One of today’s biggest gainers is a small-cap, Nasdaq-traded, application software company, Net1 UEPS Technologies (NASDAQ:UEPS), and at one time was up over 30% in just this one trading day. As of the time of this writing, Net1 UEPS Technologies is rising approximately 28% from a close of $6.72 on Tuesday, January 18, 2012 to its current price of $8.60. The magnitude of this one-day performance begs questions. First of all, is it possible that a business can change in value by over 25% in one single business day? Number two, if the answer is yes, then what could cause such a startling advance?
Moreover, questions about the rational nature of the market also arise. Was the market correctly pricing this company yesterday, or is today’s price correct, or is the market continuing to improperly value the business behind the stock? When you think about a change of this magnitude occurring so quickly, a logical explanation seems difficult to imagine. Let’s take a look at this company to see if there are any sensible answers to any of the questions posed.
Net1 UEPS Technologies
Net1 UEPS Technologies bills itself as the leading provider of secure and affordable transaction channels between formal business and un-banked and under-banked individuals. The primary business is supplying chip card technologies and systems that provide alternative payment solutions for populations in developing economies. Typically these populations, estimated at 4 billion, have limited or even no access to traditional banking facilities. This company’s signature product is its Universal Electronic Payment System (U.E.P.S.).
The following F.A.S.T. Graphs analyzes Net1 UEPS Technologies since its public offering. Net1 when public on April 4, 1998, and like many IPOs, its stock price ran from approximately $40 a share to just under $50 a share between April and June of 1998 (see red circle). At this time, the company had no earnings, and therefore was trading mostly on promise. Over the next six years or so, Net1’s stock price, although volatile, essentially fell to single digits because there were no earnings to support valuation.
Then, after reporting first earnings per share of $.36, followed by earnings increasing 67% to $.60 per share (see yellow shading at bottom of graph), their stock price skyrocketed from approximately $6.90 a share to over $64 a share by May of 2004. However, once the reality of the company’s earnings potential came into focus, the company’s stock price plummeted back to its earnings justified single-digit levels (see red arrow). From this point, stock price more or less moved with earnings, although at a high valuation, until May of 2008. Then, the recession of 2008 brought an earnings drop of approximately 18% from a $1.52 to $1.25. This caused a precipitous drop in stock price once again into the single digits. Then after the stock price recovered to almost earnings justified valuation, it has drifted down ever since from the low $20s to under $7 per share. Earnings growth has been semi-cyclical, rising then falling, then generally drifting sideways.
Sum all this price volatility up, and long-term shareholders in this interesting software application small-cap company would have seen their capital eroded to the tune of -83%. This represents a compounded annual loss of -12.3% per annum since the company went public in 1998.
What Has Stimulated Today’s Almost 30% Rise?
Net1 UEPS Technologies announced today that its wholly-owned subsidiary, Cash Paymaster Services, received a letter of award from the South African Social Security Agency (SASSA) for the provision of payment services for social grants in all of South Africa’s nine provinces for a period of five years. According to Net1 UEPS Technologies' CFO, Herman Kotze: “Given the magnitude of the SASSA tender award, we expect a significant impact on the group’s financial affairs when the contract period commences as a result of new volume and pricing, additional costs, capital expenditure and additional contractual obligations.”
Let’s first look at what Net1 UEPS Technologies’ historical earnings and price graph looked like prior to the above announcement, followed by what the estimated earnings and return calculator looked like based on consensus analyst estimates. After rising to $1.55 per share for this fiscal year, earnings were expected to drop to approximately $1.10 per share next fiscal year. Then, after falling to $1.10 per share, earnings were expected to advance approximately 10% per annum over the next five years (note that there is only one analyst reporting to Capital IQ). Nevertheless, Net1 UEPS Technologies’ shares appear to be significantly undervalued with a PE ratio of only five.
A Hypothetical Earnings Acceleration Due To This Win
Management has stated that they will give further guidance on how much impact the five-year SASSA contract will make on their business during a February 10, 2012, conference call. However, we offer the following hypothetical analysis to justify today’s 30% advance. Assuming that the one analyst reporting to Capital IQ was reasonably correct with his expectation of 10% earnings growth prior to the contract win, we present the following hypothetical possibility: We will assume that future earnings growth accelerates from the 10% expectation to 12% per annum. This number is consistent with the 12.6% average earnings growth rate the company has achieved since calendar year 2005.
We have overwritten Net1 UEPS Technologies’ future earnings graphs as follows, and we have added a green dot that represents today’s stock price of approximately $8.80. The yellow line indicates the cost basis of today’s purchase, and together the dot and the yellow line show that the company remains significantly undervalued even after today’s 30% rise. Notice that even though the price rise exceeded 30%, it is hardly noticeable on the graph.
The following estimated earnings and return calculator illustrates the potential that this small-cap technology stock offers given the assumptions of an accelerated 12% growth rate as discussed above. The 39.2% five year estimated annual total return is calculated based on an accelerated 12% growth rate of earnings and the PE ratio expanding to a more rational 15. Both of those currents are reasonable and indicative of how undervalued the company is. In other words, it’s the undervaluation that can be attributed to such a high long-term potential rate of return.
Summary and Conclusions
This article was motivated by the over 30% rise in the stock price of Net1 UEPS Technologies, a small-cap Nasdaq technology stock in one trading day. We believe that the primary reason this is happening is because the market was grossly undervaluing this company shares. Consequently, a piece of good news stimulated an incredible 30% advance in one single trading day. Common sense would tell us that the intrinsic value of a business, even a small business like Net1 UEPS Technologies, could not logically change by a magnitude of over 30% that quickly. Unless of course, it was through a merger, that increased the size and the value of the business by that much. The win of a contract, even a big contract like they announced today, would be unlikely to have such an impact.
On the other hand, when reviewing the company’s stock price prior to the announcement, it was obvious that this profitable small business was being significantly undervalued by Mr. Market. The fundamentals underpinning this company, and therefore its stock price, were far better than what the market was, in our opinion at least, applying. The point we are attempting to illustrate with this example is the undeniable reality that Mr. Market can and often does completely miss the mark when pricing businesses. It is our contention that when the market does this through undervaluation, it simply means that the business has temporarily become illiquid. In other words, it cannot be sold for what we refer to as True Worth and what others call intrinsic or fair value.
Of course, when the market significantly overprices a stock like it did Netflix (NASDAQ:NFLX) in the summer of 2011, we would argue that the stock becomes highly liquid. In other words, it is begging to be sold. But, when a company is being ridiculously undervalued based solely on negative psychological sentiment, we believe the stock is begging to be bought. The fundamentals of Net1 UEPS Technologies represent a significant bargain based on a true and realistic value of its earnings and cash flows. This was true prior to today’s announcement, and therefore, should be even more true now.
The last two graphs in this article are hypothetical in nature for 2012 and beyond, and therefore, should not be relied upon as accurate. Moreover, these graphs were drawn utilizing some basic assumptions, that although we felt were logical, are as of yet unsubstantiated. Management has indicated that they will offer updated guidance on February 10, 2012, during their regularly scheduled earnings conference call. Nevertheless, we believe that based on the expectations for this company prior to this great new contract, that the shares were being significantly undervalued. However, each investor is advised to conduct his or her own due diligence prior to investing.
Disclosure: No positions at the time of writing.
Disclaimer: The opinions in this document are for informational and educational purposes only and should not be construed as a recommendation to buy or sell the stocks mentioned or to solicit transactions or clients. Past performance of the companies discussed may not continue and the companies may not achieve the earnings growth as predicted. The information in this document is believed to be accurate, but under no circumstances should a person act upon the information contained within. We do not recommend that anyone act upon any investment information without first consulting an investment advisor as to the suitability of such investments for his specific situation.