GMP research on Intrinsyc Software

With the closing of a $30 million equity offering now in the rear view mirror, lead underwriter GMP Securities has issued this new report on Wellington Financial Fund II portfolio co. Intrinsyc Software (ICS:TSX). If you are a shareholder, focus on the ending of this excerpt – Microsoft (MSFT:NSADAQ) takeout speculation:

“Reaping the rewards

• Leading provider of mobile software solutions for consumer-oriented converged mobile devices
• Strong management team that has demonstrated ability to execute
• We believe Soleus is uniquely positioned to address critical needs of a very large and growing market
• Soleus is at the cusp of transforming the company to one that is more scalable, has higher margins and predictable royalty revenues
• Seven design wins with six customers provide visibility to revenues for Soleus as early as mid-2008, with additional design wins expected

We are initiating coverage of Intrinsyc Software with a BUY recommendation and a target price of C$1.50, which represents a potential return of 56% from current levels. Intrinsyc is a mobile software solutions provider for handheld devices. Leveraging over 11 years of systems integration experience from its Engineering Services business, Intrinsyc has developed an end-to-end software platform called Soleus, which is a high-level operating system (HLOS) designed for feature phones/converged mobile devices. Soleus addresses key issues facing handset makers today, including pressures to introduce new devices faster with more advanced features and functionality but with fewer development dollars.

Our investment thesis: We believe Intrinsyc is an exciting story with significant upside potential for growth-oriented investors. The company is led by a strong management team that has proven its ability to execute. Intrinsyc is now at the cusp of finally reaping the rewards of transitioning from an engineering services business to a more attractive royalty-based software business model, which comes with more scalability, higher margins and greater predictability of revenue streams. With Soleus, we believe Intrinsyc is in a unique position to address the critical needs of a very large and growing market for consumer-oriented feature phones and converged mobile devices. The impressive pace of design wins to date, as well as the increasing quality and potential of recent wins, speaks to Soleus’ ability to address the critical needs of this market. Intrinsyc already has seven design wins with six customers (and we expect more to follow), setting the stage for a strong ramp in revenues from $22 million in 2008 to $60 million by 2010. We believe the key catalysts that will drive the shares higher in the near term include the success of Soleus-based devices in the market and additional design wins (particularly higher-volume opportunities). Longer term, we believe Intrinsyc could be an attractive takeout candidate, particularly as the company increasingly demonstrates success with Soleus.

Recommendation & Valuation

Our target price implies a C2009 EV/S multiple of 4.1x and is supported by a sum-of-the-parts analysis and a DCF valuation. At current levels, the shares are trading at a C2009 EV/S of 2.2x, a discount to the group average of 3.1x. We believe a premium multiple for Intrinsyc is justified given the strong expected growth as Soleus revenues ramps up. We are projecting Intrinsyc’s 2009/2008 sales to grow 95%, compared to the group average of 23%.

Our sum-of-the parts analysis yields a total value of $1.37 per share. We ascribe a value of $21.9 million, or $0.14 per share, for Intrinsyc’s Engineering Services business based on 1.1x our C2009 revenue estimate of $19.9 million. For Soleus, we ascribed a value of $187.1 million, or $1.23 per share, based on 5.0x our 2010 revenue estimate of $38.0 million. We used our 2010 revenue estimate given the early stages of growth for Soleus and discounted it by 1 year at a discount rate of 15%. In valuing the Soleus business, we used a 5.0x sales multiple to reflect a strong growth rate. Our DCF model yields a value of $1.74 (which assumes a WACC of 13.7% and a terminal growth rate of 3%) In addition to these valuation methodologies, recent acquisitions support our implied target multiple.

The most recent example is Nokia’s plan to acquire Trolltech (a Linux OS vendor) for $153 million
(announced January 2008), which implies a P/S multiple of 3.25x trailing revenues. At the MWC in Barcelona last month, Microsoft announced the acquisition of Danger. Although financial terms were not disclosed, there have been reports that Microsoft acquired Danger for $500 million, implying a P/S of 8.9x. In 2006, Motorola acquired TTPCom for US$193 million at an implied P/S multiple of 2.8 times.

In 2005, Access acquired Palmsource for US$324.3 million at an implied P/S multiple of 4.7 times.
Longer term, we believe that Intrinsyc could be an ideal acquisition target for Microsoft for the following reasons: 1) Intrinsyc has strong expertise in Windows-based OS (one of the top five systems integrators for Microsoft), particularly WinCE and Windows Mobile; 2) Intrinsyc has strong ties to Microsoft – CTO Randy Kath (ex-Microsoft) opened its Bellevue office to allow for convenient colocation and collaboration with Microsoft; 3) Soleus would allow Microsoft to easily move downstream to target consumer-oriented mobile devices and other consumer electronics devices. Given what Microsoft reportedly paid for Danger and the higher synergistic benefits between Intrinsyc and Microsoft, we believe that an even higher take-out multiple (relative to our target) would not be unreasonable.”

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