Via value based research firm, Prescience Point Research Group
We believe shares of Fleetmatics Group PLC (“the company”, or “FLTX”) are grossly overvalued, reflecting few, if any, of the serious risks that warrant questioning the credibility of the company’s financial statements. In this report, we discuss the company’s use of various accounting shenanigans that inflate profitability, the material weaknesses in its internal controls, the inexplicable discrepancies between related accounts in its financials, and Fleetmatics’ founding backer’s ties to a previous accounting fraud. According to our analysis, Fleetmatics’ 2012 gross margin was inflated by 400bps and reported Adjusted EBITDA and Adjusted EPS were overstated by 27% and 33%, respectively. We believe the company faces many headwinds, with its vehicle churn rate set to continue accelerating in 2H’13 and beyond; as churn picks up, FLTX is forced to accelerate its deferred costs, potentially resulting in both a revenue and a margin contraction problem, at the same time.
We believe the company has presented itself to the investing public in a highly questionable manner and that, as a result, it has been successful in its efforts to inflate its stock price beyond any reasonable measure of valuation, enabling its insiders to cash out big before the cards come tumbling down. Based on our analysis, Fleetmatics’ stock has an intrinsic value today of ~$11 per share, ~75% below current trading levels.
Accounting shenanigans distort Fleetmatics’ true economics – FLTX appears to be inflating its GAAP and non-GAAP financial metrics with an aggressive cost capitalization strategy that results in a highly misleading reflection of its business model and economics, and that render its reported financials ineffective toward evaluating its business. Several accounting policy levers pulled in unison have enabled the company to report inflated reported Gross Margins, Adjusted EBITDA, EPS, and Operating Cash Flow. We also believe FLTX’s reported vehicle churn rate is set to continue increasing in the back half of this year, resulting in the unwinding of financial statement benefits previously reaped through aggressive accounting policies (i.e. contracting revenue growth and, coincidentally, contracting margins).
FLTX’s original backer and long-time board member is tied to a fraud perpetuated by his former company Smartforce PLC – FLTX was originally backed by Oyster Capital, the private investment entity of Irish businessman Bill McCabe. Mr. McCabe had previously founded and served as CEO & Chairman of SmartForce PLC an e-learning company that twice settled on charges alleging fraud. The lawsuits claimed that SmartForce capitalized expenses that dramatically inflated its financial results, backdated revenues, improperly booked revenues from multi-year contracts, and issued materially misleading statements to illicit gains from sales of stocks.
Mr. McCabe sold his FLTX stake to a private equity group and resigned from its board in 2010, but would continue his involvement with the company through 2012 via an opaquely structured Management Services Agreement executed by and between FLTX and a separate entity affiliated with him. This agreement was structured to terminate in 2014, but was prematurely terminated on August 20, 2012, immediately preceding FLTX’s October 5, 2012 IPO; the timing indicates Fleetmatics sought to distance itself from McCabe so as not to draw the kind of scrutiny it might have drawn were he still associated with the company. Regardless, Fleetmatics’ severing of ties with him immediately ahead of its IPO appears suspicious and begs the question: Is there anything to hide?
Beyond our study of the legal suits brought against him, we are neither certain as to how hands-on Mr. McCabe was in perpetuating any wrongdoing alleged upon him, nor have we formed any opinion; in light of the numerous allegations of accounting frauds committed, his close association with Fleetmatics since its very beginnings, and FLTX’s choice to adopt aggressive accounting measures that obfuscate its profitability, we must acknowledge our belief that FLTX has an elevated risk profile.
Material weaknesses in internal controls leave open the door for frauds and improprieties – Based on experience from having been at the forefront of exposing scores of fraudulent, US-listed Chinese reverse-mergers, weaknesses in internal controls are amongst the most glaring warning signs in public companies; they leave the door wide open for frauds and other improprieties to be committed. Fleetmatics’ deficiencies are significant enough to have necessitated the restatement of certain 2011 and 2012 statements of cash flows and to have been highlighted as one of the company’s highest risk factors, something we find atypical. Further, we have identified significant inconsistencies between the company’s PP&E and capital expenditure accounts. We are not certain of why the discrepancies exist, but in light of the company’s choice to adopt aggressive accounting measures that obfuscate its profitability, we must acknowledge the risk of an attempt to artificially boost EPS.
Beyond the pitch – Management’s investor pitch is in part centered on the claim of a $30 billion global market potential for fleet tracking solutions in the small and medium business (SMB) market; they also point to very low levels of current penetration for fleet telematics solutions, implying sustainability in the company’s growth trajectory. These numbers provide little informational value toward understanding FLTX’s prospects. The market penetration of fleet telematics services amongst SMBs is low for a reason, and it is likely to remain so: FLTX’s primary end market of SMBs operates on thin margins, with high business failure rates, and low technology adoption rates. The results of a survey published by Automotive Fleet magazine indicate that of SMBs with less than 100 vehicles in their fleets, 80% are not considering telematics and only 15.7% who aren’t current users are considering telematics. And FLTX faces a high risk of failure due to an intensifying competitive landscape characterized by low barriers to entry, limited product differentiation, and intensifying price pressure. FLTX’s key hardware and network suppliers are now directly competing against the company.
Management’s reported gross churn metric is distortive and understates true churn – In the first two quarters of 2013, Fleetmatics reported an annualized gross churn rate of 8-9%. They use an ‘aggregate gross churn rate’ calculation, which for a fast-growing aggregate customer base, like FLTX’s, will understate the true churn rate compared to a cohort based approach to the calculation. Using the cohort approach we estimate the FLTX’s ‘true’ gross churn to be 20-25%, indicating management’s figure understates the churn rate by >50%. 20-25% gross churn seems far more appropriate than the reported figure for a company whose primary end market consists of SMBs. Our calculation implies FLTX’s average customer life is 4-5 years, as opposed to the company’s claim of a 6 year average customer life. Our 4-5 year customer life estimate also matches up with that claimed by FLTX’s closest comparable MiX Telematics (MIXT), a pure-play fleet telematics company.
Churn set to acellerate, and Revenue Growth to Slow in 2H’2013
FLTX’s reported gross churn rate rose from 6.7% to 8.4% in the 4 quarters from Q2’2012 to Q3’2013. We expect its reported gross churn rate to continue accelerating in 2H’13 as increasingly larger numbers of its customer contracts begin to expire relative to the size of its vehicle base. If vehicle churn were to increase as a percentage of FLTX’s entire vehicle base without an accompanying acceleration in revenue growth (as we discuss in the sections that follow), the dodgy accounting that may have facilitated FLTX’s easy VC exit comes back to haunt, as the negative effects from the capitalized cost write downs begin to outweigh the margin benefits from signing new customers: The benefits previously realized from these policies come unwound, resulting in a disproportionately negative impact on profitability, or deflated margins.
FLTX is overvalued, and on almost every metric – FLTX has gone to great lengths to dress up a capital-intense software company with low entry barriers as a high margin SaaS company. Sell-side analysts have obliged, with a consensus stock price target of $44.75 based on premium multiples. Regardless, FLTX’s stock price has blown through the consensus target, currently trading in the $46 – $48 per share range, and appears on the surface to be very richly valued, trading at 9.5x and 30x 2013E revenue and reported Adj. EBITDA, respectively; but, because FLTX is aggressive in its use of cost capitalization accounting, its reported Adj. EBITDA calculation does not reflect the true costs of its business, meaning that its stock’s nosebleed 30x EBITDA valuation is understated relative to its economic reality. By adjusting FLTX’s financial statements for its aggressive accounting policies, we calculate that FLTX is selling at true 37x 2013E EBITDA… truly preposterous. Fleetmatics’ comparables in the mobile asset tracking and GPS services markets trade at approximately 2.0x and 12.5x 2013E revenue and EBITDA, respectively – much lower valuations; a plethora of recent private deals in the sector also warrant dramatically lower average multiples – 2.6x and 9.1x LTM revenue and EBITDA, respectively.
Follow the money! Insiders cashing out – The truth is between the lines. FLTX’s equity appears inflated beyond reasonable measure, explaining why its largest shareholder and management team have rushed to liquidate their holdings at prices ranging from $17 and $46 per share in 3 secondary offerings all having taken place in less than a year (January, July and September, 2013). In less than one years’ time, the company’s largest shareholder has liquidated $760m worth of shares, reducing its equity ownership to just 1.6% from 94.6% pre-IPO. Management has sold shares alongside its anchor shareholder, collectively reducing their ownership from 6.3% at IPO to 4.2%. The mirage of FLTX’s reported gross margin, EBITDA, and EPS, has existed for long enough to keep the stock price levitated and for insiders to dump their holdings at inflated prices, leaving shareholders holding the bag just as the business appears to be peaking.
We have heeded the signal from insiders’ departure and have connected the dots for shareholders. We are short share of FLTX.
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