friend who works for Argus (a competitor with similar products) that confirmed my suspicions regarding the profitability and function of the maintenance service. He said the money is in developing and selling the product, not offering support for it. Take that with a grain of salt, and DYOR.
 
Ves said:
Hi again SKC,

I may be wrong in my posts - it is also possible that the licence fee is received as part of the monthly / annual contract payment in terms of cash flow. Their website seems to indicate this.... apologies if I've misled anyone.
Click to expand...

This from the annual report p.37. Note the term "product enhancements". Does that mean ongoing software updates? Don't know...



It's definitely about value add... it doesn't sound like the maintenance fees are discretionary. A company buys the software and it pays for ongoing support. GLH will simply charge a margin above what it costs them to provide the support. The demand is easy to predict and so it's easy to resource. The margin can cover anything from corporate costs, R&D spend and net profit

Anyhow... I don't see anything particularly wrong or different in its business model compared to most "software as a service" type companies and I don't see anything to suggest the statement below is true. To me R&D spend can easily be funded by a combination of initial licence and ongoing maintenance revenue.



That's interesting to know. Although I will take it with a grain of salt Depending on their level within the organisation they may or may not be an informed view.
 
SKC - thanks for the robust and friendly discussion.

It's possible that I did misunderstand a few things in terms of the way they are charging for their software. And after reading your post and again consulting the website it appears that you're correct, the customer pays an yearly fee (not sure if timing of payment is monthly instalment or yearly). Which is as you say is probably pretty standard across the board these days in software companies.

My understanding is that a product enhancement is a minor addition or improvement to the latest version that could not be marketed as an entire release on it's own. It's just a patch with say a new button or feature or something that isn't too substantial. Most companies will have say V1.0, V1.1, 1.2 etc etc I know that's how the accounting software provider our firm uses does it.

I'm still standing by my comments that capitalising the R & D expenses is wrong though because of the nature of the business.

Forecast profit is $1.5m. Let's say that includes similar development expense to 2013... of around $100k. Add back in $750k development costs so it's a total of $850k development costs (company said R & D will be 20% of revenue at the AGM). Similar to 2013 also. That's $750k profit. 2.3c earnings per share. P/E of 14-15 on current price. I'm also assuming that it includes the government grant again?? Is it conservative to leave this out? It's almost half of the revised forecast profit! Lots of questions that need to be answered before diving into this one IMO.
 
Ves said:
SKC - thanks for the robust and friendly discussion.
Click to expand...

Same here. You made me actually read the annual report in detail.


Remember I am not saying you are wrong, I just don't see evidence to conclude that you are right. And I don't see any logic to support your assertions that R&D funding relies solely on new licences. Although the anecdote from your friend in the industry should be kept in mind if he's indeed an informed person.

Ves said:
I'm still standing by my comments that capitalising the R & D expenses is wrong though because of the nature of the business.
Click to expand...

No disagreement here. This boils down to the issue of value as opposed to business model. As you said, the cashflow vs NPAT comparison over the next few periods will reveal the story. IMO the current price is reasonable in the current market, given the operational leverage potential and a pretty clean balance sheet.
 

I was once sitting through a course on project change/management and the speaker was regaling a tale of an Australian bank that tried to upgrade its systems a long time ago; blowing millions (this is a while back); and never dreaming of doing an IT upgrade again...
 
Ves said:
I hate paying for blue sky and hope though. So count me out.
Click to expand...

Hi V great post - maybe because we tend to think pretty much along the same lines it really appealed to me.

Previous, expensing of R&D run up accumulated losses of 20Million. Changing to capitalisation of R&D just shuffles the numbers from the P&L to intangibles on the balance sheet. If the excitement about this one is that it’s about to start making an economic profit I hope that’s based on more than the superficial numbers.

In saying the above, getting in when the investment phase is just about to start paying off can be very lucrative - I can attest to that with ALU.


ps.
I know nothing more than a 5 minute look at the last report – which indicates it doesn’t suit me at this stage, but that doesn’t mean anything about the suitability of GLH to others.
 
thanks for the quality discussion guys, an example of what makes this site great and a valuable lesson in attempting to value these sort of companies.
 
craft said:
In saying the above, getting in when the investment phase is just about to start paying off can be very lucrative - I can attest to that with ALU.
Click to expand...

Welcome back Craft. I was looking through my notes the other day and and this is what I had on ALU (April 2011 at the time it was 16c).

102.5m SOI. Cash US$5m. HY Loss $2.5m. Growing revenue + growing platform software => scale benefits will build if successful. Conclusion: Wait for next result
Click to expand...

Not sure what happened but I never got back to it. ALU last close was $2.56 for the record

I think there's merit in a strategy where you plant seeds in various stocks of such nature... you don't need a high hit rate to earn a decent overall return, but you must also be prepared to hold, perhaps through a few up and down reporting periods.

P.S. SOI = shares on issue
 
Looking at the latest result shows that GLH have amortised $105k in this half compared to nil in the previous half.
They did amortise $105k in H2FY13 so will be interesting to see what they amortise for the second half of this year.

Despite this increase in amortisation, the intangibles are still growing as the $105k amortisation compares to $435k in reinvestment for software development over the half. Not flagging this as a problem (see above for relevance) but it's a good case study to keep track of.
 
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