Dye & Durham (TSX: DND) stock fell 27% in the last two months to $12.31 after activist investors Engine and Blacksheep wrote a letter to shareholders complaining about the tech company’s acquisitions and debt refinancing. Dye & Durham contested Engine’s arguments, stating there were factual errors. But this whole episode caught shareholders’ attention and pulled the stock down.
The tech stock launched its initial public offering (IPO) in the 2020 tech bubble. Its latest third-quarter earnings showed tepid revenue growth of 3% year over year. The December and March quarters are seasonally weak for the company.
What went wrong with Dye & Durham?
Dye & Durham provides practice management and analytics software to legal and finance professionals. Its Unity platform helps legal professionals manage workflow. The company was doing well in 2020. It was growing through acquisitions and organic growth. However, the company became too aggressive and tried to grow faster and made some expensive acquisitions. It has been in the doldrums since the 2022 tech meltdown.
While the interest rate was rising, DND was willing to take a loan to acquire Link Group in Australia. After 10 months of back and forth, Link finally cancelled the acquisition in December 2022. If this alone was not enough, another large acquisition of TM Group failed. DND acquired TM Group but was later forced by the regulator to sell it due to competitive concerns. The company divested TM Group in August 2023.
The failure of these two expensive acquisitions pushed DND into significant debt of $1 billion and increased its financing cost to $131.9 million (12% of its debt). In the absence of these financing costs, the software company would be reporting profits.
Dye & Durham’s bulls
Dye & Durham’s operations are stable and profitable, given its 54% adjusted EBITDA (earnings before interest, taxes, depreciation, and amortization) margin. The company’s strategic objective for the next three years (fiscal 2024-2027 ended June 2027) is focused on three things:
- Reduce its revenue from real estate to less than 33%
- Increase annual recurring contracted revenue share to more than 50% of its revenue
- Build an adjusted EBITDA of $1 billion
For a software company, contractual revenue makes cash flows predictable. If that revenue is annual recurring, the long-term revenue is strong. In the third quarter of fiscal 2024, DND has increased its annual recurring revenue under contract to 30% from 19% a year ago. It has also reduced its real estate exposure to 43% from 50%, hinting that it is diversifying its verticals.
As for the $1 billion adjusted EBITDA target, Engine said such a target incentivizes acquisitions while putting shareholder returns on a back seat. DND replied to Engine’s letter stating some factual errors in them. Nevertheless, the thrill of achieving this $1 billion EBITDA target beforehand got Dye & Durham to pursue Link and TM Group acquisitions.
These acquisitions have made DND cautious with its growth. Instead of aggressive acquisitions, it is prioritizing deleveraging and organic growth. Even if it does not achieve its mid-term target, sustained growth and streamlined operations are the way forward. This could drive DND’s stock in the long term.
Dye & Durham’s bears
While Dye & Durham has a profitable software platform, its biggest challenge is its large debt and mounting finance costs. It has refinanced US$905 million in debt, pushing the dates further ahead. The activist investors are not happy with the way the company is restructuring its debt and have proposed the replacement of three directors in the special shareholder meeting in August 2024. Its net debt is 4.9 times its adjusted EBITDA, which it aims to reduce to four.
Any interest rate cuts could push DND stock up double digits as that could increase its interest savings from debt restructuring. Once the company is out of the woods with its debt situation, it could see a sustainable surge in its stock price.
Investor takeaway
While DND stock is down due to its failed acquisitions and significant debt, it is not out. Its operations are growing organically at a steady pace. A recovery in the real estate sector could convert its high exposure into opportunity. It is a stock you could buy and hold for some time as the company learns and recovers.
