Comverse - Acquisition Candy At $24?

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Comverse has market leading software in two sizable segments.

CNSI stock is at $24 with $14.30 a share in net cash and a $1.4 billion Net Operating Loss carryforward.

CEO is a credible turnaround guy who has sold companies in the past.

Comverse, Inc. (CNSI) is a major player in the telecom billing software arena and the voicemail / videomail space. The company's flagship product, Comverse One, is a technology leader in the converged billing segment, evidenced by the company's position in the Leader's Quadrant in Gartner's latest billing software Magic Quadrant. Converged billing means that the system can do both pre-paid billing and post-paid billing in one system with one database. Comverse developed this system before its competitors and maintains a technology lead since its competitors each already have a pre-paid or post-paid system and would need to scrap them to develop a whole new integrated system.

Comverse was spun out of a holding company by the same name two years ago. That holding company owned Comverse as well as a significant slug of Verint (NASDAQ:VRNT) stock. In the spin Comverse got its freedom as well as a lot of cash and a large NOL. The older holding company had a checkered past as there was a big option backdating scandal ten years ago and the CEO fled to Africa to avoid prosecution. The company then embarked on a multi-year restatement process which left its customers not feeling too comfortable and its competitors had ample ammunition to use against the company in competitive situations.

Near the time of the CNSI spin-off, the company hired Philippe Tartavull as CEO. His mission was to restructure the company and grow bookings so that the company would be meaningfully profitable. When Philippe first addressed investors, he stated that his goal was to reach 15% operating margins in a two year time frame. So far he has been successful on the restructuring front, cutting $45 million out of the company's cost structure.

The bookings increase has been more problematic and indeed, the company actually lowered its 2014 bookings estimate from $545 million to $495 million on the last conference call. This decline led to the stock getting crushed the next day from $34 to $24. The reason the company gave for the decline was that telecom carriers are currently more focused on building out their LTE network hardware infrastructures than updating their billing systems. It is reasonable to believe that once LTE build outs are done then the carriers will begin to prioritize software spending again and the billing software sector should experience a comeback.

The other half of Comverse's business is the voicemail / videomail piece. Comverse is the leading player in this business worldwide and it sports high margins for the company. The business is moving from analog to IP so there is churn in CNSI's customer base as its customers make the transition. This is predicted to be a slow growth business for the company but one that generates positive cash flow.

So, what are you getting when you buy Comverse stock today at $24? To start, you are getting $14.30 per share in net cash. When netted out, the Enterprise Value of $220m compares to $495m of expected bookings equaling an EV / Rev ratio of 0.4x. This is ridiculously cheap even for an ailing software company, never mind one that has leading technology in two sectors. Second, you are getting a $1.4 billion NOL which guarantees that CNSI will never pay taxes again. If management at some point is able to get its 15% operating margin, a 10x EBIT multiple would yield a target price of $47, or roughly double where the stock is today.

It might take some time for the billing software market to get back on track or for management to implement more spending cuts to rightsize the organization to current revenue levels. In the meantime, there is a decent shot that the company gets acquired. Given its financial and technological attributes, the company would make a nice addition to a strategic or financial buyer. In addition, the CEO and CFO most recently were at Hypercom, where they engineered a turnaround and then sold the company to VeriFone. If the acquirer paid 1x sales, which is a very cheap price, that would imply a 50% return versus where the shares are today. Also, an activist shareholder already has a seat on the board of directors so shareholder interests are being represented there.

Disclosure: I am long CNSI. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it. I have no business relationship with any company whose stock is mentioned in this article.