Donald & Co. Securities Inc.|
The Source Information Management Co.
(SORC - NASDAQ)
Rating: Strong Buy
November 20, 1998
Upgrading to a Strong Buy on acquisitions and improved ICN visibility.
Revenue and margins in core businesses continue to increase.
Acquisitions to accelerate front-end/ICN penetration into general merchandise.
Source provides information gathering, processing, consulting and other information-based services to operators of mass merchandise, grocery, convenience and pharmacy stores throughout the US, including Wal-Mart, K-Mart and Food Lion. These services, which currently pertain mostly to retail magazine sales, are being extended to other items such as candy and batteries through its active management of the front-end location for these retailers. Source also sells this much-needed information to the publishing community. Source's web based Interactive Communications Network (ICN) is the only electronic information exchange mechanism between the publishing and the retail communities.
- Since our last report Source has made rapid progress in deploying the ICN. The communication network is currently accessible to over 15,000 retail locations. Originally conceived as a solution to the pervasive problem of UPC errors in magazines, it is now being looked upon as the only practical mechanism for vendors such as magazine and book publishers to reach store managers directly. The feedback about publishers' interest is very positive and we expect significant contracts near-term. Current pricing model is suggested at $3000 per title per year plus additional advertisement page views charged at $1000 per page. Our current estimates do not reflect our expectation of a meaningful EPS contribution in FY2000 from this division.
- The company has just announced the planned acquisition of two front end hardware manufacturers which - at a $30 million rate currently - account for approximately a third of the estimated $100 million front end manufacturing industry. Historically, given their involvement in the design process of the checkout counter hardware and consequent processing of pocket payments, these manufacturers have developed long relationships with general merchandise vendors such as candy, film and battery manufacturers that need a presence at the front end. Their high operating margins (estimated at approx. 15%) are also a reflection of the value of these services. It will allow Source to vertically integrate at the front end, improve margins through efficiencies and synergies, capture additional front end business and most importantly accelerate penetration into general merchandise categories for ICN and other information based high margin services.
- The acquisitions, if consummated will substantially add to Source's revenues and asset base. Source has proposed to finance these acquisitions using cash and a small amount of stock, which is not meaningfully dilutive. The company does not have any significant long-term debt at present and any debt assumed for this purpose can be rapidly paid off through its strong cash flow generation. We believe that these acquisitions would be significantly accretive to earning in FY2000 if they are consummated.
- Source's core businesses continue to grow. Advance pay penetration is increasing with the current rate at around 68 million per year. Stores under front-end management now exceed 18,000. PIN penetration is now at 1200 titles and it remains indispensable for the magazine publishers who need it to run their business more efficiently.
- We believe that ICN is close to fruition now and expect it to add to earning next year. The recently announced plan for acquisitions appear to be far more strategic than simply acquiring a profitable business as this will allow Source to consolidate its position not only at the front-end but also with non magazine vendors who are a big potential market for Source's high margin information based services. We are looking at a substantial upside to Source's FY2000 earnings as a result of ICN and the accretive potential of the acquisitions and have increased our three-year growth estimate to 40% from 35%. We are upgrading Source stock to a strong buy with a 12-month target price of $12.