COMVERSE INC CNSI
December 18, 2012 - 6:07pm EST by
aviclara181
2012 2013
Price: 27.21 EPS $2.42 $3.85
Shares Out. (in M): 22 P/E 11.2x 7.1x
Market Cap (in $M): 597 P/FCF 9.9x 6.5x
Net Debt (in $M): -316 EBIT 59 94
TEV ($): 281 TEV/EBIT 4.7x 3.0x

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  • Underfollowed
  • Spin-Off
  • No Debt
  • Potential Acquisition Target
  • NOLs

Description

Summary

CNSI is an undervalued and underfollowed spin-off opportunity with favorable industry fundamentals and multiple positive catalysts in the near-term.  CNSI was spun out of Converse (CMVT) on October 31, 2012.

Business Description

CNSI has two divisions, BSS and VAS.

BSS:

CNSI provides converged, prepaid and postpaid billing and active customer management systems (referred to as Business Support Systems or BSS) for wireless, wireline and cable network operators delivering a value proposition designed to ensure timely and efficient service monetization, consistent customer experience, reduced complexity and cost, and enable real-time marketing based on all relevant customer profile information.

CNSI has a leading position in the high-growth converged billing market segment with over 150 customers, including more than 30 customers in the converged BSS market segment. CNSI believes that we could leverage its leading market position and its BSS solution offering to take advantage of the growth in the emerging converged BSS market segment.

CNSI believes that its Comverse ONE converged billing solution is differentiated in the market through its single-system approach to BSS convergence. CNSI also believe that its BSS solutions offer several advantages over competitors’ offerings, including faster time to market and lower total cost of ownership.

VSS:

CNSI enables wireless and wireline (including cable) network-based Value-Added Services (or VAS), comprised of two categories—Voice and Messaging—that include voicemail, visual voicemail, call completion, short messaging service (or SMS) text messaging (or texting), multimedia picture and video messaging, and Internet Protocol (or IP) communications.  VAS is designed to facilitate the transition of customers’ existing network infrastructure and attached systems to IP as part of their efforts to reduce costs and provide next generation services.

VAS is a $900 million value-added services market with CNS is the market leader by a wide margin with more than 300 customers.  

Investment Thesis

 Very Cheap Stock: CMVT is one of the cheapest stocks in the market today trading at 0.4x EV/2014 Revenues and 2.5x EV/2014E EBITDA.  Nearest competitors are DOX (1.5x Rev, 7x EBITDA) and CSGS (1x Rev and 5x EBITDA)

 Overcapitalized: CNSI is well capitalized with no debt and cash of 316 million (280mm cash by year end 2012 + 11mm VAT refund + 25mm in escrow) million expected on balance sheet by Q1 2013.  Cash is approximately 50% of market cap.

 Attractive Potential Takeover Target: We believe the free cash flow characteristics of this business would be attractive to strategic buyers or PE.  When CNSI was under the CMVT holding company structure, the press reported strategic interest in the business. See for example: http://www.reuters.com/article/2011/11/23/us-comverse-idUSTRE7AM2B220111123 (reporting DOX and ORCL as interested strategic buyers).  Problems at the CMVT holdco level that may have prevented sale of this unit in the past are now removed with the completion of this spin. 

 Significant, Identified Cost Cutting Opportunities:  Management believes they can expand EBIT margins to 15% through identified cost cuts.  Q3 adjusted operating margin was 7.4%.   On the Q3 call management identified 40mm+ of SG&A cuts they will implement in the next 18 months.  This is 700 bps of margin expansion on 600mm of sales.  Gross margin improvement opportunities identified in BSS account for the majority of the remainder of the cost cuts.

 Large NOL Balance: The company has ~1.5 billion in gross NOLs (0.5bn federal, 0.25bn state and 0.8bn foreign) and should ultimately have a low tax rate, especially given large OUS sales.  Management is still analyzing potential usage of tax credits and we believe will eventually be able to give more guidance (likely on the Q4 earnings call) as to what tax rates may look like.  Management stated on the Q3 call that taxes on non-US income will likely be 10-15%.  We believe the PV of the NOL is approximately $325 million or ~$15 per share.

 Experienced, Incentivized Management Team: Both the CEO and CFO have worked together at Hypercom, where they successfully restructured the company and sold it to VeriFone.  Mgmt compensation to be set in Q1 2013 and will compensate salespeople on both sales and margin, not just sales as is the case now.

 Underfollowed by the Street: Only three mid-tier banks currently cover the name with potential for more research coverage as the company executes. 

 FCF Estimates and Price Target

 FCF Calculation

 

 

 

 

2013

2014

 

 

 

EBITDA

76

111

Capex

(10)

(10)

Cash Interest Expense

0.0

0.0

Cash Taxes(1)

(6)

(9)

FCF

60

91

 

 

 

Current TEV

297

297

FCF/TEV

20%

31%

1.  Assumes 10% total company tax rate, actual tax rate could be lower given large NOLs and large operations outside the United States.  Also assumes no cash restructuring charges (possible in 2013)

 Price Target Calculation

On the Q3 conference call, management said they believe they can get to mid teens operating margins in 24 months.  Q3 adjusted operating margin was 7.4%.  On the Q3 call management identified 40mm+ of SG&A cuts they will implement in the next 18 months.  This is 700 bps on 600mm of sales).  The balance of identified margin improvement will come from gross margin improvements primarily from the BSS side.

 

2013

2014

 

 

 

Bookings

590

625

EBIT Margin

10.0%

15.0%

EBIT

59

94

DA

17

17

 

 

 

EBITDA

76

111

Target Multiple

7.0

7.0

EV

532

777

Net Cash

316

316

PV of NOL

325

325

Equity Value

1249

1527

S/O

21.9

21.9

Target Price

57.0

69.7

% Return

110%

156%

 

Risks

Economic weakness

Continued carrier consolidation

Share loss to competitors

Failure to cut costs

I do not hold a position of employment, directorship, or consultancy with the issuer.
I and/or others I advise hold a material investment in the issuer's securities.

Catalyst

  1. Management continues to execute and cut costs
  2. Potential for special dividend or buyback
  3. New customer announcements
  4. Increased street coverage and familiarity
  5. Potential for acquisition by a larger player (economies of scale) or private equity
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