This article was written by Brandon Da Silva
There are two trends that the automobile industry is experiencing. First, there is an increase in production of vehicles worldwide as lower gas prices and a recovering economy have spiked auto demand.
Additionally, consumers are becoming more environmentally conscious. Climate change is becoming a social norm, which is being supported by tighter government regulations. As a result, vehicles are becoming “greener.” Both of these trends are going to serve as tailwinds for Exa Corporation (EXA) because their services allow car manufacturers to not only cut cost, but also become more environmentally friendly.
Exa at Forefront of Automotive Testing Shift
Exa Corporation develops, sells and supports simulation software and services that is mainly used for ground transportation vehicles. These simulations are used to replace conventional (and expensive) methods of testing such as building prototypes and using wind tunnels. In fact, Exa’s simulations are proven to be just as effective, if not more, than conventional methods. The industry for these simulation services have grown tremendously over the past decade and their “global adoption has revamped the manufacturing industry.” This industry is expected to grow exponentially, while at the same time make physical testing facilities obsolete. The reason for this growth is that these simulations are able to maintain high quality of vehicles, while allowing manufacturers to save on costs.
In fact, manufacturers can get even more savings by using Exa’s new cloud computing service. The cloud computing software as a service allows vehicle manufacturers to test out Exa’s product using a pay-as-you-go model with no upfront costs. The cloud computing software is new to Exa’s product line, and is being well received. Consumers are converting to full-year licences after using their cloud service, and it seems to be acting as a bridge between the two revenue streams.
Strong Revenue Being Masked by Exchange Rate
Exa Corporation receives 75% of its revenues from international customers, making the company susceptible to foreign exchange rate fluctuations. The USD strength has worked against Exa as revenues rose 7%, but would have otherwise seen an 18% increase with constant currency. This means that the company is growing top line regardless of the economic conditions in Europe and Japan. Exa boasts a diverse client base with only one customer accounting for 10% of revenues.
Even more interesting is the proportion of the revenue increase that is attributable to project revenue. Customers generally take on projects when getting introduced to Exa’s product on a trial basis. There was a 20% increase in project revenue, and a 33% increase in project revenue holding currency constant. Management said that most of the growth in project revenue was due to their cloud computing service. With revenue licenses increasing only 5%, and 16% if currency is held constant, it is clear that cloud computing is the driving factor for revenue this quarter.
Exa’s best first quarter as a public company was driven primarily by the rapid growth of their cloud computing service. The company projects this segment to become a larger portion of their revenue mix, indicating greater upside in margins as well. As a result, investors should expect the company to utilize their “considerable margin leverage” in the near future to see margins increase from current level of 69%.
Exa’s top line growth has been without the penetration into China, the largest vehicle market in the world. Only 3% of the company’s sales are being generated from China, showing the potential business upside in this region. With about a quarter of the company’s valuation in cash, expect Exa to focus growth initiatives on the emerging nation.
Impressive Ownership Group
Exa Corporation is backed by George Soros’ fund, which disclosed a 9% ownership in the company. Soros has a knack for picking winners, usually in the blue-chip area. Having a small cap in his portfolio is quite telling of his Exa outlook. Overall insider and institutional holdings amount to 68.2% of the shares outstanding, which means that only about 4.6M shares are exchanging hands.
As seen from the table below, Exa Corporation is trading at lower sales and free-cash flow multiples to comparable peers. The company would need to appreciate 79% to match up to the next cheapest peer.
Since Exa Corporation is still in the growth stages, it has a fairly low EBITDA. The company is on the verge of being profitable. This ultimately distorts the EV/EBITDA ratio and does not paint an accurate picture of their intrinsic valuation. Management expects EBITDA to reach $2.5 million by the end of this fiscal year which would bring the EV/EBITDA multiple to 50, closer to competitors. Due to this distortion, I believe the other two multiples in the table are a much better representation of Exa Corporation’s true value.
In addition to the strong top line and cash flow generation, the catalyst that will drive Exa’s stock price will be positive earnings. With tremendous growth prospects, expect the bottom line to hit green as soon as the next fiscal year. By this time, Exa Corporation should be valued as a profitable company with large cash position, low debt, and upside to continue growing.