February 16, 2005 - 8:37pm EST by
2005 2006
Price: 19.00 EPS
Shares Out. (in M): 0 P/E
Market Cap (in $M): 540 P/FCF
Net Debt (in $M): 0 EBIT 0 0

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TNS is a free cash flow story (8% FCF yield) with excellent international growth opportunities. Currently there is a buying opportunity becuase TNS' venture capital backers have distributed 3 million shares to their investors in order to wind down one of their funds.

Market Cap: $540
Cash: $20
Debt: $40
EV $560
FCF $40 million 2005E

EV/EBITDA: 8x 2005E
EV/EBITDA: 8x run-rate
FCF Yield: 8% 2005E (assumes $5m of qtrly capex)

TNS provides data communications for payment processing (76% 04 Revs), financial services (10%), and telecom (14%) industries. What does this mean? Every time you use a credit card at a point of sale, there is a 70%-80% chance that TNS' network and equipment move the data between the point of sale and the relevant processing company (such as First Data, Global Payments, etc). TNS services 9 of the 10 largest processors in North America and provides similar services for ATMs.

What excites me about this company is the explosive growth in international markets and the international markets are not just some elusive opportunity, but are coming to fruition and in 2005 will easily be largest revenue and earnings contributor. I believe that as international operations grow, the internal growth rate of the company will dramatically accelerate from -2% in 4Q to +7% to +8% by mid-2005.

International Revenue: Sequential Revenue NOT annualized
1Q04: 9%
2Q04: 7%
3Q04: 15%
4Q04: 8%
2004: 60%

As shown above, the annualized revenue growth from the international segment has been ranging from 30-60%. International operations currently represent 35% of consolidated revenue and by 4Q05 I expect them to represent over 40% of consolidated revenue. So as the high growth international segment becomes a greater piece of the whole, internal revenue growth will accelerate and accordingly the multiple should expand. Additionally, management has stated that International is its highest margin segement as well. I expect the international segement to continue its strong growth in 2005 from: 1) the Royal Bank of Scotland recently signed as a client and will be coming on in mid-2005, 2) recently entered markets will gain scale and acceptance of credit cards - such the company's recent entries in Czech Republic, Hungry and Poland and 3) pilots in such places and Mexico, Brazil and other Latin coutries set up new opportunities.

I believe the best comparable to TNS' international division is Euronet Worldwide (EEFT). This company also is a transaction processing company benefiting from the international adoption of electronic payments and experiencing similar growth rates. This company trades @ 12x 2005E EV/EBITDA.

The financial services segment is another division I am excited about. TNS connects brokers and fund managers electronically to each other and to ECNs. Revenue from this division grew 23% in 2004. I believe this growth will be sustainable because the shift to electronic trading is still early - and with the NYSE likely going electronic in 2006, the need for electronic connectivity theoretically doubles (because the listed market is still largely a phone based market while NASDAQ is fully electronic, therefore electronic trading of listed trading should spur increased need for electronic connectivity).

The telecom part of TNS' business is used to identify the route to be used to connect a call (TNS does not handle the actual call only identifying the route for the call). The segment grew 9% in 2004 and has some recent wins such as XO communications. As the # of possible routes for a call increases (i.e. does the call start at a cell phone then travel to a wire line or does it travel over high speed internet and is that over a cable line or dsl? - you can see the multitude of routes) the demand for TNS's services should increase as well. For 2005, I'm expecting similar growth to 2004 (8%).

So why does TNS trade at near an 8% FCF yield? This is because of recent pricing pressure as AT&T has decided to re-enter the domestic market (after exiting in the 90s). Domestic POS respresent 40% of revenue. AT&T won a large part of First Data's business last year and much of the First Data volume left TNS on November 1, resulting in a 17% year-over-year decline in domestic POS revenue. First Data does still have revenue minimums with TNS. Additionally Global Payments renewed in 2004 at a lower rate than before (although GPN is a much larger company today). There are two important points here: 1) there are no major contracts up for renewal in 2005, 2) TNS is testing with Subway and Quiznos, a full contract with one would be a huge win, 3) we don't know how committed AT&T is to this business - they failed once - and in the middle of a major merger a niche new initiative that is unprofitable could easily get cut (AT&Ts only client currently is First Data), and 4) I believe the market is valuing this business at only 5x 2005 EBITDA (implied value thru a sum of the parts valuation).

The second reason for the cheap valuation is that TNS' majority owner announced last night that it will distribute over 3 million shares to investors. This VC fund is winding down one of its funds and thus the distribution. Therefore, with TNS shares hitting a 52-week low, driven by a coming supply of shares, not a fundamental reason, I believe this creates an opportunity. In fact, management just last week gave 2005 guidance that was slightly above with previous guidance.


1) Major contract with Royal Bank of Scotland starts mid-2005
2) Highest growth and highest margin segment, International will become the dominant division in 2005 which will accelerate the company's overall internal growth rate and margins.
3) In tests with Quiznos and Subway, a contract with either could be large
4) Possible announcement of a share buyback to partially offset the recent share distribution by a large VC fund.
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