Value Investors Club / SEACHANGE INTERNATIONAL INC (SEAC)

Description

DOUBLE

- Seachange is a leading supplier of Video Delivery Software Solutions which powers 200+

cloud and on-premise video delivery platforms.

- Following years of mismanagement and a misguided sales approach which created a bevy of

earnings disappointments, after successfully streamlining its product set into one software

offering (Framework Solution), Seachange’s new management team has quickly energized and

transformed the company’s culture to a winning and a profitable one.

- With its Framework Solution’s 70-75% gross margins, as these new software revenues become

a bigger part of the overall revenue mix and its lower margin services revenues get phased out,

Seachange’s operating margins are poised to inflect materially. Importantly, with the company

continuing to take costs out of its business, Seachange’s underlying profitability inflection is

poised to manifest itself when Q3 results are released.

- After doubling the past six weeks, Seachange’s shares are poised to double again over the next

9-12 months. I see ten reasons for this thesis taking root; let’s examine now.

REASON #1 - SEACHANGE’S CEO IS A WINNER:

Seachange’s CEO, Yossi Aloni, is a winner, replacing a CEO who destroyed shareholder value

since he took the helm as COO/CEO in 2015 and 2016. During that time, SEAC’s stock lost

north of 60% of its value. Enter Yossi Aloni.

During his role as Chief of Corporate Operations at Ateme, a leader in video delivery

infrastructure, the company grew revenues at a 25% CAGR.

At first, Aloni stepped into Seachange as its Chief Commercial Officer earlier this year. He

immediately spearheaded positive change and was formative in developing the company’s new

Framework solution and its go-to-market strategy. Here is some additional 411 on the

Framework solution:

“The Framework is a complete video delivery platform enabling service and content providers to

deliver personalized live and VOD services. The cloud-based business intelligence and

behavioral analytics results in highly relevant advertisements increasing operator revenues. The

expansion of our product capability and our enhanced go-to-market strategy together are

strengthening our presence in the market," said Mark Bonney, Executive Chairman of the Board.

"Our customers are recognizing the effectiveness of SeaChange's product framework in driving

viewer engagement while lowering their costs and enhancing their profitability."

We had the opportunity to speak with Aloni recently. We came away impressed with Aloni’s

depth of technical knowledge and his ability to not only get new customers onboarded with the

Framework solution, but to also bring back old customers and to re-engage with the company’s

impressive base of entrenched customers. In this regard, note the impressive array of Tier 1

carriers/service providers that Aloni can upsell to in the coming months/quarters:

In our conversation with him, it became clear that the previous CEO’s strategy of casting

Seachange as a professional services organization providing customized solutions to MSO’s was

not only an inconsistently unprofitable model, it was also the wrong go-to-market strategy. Aloni

explained that this is no longer the case with the Framework solution, which is a much easier

end-to-end solution to sell, and one that carries with it much higher software margins and, very

importantly, long-term recurring revenue as well. I found the following excerpts from the

company’s most recent earnings call very informative:

”We closed six Framework deals in the quarter, bringing the total for the year to seven. It's

important to note that these transactions were achieved in a remarkably short time considering

we launched the Framework solution in April, and our sales force wasn't fully in place until

May. Our backlog ended the quarter at over $16 million, an increase of $5 million or 45% from

the end of our first quarter.

We believe these wins as well as the additional customer agreements we are finalizing these

days, along with our ability to deliver an end-to-end solution within 90 days validate our

strategy. Earlier this year, in April, we launched the SeaChange Framework solution, which

encompass all our previously standalone products. The goal of the Framework is to allow us to

execute on our corporate strategy by enabling our customers to increase the revenues on their

customers, to increase their customer base, to improve their customer retention, and to achieve

OpEx savings.

During Q2, we completed and validated the pipeline needed to enable us to meet our yearly

targets in terms of revenue and number of wins. In addition to the reported wins in Q2, we are

finalizing a decent number of customer engagements for both Q3 and Q4. This provides us a

solid confidence in meeting our revenues and customer win goals for this year.

Given the Framework engagements will be contributing revenue for multiple products over

multiple years, we expect our backlog will continue to grow as we close additional Framework

arrangements in the second half of this fiscal year. And our recurring revenue from backlog

will become more predictable.”

REASON #2 - SEACHANGE’S SALES TEAM HAS BEEN TURNED OVER WITH

INDUSTRY VETERANS, ALL OF WHOM WORKED FOR ALONI AT ATEME, HIS

PREDECESSOR COMPANY:

#2: Seachange’s sales team has been completely turned over with winning salesmen with deep

industry contacts, each of whom worked with Aloni at Ateme, his predecessor company,

together. Using LinkedIn, I found five of these sales guys.

While there is no guarantee of success, we find it extremely encouraging that most of the big

sales guys from Ateme jumped ship to join Aloni at Seachange. Nonetheless, this should not be

too surprising, as there is a very big opportunity to double the size of Seachange the next 3-4

years, from $75M in revenues to $150M, which would equate to a 30% market share for the

company.

Considering how the company can now integrate and deliver an end-to-end Framework solution

from agreement to production in less than 90 days, the velocity of wins for Seachange is poised

to accelerate in the coming quarters as the new sales team executes on its entrenched customer

base.

Throughout my call with Aloni, there was one consistent message: the company’s visibility is

improving weekly due to these new sales adds, with a # of “significantly higher ASP deals”

either on the goal-line or already having been closed.

This echoes the confidence exhibited when Aloni presented earlier September at the Liolios

Gateway Conference.

Among the more notable quotes from his presentation, the following stood out:

“We believe we are going to do well because we address the three pain points are customers are

facing.” (More on this in the next section).

“Today when we go to market, we are in a position today, when we go and compete for business,

we have the best solution in the market, because the investment in the product was like nothing

nobody invested. Having the best solution in the market today will allow us to meet our revenue

targets for the year.”

“We will continue to reduce our OPEX. We have taken some actions to date. We will take more

actions and plan on exceeding our OPEX costs.”

“We have communicated that we would win 20-25 significant deals ($2.5M-$3M) this fiscal

year. We may do a bit more.”

“We are in process of finalizing a decent # of new agreements. This a very decent # and will

take us closer to our target for this fiscal year.”

To me, when I hear a CEO confidently state these words only one week after taking the reins as

CEO, it seems very likely that not only is the current quarter going to be another strong quarter

of bookings, it could very well be a blow out quarter of bookings, one which dwarfs what the

company did last quarter.

If I am right, a pre-announcement in early November could be in the cards and become an

unexpected catalyst for the stock.

REASON #3 - SEACHANGE HAS THE BEST SOLUTION ON THE MARKET:

Because the Framework solution is the only solution in the market that is an end-to-end solution

capable of running both on the cloud and on-premises, Seachange has developed the best

solution on the market.

This should not be too surprising when you review the entrenched customer base (note again the

Tier 1 customer base highlighted), note how industry sales veterans quickly flocked to

Seachange once Aloni came on-board, and how the company has invested $250M-$300M of

R&D into its technology stack the past ten years.

As for the three pain points customers are facing and how Seachange addresses them, note

highlights in below slide:

REASON #4 - AS THE COMPANY’S BACKLOG GROWS, RESULTS WILL BECOME

MORE CONSISTENT & PREDICTABLE, LEADING TO A HIGHER SOFTWARE

MULTIPLE FOR THE STOCK IN THE COMING QUARTERS:

Whenever the company executes a Framework deal, ~65% of the attached revenues are

immediately recognized, with the remaining amounts placed into the company’s backlog and

ratably recognized over the next 3-5 years. As more Framework deals get closed, the company’s

backlog will grow considerably, providing both the company and investors a predictable revenue

stream easy to model out. Note how strongly backlog has already grown the past two quarters

and is up 100% y-o-y after Q2:

While I do not expect this growing backlog and more predictable, recurring software mix to

translate into a 10X SAAS Price-to-Sales multiple, eventually, it should allow SEAC’s Price-to-

Sale multiple to expand strongly.

A re-rating to 2x-3x on forward #’s seems highly likely.

Using the mid-point, or a 2.5X multiple on $92M in Fiscal 2021 sales, gets us to a $230M

market cap. Add in the $20M in cash and we get to a $250M cap, or $6.25.

REASON #5 - SEACHANGE IS POISED TO DELIVER NOTABLE OPERATING

LEVERAGE IN ITS MODEL:

With software revenues carrying 70%-75% gross margins (much higher-than-average corporate

gross margins) becoming a bigger part of the mix, as Seachange’s new management team

continues to take additional costs out of the business, the company is poised to demonstrate its

inherent leverage in its operating model. First, regarding costs, note how the company’s

operating expenses were 21% lower last quarter, even as revenues jumped dramatically higher y-

o-y.

Because the company is still servicing lower margin revenue commitments, it will take another

quarter or so before we see its break-out quarter manifest itself. The key point is this: as these

software revenues become a bigger part of the mix, a $.12-$.14 quarter is forthcoming and can

be easily modeled at $22.5$23.5M in quarterly revenues. In this regard, note Dougherty’s model

for next year and how the company could earn $.35 on $80M in revenues:

As seen just above, with operating margins expected to expand toward, if not, above 20%, it is

not difficult to model the company earning $.45-$.55 on $92M in Fiscal 2022. In 3-4 quarters, as

new investors discount this possibility, expect a re-rating of the stock’s multiple on both its sales

and earnings to propel the stock to double again from current levels.

Considering its tight share structure of only 36.7M shares outstanding and the dearth of organic,

inflection-point growth stories public, particularly, in small-cap land, this re-rating could occur

much more quickly than anybody is currently envisioning.

REASON #6 - HUGE DISPERSION EXISTS BETWEEN 2021 CONSENSUS AND

LIKELY FORWARD #’s:

Simple math suggests that in addition to handily beating consensus in its next two quarters, with

its backlog poised to build into the $30M range by its next Fiscal Year, it will not take much for

the company to top forward #’s. Remember, recurring revenue has only just begun to build;

henceforth, it will stack exponentially as new contracts are closed each quarter.

As such, I view it as much more likely that the company will see revenues come in at $92M in

Fiscal 2021, up 23% from the $75M I expect to see this fiscal year. As gross margins inflect and

close in on 70% next fiscal year, $.45-$.55 in non-taxed EPS should be forthcoming as well.

Therefore, there is a huge dispersion between next year’s consensus and what the company is

more than likely poised to end up achieving. This is always one of the best formulas for

continued outsized moves to take shape in a stock which has already doubled.

REASON #7 - SEACHANGE IS UNDER-OWNED AND THE SELL-SIDE IS STILL

SKEPTICAL, PAVING THE WAY FOR NEW OWNERSHIP & SPONSORSHIP

SHORTLY:

Not surprisingly, considering its spotty history of execution, Seachange is under-owned with

only approx 60 funds long the stock according to bloomberg data.

Once the company prints its first $.06-$.08, which I believe will occur when the company reports

in late November/early December, a multitude of new institutional investors will aggressively

establish positions in the stock. It will not take much new buying to re-rate the stock 50% higher

after another big quarter.

Moreover, because the sell side has been burned on SEAC for years, it is easy to understand why

certain analysts have dropped coverage (i.e. BWS Financial) and why those who still do cover it

are not yet banging the table on it. This will change, however, with one more quarter of

execution and strong bookings.

Once this occurs, in addition to Lake Street and Dougherty finally getting behind the stock again,

I would expect other firms to initiate coverage as well. Seachange strikes me as a perfect

candidate on which a Craig Hallum may choose to get involved with once execution is proven

out.

REASON #8 - SEACHANGE IS STILL UNDERVALUED:

In addition to trading for only 1x Fiscal 2021’s sales – after netting out its cash -, when you also

add in its $115M in NOLS and the $250M-$300M in R&D investments which went into creating

its technology platform, Seachange has a tremendous amount of latent assets as well.

Add in the very high likelihood that the company can earn $.45-$.55 in its next fiscal year and

the stock’s cheapness radiates ever more so.

REASON #9 - SHORTS ARE COVERING, NOT DIGGING IN:

Often, shorts will quickly move into any stock that has doubled. For me, I therefore view it as

very bullish that the SEAC shorts are doing the opposite – covering their positions, as they

clearly believe the stock is heading higher, not lower:

REASON #10 - SEAC’s TECHNICALS HAVE ONLY JUST TURNED UP;

ADDITIONAL UPSIDE WILL ACTUALLY BECOME MORE DYNAMIC AND

FRENZIED ONCE WE SEE THE EPS STEP UP STRONGLY

First, SEAC’s three-year weekly chart shows very clearly that its long-term downtrend was only

just breached to the upside last month. Minimal resistance can be found at $4-$5, with heavy

resistance nowhere to be found until the $6-$7 range.

Turning to its monthly chart, SEAC is finishing its second biggest month of accumulation in the

past ten years. Unlike the quick spurt in late 2017, however, I do not expect last month’s

accumulation to be a one-off, when you consider the forthcoming catalysts expected for the

stock. Also, note how even after its recent doubling in price, SEAC is still 80% off its highs from

six years ago. As such, while a few more weeks of consolidation will be needed to wear off its

overbought levels and for the stock to complete a very constructive second stage base, SEAC

remains at very depressed levels relative to its long-term trading history. Even if the stock were

to double again, it would still be 60% off its 2013 highs.

RISKS TO BE MINDFUL OF/THINGS NOT TO LIKE

Of course, there are a set of risks to consider. These include:

- The largest shareholder, Tar Holdings, is being run by husband and wife team in which the

husband, Gary A. Singer, is a convicted felon from the 1990s. Clearly, Singer is not a good guy.

Nonetheless, to his and his wife’s credit, they have engineered a wonderful turnaround here and

brought in this winning management team. I find no fault with them currently, although I am

keeping a watchful eye on short interest, as eventually, more likely than not, if the stock does

embark upon the type of parabolic move I expect it will, the shorts will bring this out as a reason

to short the stock.

- Seachange’s TAM only measures $500M. While there is plenty of room to grow the company

to a $150M company the next 3-4 years, thereafter, I have a hard time making the case that

Seachange can grow into a much bigger company than that.

- In order to achieve its $75M mid-point in revenue guidance for its current fiscal year, the

company will need to deliver $47M in revenues the next two quarters. This is a big bogey to hit,

especially for a new management team in a company with a spotty history.

And yet, with many of the new contracts in the queue carrying higher ASP’s than the $3M ASP

seen thus far this fiscal year, I believe they will hit their guidance. This interaction from the last

earnings call, in addition to the excerpts from the company’s presentation at the Liolios Gateway

conference, highlighted earlier, also support these views:

“Okay, great, that's very helpful. And to do these, let's call them then, 13 to 18 deals between

now and the end of the year, how big is the pipeline, what's your coverage on those 13 to 18

deals?

Yossi Aloni

We are in very decent shape. We expect to meet our targets. We are very confident in meeting

our target, meaning we are engaging with all the targets that we need to finalize by the end of

the year, with most of them we are in a very advanced stage of the engagement.”

CONCLUDING THOUGHTS:

After more than doubling the past three months, SEAC is currently consolidating below $3. I do

not think it stays below $3 for too long though; there is simply too much value in Seachange’s

shares, along with a very strong likelihood we will see a blow out quarter of bookings

forthcoming in either Q3 or Q4, if not, in both quarters.

With its costs being lowered, gross margins poised to inflect into the mid-60s near-term and into

the 70s its next fiscal year, its sales force initiatives coalescing this quarter and next, the stage

has been set for two more big up-legs in SEAC to materialize the next 2-3 quarters.

Additionally, with its backlog poised to expand materially with very high software revenues and

its recurring revenue line expected to become incrementally profitable the next two fiscal years,

consistent execution should manifest itself in not only a dramatic inflection in its underlying

profitability and results, but also, as well, in its stock price.

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

Catalyst

Q3 Earnings Report, Possible Preannouncement, Analyst Coverage

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			2019	2020
Price:	2.99	EPS	-0.03	0.225
Shares Out. (in M):	37	P/E	0	13
Market Cap (in $M):	108	P/FCF	0	0
Net Debt (in $M):	-17	EBIT	0	0
TEV (in $M):	92	TEV/EBIT	7.6	6.5