Rainmaker Systems: A good deal with a little faith
The original Rainmaker was a 1950s play by N. Richard Nash, in which a charming rogue promises to bring rain to a drought-stricken farmer, despite the doubts of the farmer’s daughter. She ends up falling in love with and developing faith in the man, if not his rainmaking abilities.
Rainmaker Systems, Inc. (Nasdaq: RMKR) is a Campbell, Calif.-based company that promises to help clients turn prospective buyers into paying customers through online sales and marketing services. It’s a great trick if you can do it, and Rainmaker has had good momentum of late.
At least, until the close of the market on Thursday, Nov.1, when the small cap announced third-quarter earnings. Although results were in line with expectations, company executives warned that one line of business—its short-term lead generation business—was slowing in the fourth quarter, and the doubts began.
At the end of Rainmaker’s earnings conference call, Craig-Hallum analyst Jeff Van Rhee told SmallCapInvestor.com, “This guidance isn’t going to make anybody happy.” He was right. On Friday, the stock dropped almost 19% to $6.91 from a Thursday close of $8.52.
Nevertheless, most analysts—Van Rhee included—see this as a buying opportunity. They’re willing to forgive what they’re betting is a short-term problem and are looking forward to a strong 2008. Van Rhee maintains his “buy” rating with a $12 target. Because of an acquisition spree and expansion program this year, he says, “This was never a 2007 story. This is a 2008 story.”
Rainmaker uses data analysis, online and direct marketing and professional telesales to help its customers outsource their marketing and sales efforts. Unlike much larger competitor Salesforce.com, the small cap isn’t focused just on customer relationship management (CRM). It’s trying to provide “closed loop” services, from lead generation to post-sale servicing to creating and maintaining long-term sales contracts with customers.
Rainmaker provides telesales teams in the Philippines to make cold calls and even provides its own list of prospects. It helps with online advertising programs, analyzing data from prospective buyers (such as who clicked on banner ads, who downloaded a white paper or requested more information on a product) to pinpoint prospective buyers. It helps with direct marketing campaigns, hosts e-commerce systems, provides training workshops, database and list management services, invoicing and collection services.
Rainmaker’s investors, however, have long bounced back and forth between faith and despair like a farmer’s daughter with bipolar disorder. This is another dot-com comeback story. The company went public in late 1991 and its stock peaked then at just over $26 per share. By late 2001 it was trading at about $0.20. Things started picking up in 2004, when it recovered to about $3, but increasing competition kicked it back down to $0.45 a year later.
Finally, in late 2005 it started its comeback. It did a 1:5 reverse split to bring the stock back above $2. Last year was its year of recovery. Its traction in the business-to-business market began to catch on with clients in technology, telecommunications and financial service industries. Dell Inc. (Nasdaq: DELL) and Hewlett-Packard Company (NYSE: HPQ) have become its biggest customers—perhaps too big. They account for a scary 43% of its total revenue. RMKR stock rose 163% in 2006 and peaked at its current 52-week high of $11.21 in February 2007. Its 52-week low is $6.10. Shares of Rainmaker closed at $6.85 on Tuesday.
With equity at its disposal, the company has spent much of 2007 acquiring still-private competitors. It started with the purchase of competitor ViewCentral, doubling its installed base to 100 customers. That was followed by the acquisition of CAS Systems, which increased its presence in the financial services industry. Most recently (in late July) it bought Qinteraction, a Philippines-based calling center with 640 sales reps.
That has kept revenues growing at a good clip, while depressing earnings. Organic growth maintained a 25% to 30% rate. The stock settled in to the $9 range.
Then came Thursday’s conference call. Revenues were $19.1 million, up 56.2% from a year ago. Excluding acquisitions, organic growth was up 20% from 2006. GAAP net income was $158,000, or $0.01 per share, beating analyst estimates for a loss of $300,000, or $0.02 per share. But the unexpected profit came from improved cost controls in sales and marketing. Most alarming, the company reported that for the fourth quarter, it is seeing unexpected weakness in its short-term lead generation business line and seemed to have no explanation for it.
Wall Street is taking this setback in stride. Thomson/First call reports price targets from four brokers ranging from $11 to $15. ThinkEquity Partner maintains its “buy” rating, but lowered its target price to $11 from $12. Analyst Nate Swanson writes that after its year of acquisitions, “we look forward to strong EPS growth in 2008.”
Similarly, Craig-Hallum’s Van Rhee has decided to keep his “buy” rating and $12 price target. Both analysts are valuing RMKR on a price/revenue model of 2.5 times the valuation that technology companies being acquired are getting. “This is a great entry point with every good upside potential.”
That is, as long as you’re willing to forgive its unexpected setback in the current quarter, and have a little faith.
