Paradigm Research initiates on Intrinsyc Software

On the heels of a $30 million bought deal last evening, Paradigm Capital initiated research coverage this morning on Wellington Financial Fund II portfolio company Intrinsyc Software (ICS:TSX) with a $2 target.

Yesterday’s financing was led by GMP Securities, with Canaccord, Haywood and Raymond James in the syndicate. Intrinsyc’s three prior financing leads were Genuity (October 2005), TD Securities (April 2006) and Canaccord (May 2007), proving that 1) near term sales/trading (Shawn Aspden) and coverage matter to Intrinsyc’s management team, 2) there’s no loyalty to anyone that lifted a finger for the company prior to today, 3) some investment dealers may have justifiably felt that the Soleus story had taken too long to come to fruition, and didn’t want to stick their necks out once again on another financing, and 4) institutional investors have concluded that Canaccord and Paradigm’s research analysts are right and that Samsung’s Soleus announcement (see prior post “Canaccord on Intrinsyc’s big Samsung win” January 31-07) truly is the big time. Here is a summary from Paradigm:

“Company Background

Based in Vancouver, Intrinsyc was founded in 1992 and is a provider of software and engineering services for mobile phone manufacturers. ICS runs a solid engineering services business for cellphone design (~$15m per year) and in 2004 leveraged that expertise into the development of a new software product branded as Soleus. Soleus is a turnkey operating system, designed to run on mobile phones, with an addressable market of 150-500m units per year (at ~$3 per unit). Microsoft is helping ICS with joint marketing efforts and other development support. A new world class management team was appointed at Intrinsyc in 2006 and they completed Soleus in December 2006, with six design wins for Soleus over the last year.

Catalysts and Risks

The main catalysts for Intrinsyc’s stock include new cellphone design wins, new product launches, licensing agreements, rapid revenue growth and a turn to profitability. The main risks for Intrinsyc include competition, alternative technologies, managing growth, customer concentration and reliance on Windows CE.

Valuation and Recommendation

We acknowledge that Intrinsyc is still early in its commercialization but we believe the stock will trade higher with each successive new design win. The stock has traded in a narrow range of $0.50 to $1.50 over the last five years, but seems poised to break out of that range. Overall we believe Intrinsyc is an exciting company which could trade up as high as 5.0x 2010 blended sales over the next 12 months. Consequently, we initiate coverage of Intrinsyc with a $2.00 target price and a BUY rating.

Investment Thesis

2008 is set to be a big breakthrough year for Intrinsyc. The company has been flying below the radar screen for most of its 10 years as a public Company, but that is all about to change. The company has built a long term reputation as a consultant to the world’s biggest cellphone makers. Intrinsyc is now putting that experience to good use, introducing its own new cellphone operating system.

Intrinsyc plays in the complex and obscure world of “embedded systems”. The term typically refers to the “chip level” software or hardware used in special purpose computer systems like cellphones, photocopiers, PDA’s, calculators and countless other electronic devices. The cellphone market remains attractive with over 1 billion units shipped in both 2006 and 2007 and continues to evolve from voice calls to the much more profitable data traffic. Legacy embedded systems known as real time operating systems or RTOS are incapable of dealing with data and are being replaced with new higher level operating systems (like Intrinsyc’s Soleus). These new systems offer amazing graphics and a wide range of software applications comparable to what
one might find in a computer. Soleus is “cellphone rocket science” allowing the phone to perform its most basic functions, while also offering design tools to personalize the look and feel of the phone. Apple’s new iPhone, with its touch screen interface, is a great example of this trend to the high level operating systems and is stimulating significant interest in Soleus.

The battle of competing operating systems is in full swing, but Intrinsyc did well to pick its source code partner. Intrinsyc’s has a long term relationship with Microsoft, having decided to build Soleus around a Microsoft software “kernel” and leveraging Microsoft’s significant marketing and development resources. For the last five years Microsoft has been battling with the likes of Research in Motion and others in the wireless market and is realizing increasing success. Intrinsyc also has significant experience with competing platforms including Symbian, Windows Mobile and Linux. Microsoft is not currently interested in stripping down its Windows Mobile system and removing Microsoft branding to compete with Soleus in the consumer phone market.

Most Soleus design wins will range from $1-10m per year, although a homerun design win with the likes of Samsung, Motorola or Nokia could add $10-25m per year. Intrinsyc’s biggest strength is its management team and in particular its new executive team led by Glenda Dorchak and Mark Johnson, both from Intel. This team has already proven its ability to secure high profile customers and we look for more exciting design wins in the early part of 2008 (around 3GSM and CTIA trade shows).

Overall, we believe that Intrinsyc is a very exciting company and we applaud the Company’s strategy, most notably the move into the feature phone market.

Specifically, we believe the upside on new business offers significant upside for the stock over the next year. As a result, we are initiating coverage of Intrinsyc with a Buy rating and a $2.00 target price.”

MRM
(disclosure – our Fund II holds warrants and shares in ICS)