A few points on this table:

1. You can see that all but one of the companies was ultimately acquired, and all were acquired by year 3 or early year 4. We are now in Year 3 for Absolute.

2. In all but two cases they had board representation…with GEAC, they sent a threatening letter asking for board representation, then withdrew the request, then the company was sold two months later.

3. The acquirers range from other public companies (Amdocs) to Private Equity (Golden Gate Capital, twice), indicating an ability to facilitate different types of transactions.

4. The one misfire we could find, Hip Interactive, is a video game company, an area we believe is probably a bit outside of Crescendo’s expertise and more prone to catastrophe. We would place Absolute and its characteristics more in line with Bridgewater or Dalsa.

Does this mean Absolute is definitely going to get sold? Of course not. We merely point it out to show the quality of current shareholders/Board, and to state our belief that there is a significantly higher than normal likelihood given Crescendo’s track record, combined with what we believe are desirable, cash generating (but under generating) assets and a nice balance sheet.

The CEO Search

The old CEO, John Livingston, was a co-founder with 20 years of leadership experience with the company. He resigned at the end of 2013 and a new search was put out. At the time, there was speculation that this might pave the way for a quick sale of the company. In fact, when we spoke with the IR guy this summer, before Geoff Hayden was selected, our impression was that if an “insider” was selected as the new CEO it would greatly enhance the chance of a quick sale, while if an outsider was selected it would lessen the chances.

We believe the stock has stagnated partly because of the selection of an outsider CEO, for those hoping for a more immediate sale. We agree a sale is unlikely in the next couple quarters, however, we do not think Hayden’s hiring precludes a sale in the next 12-15 months. On the contrary, we expect Hayden was brought in to hit the low hanging fruit and make a sale that much more attractive.

The New CEO’s Early Message

It is early, but Geoff Hayden (presumably with coaching from Crescendo) is saying all the right things, in our view. His public appearances have been limited to two earnings call, and a presentation at a Cantor-Fitzgerald Canada Tech conference, but have provided solid insight into the direction they are heading.

1. No acquisitions: we worry about this for tech companies with way more cash than they need. Hayden was asked about his “focus on acquisitions and adding more IP to the portfolio”:

“Certainly over time, the breadth of our technology portfolio will emerge as an obstacle to growth, but I just don't see that at all moving into 2015. I think we've got a tremendously robust, compelling, competitive set of offerings that are substantially under-realized in terms of their growth potential, and the primary focus this year was on executing against the opportunity that they represent.”

We suspect Crescendo is influencing this statement, and there was likely tacit understanding between Hayden and the board that this would not be an empire building position. The large cash balance can instead be used for other purposes, be it a special dividend or a larger buyback. In the latest quarter, the company bumped up their DPS from $.06 to $.07 and renewed their option to buy up to 10% of the public float in the next 12 months.

2. Operating Targets: for the first time we are able to locate, the company laid out margin targets at the Cantor presentation (not on the call, so perhaps still unknown to most investors). These are longer term targets in the tradition of how a high flying IPO might present them (or old company like CAT, IBM, KR), but it is still a step up from a company that spends a puzzling amount on Sales & Marketing. Below is a recreation:

We went through each of these line items with management, and were pleasantly surprised to hear how well thought out and less “hopeful” than one might imagine.

Gross Margin (+600 bps): this is primarily a function of product mix and the industry verticals where growth opportunities are more likely. Both Absolute Manage and the non-Education verticals of Computrace carry higher gross margins, as the Educational vertical is more known for opting in to the “theft protection” plan. This carries a lower gross margin % (although higher gross dollars), as they have to include recovery agents (real people knocking on doors investigating theft) in the COGS. Health Care and Government tend to care less about recovering the device and more about protecting/eliminating the data. The timing here will be gradual but should start right away. From a GAAP perspective, they have some amortization in COGS that is running off in the next couple years, and will result in GAAP gross margin expansion as well. We model slow but steady expansion here, as has been the case the last few years:

Sales and Marketing (+700 bps): spending too much on S&M has long been a bugaboo for the company and we touch on it in other parts of the report. To reiterate, they are spending 45% of sales on S&M despite a) generating 80% of revenues through OEM partners and b) generating 75-80% of revenues from existing customers. They have a three prong plan here. One is to reallocate extremely inefficient sales force to more productive geographies (New York, Texas, and Chicago were cited). The second prong is a particular strength of the new CEO, which is to develop the VAR channel further in order to effectively lower S&M expense. Finally, they are continuing an effort made by the previous CEO to make renewals less valuable for the sales team and make cross-selling and new sales more valuable. The timing here will be gradual but should begin over the next few quarters. Management has guided to a small y/y increase in S&M, but a lot of that spend will be one time brand marketing to increase commercial awareness of Computrace.

General & Admin (+300 bps): they have lowered corporate overhead fairly significantly, apparently, and believe this range can be seen almost immediately. We are modeling G&A moving to 10% of sales contracts this year.

3. 2015 Expectations: Fiscal 2015 is already underway and we are now into Q2 of 2015. The company is always coy with guidance, stating simply that sales contracts and cash flow would be higher than the previous year (same guidance as last year). However, Geoff and the CFO Errol Olsen made a pair of bullish statement about the pipeline and renewal base during the call for the upcoming year.

“The comments I'll make about pipeline based on the analysis that we've done is it's certainly richer in terms of quantity and quality than it was a year ago or a quarter ago as you'd expect…there is a concentration of opportunity in education, but as well above-average growth in pipeline, in some of the key corporate and healthcare sectors.”

On the most recent call, there was not much more added, except the CFO did state:

We believe that we have the right strategy, product portfolio and team for success, and our outlook for fiscal 2015 remains robust and on track.

And on the upcoming renewal base:

“Directionally, it is higher. Right. And with our average contract term being about two-and-a-half years, I think that if you just look at the increase, going back two-and-a-half years compared to three-and-a-half years ago it's probably directionally the best indicator there."

This is a bit rough, but based on this commentary we do believe the company probably has a 2-3 quarter tailwind of companies

renewing (e.g. the growth of customers 2.5 years ago who will be up for renewal now is significantly higher than it was entering last year). The 2.5 years number is based on the average contract length (~29 months).

Additionally, they guided to a 5-10% growth in operating expenses, which should (hopefully) be lower than sales growth and should thus provide some of the margin expansion described above.

Other Tidbits:

1. Consumer Business: they sell a consumer anti-theft product called Absolute Lojack that has declined to less than 5% of Sales contracts. We know this business is in severe decline (consumers simply do not care about their data as much, so the “persistence” technology advantage is lost for most consumers), that it loses money, and that competition is fiercer. We expect it to get nominal priority at best, and potentially get sold or liquidated, which should marginally improve underlying profitability at the cost of very little revenue. As it becomes less and less significant, it will also become less of hindrance on growth. In the latest quarter it managed to lower overall billings growth from 14% to 10% (commercial billings +14%, consumer billings -38%); however, we just lapped the last quarter of relatively “difficult” comps and future headwinds won’t be as pronounced.

2. Airwatch Acquisition: VMWare recently acquired Airwatch, a pure play Mobile Device Management company, for $1.54 billion dollars, which was roughly 15-16x sales. This is not to suggest Absolute could sell their MDM product for that much, but does indicate just how valuable firms perceive Mobile Device Management, and how hot a sector it is. Absolute management also noted that after this deal “pricing” got better, as apparently Airwatch was pricing extremely aggressively.

3. International Market: this market has been somewhat weak the last few quarters, but management claims the pipeline is stronger than ever and that some particularly large deals are waiting in the wings. Management is taking their “geographic focus” and applying it internationally, where they see plenty of opportunity in Brazil, Australia, and Asia. Certainly upside to target sales contracts could come from the International space if some of the larger contracts (e.g. $1 million plus) are consummated.

4. Screening: company may not screen as cheap on an EV basis as it actually is, given that they have $15 million of cash in “Long Term investments.” However, this is liquid and is included when they refer to their own cash balance. They state in their MD&A that their cash balance is $80.3 million.

5. Q1, 2015: was something of a non-event, as Geoff reiterated his core message and billings came in roughly as expected (cash flow was higher). Geoff mentioned two interesting tidbits, perhaps leveraging his strengths with EMC Asia:

   1. VAR Channel. In Q1, the revenues from the VAR channel were greater than the whole second half of 2014. He seemed bullish in the opportunity to leverage the VAR channel for greater S&M efficiency.

   2. New OEM Partnerships. Geoff stated he expected to announce “major” new Asian partnerships in the coming quarter.

6. Geoff’s incentives: we are awaiting a “circular” that will describe Geoff’s incentives more explicitly, and will be looking for any language on change in control payouts.

7. Taxes: They paid almost zero in cash taxes in 2014 due to R&D credits, and expect to pay close to zero in 2015. However, the CFO has said a longer term tax forecast should ramp up to 25%, which could be a longer term FCF headwind.

Valuation:

Given our expectation that Crescendo Partners will want to exit the position in the next 1-2 years, we believe a relative comp and transactions comps analysis is appropriate. However, we have also done some detailed DCF work to reflect some of the longer term margin upside we believe exists in the company.

1. Relative Valuation. The company is cheap given its profile, at ~10% FCF yield, ~4% Dividend yield, and 2x EV/Subscription Revenues. We have put together a group of software peers ranging from SaaS subscription companies that are not of the RGAAC (revenue growth at all cost) variety, along with some other security firms and a couple of other small/midcap software firms that manage to some kind of margin. A table is below.

Give our opinion that the company is about to start showing more operating leverage, 10-15% sales growth, along with the Crescendo ownership dynamic, we believe the company should trade at least close to inline to the median of this comp group. More directly, 18x FCF seems like a good starting point and yields 50% upside with what we believe is low FCF.

On the downside, we believe dividend investors would support the stock at around a 5% yield ex some kind of Black Swan event for the company. This would put the stock at $5.60 (CAD), or down 22% from current levels.

2. Transaction Comps. As we’ve mentioned Ad Nauseam, the ownership dynamic combined with the pristine balance sheet and depressed margins should make Absolute a takeout target. What has private equity been willing to pay the last few months? Here are three of the most recent pure play software comps:

We believe Absolute would sell well above the troubled CPWR but below RealPage, and probably roughly around what Tibco sold for to Vista Equity. Tibco had a similar narrative to Absolute (founder likely overspending and mismanaging, activists circling the stock, but attractive assets). A sale tomorrow at 4x sales contracts would be an ~80% premium, or about 50% using the EBITDA multiple.

3. DCF

We have included a 5 year DCF Base Case (and Bear/Bull in the Appendix). The key points on the DCF are as follows:

1. Billings Growth this year stays at the company’s longer term CAGR (~10%) despite consumer becoming less of a tailwind and a larger base of customers up for renewal this year than last year. This imbeds reasonable conservatism, although we’ll leave the real conservatism to our Bear Case. Growth then steps down each year until 2019.

2. Given our opinion that S&M is inflated, we model lower S&M as % of billings over the next 5 years, as growth in S&M is muted while billings rise.

3. We model a steadily increasing cash tax rate to management’s 25% target.

4. We believe we are being a bit high on capex in 2015 and beyond.

5. Gross margins rise slowly as mix slowly changes each year

Risks

1. Chromebook: hard to quantify is Google’s inroads into the Education market. Chromebooks are building market share in the Educational market, with some sources claiming they jumped from 1% to nearly 20% of educational shipments in 2013. Balancing that worry is Absolute’s strong recent performance in Education, with Education growing 37% y/y in Q1. Additionally, there is no reason their persistence technology could not be placed on Chromebooks, as Chromebook manufacturers are the same partner base that makes the laptops. We would point out, though, that Absolute specializes in protecting local data, while Chromebooks champion keeping data out of harm’s way in the cloud. In other words, the value proposition for Computrace on Chromebooks (or any cloud device) may not be as strong as on laptops.

2. Sell side sentiment: while the stock is relatively underfollowed in the US and by larger shops, it does have coverage from 7 smaller players (most notably BMO), who all have Buys on the name. We tend to steer clear of stocks with universally positive sell side sentiment, as it can only go one way generally (down).

3. Sales Disruptions: as mentioned before, they are moving around sales people and setting up a renewal center for lower value customers. This always has the chance of hitting some sales in the short term, as people changing geographies don’t make new sales right away while potentially losing the sales they could have had in their previous geography.

4. Cash flow: cash flow has been relatively stagnant, particularly from 2013-2014 at around $17 million USD. This occurred even as Adjusted EBITDA rose 23% Y/Y. The discrepancy is accounted for by a negative $4 million hit in working capital. We expect several factors to help cash flow this year, from the higher renewal base this year to the more prudent cost management to some working capital improvements. Nearly $9 million in CFO in Q1 gives us quite a bit of confidence they can hit over $20 million in FCF (current estimates at $19 million). Per management, capex will be slightly elevated this year as they complete a server refresh.

5. Canada/Dollar: as a Canadian stock, the company can be (perhaps unfairly) moved with energy stocks, which occupies a large percentage of Canadian market cap (along with Financials). Of course there is also general currency translation risk.

Appendix