Conveys Concern Regarding the Board’s
History of Presiding Over Poor Governance, Problematic Related
Party Transactions, Operational Missteps and Sustained Value
Destruction
Expresses Disappointment Regarding the
Board’s Anti-Shareholder Actions, Including its Recent Decision to
Undermine Private Negotiations by Unilaterally Announcing
Insufficient Boardroom Changes
Urges the Board to Add Indaba’s
Highly-Qualified, Independent Director Candidates and Establish a
Special Committee to Conduct a Credible Review of Strategic
Alternatives, Including a Sales Process
Sees an Opportunity to Secure a Meaningful
Premium for Shareholders Via a Sale of Benefitfocus to One of the
Many Potential Acquirers Focused on Human Capital
Management
Indaba Capital Management, L.P. (together with its affiliates,
“Indaba” or “we”), a significant shareholder of Benefitfocus, Inc.
(NASDAQ: BNFT) (“Benefitfocus” or the “Company”), today issued the
below letter to the Company’s Board of Directors. In addition,
Indaba filed a Schedule 13D Amendment with the U.S. Securities and
Exchange Commission and disclosed its recent communications with
the Company.
The Board of Directors Benefitfocus, Inc. 100 Benefitfocus Way
Charleston, SC 29492
Dear Members of the Board of Directors:
Indaba Capital Management, L.P. (together with its affiliates,
“Indaba” or “we”) is a significant shareholder of Benefitfocus,
Inc. (NASDAQ: BNFT) (“Benefitfocus” or the “Company”). In addition
to owning approximately 9.6% of the Company’s outstanding common
shares, we hold approximately 22.9% of the outstanding issue of the
1.25% convertible senior notes (the “Notes”). We are writing to you
today to convey three primary points:
1.
We are extremely disappointed with the
Board of Directors’ (the “Board”) decision to undermine our private
discussions by unilaterally announcing incremental governance
changes that should represent the start – not the conclusion – of
boardroom improvements.
2.
The Company’s long-term
underperformance and years of negative returns stem from an array
of governance, operational and strategic failures that the Board
still seems reluctant to substantively
address.
3.
The Company should adopt
our logical suggestions, that include refreshing the Board with
additional, diverse, independent directors and forming a special
committee to conduct a credible review of strategic alternatives,
including a sale of Benefitfocus.
Indaba is a firm that focuses on opportunistic, long-term value
investments – not public activism. We have a strong track record of
maintaining constructive, private dialogues with boards of
directors and management teams.
We invested in Benefitfocus because it is an attractive,
established business that operates in the stable, high-potential
benefits administration market. Although we understood that the
Company’s shares had dramatically underperformed peers and traded
at a steep discount to intrinsic value for years, our due diligence
led us to conclude that these headwinds were the result of
addressable and correctable missteps. This is why we spent the past
eight weeks trying to convince the Board to implement clear,
practical solutions.
Unfortunately, the Board’s recent actions indicate it is
uninterested in implementing the meaningful changes required to
turn around Benefitfocus and realize its standalone potential. The
Board appears to be more interested in maintaining the status quo
that has already given shareholders years of dismal governance,
problematic related party transactions, poor oversight and weak
strategic execution. In the subsequent sections of this letter, we
have outlined why the Board would be remiss to continue down this
path. We hope that this leads the Board to reconsider its
opposition to adding new, independent shareholder representatives
as directors and creating a special committee of independent
directors to undertake a full review of strategic alternatives,
including a good faith sales process. This is clearly the best path
forward for Benefitfocus and its shareholders.
We are concerned about the Board’s
recent attempt to pass off incremental, half-measures as meaningful
governance enhancements.
After sending a private letter to Benefitfocus on December 14,
2020 regarding the issues that have led to the Company’s untenable
valuation, we were pleased to enter into discussions with the
Board.1 We believed that we were involved in earnest, private
negotiations to add meaningful shareholder representation to the
Board and secure prompt, substantive changes. This is why we
maintained a private dialogue even when the Board missed our
original mid-January target for a joint resolution.
On January 26, 2021, however, the Board abruptly undermined
these private discussions by unilaterally announcing certain basic,
long-overdue corporate governance improvements that Indaba was
advocating for. While it was a small step in the right direction,
the announced changes fell woefully short of what is needed. They
suggest only a wink to cleaning up the mess, with no real
commitment to value-enhancing change.
Although Benefitfocus accepted our recommendation to put to a
vote at the Company’s 2021 Annual Meeting of Shareholders (the
“2021 Annual Meeting”) a proposal to declassify the Board, it has
not disclosed whether directors will be elected for one year or
whether declassification will be delayed until 2022.
Benefitfocus also announced the planned resignation of Executive
Chairman Mason Holland Jr., who in our view participated in
multiple problematic related party transactions. However, just a
few days later Benefitfocus announced it intends to retain Mr.
Holland in a paid advisory role and allow him to continue attending
Board and committee-level meetings after the 2021 Annual Meeting.
This suggests that his influence over the Board has not been
significantly diminished. The Board must recognize that it will not
be lost on shareholders that Mr. Holland’s recent track record
includes leading Benefitfocus down a path of considerable value
destruction, including negative returns over the past one-, three-
and five-year periods. While we anticipate that incoming
independent Chairman Doug Dennerline will be more suitable to
formally lead the Board, his lengthy boardroom tenure and
complicity in enacting self-serving, half-measures force us to call
into question his independence from Mr. Holland.
At our urging, Benefitfocus also announced certain amendments to
the voting agreement entered into by Mr. Holland and BuildGroup LLC
(“BuildGroup”), an entity controlled by director A. Lanham Napier.
The amendments eliminated the requirement that BuildGroup vote to
elect Messrs. Holland and Napier and any of their designees to the
Board. However, the Company rejected our demand to renegotiate the
most egregious aspect of the preferred stock agreement:
BuildGroup’s right to separately elect two directors to the Board
while also voting on an as-converted basis with the common
shareholders to elect all other directors. It defies logic for
Benefitfocus to provide BuildGroup two bites of the apple at the
expense of other shareholders.
Following the Company’s unilateral announcement last month,
Indaba sent a second letter on January 28, 2021 that indicated our
willingness to compromise on the renegotiation of the convertible
preferred voting rights in the interest of expediting a
resolution.2 The Board subsequently rejected a key element of our
proposal: the formation of a special committee with the purview and
external advisory resources to make recommendations regarding
operational and strategic initiatives. The Board also rejected our
proposal to appoint any two of the three highly-qualified,
independent director candidates that we had identified. One of our
candidates has a legal background and currently serves as a
director at two public companies with market capitalizations of
more than $1 billion. Our second candidate possesses strong
executive-level and product development experience in consumer and
enterprise software businesses, while our third has significant
strategic and commercial transaction expertise. The latter two
candidates also self-identify as African American, an added benefit
to a Board that had no racial diversity prior to Indaba’s
engagement.
It should also be noted that while the Board rejected any two of
the candidates we proposed, Mr. Napier expressed some willingness
to “fast track” consideration for our third candidate because the
individual happens to be his former graduate school classmate. It
was disheartening to learn that the Board was only willing to
consider additional shareholder representation upon the revelation
of a prior relationship with Mr. Napier. The Board’s focus on
maintaining interlocks and protecting insiders’ interests severely
limits its ability to engineer a turnaround of Benefitfocus.
The Board remains far too inattentive
to the Company’s long-term financial underperformance relative to
peers and relevant indices.
In light of the Board’s actions, we have been forced to question
whether the current directors are more focused on enhancing
shareholder value or maintaining some semblance of the status quo
that the insiders clearly prefer. Why is the Board not devoting all
of its energy to reversing the value destructive tailspin that has
been unfolding in recent years? As shown below, the Company’s share
price performance versus its self-identified peer group (the “Peer
Group”) and the Russell 2000 Index is appalling. 3
Share Price
Performance
1-Year
3-Year
5-Year
Benefitfocus
(23.7
%)
(39.0
%)
(43.0
%)
Peer Average
55.7
%
209.9
%
527.5
%
Russell 2000
32.8
%
49.8
%
126.6
%
Source: Bloomberg. As of February 5,
2021.
Benefitfocus’ shares also trade far below the Peer Group average
based on forward sales estimates for 2020 and 2021. We suspect this
persistent gap is why several large institutional funds have been
exiting or dramatically reducing their ownership positions.
Valuation
EV / Gross Profit
EV / Revenue
FY2020E
FY2021E
FY2020E
FY2021E
Benefitfocus
4.2x
3.9x
2.2x
2.1x
Peer Average
16.1x
14.0x
10.3x
9.0x
Source: Market data and Bloomberg
consensus estimates. As of February 5, 2021.
In addition, Benefitfocus’ revenue growth has materially lagged
its Peer Group over the past several years. Consensus estimates
project continuing lagging growth versus the Peer Group in 2021.
This disparity becomes even more stark when neutralizing for the
impact of the COVID-19 pandemic, by comparing 2021 expectations
with 2019 results.
Revenue Growth
FY2017
FY2018
FY2019
FY2020E
FY2021E / 2019
Benefitfocus
0.1
%
9.2
%
14.3
%
(9.8
%)
(5.9
%)
Peer Average
20.8
%
21.4
%
23.1
%
18.0
%
29.2
%
Delta
(20.6
%)
(12.1
%)
(8.8
%)
(27.8
%)
(35.2
%)
Source: Company filings and Bloomberg
consensus estimates. As of February 5, 2021.
The Board and management team have
presided over misguided strategic decisions that continue to cast a
long shadow on performance.
It is clear to us that poor financial results are a consequence
of the Board’s misguided strategic decisions. For example, in a bid
to grow revenue, the Company previously launched BenefitStore to
disintermediate brokers. This initiative was approved despite the
fact that brokers are the very source of lead generation and
end-customer adoption for benefits administration products. This
was an unwise strategy from the outset and proved to be highly
unsuccessful.
Benefitfocus further alienated the broker community by entering
into a strategic partnership with Mercer LLC (“Mercer”). While the
Company has unwound the initiative, such poor decisions cast a long
shadow. The Mercer separation continues to be a direct revenue
headwind and the broker community has not forgotten what then-Chief
Financial Officer and current Chief Executive Officer Steve Swad
referred to as its “adversarial relationship” with Benefitfocus.4
If the Board had been more attentive and engaged in its oversight,
perhaps these misguided actions could have been avoided.
The Board has failed to fulfill one of
its most essential duties: identifying and retaining stable
management.
Since 2015, Benefitfocus has had three Chief Executive Officers and six Chief Financial Officers. It does not appear
that the Company has ever undertaken a thorough process by
retaining a top search firm to find the most highly-qualified chief
executive from an external candidate pool. The Company’s three
internal appointments can be understood – but not excused –
because, until two weeks ago, Benefitfocus maintained Mr. Holland
as Executive Chairman, effectively resulting in two Chief Executive
Officers for the Company.
At the Chief Financial Officer level, we note that the six
individuals who have served during the past five years have all had
abbreviated tenures. Indeed, one of the individuals served for only
one month. Based on public filings, other members of the management
team, including most recently Benefitfocus’ Chief Technology
Officer, have also left with concerning frequency.
This level of management turnover is both disruptive and
disturbing. Hiring and retaining key executive leaders should be
among the Board’s primary focus areas and most fundamental
fiduciary responsibilities. Clearly, the Board has failed one of
its most important tasks.
We are alarmed with the Board’s history
of approving problematic related party transactions – this must
end.
As you know, we continue to urge the Board to form a special
committee that is empowered to evaluate past and future related
party transactions. Most importantly, we urge Benefitfocus to
renegotiate its related party transaction with Mr. Napier’s
BuildGroup to remove the ability to vote on an as-converted basis
with the common shareholders on the election of directors (since
BuildGroup has had the right to separately designate two directors
to the Board).
Equally troubling are the unusually favorable economics given to
BuildGroup at a time when Benefitfocus was underleveraged and did
not appear to have a need for additional capital. In March 2020,
the Company had the financial means to prepay nearly $4 million of
future rent to entities controlled by Mr. Holland (the Company’s
Executive Chairman).5 In May 2020, the Company reported $115
million of cash on its balance sheet and guided 2020 free cash flow
to be a usage of $15 million.6 Despite this stable position in the
spring of 2020, Benefitfocus chose to disclose an $80 million
convertible preferred investment from BuildGroup. The terms include
an 8% coupon and rights to convert into common equity at $15 per
share for a total of 5.3 million shares, or 13% of the total
outstanding shares. Just a few months later, Benefitfocus revised
its free cash flow guidance upward by $30 million in its third
quarter earnings release.7 The Company also reported repurchasing
almost $19 million in principal value of 1.25% convertible senior
notes.8
We seriously question these capital allocation decisions. Why
raise capital at an 8% interest rate when capital was not needed,
only to then use that expensive currency to repurchase deeply
out-of-the-money 1.25% convertible notes (convertible at $53.17 per
share) at a yield to maturity of only 9%? What would compel the
Board to approve a sale of 13% of Benefitfocus to BuildGroup in
return for only a 1% improvement on the capital allocated? We do
not believe that this proposed financing was widely marketed and
maintain that Benefitfocus could have raised capital at much more
attractive terms.
In another example of directors unfairly benefitting at the
expense of shareholders, Benefitfocus is party to three lease
agreements with entities controlled and owned by Mr. Holland and
former Chief Executive Officer Shawn Jenkins. Total payments paid
since 2014 and owed through the life of the leases amount to
approximately $186 million (See Indaba’s private letter to
Benefitfocus from December 14, 2020 for additional detail).9 We
question the inherent conflicts and misalignment of incentives in
these seemingly excessive related party transactions.
We urge the Board to immediately pursue
a credible director refresh process based on shareholder
input.
In light of the aforementioned issues, shareholders deserve more
Board representation and input in any refreshment process. But
rather than provide shareholders the opportunity to vote for or
against Mr. Holland at the 2021 Annual Meeting, the Board
proactively shifted him into an advisory role as a non-voting
member of the Board. He is still slated to be compensated at 75% of
what is paid to non-employee directors. This leads us to believe
that Mr. Holland’s influence at Benefitfocus has not been
significantly altered.
Further, the Company’s seven-person Board appears far too
interconnected. The Board currently has two members from F5
Networks, Inc. (“F5 Networks”): Ana White and Frank Pelzer. Though
the Company disclosed Ms. White’s resignation yesterday for
“personal reasons” effective March 23, 2021, we question why both
these directors served on this Board when F5 Networks is not
regarded as a model of effective corporate governance or
shareholder value optimization and it shares no discernible
industry overlap. According to The Wall Street Journal, F5 Networks
is also reportedly facing pressure from investor Elliott Management
regarding ways to boost its own lagging share price.10
We believe the Board is clearly lacking when it comes to
independence, objectivity and diverse skill sets. To facilitate a
legitimate strategic review process, it will be critical to add
highly-qualified, independent individuals with fresh viewpoints.
This is why we devoted the energy and time to finding ideal
candidates for Benefitfocus.
We urge the Board to augment a director
refresh with the formation of a special committee to run a sales
process.
Given the present realities at Benefitfocus, Indaba believes the
only viable path forward is for the disinterested members of the
Board to comprise a special committee, retain an independent
financial advisor and undertake a full review of strategic
alternatives, including a good-faith sales process.
We recognize that the Board may want to point out that Indaba
previously entertained the idea of giving leadership more runway to
effectuate operational improvements and pursue a turnaround.
However, that consideration was given prior to the Board’s
unilateral breach of our dialogue and stated unwillingness to
accept meaningful shareholder representation on the Board. The
Board’s focus on maintaining the broken status quo has convinced
Indaba that the current leadership has lost the privilege of
running Benefitfocus.
In its Benefitfocus initiation report published on July 3, 2019,
J.P. Morgan Chase stated that its price target was based on an
enterprise value to 2020 revenue multiple that was a ~7-turn
discount to their “comparables group of well-executing human
capital management companies” (“HCM Peers”).11 This valuation gap
has persisted, with Benefitfocus trading at a significant discount
to the HCM Peers and recent transaction multiples in the sector.
This suggests that substantial value could be immediately unlocked
for shareholders if Benefitfocus is sold. On an enterprise value to
revenue basis, the Company trades at a meager 2.1x consensus 2021
revenue. This represents a significant discount to the HCM Peers
average of 13.1x and less than half of the lowest multiple in the
group. The disparity is similar when compared to the Company’s
self-identified Peer Group, which trades at an average multiple of
9.0x (more than 4x Benefitfocus’ multiple).
The valuation gap is equally stark on an enterprise value to
gross profit basis. Benefitfocus trades at 3.9x 2021 consensus
gross profit versus the HCM Peer average of 19.9x. Again, the
analogous average multiple for the Company’s self-identified Peer
Group is 14.0x.
Transaction multiples tell the same story as there has been
significant strategic and financial sponsor interest for
well-managed human capital management companies. In 2019, peer
company Ultimate Software was bought by a private equity sponsor
for 8x the next 12 months’ revenue.12 In 2020, Cornerstone OnDemand
acquired Saba Software, a talent software company, for 4.9x the
next 12 months’ revenue.13 These multiples and levels of interest
are not just a recent phenomenon. In 2011, SAP acquired
SuccessFactors for 8.7x the next 12 months’ revenue.14
Simply put, Benefitfocus is a quality asset in a growing
industry and there is a plentiful value creation opportunity under
the right stewardship. We believe having a refreshed Board pursue a
sales process would be in the best interests of shareholders,
including the many long-suffering investors forced to endure the
incumbent directors’ self-dealing and value-destructive
blunders.
Indaba intends to remain actively engaged with Benefitfocus. We
hope the Board will now act in good faith by taking the
aforementioned actions, including appointing highly-qualified and
independent directors and forming a special committee to explore
strategic alternatives. If the Board fails to take meaningful
action, we reserve our rights as shareholders to protect our
investment.
Sincerely,
Derek Schrier
Managing Partner
Indaba Capital Management, L.P.
Alex Lerner
Partner
Indaba Capital Management, L.P.
About Indaba Capital
Indaba was founded in 2010 to invest opportunistically in
corporate equity and debt. Based in San Francisco, Indaba currently
has over $1.5 billion of assets under management. Learn more at
www.indabacapital.com.
1 The December 14, 2020 letter to Benefitfocus can be found as
an exhibit within Indaba’s Schedule 13D Amendment filed with the
U.S. Securities and Exchange Commission on February 11, 2021. 2 The
January 28, 2021 letter to Benefitfocus can be found as an exhibit
within Indaba’s Schedule 13D Amendment filed with the U.S.
Securities and Exchange Commission on February 11, 2021. 3 Publicly
traded peer group constituents, as identified in the Company’s 2020
Proxy Statement filed April 29, 2020: AppFolio, Inc., Castlight
Health, Inc., ChannelAdvisor Corporation, Cornerstone OnDemand,
Inc., Evolent Health, Inc., Five9, Inc., HealthEquity, Inc.,
HealthStream, Inc., Inovalon Holdings, Inc., LivePerson, Inc., NIC
Inc., Paylocity Holding Corporation, Q2 Holdings, Inc., SPS
Commerce, Inc., Upland Software, Inc., Workiva, Inc. 4 Transcript
from the Raymond James Technology Investors Conference on December
10, 2019. 5 Form 8-K filed with the U.S. Securities and Exchange
Commission on March 19, 2020. 6 First quarter 2020 financial
results announcement released on May 6, 2020. Cash flow usage of
$15 million represents midpoint of Company guidance of a usage of
$10-20 million. 7 First quarter 2020 financial results announcement
released on May 6, 2020 and second quarter 2020 financial results
announcement released on August 5, 2020. Increase of $30 million
calculated as the difference between the midpoint of a usage of
$10-20 million as disclosed in the first quarter earnings
announcement and the midpoint of an inflow of $10-20 million as
disclosed in the second quarter earnings announcement. 8 Third
quarter 2020 financial results announcement released on November 5,
2020. 9 Company DEF 14As filed April 25, 2014, April 30, 2015,
April 22, 2016, April 21, 2017, April 20, 2018, April 19, 2019, and
April 29, 2020. Future amounts owed as of December 31, 2019. 10 The
Wall Street Journal: Elliott Management Takes Stake in Software
Company F5 Networks (November 2020). 11 HCM company peer set per
J.P. Morgan Benefitfocus initiation report “Best-of-Breed Benefits
Administration Platform; Initiating at Neutral” published July 3,
2019. Includes Automatic Data Processing, Inc., Ceridian HCM
Holding Inc., Cornerstone OnDemand, Inc., Paycom Software, Inc.,
Paylocity Holding Corporation, Workday, Inc., and Workiva Inc. 12
RealPage, Inc. Schedule 14A filed February 5, 2021. 13 RealPage,
Inc. Schedule 14A filed February 5, 2021. 14 Ultimate Software
Group, Inc. Schedule 14A filed March 26, 2019.
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Profile Greg Marose / Charlotte Kiaie, 347-343-2999
gmarose@profileadvisors.com / ckiaie@profileadvisors.com
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