Ebix Inc (NASDAQ:EBIX) stock has tanked since Goldman Sachs cancelled its buyout plan, and Gotham City Research issued an extremely negative report. Shares of the company are down close to 60 percent this week. Many have debated back and forth whether the company is a value stock or value trap.
Nicholas Wesley Yee, Equity Analyst, Gradient Analytics is of the opinion that EBIX could be in big trouble. Below is the latest commentary from the analyst.
Ebix Inc. (EBIX) has benefited from a single-digit effective tax rate (ETR) in eight of the last 10 years. Moreover, during the last 10 years the firm’s median annual ETR was just 5.1%, with a range of 1.1% to 14.8%.
EBIX’s unusually low tax rate contrasts sharply with the ETRs reported by peers. Additionally, the firm had the lowest ETR of its peers in nine of the last 10 years, with an average difference of 2,860 bps below the peer median.
EBIX: CAUSES OF THE FIRM’S UNUSUALLY LOW ETR
Since 2002 EBIX has benefited from a persistent release of its deferred tax valuation allowance (DTVA). From 2002 through 2009 the release of EBIX’s DTVA reduced the firm’s tax rate in a range from 9.8% to 33.1%, with an average annual reduction in its ETR of 1,890 bps. The benefit declined to 4.1% in 2010 and 9.0% in 2011, after which the account was reported to be completely depleted (i.e., reduced to zero). As a result, Gradient believes that the firm is unlikely to benefit from additional DTVA releases in the future.
Though the firm’s DTVA reserve releases have diminished somewhat in recent years, EBIX has reported increasingly larger benefits from the allocation of profits to subsidiaries in lower-tax jurisdictions. Specifically, the tax impact of foreign subsidiaries reduced the firm’s ETR by 20.3%, 19.5%, and 25.6% in 2008, 2009, and 2010, respectively, for an average reduction of 21.8% over the last three years. It further appears that the firm may have realized a similar benefit in 2011, though it was reported in the “other” line item in its reconciliation of its ETR to the statutory rate. According to disclosures in the 2011 10K, the benefit reported within the “other” line was driven primarily by “Tax holiday – India (Permanent Difference)” and “Passive income exemption – Sweden (Permanent Difference).” These benefits reduced the firm’s 2011 ETR by 15.1% and 3.0%, respectively.
Though the company described the tax savings attributed to business in India and Sweden as “permanent differences” (i.e., income items that will never be taxed), we caution that the IRS may still tax any amounts repatriated back into the United States from these countries. Moreover, even if the company never repatriates any of these foreign earnings back into the United States, there can be no guarantee that the IRS will agree with the company’s attribution of income to these lower-tax jurisdictions. Thus, if the IRS disagrees with the allocation, the company may still incur a material amount of additional U.S. income taxes on the underlying income.
EBIX ALLOCATION OF TAXABLE PROFITS APPEARS AT ODDS WITH LOCATION OF PP&E AND SOURCING OF REVENUES
We have a number of concerns about the sustainability of EBIX’s unusually low ETR. One cause for concern is that the firm’s geographic allocation of pre-tax profits over the period 2008–2011 appears at odds with the geographic location of its assets and the sourcing of its revenues. According to EBIX’s 10K filings, the United States accounted for just 25.8% (between 16.4% and 36.4%) of its pretax profits over the last four years. In contrast, the firm’s 10K filings for the same period indicate that the United States accounted for an average (range) of 70.5% (64.7%–75.1%) of total revenue. In addition, the company reported that 67.6% (62.4%–74.6%) of its total PP&E was located in the United States during the last four years. In our view, these disparate trends may be indicative of a tax position that could draw scrutiny from IRS auditors.
To further put this issue in perspective, during 2011 EBIX reported pre-tax earnings in the United States of only $12.0 million on domestic revenue of $120.8 million, implying a pre-tax margin of just 10.0%. This contrasted greatly with foreign pre-tax earnings of $61.5 million on foreign revenue of only $48.1 million, for a pre-tax margin of 127.8%. The fact that the company reported pre-tax margin well over 100% of sales also appears to be a potential red flag.
UNCERTAIN TAX RESERVE MAY BE DANGEROUSLY LOW
One final reason for concern about the sustainability of EBIX’s reported ETR is the fact that its uncertain tax reserve is far less than that of peers. In fact, EBIX’s uncertain tax reserve was one of the lowest of the companies analyzed, at an average of 1.6% of total pretax income for the last four years.
A review of EBIX’s 10K filings indicates that, to date, the company has not offset any settlements with the IRS against its uncertain tax reserve. However according to the 2011 10K the IRS has not yet reviewed years 2007 to 2011—the periods in which the company appears to have taken a more aggressive position with respect to its allocation of taxable income to foreign subsidiaries.
If the firm receives an unfavorable outcome upon review of its 2007–2011 tax returns, it may not have a sufficient reserve to offset the assessment. As a result, Gradient is concerned that the firm’s income-tax provision could skyrocket unexpectedly. In this context, had the company had reported an ETR equal to the peer-group median in each of the last four years, we estimate that EPS would have been reduced by approximately $0.42 (44.7%), $0.55 (44.1%), $0.67 (39.7%), and $0.70 (36.9%), respectively.
Nicholas Wesley Yee is an Equity Analyst at Gradient Analytics. He specializes specialize in earnings quality and tax based research and focuses primarily in the banking and industrial sectors. Nicholas has researched over 150 small-to-large cap equities with a focus on earnings quality, executive behavior and tax related matters. He is licensed as a Certified Public Accountant in the state of Arizona and received his MBA with a tax designation and accounting degree from the WP Carey School of Business.
COMPANY DESCRIPTION
EBIX provides on-demand software and e-commerce solutions to the insurance industry. The company operates data exchanges, which connect multiple entities within the insurance markets and enable the participants to carry and process data from one end to another in the areas of life insurance, annuities, employee health benefits, risk management, workers compensation, and property and casualty insurance. Additionally, EBIX provides software development, customization, and consulting services to various companies in the insurance industry, such as carriers, brokers, exchanges, and standard making bodies. EBIX was formerly known as Delphi Systems Inc. and changed its name in December 2003. EBIX was founded in 1976 and is based in Atlanta, Georgia.
