Velti (VELT) first came on my radar in 2005 when I was working for a mobile operator and was looking at SMS campaign management systems. I first looked at it as an investment in 2008 (market cap $90 million, 32.8 million shares) after reading an article on it in UK publication Investor's Chronicle (part of the Financial Times group). I've been long Velti since 2008, (briefly out after I sold my UK AIM listed shares and bought the Nasdaq listed ones). I have had several opportunities to sell at a generous profit, but it never got to my valuation level.
Following the latest 25% drop, I decided to add my thoughts to the collective knowledge.
The bull thesis is that Velti is the leader in an exploding market for mobile advertising. Revenue grew 60% last year and 60% in the last quarter and there is still a very long runway. With gross margins around 60% the company is only one or two quarters away from sustained profitability. Management took all the difficult decisions last quarter (selling off the parts of the business with slow paying customers and ending factoring arrangements), so the business will only get stronger from here. And at just one times sales and below book value it is cheap.
The bear thesis is that Velti is all hype and no substance; lots of top line growth but no profits and no cash flow and with Days Sales Outstanding (DSOs) at 270 days the whole outfit is just laughable. Even if you don't laugh don't expect any free cash in your lifetime. Its Greek heritage (Velti used to be a Greek company before it moved to Ireland) and Middle East and African customers generating millions of dollars which won't be paid for another 9 months (if ever) makes the whole operation suspicious (DSOs for these customers are between 270 and 450 days). In addition, the rate at which Velti is burning cash ($30 million in the last quarter) means that it will be raising more cash (diluting) or worse (bankrupt) within the next few quarters. Nothing is cheap if you get zero dollars back.
This is what I think.
For a company in the rapid growth stage of its development, Velti's quality is slightly above average.
Velti has a weak competitive advantage - customers tend to be sticky. Once an advertising agency or mobile operator has its clients on the platform, it requires some effort to change.
It is also the market leader, a position which it has the ability to defend.
The management team has deep experience in the sector (Alex Moukass, CEO, has been running Velti for almost 10 years) however his experience is in running a start-up/small company, the team needs to prove it can provide the level of leadership needed for a large company operating in dozens of countries. The recent appointment of a new CFO is one of a number of steps being taken to strengthen the team.
The company makes no profit (which is not unusual for a firm at this stage of development). However it generates no operating cash flow which is bad, and the result of a very rapid global expansion. As a long-term shareholder since 2008 (when it was listed on AIM), and market cap was £58 million ($93 million), I remember when the firm was profitable (making £3.5 million) and I know that it went into the red in order to implement a better business model and a global expansion, rather than as a result of weak trading performance.
It went into losses as it changed its business model from licensing software (high upfront and low ongoing) to SaaS (software as a service). And the expectation was that it would turn profitable once the changeover was complete, (which it did for one quarter). I like SaaS and thought it made sense and used the price dip as an opportunity to put some more in my basket. However, management decided to invest in a global expansion and went back into the red (where it currently remains). It also decided to exit AIM and list on Nasdaq.
The global expansion makes sense, but should have been implemented more slowly by focusing on fewer high impact countries first. However, it has now been done and I believe that over the next few quarters the profits will return (though management have signaled that they will be spending all of the cash on further acquisitions during the year). Again I'm not averse to investing in growth where there is a growing market and a competitive advantage to be had.
The balance sheet is solid (Total Assets: $490m Share Equity: $288m Debt: $15m Cash: $29m CA / CL: $288m / $165m).
Gross margins have been fairly stable, fluctuating between 58% and 63% over the past six quarters (61%, 58%, 62%, 61%, 59%, 59% - current quarter last). Operating margins have fluctuated between -3% and -16% (-16%, -16%, -5%, -7%, -3%, -10% - current quarter last).
Receivables remain high, but have reduced over the last quarter (38%, 40%, 46%, 42%). Prior to the new CFO being appointed, management announced measures to reduce the receivables, including terminating some of the slower paying customers. The new CFO plans to introduce better fiscal discipline within the sales force. We'll see what happens over the next couple of quarters.
The market for mobile advertising is expected to quadruple over the next five years (+30% annual growth) and many commentators are expecting even faster growth. Velti, a proven leader in the sector, will most likely grow at least as fast as the industry.
Historically, Velti has delivered impressive top line numbers (past 3 year revenue growth: 45%, 29%, 63%; past 3 quarters revenue growth: 73%, 74%, 63%). Key factors driving historic growth have been the market growth and its global expansion.
Moving forward, I expect market growth and acquisitions to become the main growth drivers. Our expectation is top line growth of about 35% over the next few years.
I value Velti between $12 and $15 - using a discounted cash flow model - based on expected 25% revenue growth per annum over the next five years, and a 33% reduction in working capital and DSOs. My growth and working capital estimates are more conservative than many other shareholders and observers (so Velti could well go higher). Its current price of $4.00 offers a generous margin of safety (Price to sales ratio 0.9, price to book ratio 0.9).
The price drop and opportunity to buy is the result of a combination of things that came out of the last call.
Firstly, the plan to sell off part of the business to insiders - with much of the proceeds from the sale only showing up in 3 years. The aim is to get rid of the high DSO (450 days or more) parts of the business, in order to address the concerns of analysts.
Secondly, the company missed consensus EBITDA and expects further hits to EBITDA as it stops capitalizing software development costs. This has only a cosmetic impact and I think is positive from a transparency point of view.
Finally, it dipped into the $50 million HSBC credit line to borrow $15 million to buy back (pay off) factoring arrangements which were costing upwards of 10% in interest. Overall this has a positive cash flow implication (a debt to Peter at 10% paid off by borrowing from Paul at 5%).
Neither the call nor the results indicate any deterioration in the business fundamentals or the outlook. However, the combination of these 3 things caused some investors to panic (in my opinion) and being a low volume stock, the pricing is the consequence. A more experienced management team would have either staggered the changes over 3 quarters or ignored the analysts completely.
The bottom line
Overall I see Velti as being of above average quality (though not excellent), with excellent historic growth and future growth prospects, selling at an unbelievably low price. I also believe the next two to three quarters results will provide a catalyst for the pricing to be re-evaluated upwards.
I recall Chapter 8 of the Intelligent Investor (Benjamin Graham) where he describes the fortunes of the common stock of some highly regarded and high quality companies which have prices gyrate up and down by over 100% in just 18 months, for no reason that an intelligent investor would fathom from the performance or prospects of the business. He ended the chapter giving the allegory of Mr. Market and the warning that the Intelligent Investor should not take Mr. Market as his guide, but as a person to take advantage of when his moods swing to extremes. Mr. Market is certainly depressed about Velti right now.