Here's my write-up on Supercom. Unfortunately, I am posting this later than I wanted since I submitted the post to ValueInvestorsClub (VIC) and was waiting to hear back. Since it got rejected, I feel free to post it here now. I think there's still great value in the stock at this price, but it has run up a little bit since my original post:
Thesis
What would you pay for a recurring revenue business with
gross margins over 75%, expected growth of 100% from FY2014 to
FY2013, a flywheel of growth every time the business wins a new
contract, and a newish management team with large insider ownership
(30%) who have turned the company around? If your answer is over 7.1
EV/EBITDA or P/E then the market would disagree with you.
Supercom is a growth story hiding in plain site, with
announced contract wins so far this year that amount to over 100% of
their pro-forma revenue from last year, but the revenue is yet to be
recognized over the next 3 quarters so Wall Street has not taken
notice yet.
Looking at the TTM earnings numbers you would get a P/E
of 15.6, however we estimate that the EPS will ramp up quarter by
quarter for the next 3 quarters, resulting in a P/E or EV/EBITDA of
7.1.
The
Business
Supercom's
core
business is in the EID market. Supercom provides
advanced smart card and identification technologies and products for
governmental customers around the globe. They offer a complete
end-to-end in-house solution for credentialing, identifying and
verifying individuals by combining the capability to support
biometric identification with the portability of smart cards. The
solutions are a complete end-to-end system for such items as
electronic passports (e-Passport), national identity cards (national
ID), voter identification cards, drivers’ licenses, visas and other
border entry documents and military, police and commercial access
identification.
Market:
The global EID market is $12 billion per year, and growing at a 14%
CAGR between 2010-2019 for the biometric ID industry. Supercom
targets developing countries which account for $1.2 billion of the
$12 billion market. By limiting themselves to this smaller niche of
developing countries, Supercom avoids bidding against the larger
companies like Gemalto and 3M. Instead, Supercom's competition is
largely smaller private companies and in the last 12 months they
purchased their largest competitor in the space, OTI's SmartID
division.
Winning
a Contract:
The bidding process can include up to 10 to 20 of these smaller
companies, but realistically less than a dozen are full service
solution providers. In addition, governments only like to work with
the countries that have a history of successfully implementing
sensitive security systems, making this a very difficult industry for
new competitors to enter. Supercom's bids range from $10 million to
$200 million in total, and up to $50 million per year. A single large
contract win has a chance to increase Supercom's revenue by over 100%
as we have seen over the past year.
Once
Supercom wins a contract, the customer is very sticky. First, these
programs are essential to countries' operations and also serve as
revenue sources for governments, so these governments are unlikely to
ditch the solutions altogether. In addition, once Supercom wins a
contract, they install their technology infrastructure into the
country. As the country decides to purchase additional products, or
open new contracts for bidding, with their infrastructure in place,
it is much cheaper and quicker-to-market for Supercom compared to its
competitors. Thus, the countries usually end up continuing to work
with Supercom for successive contracts.
The
name of the game is winning new countries. Once Supercom wins 1 bid
in a new country, it leads to years of successive new contract wins
and recurring revenue. As an example, a Eastern European country that
had been a customer since 1995 made a successive order in 2006 for an
additional product that has provided Supercom with $45M in revenue
over the past 7 years.
Revenue
Model
Once
Supercom wins a contract with a company, it takes 1 to 2 years to
recognize the revenue and complete the installation process.
After
this 2 year period, the company continues to provide service for the
already installed products, which leads to recurring revenue of
20-30% of the contract value each year.
In
addition, the countries usually request additional upgrades or
additional product suites which Supercom will usually win.
When
all is said and done, Supercom generates 60-80% of the contract price
in recurring revenue each year.
Example:
Supercom won a $25M contract from a new country in March. They will
recognize the majority this year, with the remainder over the next
year. Assuming 2 years total to finish all of the installation,
Supercom will recognize $25M between 2014 and 2015. Starting in 2016,
Supercom will generate 5M-7M in recurring revenue at a very high
margin. In addition, Supercom will likely win more contracts from
this country leading to additional revenue. At a minimum Supercom
will generate $5M/year for the next 5-10 years from this one $25M
contract.
Valuation
Supercom
currently has 1 contract in place since 2006 that generates $5m-$7m
in recurring revenue every year.
Supercom
also has contracts with 4 other countries with varying amounts of
recurring revenue that could range anywhere from another $5m-$10m in
recurring revenue every year.
At
a minimum, Supercom should generate $10m in recurring revenue this
year.
In
addition, as stated earlier, Supercom has won contracts so far this
year worth $54.6m. The
company has announced they will recognize the revenue as follows:
$4m
contract from an existing customer – all recognized in the 1st
half
$3.6m
contract from an existing customer – majority recognized in the 2nd
half
$25m
contract from a new customer – majority in the 2nd
- 4th
quarters
$22m contract from a new customer – majority in the
nine months from announcement in August 2014
Majority can mean anything from 51% to 100%, however if
it was 51% or close to it, presumably Supercom would have reported it
by simply stating half, so in my assumptions, I am going to go with a
75% recognition to mean majority.
Thus, the new contracts plus ¼ of the recurring revenue
in each quarter should breakdown roughly as follows:
Revenue
|
Q1
|
Q2
|
Q3
|
Q4
|
Recurring
Revenue
|
2.5
|
2.5
|
2.5
|
|
$4M Contract
|
2
|
|||
$3.6M Contract
|
1.35
|
1.35
|
||
$25M Contract
|
6.25
|
6.25
|
6.25
|
|
$22M Contract
|
3.67
|
5.5
|
||
Total
|
5.3
|
10.75
|
13.77
|
15.6
|
Total
Revenue = $45.42M
Gross Margins: Supercom reported 81% gross margins this
quarter. On their latest conference call they stated that
implementation of a new contract will usually result in slightly
lower margins. 2014 will consist of a large amount of new contract
implementation, and thus a conservative lower margin of 75% seems
applicable.
Operating Expenses: Supercom does not require a large
amount of operating expenses for each new contract. Q1 Operating
Expenses of $2.925M consisted of: $1.25M R&D, $1.17 Sales, and
$.55 G&A. They don't anticipate increased expenses in G&A
this year, normalized R&D should be lowered to 500k, and Sales
and marketing will go up to account for commissions on sales.
Conservatively assuming operating expenses increase to 4M/qtr for
Q2-Q4 results in:
Revenue
|
45.42
|
Cost of Revenue
|
11.36
|
Gross Profit
|
34.07
|
Operating Expenses
|
15
|
Operating
Income
|
19.07
|
Net Income
|
19.07
|
Supercom has $50m of NOLs and therefore will not be
paying taxes for a couple of years at least.
With
a current EV of $136m and an EBITDA of $19.07m, we get an EV/EBITDA
of 7.1x.
With Net income of $19.07M and outstanding Shares of 13.3M, Supercom
should achieve EPS
of $1.43
in 2014.
With almost 100% growth, sticky customers, and recurring
revenue streams, at minimum a company like this should warrant a 15x
multiple.
At
a 15x multiple, the fair value is $21.51 or 108% upside.
Having used mostly conservative estimates on the
numbers, another 2-3 million would have a large effect on this
estimate
Additional
Growth Opportunities
Up until now, I haven't made a single mention of
Supercom's RFID division, which focuses on electronic monitoring,
healthcare & homecare, and animal monitoring. This division makes
up less than 5% of Supercom's revenue and management sees this
division as a driver of significant revenue in the future. Without
any ability to forecast revenue from this division, it is currently
just a nice call option on potential future upside.
Second, Supercom announced a new Mobile Money division
which aims to win a material market share of the fast-growing mobile
money transaction market by 2016. If successful, this could be
another avenue of growth for the company in the future.
Finally, here's a quote
from Supercom's CEO from late last year - “Our goal is to increase
our market share to a point that our company will be in the range of
$200 million to $250 million of revenue in the next five years. No,
that's not guidance, but I'm telling you what my goal is. And I'm
talking about growing organically. I'm not talking about acquisitions
on that scale, although we may do some very selectively.”
This may have seemed
somewhat ridiculous to state at the beginning of the year with a
pro-forma revenue of $26m and no historical growth to back this up,
but since management took over in 2010, they have had success after
success in rebuilding this company, and it's getting harder and
harder to question the CEO's lofty goals.
Conclusion
We believe that this little known company has had a
phenomenal year that is not yet priced into the stock. As the next
2-3 quarters of earnings come out, Supercom's increasing revenue and
EPS will bring attention to this company's success over the past few
years. After focusing on a turnaround of the company until this year,
management has over-delivered on their goals of increasing revenue.
With a growing pipeline of bids in an industry with a substantial
moat, Supercom is primed to take advantage of the growing EID market.
Since countries look at a company's balance sheet and operations when
deciding who to award a contract to, contract wins beget more
contract wins and increase Supercom's odds of winning the bigger
contracts in the emerging markets EID space, leading to a bright
outlook for Supercom's pipeline of bids beyond 2014.
Risks
- Shelf filing could dilute shareholders. Supercom does
not currently need to raise capital but if they win more big
contracts they may need to raise more equity to fund working capital.
- Supercom fails to win any new contracts in 2015 from
their pipeline leading to a drastic reduction in 2015 revenue,
resulting in decreased margins and multiple contraction.
Disclaimer
The
author of this posting and related persons or entities (“Author”)
currently holds a long position in this security. Author may buy
additional shares, or sell some or all of Author’s shares, at any
time. Author has no obligation to inform anyone of any changes to
Author’s view of Supercom. Please consult your financial, legal,
and/or tax advisors before making any investment decisions. While the
Author has tried to present facts it believes are accurate, the
Author makes no representation as to the accuracy or completeness of
any information contained in this note. The reader agrees not to
invest based on this note, and to perform his or her own due
diligence and research before taking a position in Supercom. READER
AGREES TO HOLD AUTHOR HARMLESS AND HEREBY WAIVES ANY CAUSES OF ACTION
AGAINST AUTHOR RELATED TO THE NOTE ABOVE. As with all investments,
caveat emptor.
