Intrinsyc Software acquires Destinator Technologies

Our friends at Intrinsyc Software (ICS:TSX), a Wellington Financial Fund II portfolio co., have closed their acquisition of Destinator Technologies. Decent-sized deal for Glenda and the ICS team. Here are the summaries of two of the three research reports that came out this morning:

GMP Securities

Event: We are resuming coverage of Intrinsyc Software (“Intrinsyc”) subsequent to the acquisition of Destinator Technologies (“Destinator”), which was announced on May 20, 2008. Yesterday after the market close, Intrinsyc announced the closing of the Destinator transaction. The purchase price is approximately US$16 mm, which was comprised of C$8.5 mm in cash and the issuance of 11 mm common shares. Intrinsyc will start to generate revenue from Destinator products beginning July 10, 2008.

Impact: Positive. We believe the acquisition of Destinator’s assets makes strategic sense for Intrinsyc as it provides the following benefits: 1) access to a high-calibre development team in China at a low cost to support the development of new Soleus products; 2) the addition of navigation software (which is growing in popularity and increasingly being demanded by Soleus customers) to its mobile software offering; and 3) immediate revenue contribution from recognized handset makers (i.e., Motorola, LG, AsusTek) that could potentially become future Soleus customers.

Our attention continues to center around Intrinsyc’s ability to transition from an engineering services business to a higher-margin, more scalable royalty-based mobile software company. During the conference call, management reiterated its ability to announce three new design wins by the end of this year and indicated that existing Soleus devices are tracking to plan to launch during H2/08.

DESTINATOR TRANSACTION DETAILS

On May 20, 2008, Intrinsyc announced that it will purchase certain Destinator assets at distressed prices as a result of Destinator’s filing for bankruptcy. Specifically, the assets acquired included:

• an 80-person wireless software development center in Beijing, China;
• a 25-person development center in Herzliya, Israel;
• navigation and wireless software products; and
• 17 patents granted or pending.

The transaction closed with a purchase price of approximately US$16.0 mm, of which C$8.5 mm was in cash (or assumption of liabilities pertaining to the China and Israel subsidiaries) and C$7.5 mm was in stock (11 mm shares at C$0.68 per share subject to a six-month lock-up agreement). Management indicated that the purchase price reflects a revenue multiple of roughly 1.4x based on Destinator’s historical net revenue (excluding third-party pass through map data revenue).

We like this acquisition because Intrinsyc acquired only the assets they wanted. More specifically, Intrinsyc is not assuming Destinator’s financial liabilities except those that pertain to the acquired subsidiaries in China and Israel. In addition, Intrinsyc is not taking on Destinator’s management nor the higher-cost European operation.

Since Intrinsyc announced this acquisition, management has worked aggressively to ensure a
seamless transition. Intrinsyc has hired roughly 130 people from Destinator, which will be reporting into the senior executive team at Intrinsyc and some of whom will relocate to one of Intrinsyc’s facilities.

WHO IS DESTINATOR TECHNOLOGIES?

Destinator is a navigation software provider headquartered in Toronto. The company’s navigation software is instrumental in enabling navigation functionality such as routing and 3-D mapping on personal navigation devices (PNDs) and smartphones – two markets that are in a high-growth phase of their product lifecycle. Among Tier 1 vendors, Destinator is an exclusive provider of onboard GPS technology to Motorola, and also has supply contracts with ASUSTek and LG Electronics.

The Destinator software is compatible with all major operating systems such as Windows Mobile,
WinCE, Symbian, and Linux. In addition, the software can be customized to work on any hardware vendor’s platform, which provides a large addressable market for the software. To further capitalize on the opportunities in location-based services, Destinator has been developing core functionality to enable content delivery based on user’s location, destination, and preferences, which coincides with what Intrinsyc has been envisioning for Soleus.

FINANCIAL IMPACT

As a result of this transaction, we have made preliminary adjustments to our model. We will revisit our model with more detailed financial disclosure following the next quarterly conference call on August 12, 2008.

For F2008, we expect revenue of $27.7 mm (from $22.2 mm) to reflect $5.5 mm in incremental revenue for Destinator. On the bottom line, we expect a loss of ($20.4 mm), or a loss of ($0.13) per share. This compares to our previous loss estimate of ($16.5) mm, or a loss of ($0.11) per share. Our revised estimates are in line with management’s guidance for $26-29 mm in revenue and 49-55% in gross margin.

For F2009, we expect revenue of $51.0 mm (from $39 mm) to reflect incremental revenue of $12 mm for Destinator. On the bottom line, we expect a loss of ($13.7 mm), or a loss per share of ($0.08). This compares to our previous estimate of ($4.5 mm), or a loss of ($0.03) per share.
In addition to the incremental revenue for Destinator, the following highlights other changes made to our model:

• The addition of roughly $13 mm per year in incremental operating expenses to reflect additional headcount from Destinator. According to historical financial statements from Destinator, operating expenses amounted to $25.4 mm in its fiscal year ending Jan 2008. Intrinsyc believes it can cut operating expenses by at least half immediately.

• Integration expenses of $1.5-$2 mm over the next 12 months.

• We have estimated amortization expenses to be $3 mm per year (we may need to adjust after next conference call).

• We have increased the share count by 11 mm to reflect the shares issued for the transaction.

HOW DOES THIS TRANSACTION BENEFIT INTRINSYC?

Development center in China accelerates Intrinsyc’s development of Soleus 2.0

The addition of Destinator’s wireless software development center in Beijing, China allows Intrinsyc to add a workforce of 80 highly skilled people in a low-cost environment, effectively increasing the development capacity for Soleus while lowering the R&D expense. Management estimates that the acquisition of this development center shaves approximately six months off the company’s plans to expand its operations in China as it saves Intrinsyc from having to search for a suitable location and from having to recruit qualified personnel. We believe the time-savings and expanded development capability will help Intrinsyc maintain the company’s momentum and hit an important product window to launch Soleus 2.0 by the end of C2008.

Navigation software added to its mobile software offering

Intrinsyc adds navigation software products to its mobile software offering, which is an application that is growing in popularity and increasingly being demanded by Soleus customers. Industry forecasts from Berg Insight predict 560 million handsets will be GPS-enabled and over 100 million mobile subscribers will use location-based services by 2012. Since Destinator software is compatible with all the major operating systems (i.e., Windows Mobile, Linux, Symbian), we expect the Destinator software to be sold as a stand-alone offering, and be integrated with Soleus as a bundled product making it more attractive to both handset and personal navigation device (PND) manufacturers.

Beyond the general statement that offering navigation functionality is becoming more of a requirement than an option, adding Destinator software to the Soleus offering should help Intrinsyc in two ways:

• Intrinsyc no longer needs to look at paying a third-party license fee to include navigation capability into Soleus devices. By adding Destinator’s navigation software to its Soleus offering, we believe the company will be able to increase its software bill-of-materials component in a device.

• With built-in navigation software, Soleus will be more marketable as a package (particularly given rising demand for navigation and location-based services), which could result in a higher win-rate.

Intrinsyc gains access to an $11 mm+ existing revenue stream Destinator has averaged revenue between $25-$30 mm per annum. Excluding the third-party pass through map data revenue, we estimate the incremental revenue contribution for Intrinsyc will be more than $11 mm (based on the revenue multiple and purchase price) with gross margins of 75%-80%. As a
result, Intrinsyc expects software revenues (including Soleus, Destinator, and a minor component of legacy software) to represent 32-37% of overall revenue in 2008 (from just 10% in F2007), helping the company to accelerate its transition to a mobile software business model.

Opportunities for cross-selling

Destinator has a number of customers that Intrinsyc’s management believes to be prospective
customers of Soleus, including Motorola, LG, and AsusTek. A look at the court filings reveals other notable customer names such as Acer, Sony Ericsson, HP, and “several Asian ODMs”. A business executive has already been appointed to address these accounts. Working with these accounts will give Intrinsyc insight on their future device requirements.

Similarly, some of Intrinsyc’s existing customers are interested in adding GPS functionality to Soleusenabled devices. For example, we believe MSI is already using Destinator software in the 5608 device, which is expected to be launched imminently. Furthermore, because the Destinator software will be compatible with the major operating systems (i.e,. Windows Mobile, Linux, Symbian), the software’s large addressable market could be attractive to Intrinsyc’s silicon vendor customers.

Conclusion: Merging the two companies with complementary products and similar customer needs should drive cross-selling synergies, something that neither company could do alone.

SOLEUS UPDATE

Intrinsyc currently has 6 design wins, including two silicon vendor wins. During the conference call, management reiterated its ability to announce four design wins for 2008, which implies that the company expects to announce three new wins between now and the end of the year. In addition, management indicated that the Soleus devices that were expected to launch in H2/08 are tracking to plan.

Raymond James

Yesterday, Intrinsyc closed the acquisition of Destinator assets.

Action

We are maintaining our $0.65 target and OUTPERFORM rating.

Analysis

The transaction (Intrinsyc paid $16 mln with $8.5 mln in cash) is closing as scheduled. We estimate Destinator will bring in an additional ~$11.5 mln in software revenues annually and are adjusting our model accordingly.

Destinator also brings: 1) Customers. Destinator customers include the likes of Motorola (MOT?NYSE), ASUSTeK (23571?TWO) and LG (LPL?NYSE); ASUSTeK and LG; 2) Improved cross?selling and up?selling opportunities.

For example, silicon vendors are interested in Intrinsyc’s Soleus with navigation applications. Intrinsyc no longer needs to license these applications from third parties; and 3) A low cost development centre in China and an advanced R&D team in Israel and a portfolio of 17 patents granted and pending. These enhance Intrinsyc’s capabilities beyond Windows Mobile and
accelerate implementing Soleus’ road map. The transaction leaves Intrinsyc with $22 mln in cash. As a result of the transaction we estimate that Intrinsyc’s cash burn has now increased to about $6 mln per quarter.

Valuation

Intrinsyc trades at 1.2x C2009E revenues vs. comparables at 2.6x.

Risks

Risk of design wins not translating into material revenue due to failed device launches. Heightened competition from competing OS providers.Exposure to currency fluctuations. Lumpiness inherent in Engineering services business.

MRM
(disclosure – Fund II holds warrants in ICS)