CSG Systems (CSGS) is a tech company with an attractive core business. It recently made a major acquisition, which could either take the company to the next level or drag down the legacy business.
CSGS is a provider of customer care outsourcing solutions, whose customers have historically been cable and satellite operators (such as Comcast (CMCSA) and DISH Network (DISH)). CSGS has the capability to manage the systems behind all facets of customer interaction- such as order processing, billing, and statement mailings (you probably get your cable bill from them). As an outsourced solution, the systems reside on CSGS hardware and the customers just plug in to them through a network.
CSGS was founded in 1982 as a division of First Data, and became an independent company in 1994. The company rode the consolidation of the cable industry as its customers such as Comcast and Time Warner (TWC) grew their subscriber bases through acquisitions. CSGS now serves almost 49 million customer accounts on behalf of cable and satellite companies.
There is quite a bit to like about the business. It is very stable with largely recurring revenues. CSGS manages mission critical processes that are not discretionary for its customers. It is also still a high margin business (25% EBITDA margins) with minimal ongoing capex (CSGS themselves outsource the data center hardware management) and strong free cash flow. Competition has crept into the sector over the last decade but only lowered margins from incredibly attractive to merely attractive. There are only two other competitors who can handle the larger operators, Amdocs (DOX) and Convergys (CVG) (although Oracle (ORCL) is becoming more competitive in the space). The niche appears to have developed into an oligopoly where pricing will remain rational. Additionally, there does seem to be a moat around the business due to the high switching costs of retraining staff and migrating to a new system.
The knock on the business has been customer concentration, and analysts are concerned about the Comcast contract that is up next year. Before the recent acquisition, CSGS had about 65% of revenues from 4 customers (Comcast, Dish, Time Warner, and Charter). These concerns seem overdone, as due to the switching costs companies rarely switch outsource providers. It has happened, as CSGS took half of the Charter business it didn’t have from Convergys. However, in that case CSGS already had half of the business and Charter was looking to consolidate its billing operations. In the case of Comcast it is currently using all three providers as its operation is so large. It seems unlikely it will spend the money to consolidate its billing systems and move to one provider.
The other concern is that the company's growth avenues are drying up. CSGS has not been able to successfully expand into new verticals, leaving its growth basically in line with the subscriber growth of its current customers.
In November of last year, CSGS closed on the acquisition of Intec, a British software company that makes billing systems for the telecom industry. This will help CSGS in terms of customer concentration (bringing its big 4 customers under half of revenues), as well as give them access to a new vertical. But it appears the main driver of the acquisition was another concern. Intec specializes in “real time billing”, which is needed for the wireless phone industry. As cable operators move into the wireless domain (as part of the so called “quad play”- landline, video, internet, and wireless), CSGS needs this technology to stay competitive. With the Intec acquisition CSGS has rounded out its product portfolio and enhanced its depth of expertise.
So, what’s the catch? Intec's business appears much less attractive than CSGS. First of all, Intec is based around a software license and maintenance model, and not an outsource model. That means most of its revenues are not recurring. Additionally, the telecom industry that Intec sells into is very cyclical. There are periods where discretionary capex spending basically shuts down, and Intec was very cognizant of this. The British press says the company had been looking to sell for a while, and some even described it as desperate. CSGS paid $255 million for Intec (net of Intec cash), which is only 5X peak EBITDA of $51 million that Intec did in the fiscal year ending September of 2009. In the six months ending in March 2010, EBITDA had shrunk to $7 million.
Things don’t appear to be getting much better for Intec as a part of CSGS. CSGS reported lower than anticipated revenues in Q1 (ending in March) and in its Q1 press release and conference call the company seemed very careful not to directly address revenues from the Intec division. Based on what CSGS did tell investors, my estimate is that Intec did about $50-55 million in revenues for the quarter, well below the $275 million annual revenue run rate it did in FY 09.
CSGS actually made a somewhat similar acquisition in 2002, buying the telecom billing unit of Lucent (Kenan) for $256 million. The acquisition was disastrous, as the telecom unit dragged down the cable side, and CSGS sold Kenan to Comverse in 2005. Admittedly, the strategy there was different, as CSGS attempted to put elements of its system into the Kenan system to sell to telcos. It seems the main motivation with Intec is that CSGS needs Intec technology for the cable companies. And CSGS’ CEO claims that this time around there will be more desire on the part of telecoms for CSGS technology. Perhaps Intec is a better company with better assets than Kenan. But I still think the Intec acquisition is fraught with the risk that Intec’s volatile telco sales prove to be a drag on the stable CSGS business.
CSGS has a market cap of about $675 million with $170 million in net debt. Management has guided for $177-$181 million in EBITDA with only $20-25 million in capex. So you might be getting a solid, recurring revenue business for under 5X EBITDA, but the risk on the Intec side is something to consider.
Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.