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Qualiport

[ June 21, 2000 ]

Misys Uncovered II

By Maynard Paton (TMFMayn)

Carburton Street, London -- On Monday, I reviewed the historic financial performance of Misys (LSE: MSY). Today, I'll continue our appraisal of the company, touching upon the different divisions within the group, the company's valuation and round off with some overall conclusions.

Misys 2000

Here's a breakdown of the current Misys business.

                          12 months to  6 months to
                          31/05/1999     30/11/1999
                              (Łm)          (Łm)

Turnover
 -- Banking and Securities     329           161
 -- Healthcare                 170            92
 -- Insurance                   50            28
 -- Internet Services            0             0
                               549           281

Operating Profit
 -- Banking and Securities      98            42
 -- Healthcare                  29            15
 -- Insurance                   16             8
 -- Internet Services           (1)           (3)
 -- Other                       (6)           (3)
                               136            59

There was a deterioration in the latest half-year, all of which was caused by the decline in Euro-related work and the recent Y2K-inspired slowdown.

For this feature, I'll concentrate on the two main divisions at Misys -- finance and healthcare. I'm going to skip the insurance business because of its relatively small size, its very unFoolish links with Wise IFAs and, er, because its insurance.

Finance

By far the largest contributor to group's coffers is the Banking and Securities division. The operation, formed from the acquisitions of Kapiti, Summit, Frustrum and ACT, supply a diverse range of software and services to the financial industry.

Is there an industry more susceptible to a significant IT-based transformation than banking? I can't think of one. The evolution of the Internet and online banking spells great potential for Misys. The group is quite clear who will be the long-term industry winners -- the present banking giants. You wouldn't really expect any other vision though, given that Misys' customers are primarily those current leaders.

During a recent Misys seminar, the problems the new web banks were said to possess mainly revolved around the huge marketing spend required to establish a customer base and brand. In fact, it is other high-profile operators moving into the sector, like J Sainsbury (LSE: SBRY), Tesco (LSE: TSCO) and Virgin, that Misys fear could shake up the banking tree.

Banking Brands

"An established brand is not to be underestimated" Misys have declared, referring to the inherent advantage that the existing industry players possess. That statement though, is a bit of a double-edged sword, after taking into account the existing consumer favourites such as Tesco entering the banking arena. Misys also stated at the investment seminar that "the biggest web banks are and will remain, under all but the most apocalyptic scenarios, the present incumbents".

So what are the risks? Well, perhaps Misys' customers, and thus Misys itself, will suffer badly should Egg (LSE: EGG) and the supermarkets steal a march over the present banking leaders. This scenario I think is unlikely. There's also the possibility that Misys won't get a slice of the lucrative e-banking development action. Again, this is unlikely. Once Misys have established their IT systems within a client's operation, it's then very difficult, if not impossible, for the client to suddenly chop and change it's software infrastructure without Misys' involvement. If changes are needed, then Misys will have to play a part.

On this subject, perhaps the biggest question mark is whether Misys have the inherent capability of developing the IT solutions needed for the future, after having relied in the past on acquisitions to build up a portfolio of established products.

How much all this e-development work will contribute in the future is unclear. Kevin Lomax, Chairman of Misys, was confident at the January interim stage that the division could sustain a 20% forward growth rate. However, a recent cloud has descended over the IT services sector, as various companies have told of the unexpected delays after the original Millennium deferments. Logica (LSE: LOG), for one, recently informed investors of a "slow recovery in the finance market leading to a revenue decline in the sector". With Misys' heavy involvement in the financial world, will the forthcoming Misys annual results tell of a delayed recovery?

Heathcare

Misys bought Medic for Ł580m in 1997. Medic supplies software for use within US physician practices, and it's in this division that the real excitement is expected to occur. After announcing an agreement with Healtheon/WebMD (Nasdaq: HLTH), Misys is to set to take a slice of the lucrative online US healthcare market. The basic premise of the deal is simple.

At the moment, some $250b is wasted every year in the US healthcare through information related problems, with doctors and insurers having out-of-date records and so on. And so enter Healtheon, who are busy building an online facility that will link doctors, hospitals, insurers, laboratories and chemists to each other and thus try to cut out the problematic data and the very expensive medical paper chase.

Misys gets into the action because 10% (70,000) of all US doctors currently use Misys software in their practices. After upgrading existing users to the web-enabled software and the Healtheon online environment, the big opportunity for additional income growth comes from the recurring transaction-based revenues. Thus, whenever a doctor uses the Healtheon/Medic system to refer patients to a hospital say, Misys will collect a couple of cents from the transaction. A steady, reliable and significant income stream awaits -- perhaps. David Berger (TMFFoolUK) uses his medical expertise and "grandiose imagination" to the full when he contemplated the Healtheon agreement in this excellent post.

It's anyone's guess as to what sort of numbers will eventually filter through from the healthcare venture. How about this for a conservative stab? Say Misys collect 10 cents for each transaction, and each of their 70,000 doctors performs 50 fee-paying transactions a day. Working 5 days a week, 52 weeks a year equates to $91m of annual revenues, or about Ł55m. That figure is quite small compared to current annual Healthcare revenues at Misys of Ł170m, but it gives some sort of rough idea of the impact the Healtheon venture could have.

Misys Summary

Misys are a bit of a mixture. The favourable industry and opportunities are offset by its rather unimaginative history. I'm still wary of companies that grow by acquisition, especially when the direction of the business changes slightly. That's Misys down to the ground. It appears in the past that they've picked up a handful of steady, predictable businesses, and concentrated on creating the subsequent financial benefits from integration, rather than focusing on groundbreaking products or deft marketing. Having said that, the potential exists in all divisions. Taking the "20% growth" lead from Mr Lomax, there's obvious scope in banking division, while the Medic purchase is a very low-risk route of gaining a seat in the potentially very rewarding online US healthcare market. And recurring, deferred and transactional-based software income gives shareholders welcome reassurance over the predictability of short-term profits. At the interim stage, 45% of Misys' total revenue was generated from these reliable sources.

All in all, the current valuation of Misys appears to reflect the cautious acquisition strategy and the relatively mediocre equity reinvestment returns of years gone by, coupled with the rosy prospects of Internet development work and the stable revenues coming through the door. In other words, Misys isn't in the Sage (LSE: SGE) price-to-earnings (P/E) stratosphere, nor in the MMT Computing (LSE: MMT) bargain basement, when it comes to valuation.

At 532p, Misys stand at 32 times the forecast full-year earnings to be published next month. Brokers expect earnings growth of 14% in the year to May 2001, leaving the P/E ratio to drop to 28 times. Not cheap.

Looking ahead, I'm anticipating a robust recovery in both the banking and healthcare divisions. Certainly, positive noises were made at the interim stage, and it will be interesting to see whether the slowdown in IT finance work at Logica affects Misys too. Overall, I'm happy to keep Misys in the Qualiport. I'm not keen on its chunky acquisitive growth, but I'm hoping Misys can move towards a rather more organic approach in the future. The scope is there. At the current rating and the size of our holding in relation to the Qualiport as a whole, don't expect a Misys top-up any time soon. Misys full-year results are due late July.

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