|Shares Out. (in M):||15||P/E||7.7||4.6|
|Market Cap (in $M):||35||P/FCF||7.7||4.6|
|Net Debt (in $M):||0||EBIT||5||8|
Zoom Telephonics (“ZMTP”) trades at 8x earnings, has net cash on the balance sheet, and organic growth is +72%. With the imminent “clean up” of a share overhang, we think the company’s shares are both undervalued and timely.
Importantly, we believe Zoom’s high growth rate is sustainable for the foreseeable future. Our investment thesis is that as an asset-light business, Zoom has high incremental net profit margins on this revenue growth. As a result, the stock is cheap on 2018 earnings, but incredibly cheap on 2019 and 2020 earnings (less than 4x earnings for a growth company with net cash).
We think the shares trade at the current price for three reasons. First, there has been a non-fundamental seller weighing on the shares for 18+ months, pinning the stock to just above $2 per share. Based on an SEC filing a few weeks ago, this seller is nearly exhausted and a “clean up” trade is imminent. Second, ZMTP plans to up-list to NASDAQ once its shares trade above $3 for sixty consecutive days, but for now the shares are at $2.30 and therefore OTC-listed and off-the-radar.
Third, the company’s CEO is terrific and has earned investor trust with his exemplary business execution. But he also is the most anti-promotional CEO we have ever invested behind – he focuses on everything he worries about first, and only reluctantly shares with investors the good parts of the business. This can be frustrating (as the story remains undiscovered) but also, in a way, is a bit refreshing relative to most other management teams who do the opposite.
In our view, the first issue is on the verge of being resolved, it is only a matter of time before the second issue is similarly behind us, and the third we are happy to live with as the results speak for themselves. We think Zoom is a cheap, profitable, high-growth business with a strong businessman CEO that makes for a timely investment.
An Asset-Light Business
Zoom is an asset-light product design firm based in Boston, Massachusetts.
Zoom specializes in consumer wifi networking devices such as cable modems, routers, range extenders, cellular sensors, and MoCA adapters. Manufacturing is outsourced to high-quality manufacturing partners in Asia and distribution is outsourced to Amazon or third-party brick-and-mortar retailers such as Walmart, Target, and Best Buy. Zoom executes the difficult, IP-intensive steps of product design, engineering, qualification, and testing, including achieving the requisite partner and regulatory approvals.
With no need for manufacturing plants or brick-and-mortar stores, Zoom’s business model is asset light with high incremental margins. Zoom has a number of competitive advantages that constitute a healthy moat: scale as a top-3 seller of consumer cable modems, substantial product IP and patents, an excellent track record of product design (Zoom’s products regularly receive category-leading ratings on Amazon), long-term relationships and an excellent reputation with a variety of partners (manufacturers, cable companies, retailers/distributors, regulators, etc.), sales inertia for its products online (when products have thousands of positive reviews, it is hard for new products to displace them), and access to a global brand.
Whether Zoom sells 100 modems through Amazon, or 1,000 modems or 10,000 modems, the company’s cost structure barely changes. As a result, the incremental net profit margins are large (we estimate 30%+), which is an attractive set-up for a business in high-growth mode.
A Game-Changing Long-Term Partnership
To tell the Zoom story, it is worth highlighting Zoom’s go-to-market strategy. For many years, Zoom had a wonderful team, excellent products, a good reputation, and strong relationships with its partners. What it lacked was access to a well-known consumer brand.
In January 2016, Zoom entered into a long-term agreement to license the Motorola brand for the cable modem category in North America. In August 2016, the Motorola agreement was expanded to include the entire world and a number of new product categories. In September 2017, the Motorola agreement was expanded a third time with a global license for even more product categories.
The partnership with Motorola launched ZMTP into a new trajectory: sales grew +65% in 2016 and another +65% on top of that in 2017, with revenue growth accelerating to +72% in the latest reported quarter (Q4 2017).
Motorola’s business plan is to establish long-term licenses (and high-value royalty streams) with a small group of carefully-selected partners. For wifi networking, Motorola’s long-term partner of choice is Zoom. Motorola has shown a deep reluctance to switch out its partners absent those partners acting in bad faith – we have found only one example of Motorola ending an agreement with one of its license partners, and that was when its partner actively worked to leverage the Motorola brand to promote its own brand (and even then it took Motorola 3+ years to extricate itself from the relationship).
Given Motorola’s track record, Motorola’s desire not to disrupt a high-value profit stream, and Motorola’s twice-expanded relationship with Zoom (including the latest expansion just a few months ago), we are confident that Zoom’s relationship with Motorola constitutes a long-term, durable, win-win business relationship.
ZMTP Trades At 8x 2018 Earnings…And 3x 2020 Earnings
The onboarding of the Motorola brand required significant up-front investment from Zoom. For much of 2016 and 2017, the company was loss-making as it scaled up its business and introduced new products and product categories.
The company’s revenue break-even is $7.5M per quarter. Zoom eclipsed this figure in Q3 2017 ($8.4M revenues) and again in Q4 2017 ($8.9M revenues). The Q4 2017 results were particularly impressive, as Zoom’s sales are seasonally strongest in Q2 and Q3 (when people move to new apartments or homes and therefore buy home wifi networking devices) and weakest in Q4 and Q1 – sales during Q2/Q3 can be as much as 50% above Q4/Q1 sales simply due to seasonality. The counter-seasonal revenue increase in Q4 2017 is indicative of meaningful underlying business growth.
As Zoom has net cash (so interest costs are de minimis), NOL’s to shelter taxes for many years to come, and an asset light model that requires little added SG&A as sales drive higher, the incremental net profit margins are large (as noted above, we estimate 30%+). This jives with the results from both Q3 2017 ($8.580M sales and $377K net profit, a 34.9% incremental net profit margin above $7.5M sales break-even) and Q4 2017 ($8.862M sales and $444K net profit, a 32.6% incremental net profit margin).
Assuming normal business seasonality, we see 2018 revenues for the company reaching $45M. At a 30% incremental net profit margin above a $30M annual revenue break-even, ZMTP’s implied earnings are 30c per share ($4.5M on 15.1M shares), putting the stock at 8x 2018 earnings. Should revenues continue to grow by $10M each year in 2019 and 2020 at the same incremental profit margins, ZMTP would earn 50c in 2019 and 70c in 2020 vs. a $2.30 share price today, putting the company on 3x 2020 earnings with net cash on the balance sheet.
Why The Shares Are Cheap
We point to three reasons for the mispricing of Zoom’s shares.
First, for the last 18+ months there has been a significant non-fundamental seller overhang in the shares. In 2015, the CEO’s brother sadly passed away. He was a large passive investor in the company with a 9% ownership stake. Over the last 18 months, his estate independently began selling down its 1.3M share stake by relentlessly pushing its shares into the market (instead of selling them all at once in a block transaction).
As a result, the company’s shares – even with strong underlying business performance – have gone nowhere. A few weeks ago, the estate made a 13G filing that as of the end of 2017, its stake was down to 85,000 shares. We believe the overhang is likely close to removed and that a “clean up” trade may be imminent.
Second, ZMTP’s management has in the past repeatedly expressed a desire to up-list to the NASDAQ Stock Exchange. To do so, ZMTP’s share price would need to close above $3 per share for 60 consecutive days. Should the overhang be removed and the shares trade closer to a market multiple, Zoom’s stock could receive an extra boost from a NASDAQ up-listing.
Finally, ZMTP’s CEO is anti-promotional. As he rarely goes on the road to speak with investors – and even when he does, comes across as extremely cautious – the company has lacked an evangelist to the investment community. The company’s CEO owns more than 10% of the company (the bulk of his net worth) and his view is that if he focuses on the business results, the rest will take care of itself. However, this likely has done the stock price no favors as the company went through a period of investment (and losses) to reach the current high-growth stage (and profits).
As with any investment, there are risks to an investment in Zoom. One risk to consider is Zoom’s reliance on the Motorola brand. Our due diligence indicates Zoom’s relationship with Motorola is strong and deeply intertwined – and that Motorola’s focus is on expanding its relationship with Zoom, not shrinking it. In addition, Motorola’s track record is of building a select few committed long-term relationships to create high-value royalty streams, of which the Zoom relationship is one. That said, should anything happen to Zoom’s relationship with Motorola, our investment thesis could prove incorrect.
Another risk is that Zoom is a small company. While we anticipate $4-5M in net profits for 2018, we could be wrong and small changes in the business could have an outsized impact on business results. As an example, in Q4 2017 the company booked a one-time $800K charge for uncollected state taxes from prior years sold via Amazon. Though we believe this issue is largely in the rearview mirror (a final $200K is expected to be booked in Q1 2018, and zero thereafter), and similar issues have not occurred in the past, the charge demonstrates that the “shock absorbers” often found in larger companies may exist only to a lesser degree with a smaller company like Zoom.
Finally, there is a bit of key man risk with the CEO. We believe the CEO to be an extraordinary businessman who has built a consistent, innovative firm with substantial growth ahead of it as Zoom plows more deeply into new product ranges and new geographies. However, the CEO is nearing 70 years of age, which makes him look young relative to Warren Buffett but not so much compared to most CEO’s. From an investment perspective, this could be construed as a positive – a sale of the business may be in the offing at some point in the next year or two (there are many possible suitors). But from our perspective, it’s something we are keen to pay attention to given that we hold him in high regard.
We think Zoom is an off-the-radar, profitable, high-growth business that trades at a fraction of its intrinsic value.
At a market multiple on next-twelve-months’ earnings, the company would be worth several times the current share price. We like the company’s business model, we like the company’s management team, and we like the company’s valuation. With the share overhang about to be removed and the potential for a NASDAQ up-listing to follow, we think the set-up is attractive for a re-rating of this small gem of a business.
The author of this posting and related persons or entities ("Author") currently holds a long position in this security. Author may purchase additional shares, or sell some or all of Author's shares, at any time. Author has no obligation to inform anyone of any changes to Author's view of ZMTP. Please consult your financial, legal, and/or tax advisors before making any investment decisions. While the Author has tried to present facts it believes are accurate, the Author makes no representation as to the accuracy or completeness of any information contained in this note. The reader agrees not to invest based on this note, and to perform his or her own due diligence and research before taking a position in ZMTP. READER AGREES TO HOLD AUTHOR HARMLESS AND HEREBY WAIVES ANY CAUSES OF ACTION AGAINST AUTHOR RELATED TO THE NOTE ABOVE. As with all investments, caveat emptor.
-Share overhang is finally "cleaned up"
-Continued strong business performance gets the attention of investors
|Subject||A few questions|
|Entry||03/16/2018 08:52 AM|
enjoyed the report. 3 questions.
1. what does the largest holder want to do? they own 45% or so.
2. Asset light business model - they actually have a decent amount of inventory as raw materials and work-in-progress. from reading their financials, it appears they only outsource the chip sets? if so, are they really asset light?
3. min royalty payments to Motorola continue to increase in out years. is the thesis now that by branding their modems/routers "Motorola" is THE key to continued growth? Has anything else changed?
|Subject||Up 30% on no news?|
|Entry||04/17/2018 05:11 PM|
Hi fiverocks19 - Any idea why the strong move today, up +30%, with 8x typical volume, and no news (from what I can tell)? Great work on this by the way. I'm mad at myself for not building a full position before the move, haha (I'm still long)
|Subject||Continued investor rotation...no change to thesis|
|Entry||05/17/2018 10:36 AM|
Hi - Does anyone know anything about a (formerly) large holder of ZMTP called SF Investors LP?
The latest 13D last night says that SF Investors took their stake down from 10.44% to 2.57% (886K vs. 408K sharess). This would explain why there was a spike in volume yesterday without any news. On 5/16/18 (yesterday) 139,800 shares were traded, almost 10x the recent avg daily volume of 14,432.
Given the lack of liquidity in this name, we have seen before how much 1 motivated seller can move the stock. The filings say they have been in this name for a LONG time. Here is what I found for their historical holdings: May 16, 2018: 408,258 (2.57%) / May 12, 2015: 833,740 (10.44%) / Feb 14, 2014: 843,740 (10.57%) / Feb 15, 2013: 499,268 (7.16%)/ Sept 27, 2011: 418,220 (7.67%)
Perhaps SF Investors were the ones driving the stock back down from $3.50 down to $2.70'ish? If anyone has any thoughts as to their motivations, it would be appreciated. Thanks (P.S. I'm still very long, no change to thesis)