A hat trick, or a vanishing act?

Benj Gallander and Ben Stadelmann
Friday, April 18, 2008

This June, the sixth annual Amazing Meeting will take place in Las Vegas. Founded by magician James Randi, it is a forum for critical thinkers and skeptics.

Some might remember the Amazing Randi teaming up with that famed fan of magic, Johnny Carson, to refute Israeli psychic Uri Geller’s claims of having paranormal abilities. When we at Contra the Heard bought Magic Software Enterprises, we knew what some suspicious types might have been thinking, “Magic? Based in Israel? Is this Geller’s company? Is he making instructional CDs on how to mind-bend Studio 54 cocaine spoons and high school custodial keys?”

Not so fast, Carnac. Actually, the story behind this company is a lot less thrilling and controversial. These particular prestidigitators do their thing with software code, developing business applications and providing consulting and project management services.

After a few years of steady losses, Magic appears to be turning the corner. Revenues reached a record $19.2 million (US), the fifth consecutive quarter of growth. This figure constitutes a 19 percent increase over the $16.2 million in the fourth quarter of 2006, and a 9 percent increase compared with the third quarter of 2007.

Revenues for 2007 were $70 million, an increase of 14 percent from the previous year’s number. As for profitability, they’ve continued to post modest numbers, four quarters in a row.

The balance sheet is precisely what we look for in terms of cleanliness. No accounting hocus-pocus here. With only a whisper of debt that could easily — Poof! — disappear, there are no banker apparitions appearing in our dreams. Cash in the bank increased nicely, largely through the sale of a unit to Fortissimo for $17 million, to support operations for 2008.

There are a number of other reasons that this was the biggest position purchased of a group of five that entered the Contra portfolio in a wand of activity. The company trades below book value. Insiders own about 57 percent, so they have a major vested interest in corporate success. The organization, being based in Israel, gives us some geographic diversification. And corporate clients include a who’s who of impressive partners with the likes of IBM, Oracle and SAP.

But the equity marketplace is a notorious haven for cynics. Some investors are obviously looking at Magic as a spoon that may only bend one way before it breaks in two. A major obstacle for a company operating in the high-tech field is the ruthless nature of the competition. Today’s computer system can be replaced as suddenly as a scantily-clad assistant turns into a snarling Panthera tigris. So, even though Magic’s revenues are increasing and there’s profitability, nothing says that the good fortune won’t disappear.

The current share price, below the $1.81 per share we paid, reflects this. It’s far beneath the $8.70 reached in 2004, and only a sliver of the previous zenith of almost $30 that was achieved right before the tech-wreck of 2000. We’ve set the initial sell target at $7.84.

One caveat is not to confuse Magic’s stock symbol (MGIC on the Nasdaq) with the private mortgage insurance company MGIC Investments (MTG on the NYSE). The latter is the stock that Jim Cramer loves to bash. A mortgage insurer? Now that’s something we’ve been skeptical about investing in for years.