Description

Comverse Technology - Long - (OTCPK: CMVT)

12.17.09 / $9.15

Summary

• CMVT is an attractive long at current levels with upside to the low teens (30%+) through several near-term catalysts. This is a special situation, as the Company has not filed current financials in over three years and is traded on the pink sheets. The Company's core businesses seem healthy (given VRNT covenant compliance / CNS cash generation), and should grow alongside telecom spending in 2010. I expect current financials by February, allowing the Company (and subs) to re-list on the NASDAQ, and giving management the opportunity to re-market the Company to investors. I see longer-term upside to the high teens if CMVT addresses the complex holding company structure.

Company Overview

• Comverse Technology ("CMVT" or the "Company") is an Israeli holding company with several operating subsidiaries and divisions focused on the telecom industry. This write-up does not address the business segments in too much detail, given the obvious lack of disclosure / filing status. Please refer to JackBlack's February 2009 write-up for more detail on the segments. Key business lines are as follows:
  • CNS - the Comverse Network Services division, which is wholly owned, provides software & services to telecom companies that enable call management, messaging, data and content delivery, and billing. CNS' business is similar to that of Amdocs (NYSE:DOX - DOX is more service-focused) or Convergys (NYSE:CVG), and generally characterized by long-term contracts and recurring revenue serving large telecom customers (e.g. AT&T, Sprint Nextel, Bharti, BT, etc.).

§         The last actual financial data that we have on CNS is from Q2 FY 2007, which shows quarterly revenue of $288mm with 6.7% adjusted operating margins.  The world has changed meaningfully since 2007, meaning estimates for the core CNS segment are difficult at best.  The most meaningful comparison for CNS is Convergys' customer management segment, which generates annual revenues of ~$1.8bn and is up marginally from run-rate 2007 levels.  Research analysts peg CNS EBITDA in the $125mm range.  I think these are reasonable estimates given comps' performance and the actual free cash flow noted below.

§         We can also bridge CNS' free cash flow over time through the Company's 8ks (released from time to time, providing updates on cash and debt balances).  Once adjusted for non-recurring (restructuring related) and financing items, we see that CMVT generated positive free cash flow (+$49mm) during the TTM period ending 7/31/09.  This is impressive given the general business climate, and provides incremental downside protection.

• Verint (OTCPK:VRNT) - Verint provides analytic software for communication interception (law enforcement), video surveillance and contact center customer interaction management. Put another way, Verint basically provides the technology, systems & services for voice recording & analysis used in counterterrorism, call centers, and other security monitoring uses. Verint has grown substantially since the 2001 terrorist attacks, and was spun-out as a separate public company in 2002. Verint acquired Witness Systems in 2007 for ~$900mm, which was financed through (i) a new senior credit facility outstanding (~$638mm currently outstanding), and (ii) ~$293mm in convertible preferred equity purchased by CMVT. CMVT's investment in Verint is worth ~$622mm at market (assuming par for the convertible preferred). Note that Verint is not a current filer, but we can back into the Company's minimum EBITDA through their recently stated covenant compliance. JP Morgan sees VRNT generating $163mm in CY 2010, meaning VRNT is trading at ~7.5x 2010 EBITDA. This is a reasonable price for an attractive asset (discount to competitor NICE Systems, which is the closest comp).
• Ulticom (OTCPK:ULCM) - Ulticom provides signaling software to telecom equipment manufacturers. Ulticom was spun-out as a separate company in 2000; CMVT owns 68% of Ulticom ($68mm @ market, traded on the pink sheets). The business is not particularly special or attractive, and leveraged directly to telecom spending. ULCM should see some upside once the telecom spending cycle turns, and CMVT files and re-lists.
• Starhome - Starhome provides roaming technology and related services to wireless telecom operators. CMVT owns 70% of Starhome, which is likely generating ~$80mm in revenue. You are effectively getting the Starhome asset for free.

Valuation

• Near-term upside exists through two separate, related catalysts; (i) the filing of current financials, and (ii) the subsequent re-listing on NASDAQ. I should note that this has been anticipated for some time, but CMVT (and subs) have a long history of continually disappointing with respect to restatements and timing. Recent events lead me to believe that the situation is coming to a head shortly.
  • ULCM - ULCM has filed their 10-Q and re-listed on Nasdaq.
  • VRNT Press Release - Recently issued press release states that they expect to be in reporting compliance by the end of January.
  • CMVT Settlement - Reported last night, the Company has settled with investors regarding a drawn-out backdating settlement. This is the last step needed (aside from filing & re-listing) needed to get the Company's "corporate house" back in order. The terms of this settlement are reasonable for CMVT investors, as CMVT is paying ~$166mm over time to settle (Kobi Alexander is paying $60mm). CMVT will pay (i) $1.0mm on settlement, (ii) $52mm by august 2010 through the sale of ARS back to UBS at face value (held at ~$0.60), (iii) $30mm by February 2011, and (iv) $83mm by august 2011. Note that (iii) and (iv) are payable in cash or stock at the Company's election. This is a positive development as it removes uncertainty, and gives the Company flexibility in paying.
• Short-term I see upside to $12 (30%+). Longer-term, I see upside to the mid-teens once the holding company structure is addressed. The holding company structure is not optimal, and a spin-out of VRNT and ULCM to existing CMVT shareholders is the easiest, most-efficient way to monetize these assets. Once CMVT and subsidiaries have filed current financials and are re-listed, spin-offs would increase liquidity in all three companies, and allow small-cap sector investors to buy into the story (VRNT is non-core, and investors who want NICE / VRNT exposure generally cannot touch CMVT). I think these valuation estimates are reasonably conservative, however, we won't know until actual audited financials have been filed. I believe the downside (financial black hole is worse than expected) is protected through the technical factors that will come with filing and re-listing.

Risks

• Financials - CMVT has not filed audited financials in over three years, meaning actual results will differ meaningfully from any estimates. Cash flow metrics suggest that the underlying CNS business is healthy.
• Filing - Recent events suggest that they should meet the February 2010 deadline, but there can be no assurance. If CMVT does not file on time, the stock is likely to sell off even more given investor fatigue.

Catalysts

• Filing
• Re-listing - The Company (and subs) will apply for re-listing on NASDAQ once they are current on filings.  This is a powerful technical catalyst as it will increase liquidity and open the stock to a broader investor base.  I view this situation as analogous to AboveNet (COMP:ABVT) one year ago.
• Resolution of HoldCo Structure - Management has stated that the holding company structure is not optimal, and I expect this to be addressed over time.  A likely outcome involves the tax-free spin-off of the majority stakes in VRNT and ULCM to CMVT shareholders.  This spin would ultimately increase the public float and liquidity in both stocks, driving value.

Catalyst

Filing, re-listing, spin-off of subsidiaries.