A Software Company's Cloudy Picture

 | Jul 26, 2013 | 2:30 PM EDT
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A 13D filed with the Securities and Exchange Commission revealed that Altai Capital Management owns 3.6 million shares of IntraLinks (IL), the $540 million market cap cloud-based software company. That is 6.4% of the total shares outstanding.

This is up from the slightly more than three million shares of the stock which the fund had owned at the end of March, according to its most recent 13F filing. It looks as if IntraLinks is now one of Altai's five largest holdings by market value.

While IntraLinks' market capitalization is less than $1 billion, on average more than 300,000 shares of the stock are traded per day. With its stock price approaching $10, we would say that there is plenty of daily dollar volume.

The company's products allow enterprises to manage content and for their employees to collaborate from remote locations. Its stock price has risen about 140% in the last year, though it remains unprofitable. The SEC recently dropped an investigation into some of the company's secondary offerings from 2011, and this action has helped the stock to rally strongly over the last month.

In the first quarter of 2013, IntraLinks grew its revenue by 8% vs. a year earlier. As we've mentioned, profits were negative. The improvement in the company's net losses was small, with $6.3 million in pretax losses as opposed to $6.8 million in the prior year period.

Cash flow from operations was positive, an improvement from the first quarter of 2012 -- although the combination of capital expenditures and capitalized software development costs used up roughly all of the cash IntraLinks generated. The company had about $75 million in cash, cash equivalents and investments on its balance sheet. Even if cash flows dip slightly negative for a period, management should have enough liquidity.

Wall Street analysts consider the company to be slightly profitable in adjusted earnings terms. They predict adjusted earnings per share of 12 cents for this year. At the current stock price, however, that makes for a high current-year price-to-earnings multiple. IL closed Thursday at $9.85.

Consensus forecasts for 2014 are for 17 cents of earnings per share, implying a forward price-to-earnings ratio of 58. That is an aggressive multiple for a company seeing low revenue growth. From a value perspective, IntraLinks seems like a speculative buy.

We'd guess that many bulls on the stock -- including Altai -- are looking for IntraLinks to be a potential acquisition for another cloud software company. The SEC investigation would have been a serious source of uncertainty for a potential acquirer, who may have found themselves financially liable for any wrongdoing by the company's management.

Large enterprise software companies such as EMC (EMC) and Oracle (ORCL) have been making investments in cloud computing, as have more generalist technology giants including Microsoft (MSFT) and IBM (IBM).

EMC recently reported excellent results for the second quarter. It was led by its cloud software unit and supplementing that segment's growth through acquisitions may be a wise strategy. It's also widely known that technology companies generally have large cash hoards at this time. It's possible that one of them could be convinced that through synergies, or other factors, it may be worth it to acquire IntraLinks for a premium to the current stock price.

Management of an acquirer would have to be confident, indeed, to pay an even higher multiple on IntraLinks's weak financial results than is being offered in the market.

It is speculative to buy a stock on the belief that growth rates will increase enough to justify a valuation of nearly 60 times forward earnings estimates. It is just as speculative to buy a stock hoping that the company will get bought out.

We would not follow Altai in buying IntraLinks, and would assume the absence of a deal until any actual talks or the hiring of a sell-side advisor is confirmed.

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