Yak Communications has a market cap of $43M with net cash of about $13M, leaving an enterprise value of $30M.
Yak is the largest player in the Canadian dial-around long distance market with over 70% market share. That's the market where people dial 10-10-925 to reach an alternate long distance provider. They also have a strong presence in the standard long-distance market and the calling card market. Yak has more than 900,000 users, up from about 600,000 a year and a half ago.
Yak grew by targeting the growing ethnic minority segment in Canada. According to management, an example of one of their big customer groups is recent immigrants to Canada from China. The company continues to work to retain and grow this core market segment. Subscriber growth has been strong for the past 3 years. Canada's telecom situation is significantly less fragmented than in the US. Though Canada is deregulated, Bell Canada still controls most of the country. This helps Yak remain entrenched.
There are several other companies offering dial-around and calling card services in Canada. Yak has kept its prices low enough to compete with these while at the same time lowering their COGS through contract negotiations and building out their own leased-line infrastructure. In spite of industry trends toward lower long-distance costs, gross margins for this segment have increased from 37% to 41% from 2004 to 2005.
Yak has about 12.9M shares outstanding. The company does have 280k stock options outstanding, but the average exercise price is $6.50 versus the current stock price of $3.30, making them fairly non-dilutive.
Net Income declined from $5.6M to $4.2M between FY2004 and FY2005. The company has an offset fiscal year, so FY2005 ended on 6/30/2005. Results in the first two quarters of fiscal 2006 were worse, with the company earning only $200k. Cash flow has been even worse, as the company spent $5.8M more in Capex across the last 4 quarters than depreciation & amortization.
Across the past two years, Yak has been expanding into the US market. They have targeted ethnic minorities in the Florida and Southern California areas with similar offerings to those in Canada. The company has also launched a flat-rate VOIP product targeting a price point below that offered by Vonage.
The company's financial results mask what's really going on. While the USA operation is still in the inital stages, and is losing money, the Canadian operation remains very cash-flow positive:
Quarterly Data, 3 months ended Sept. 30:
Market 2005 2004 2005 2004
Canada 22,226 20,897 2,063 2,937
US 1,282 221 (1,516) (768)
Annual Data, 12 months ended June 30:
Market 2005 2004 2005 2004
Canada 89,434 79,569 14,390 9,517
US 3,036 1,074 (7,416) (1,663)
As you can see, the Canadian operation generated EBIT in FY2005 of $14.4M. EBIT in the first fiscal quarter of 2006 was somewhat lower due to compliance costs, the US dollar’s appreciation and some non-recurring items.
Using the FY2005 numbers for Canada and a $26M enterprise value, EV/EBIT was 1.8. Annualizing the lower quarterly numbers for Canada gives EV/EBIT of 3.2.
Results for the US have been disappointing so far, but revenue is growing and EBIT is becoming less negative. More detail on the US expansion is below, but even assuming they give up and shut it down, this company has an interesting hidden asset in its Canadian operation.
The company is making capital investments: $6.3M in FY2005 against a depreciation of only $2.9M, for a net hit to FCF of $3.4M. These capital investments are almost completely going into the Canadian operation. Between 2004 and 2005, long-lived assets in Canada rose from $11.5M to $15.4M, with the US rise only from $474K to $642K. Management has guided that 2006 Capex will be lower than 2005.
The company says these capital investments are primarily aimed at building out their leased-line infrastructure to handle anticipated growth and lower the cost structure still further. Even with these investments, ROA on the Canadian operation remains very high, with fixed assets of $14.5M providing the EBIT mentioned above.
The company is launching several products targeted at the US:
1. The first is a duplication of its Canadian dial-around and calling card products. Yak is targeting the Hispanic community to save on marketing costs and hopefully build up customer loyalty. This is exactly the sort of approach Yak took in Canada. This approach makes sense to me, but the US market is significantly more competitive than Canada, so it may not work.
2. The second is a VOIP-based phone service at $19.99 per month. The service is essentially a clone of Vonage or Packet 8's services, with one difference that customers need to buy the hardware themselves (a $50-100 purchase). This business would be quickly accretive to the company if it grows, however it's been hampered by the lack of Enhanced-911 capabilities in all but a few US cities. This business is also very competitive.
I would suggest that the way to think about the US expansion is as an option on potential further growth. Management has been intelligently deploying cash in the US in such a way to avoid spending down any of the company's capital. They are, however, spending the Canadian free cash flow. I would expect these investments either to pan out in the coming 12 months or not to pan out. In either case, the Canadian free cash flow should once again become available. If the investments do pan out, the company obviously becomes even more attractive. Canadian results show that the company is not becoming defocused and continues to do a good job of providing growth in their core market.
Management has a significant stake in the company. The CEO and one director combine to own 32% of the stock. The CEO alone owns 25%.
The core of this idea is that Yak contains a Canadian segment which is being significantly undervalued by the market. The company is small and competes in what most would consider an unattractive space. It has no Street coverage.
Here are the key TTM statistics for the company if you only consider the Canadian operation:
EV/Net Income: 3.3
EBIT/Fixed Assets 83%
Declining Long Distance Fees.
One key negative argument about this business is declining costs in long distance. This is a long-term trend which both hurts and helps the company. It hurts by lowering the price customers are willing to pay and helps by lowering the company's cost structure. There is nothing to suggest a precipitous drop in pricing is likely, but it is likely that sometime in the next 5+ years the business will become less profitable. 22% of the company's minutes in 2005 were international (meaning, calls placed to outside the US and Canada), and I would expect the costs on these minutes to decline more slowly than domestic minutes. More than 50% of the gross profit comes from these international calls.
Another negative argument is that management has stated that they are pursuing opportunities to grow the business. This creates the fear that management will make a value-destroying acquisition or other strategic move. While this is always a possibility, the following argue against it:
1. Management is aligned with shareholders, given their significant shareholdings.
2. The company acquired the customer base of Navigata, a business telephony company in 2005. They bought two other similar companies in 2003. While none of these acquisitions has proven terribly accretive to the business, they have not been harmful either. The company’s business products provide a stable source of revenue with 25%+ gross margins.
-- Significant activist shareholder is Wynnefield Capital Management, with 3.33%. They've taken a strong stance with Niagara (NGCN) in the past (find some other examples).
-- Increased analyst recognition/coverage as they grow the US portion of the business.
-- Clarity on the success or failure of the US rollout.