Jun 11

Written by: Brad Holtz
6/11/2006 

The recent decline in Ansys has set off fears in investors that something must be amiss with the Ansys-Fluent merger. My colleague, Richard Davis, has given me permission to post his explanation as to why that is NOT the case.

On Friday [June 2], Ansys took it on the chin.  We suspect it was some existing investors coming out of the stock.  Fluent investor Willis Stein is currently in a lockup agreement with Ansys, so they were not sellers on Friday.  A venture sale happened last week to Aspen when Advent gave a block to a firm who frankly did a dreadful job placing the stock, which produced a really fun down 7% day.  I hope the same thing didn’t happen to Ansys today (those blocks typically get reported a few days later).

In any case, the last couple of days’ decline in Ansys has set off fears in investors that something must be amiss with the Ansys-Fluent merger because Ansys hasn’t served up some guidance (aka financial pabulum).

The fact is that the guidance conference call is a week later than we would have expected.  We suspect the firm’s auditors and lawyers are torturing Ansys.  On the April 27th conference call, Ansys was never specific, but the commentary indicated that the firm might provide guidance somewhere between the “next couple of weeks” and when the firm believes it can “come out with good guidance.”

Indeed, if I had to speculate, the question is probably whether Ansys can recognize or perhaps even reveal the deferred revenues that Fluent will receive in year one.  For those of you not familiar with this dumbest ever FASB rule, when a software company acquires another software firm, you are not allowed to recognize the deferred revenues in the first year after the acquisition.  The reasoning is that these revenues, even though they generate dollars that go into a firm’s bank account, might not actually materialize.  I guess the customers could sue the software company to get out of their maintenance contracts, but I’ve never seen this happen.  This revenue recognition policy then produces truly fake revenue growth in year two as the unrecognized deferred revenues suddenly materialize in the acquirers income statement.  Wow! Look we’re growing so much faster now – when the reality is that nothing has changed.

The last time Ansys bought a substantial company, CFX, Ansys provided a deferred revenue plug to help investors understand what the real revenue growth of the combined firms was.  Auditors have become even more recalcitrant since then, so that might explain the apparent delay.  The fact that Ansys is highly valued and software stocks are getting creamed only gives investors more reason to be jumpy.

For those who care about fundamentals as opposed to innuendo, we have known Fluent for three years and the company was literally one of the best executing, best positioned and best managed firms we tracked.  In fact, I was really disappointed when they were acquired by Ansys because I had hoped that I could follow Fluent someday (to replace one of my doggy stocks).  However, Ansys won the Fluent auction with a reasonable $565 million price (4.0x revenues and about 12x EBIT).  Furthermore, for anyone who cares, we actually independently did the work to create a pro forma income statement.  Conservatively, the combination should add $0.06 and $0.21 to 2006 and 2007 EPS (totaling $1.61 and $1.91).  I’m interested, but I’m not waiting for Ansys management to spoon feed me the likely combined income statement of the two firms (see the next section for an extended wheeze on why guidance is just an opinion).  You can have a rational argument about how much you want to pay for ANSS shares, but we know the fundamentals of the industry and the two firms about as well as management does – and we believe those fundamentals are good.

 Needham & Company, LLC is a nationally recognized investment banking and asset management firm focused primarily on serving emerging growth industries and their investors. Founded in 1985 by George A. Needham, Raymond H. Godfrey and David K. Townes, the firm is headquartered in New York City and has offices in Boston, Massachusetts, Menlo Park and San Francisco, California.

Needham & Company's principal activities are public and private financings; corporate finance advisory services, including mergers, acquisitions and divestitures; equity research; sales and trading primarily for institutional investors; and asset management through public and private funds. Since its founding, the firm has acted as lead or co-manager in more than 450 public offerings, including 145 IPOs, raising in excess of $31.2 billion, and as placement agent on over 55 private offerings.