Inteliquent: Upside Likely After Recent Drop

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 |  About: Inteliquent, Inc. (IQNT)
by: Marwood Capital

Summary

IQNT is one of 12 stocks that satisfy the rule-based criteria.

Recent price falls are result of short-term pressures.

Conservative margin of safety over 50%.

As with many of my investment ideas, the discovery of Inteliquent Inc. (NASDAQ:IQNT) started off with a stock screen.

That stock screen was based on a rules-based strategy which has been shown to produce significant historical returns over several years.

One company that meets the rules-based criteria is Inteliquent, which actually fell 17% last week after reporting earnings to market.

The stock now looks like a solid investment with a 50% margin of safety factored in.

Stock screen criteria

In my view, the most successful investors are those who utilize strong quantitative and systematic elements in their strategies.

Rules-based strategies are able to eliminate a great deal of ambiguity in trading and can help to reduce the impact of emotion-based investing.

The stock screen I used to find Inteliquent is based on the following criteria:

Market cap > $100m
EPS over past 5 years > 10%
PE >5 and <25
PEG <1
P/S >0.1 and <4
Dividend yield >2% and <7%
ROE > 5%
Current ratio >1
Profit margin >5%

The theory behind this set of criteria can be left for another time but I will say that this set of rules has been shown to produce strong historical returns over time.

Running this criteria returns just 12 US listed stocks from a database of more than 4,000.

Price fall

Last week, Inteliquent Inc. fell 17% after the company reported earnings.

Although EPS per share came in 1 cent higher than the average analyst estimate of $0.27 per share, Inteliquent CEO Ed Evans reaffirmed previous guidance that full-year sales would sit between $210 -$220 million, below the $219.5 million predicted by analysts.

IQNT CFO Kurt Abkemeier also reiterated concerns over the FCC's Intercarrier Compensation Reforms which have impacted Inteliquent's revenue.

These step downs will occur again in July of next year and again in the year after that. It's likely that we will see the company move away from the free conference calling business model altogether as a result of the changing landscape.

Competitive advantage

At first glance, the intercarrier reforms seem bad news in an industry that faces fierce competition from similar sized rivals. However, Inteliquent is in much better financial shape than the majority of its rivals and is engaged in significant cost-cutting to further improve this competitive advantage.

As CEO Edward Evans said in the most recent earnings call, "There are some competitors that will simply disappear as the ability to arbitrage is diminished."

Indeed, much of the pricing pressure that IQNT has felt over the past few quarters has stemmed from ''irrational pricing'' on competitors' products.

When this irrational pricing can no longer be sustained, some of IQNT's competitors will fall by the way side and leave IQNT to fill the gap.

Evans has already said that the company is on the look out for acquisition opportunities in order to use some of the $90 million cash on its balance sheet and the fact is that IQNT traffic continues to rise.

Much of this gives the impression that the bad news is now priced in. Inteliquent will be announcing a number of new products in the back end of 2014 and that suggests IQNT's poor quarters of performance are now behind us.

Margin of safety

Probably the most important piece to all this is the fundamental valuation of the company and in this regard, IQNT is in excellent shape.

The company scored highly on the rules-based test with a PE of 5.82, PEG of 0.58 and current ratio of 5.50. IQNT has grown EPS at a rate of 22.30% over the past 5 years and the company pays a dividend of 2.70%.

Factoring this into a DCF (discount cash flow) method of valuation using a conservative five-year future EPS growth estimate of 8% and a discount rate of 12% gives the company a solid 55% margin of safety at current prices.

Click to enlarge

Source: GuruFocus.com

The fair value estimate of $24.76 is the first price target for investors and should ensure a decent level of return, along with the 2.70% in dividend.

Disclosure: The author is long IQNT. The author wrote this article themselves, and it expresses their own opinions. The author is not receiving compensation for it (other than from Seeking Alpha). The author has no business relationship with any company whose stock is mentioned in this article.