September 28, 2011 - 8:49am EST by
2011 2012
Price: 13.17 EPS $2.09 $2.40
Shares Out. (in M): 34 P/E 6.3x 5.5x
Market Cap (in $M): 442 P/FCF 10.4x 4.8x
Net Debt (in $M): 157 EBIT 0 0
TEV ($): 600 TEV/EBIT 0.0x 0.0x

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CSGS is an outsourced customer care and billing solutions company that primarily services cable and direct broadcast satellite companies. The company's Intec acquisition at the end of 2010 expanded their reach into the telecom space and took their industry exposure from 86% cable/DBS down to below 60%. At the same time, geographic reach was expanded into higher growth areas (wireless and emerging markets) while customer concentration was lessened. 

CSGS consistently generates a substantial amount of free cash flow.  FCF for the past four years (not exactly a great environment) roughly equals CSGS's current market cap for a company that will be levered at 1.0x at year end.  The valuation is simply too cheap (2.9x 2012 EBITDA, 21% 2012 FCF yield, 5.5x 2012 PE and 2.2x 2013 EBITDA, 26% 2013 FCF yield  and a 5.3x PE).  An LBO is compelling at 75%-100% premiums, let alone at the current stock price.  The industry peers trade at higher multiples, and CSGS has traded much higher in the past (more than 2x the current multiple).  Even using a 5.5x EBITDA multiple would warrant a $25 stock price at the end of 2012.  Further, management has a history of buying back shares as the share count is down 30% vs. the end of 2006. 

The company has been put in the penalty box for some recent missteps in an unforgiving tape.  CSGS guided down full year revenues slightly in Q1 but kept profit targets.  They disappointed again in Q2 with another revenue guide down while taking down annual EPS/EBITDA and FCF targets largely due to the Intec acquisition and some one-time cash flow impacts.  Clearly disappointing as they stubbed their toe coming out of the gates as a combined entity, but the punishment has been way too harsh.  FCF yield on 2011 is closer to 10% but has several substantial one-time factors that will not recur - there was a delayed working capital outflow related to the acquisition, some cash restructuring charges for announced cost savings, a substantial working capital outflow related to the extension of a key contract and a deferred tax payment related to a debt retirement made in Q2.    Also, customer pipeline conversion has been slower than they expected and they are still getting their hands around the lumpier Intec business.  Nonetheless, CSGS is a solid business with EBITDA margins in the low 20% range, low capital intensity, a consistent FCF track record going back 10+ years, organic growth in the mid-single digits in a normal environment and has a stickier than average client base.  The core CSGS business is highly visible with long-term contracts and typically 90% of revenue is known heading into the quarter.  Further, there is also a decent variable component to the cost structure. 

As a rough proxy, here's a breakdown of the business - geographically, revenues are now 84% Americas, 10% EMEA and 6% APAC.  Revenue mix is 69% processing/managed services, 11% maintenance, 14% professional services and 6% software/license.  Gross margins are in the 50% range with processing at 50%+, maintenance at 60%+, professional services at 25%+ and software at 80%+.  Expenses are highly variable/manageable with SG&A at roughly 16% of revenue and R&D at 14%. Headcount is 57% of total expenses with an estimated 80% associated with operations, development and delivery.

Some of the key issues for investors should be favorably resolved over the coming quarters.... 

a) Are more guidance cuts coming? Its possible they haven't been conservative enough on the top line for 2011 but the guidance seems a lot more reasonable now. Some of the issues that led to the top line softness are still lingering in Q3/Q4 so its possible there is some additional minor tweaking, but 2011 looks to be a transition year anyway in my view. The macro has become more challenging so its possible that there is some more leakage on the Intec side of the business but I'm not expecting material changes to the outlook. The low end appears attainable as it essentially run rates 1H. Management has done a good job controlling costs and can deal with some incremental near term softness. I think if CSGS just reiterates guidance it will be viewed positively, potentially leading to a rerating of the stock.

b) What are the risks to the Comcast contract that is up for renewal at the end of 2012? The company just renewed their contract with Dish (11% of pro forma revenue) and had to sacrifice some typical pricing (which also hurt 2011 earnings), but in return, they extended the duration much further out. The Comcast contract is coming up at the end of 2012 and accounts for roughly 16-17% of CSGS's revenues. Based on my diligence, it seems unlikely that CSGS would lose that entire business as Comcast doesn't want to have just one vendor (right now CSGS is 2x the other supplier as far as subs) and its usually a very difficult migration. Frankly, the company may end up taking more share as Comcast has given them some additional business of late and I've heard of some execution issues by the other vendor. My numbers account for a reasonable rework of the Comcast contract for 2013. In the unlikely event that CSGS were to lose the entire contract, my understanding is that there is a long changeover period (years not months or weeks) where a material amount of cash would still be pulled out of the relationship post 2012. I can see a situation where a takeout occurs once the Comcast situation is officially resolved.

c) Cable unplugging risk (i.e., we won't have a cable subscription anymore and all these cable companies are donuts). Cable companies are clearly morphing into more than just a set top box to watch HBO - offerings are expanding and technology is changing rapidly. Based on my diligence, the sub data seems stable for the next 5+ years and the core strategic rationale behind the Intec acquisition was based on globally offering a more robust product line in a converging voice/data world while at the same time diversifying from the cable/dbs sector. It just seems much less obvious to me that cable companies share the same secular issues facing directories, pagers, mail, newspapers and bookstores. Certainly, cable companies are generally not priced like those companies. Controlling the pipe to the home is valuable as broadband connections remain important. There have also been rumblings of cable morphing to a more a la carte model. All in all, I think more complicated billing is a good thing for CSGS. I'm not sure this will be resolved in the next few quarters, but as more clarity on subs/landscape is witnessed over time, it should be less of a worry.

d) Is another acquisition coming (and the associated integration risk)? Based on my conversations, I don't get that sense - the company seems more focused on doing buybacks sooner than investors think. Given the experience with Intec to date, I think management wants to right their reputation.

At a relatively unlevered 20-25% FCF yield, I think CSGS is a compelling investment.  The core business generated a decade worth of consistent FCF's and I don't think Intec is a toxic mess that will suck up all the FCF (it actually should eventually contribute $20-$30MM or so of annual FCF) which isn't baked into any of my figures. 


potential buyback
potential takeout
contract resolution 
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