PharmX - Quick Look

In which a generalist of below-average intellect tries to guess the future based on a judgment document.

TLDR

• Pharmacy EDI software for 0.7x ARR.

• EDI is dominant in Australia - virtually all pharmacies use it.

• There’s significant cash on the balance sheet, the majority of which is pending an appeals process that will come to fruition over the next month or so.

• The main EDI business is mature and slow growing, but the company has launched two new products.

• PharmX is at a cash flow breakeven, even with very high EBITDA margins, due to high CAPEX. But it’s very likely most / all of this is being spent on new products, with the EDI business being highly profitable.

INTRODUCTION

PharmX is an Australian software company. The company provides an EDI¹ called PharmXConnectivity to Australian pharmacies, to automate ordering, invoicing and order tracking.

PharmXConnectivity is the de facto industry standard. Essentially all Australian pharmacies use this as their EDI.

At a glance, the valuation for this mission-critical software seems insanely low. In fact, I assumed there was a CapIQ error when I first started digging into this.

The numbers:

• Share Price: A$0.03/sh

• Market Cap: A$18,3m (fully dilutes for performance rights)

• ”Cash”: A$14m

• EV: A$4.3m

• ARR: $6.4m

• EBITDA%: 33%

Yep, you’ve read this right. This thing is trading at <0.7x ARR.

Why is it so cheap?

1. That cash is in quotes for a reason. Much of it comes from a lawsuit, which is going through an appeals process.

2. The company has massive CAPEX spend. FCF is a lot lower.

3. Rev growth is a bit slow.

Let’s look at these three key issues. Given the importance of the cash to the valuation, we will mostly focus on that. Discussions on items 2 and 3 are pretty superficial.

CASH: PART 1. IS IT REAL?

As of 2023.12.31, PharmX reported the following items on the balance sheet:

• Cash: $12.4m

• Deferred Consideration Receivable: $1.75m. This relates to a software business recently sold to a Constellation Software subsidiary.

• Unearned Income Liability: $9.6m.

What is this whack load of unearned income liability? Given the ARR, it’s too much to be just deferred revenue. It’s from a lawsuit. But not in a bad way!

Give me a minute to explain, because this is a little complicated. I’ll explain this in the quote block below so you can skip past it if you just want the conclusion.

Well you see, PharmX has a complicated history. The company was originally called Corum Group, and used to sell pharmacy dispensing and POS software. In 2006, Corum and 3 other POS providers started PharmX as a JV. The venture succeded, and PharmX became the industry standard. But, behind the scenes, there were many disagreements between the four shareholders. Some really messy stuff happened, Corum ended up with the control of PharmX in 2019, sold the non-EDI software division in 2023, and renamed themselves.

One of the 3 other POS providers that started PharmX is FredIT. FredIT sold 50% of itself to Telstra in 2013. Now, in the shareholder agreement for PharmX, they had a clause saying that if there’s a change of control, other owners reserve the right to buy the shares from that entity.

Originally, because FredIT only sold 50% of themselves, nobody thought there was a change of control. But a few years later, during a kerfuffle regarding another JV partner being sold, they discovered that in addition to selling 50%, Telstra ended up with control of FredIT, which would deem it as a change of control event.

This minutiae matters because like all good EDI software business, PharmX had a lot of distributions - and if FredIT underwent change of control in 2013 - then other shareholders would have bought out their share and FredIT would not be eligible for all the juicy dividends, as well as transacting based on 2013 financials vs at a much higher price in 2019.

Phew - that was a whirlwind. If you skipped it, that’s OK. What’s important to know is that all the messy stuff is basically behind us. FredIT sued Corum (now known as PharmX), Corum sued FredIT, we’ve been through years and multiple rounds of court battles, and the Victorian Supreme Court has already awarded in favour of Corum (now PharmX). Cash has already been paid by FredIT to Corum, and the liability is there since we have one final appeal decision left, to come later this month. (late May 2024).

This is to say: the lawsuit liability is quite different from your garden variety line item. It is more there as a formality in case the verdict gets overturned.

CASH PART 2: THE APPEALS DECISION

What’s the likelihood of the verdict getting overturned?

First, a disclaimer. I do not have legal training. This is like the 5th judgment document I’ve read in my lifetime. I do not have experience calling these things, and I definitely do not have experience with anything in Australia, or in contract law.

Given this, I will lay out the underlying facts and arguments:

• Corum has already won the judgment.

• The dispute is not over whether there was a change of control. This judgment was handed down in December 2019 and led to Corum buying the FredIT stake in PharmX.

• The current lawsuit has to do with damages coming from a contract breach - FredIT served the change of control notice 6 years too late. Corum is arguing that had it been served the notice in 2013, FredIT’s shares would have been bought out.

• FredIT’s main defence is that had they sold PharmX in 2013, they would have created a competing gateway immediately and competed hard on pricing, causing PharmX to lose profits.

• The main reason for the judgment coming in Corum’s favour is because this seems highly unlikely. As the document states:

  • This hypothetical project scenario lacks any real numbers on set up costs and unit economics - other than how FredIT would have undercut PharmX on pricing.

  • After selling PharmX, FredIT attempted to set up a competing business, called MedViewX. It went as well as you’d expect. Wholesalers and pharmacies were reluctant, even with aggressive price discounts. As of late 2022, MedViewX had no real revenue. As of 2024, it’s still not a good enough option as an alternative.

Given this, I think it’s highly unlikely that this verdict will be overturned. But - once again, I’m not a lawyer. If anyone is familiar with contract law / this case, and have anything to add, please reach out.

CAPEX AND THE REAL PROFITABILITY

PharmX has ~33% EBITDA margins. For FY24H1, this generated ~$1m of underlying EBITDA (statutory pretty similar).

Unfortunately, CAPEX was just over $1m for the half year period. Classic.

But - it’s very likely that most of this is going to fund new product development, vs maintenance CAPEX for the EDI.

The lawsuit document is quite helpful in coming to this conclusion. Consider the following table, which highlights the distributable profits of PharmX up to 2016.

Note that the entity was clearing $2m+ of distributable profits. While there’s some additional rebate charges + corporate costs added on since then, the EDI business has also grown since 2016, and is most certainly not doing $0 in FCF. Given the profitability of other EDI businesses, I would be shocked if PharmXConnectivity was doing anything less than $1.5m in FCF.

So - what are they spending their money on? New products.

GROWTH

Unsurprisingly, PharmXConnectivity is a mature product. Most pharmacies use it. The core functionality remains the same year after year. You can see this in the numbers. In the latest period, revenue grew by only 5%.

But - the company is looking to use this market position to launch new products. Currently, they are working on a webshop-like offering called PharmXChange.

Unlike PharmXConnectivity, which is a pure EDI offering, PharmXchange will offer suppliers enhanced capabilities such as sales / promotion, education / training and integrated payments. The marketplace will also target smaller suppliers, as it will require very little integration work.

We are still in the early days, so information on this unit is sparse. The company just launched just over a year and a half ago and is still in ramp up / pre-monetization phase. They’ve managed to get most of their existing suppliers on it, and are quickly ramping up on the pharmacy side.

In addition to PharmXChange, the company is also working on a data services product.

Will these new products significantly improve the growth rate? I don’t know. I don’t think you really need a lot of growth at current prices.

WHAT COULD GO WRONG?

The lawsuit could be overturned.

• While it would suck, it won’t be a death knell for the company - nor the valuation.

• The company will have ~$5m of cash, and EV will move to ~$13m, which is not the worst price for an EDI that produces $6m of revenue a year.

• As per above, I think this scenario is extremely unlikely.

Competitive threats.

• While FredIT has not been able to get any significant traction with its MedviewX product, that doesn’t mean it’s impossible.

• FredIT does have a significant % in the pharmacy POS market and is not a happy partner of PharmX.

• Given that they have the backing of Telstra, they may continue trying to enter the market.

Mismanagement

• As with any microcaps, mismanagement of cash flow is a serious concern.

• The company is currently using all of its cash flows from PharmXConnectivity to launch new products.

• So far, this has not shown any real benefit to either revenue or profits.

• While I understand that these things take time, we better see some progress soon, given the amount of investments that are going in.

• Given the size, the corporate drag is also likely to be significant. Before reorganization, Corum Health spent just above $1m / yr on central costs.

On balance, I think PharmX is significantly mispriced here.

PharmX is a 3.5% position in Panoramic Capital.

1. EDI stands for Electronic Data Interchange. Oversimplified, EDI digitizes and automates a lot of the paper-based processes that are involved when sending orders and invoices between multiple parties. It’s one of those ‘hidden’ infra software, used in all sorts of industries from retail, manufacturing, healthcare, government - anywhere there’s lots of ordering and invoicing involved.