Great report from TD SecuritiesAbsolute Software Corp. (ABT-T) C$7.11 Q2 Has No Surprises; Still a Top Small Cap Pick Event Q2 was in line on sales contracts (bookings) and a slight beat on CFPS. In a seasonally weaker quarter against a tough y/y comparable, we consider this a positive result. Our FY14 estimates are little changed and ABT continues to be one of our top small cap ideas. BUY. Impact: POSITIVE Absolute is arguably at a crossroads. The VMware deal for Airwatch (at 14x 2013 bookings) punctuates the value of mobile device management (MDM) as an extension to all security/IT management vendors. ABT trades at 2.6x LTM sales contracts, is profitable, and is in the midst of a CEO search. Activist investor Crescendo Partners owns 6% and controls 2/6 board seats. We forecast organic growth of 14% in FY14 — one of the highest growth rates in our coverage. Q2 results did little to change our view. International growth was 42% YTD. A regional Columbian OEM is the latest embedded partner, which speaks of the relevance of Absolute in large international opportunities. Expenses remain elevated in FY14 to rightfully support growth initiatives that include growing the VAR channel presence, expanding the field force, supporting the Samsung partnership, and delivering on tighter product integration. That said, we believe that >40% of bookings spent on sales and marketing when >70% of sales are to existing customers should be looked at as a massive source of potential operating leverage. With 50% of expenses in Canadian dollars and only 5%–10% of revenue, Absolute should also benefit from C$ weakness. Our FY15 model has 40% of bookings on S&M and still drives CFPS of $0.72 vs. consensus of $0.60. This would be a FCF yield of 16%–17% (using forecast EV and FY15 estimates). Cash was $71.7mm ($1.62/share) and the stock is showing 20% annual dividend growth (yield of 3.4%). Target price remains $9 or 15x forward CFPS (ending December 2014), justified in our mind by 14% organic growth and the potential for much higher cash flow as expense ratios decline in FY15. Q2 Bookings in Line; Results Unlikely to Meaningfully Change Expectations for FY14, in Our View. Q2 bookings of $22.2mm were in line with expectations. Our bookings forecast of $101.3mm (previously $100.8mm), which reflects 15% growth, is little changed; we see Street consensus little changed from an estimated $100.6mm for FY14. Bookings in the quarter were well diversified, with no $1mm+ deals in the quarter, but “a couple” of $500k+ deals. Continued growth from corporate and healthcare verticals (now accounting for nearly 50% of commercial sales vs. less than 40% 18 months ago) is reducing reliance on the education verticals. Potential Sales Accelerators — VAR Channel Expansion and the Product Roadmap. Management has added five of six targeted hires for VAR sales. Pipeline is building and is expected to make some impact in Q3/Q4, but more so in FY15. Management said that six target VARs could do $100K–$200K each in sales initially and ramp to $3mm each. The roadmap is for accelerated integration between what are currently separate products — Computrace, Manage and Absolute Service. Absolute should have its common web console out in Q3, the endpoint DLP (data loss prevention) should be added as a Computrace module effective in the June quarter, and the timeline for functional integration between Computrace and Absolute Manage is the September or December 2014 quarters. We heard on the call that both new customers and newer products are a larger proportion of the pipeline, indicating the potential cross-selling opportunity. Management was Optimistic on the Implications from the Airwatch/VMware Deal; Lenovo’s Acquisition of Motorola is Also Potentially Interesting. MDM players were said to be in “land-grab mode”, willing to accept very low ASPs. VMware should introduce better pricing discipline in the market. Mobile now represents 15% of the business for ABT, up from 9%–10% a year ago. Although not discussed on the call, we believe that the Motorola/Lenovo deal may also have positive long-term implications for ABT’s mobile business. Lenovo has been an embedded partner since 2005 and could expand this relationship to the Motorola business. Update on the CEO Search — Ongoing. There is no definitive timeline for the process. We believe that an incoming CEO with the right industry contacts could open doors for the company. The International Business Continues to Outpace Domestic Growth. International sales contracts were up 52% in Q2 and 42% YTD. Strength was in Latin America for Q2, and in general, we see expanding opportunities relating to national programs for student computers/tablets. An interesting side note to the quarter was that a regional Columbian OEM became the latest embedded partner for Absolute — evidence of the demand internationally to have a resilient digital tether to student devices. Valuation Absolute currently trades at 12x P/CFPS on a forward basis (ending December 2014) versus a historical range of 10x–15x. Based on our FY15 estimates (which assume modest operating leverage), Absolute trades at 10x CFPS and at a 16%–17% FCF yield. We see this as attractive given the high expense ratios and our doubledigit organic growth forecast. Justification of Target Price Our target price of $9.00 is unchanged and based on 15x P/CFPS applied to our forward model. We believe that this multiple is justified by the number of growth opportunities and the potential for the business to yield much higher cash flow as expense ratios begin to decline in FY15. Key Risks to Target Price Key risks to target price include: 1) The growth of notebook computers; 2) foreign currency fluctuations; 3) theft recovery rates; 4) execution of opportunities with key OEMs; 5) the competitive landscape; and 6) Absolute’s relationship with Microsoft and other complementary vendors. TD Investment Conclusion Absolute has one of the highest forecast growth rates in our coverage, has expense ratios that could lead to meaningful operating leverage in FY15, and at the same time trades in the middle of its historical 10x–15x P/CFPS range and pays a dividend to yield 3.4%. BUY.