A cornerstone of our strategy at Pounce is to anchor our portfolio with high yield stocks paying secure dividends, while we wait for our contrarian and asset-based plays to produce capital appreciation. Sometimes, however, a buy candidate emerges that conveniently fits into both sides of our strategy, and such is the case with IDT Corporation (IDT).
IDT has drifted into obscurity since the competitive long-distance telecom wars of the 1990s. While the company still provides landline telephone services to consumers, most of its current $1.5 billion in annual revenues are derived from: (1) termination services for completing long-distance telephone calls, and (2) prepaid calling services. Despite the recent spinoff of its energy businesses, IDT still keeps a number of other tasty tidbits up its sleeves - which we'll get to later.
At the time of the October 2011 spinoff of Genie Energy (GNE), IDT stock was adjusted downward to reflect the deconsolidation of Genie's operations as well as $106 million of cash from IDT's balance sheet to fund Genie. From an operational perspective, the spun-off businesses were essentially cash-flow neutral to IDT, with IDT Energy nominally cashflow positive and Genie Oil & Gas consuming marginal amounts of cash to develop its oil shale prospects.
However, during the months following the spinoff, IDT stock continued to fall even as the broader market recovered and soared to new highs. A post-spinoff cut in the quarterly dividend from $0.23 to $0.13 per share, nominally poor headline EPS results, and a perception of IDT without Genie Oil & Gas as a less 'sexy' investment all contributed to drive IDT to its nadir of $8 in early March 2012.
The stock has recovered in the last few weeks to above $9, following an unexpected bump of the quarterly dividend to $0.15 per share in the most recent earnings announcement, implying a forward yield over 6%. However, at $9, IDT may offer considerable potential value to investors beyond the dividend.
Consider that as of the close on March 29, 2012, IDT stock carried a market capitalization of $211 million, yet the company's most recent 10-Q lists $155 million worth of cash equivalents, restricted cash, and short- and long-term investments. IDT has $29 million in long-term debt; however most of this is mortgage debt covering a company-owned office building in Newark, NJ - which the company has expressed an interest in selling or otherwise disposing of given the right opportunity. IDT's assets also include wireless spectrum licenses and VOIP patents that the company is seeking to monetize; a $6.8 million deal for a portion of the spectrum is already pending regulatory approvals.
Although at first glance IDT's balance sheet shows a working capital deficit of $18 million, out of the current liabilities, deferred revenue of $77 million will not require cash settlement. Accounts receivable, accrued expenses and accounts payable all stand at levels within the range over the last several years (after adjusting for the Genie spinoff). Thus the working capital deficit appears to be the direct result of the cash transfer to Genie, and should resolve itself over the next few quarters as IDT continues to generate cash.
On a normalized annual basis IDT's main telecom business units should be capable of generating $40-$50 million of operating cash flow. Back out potential annual capital expenditures of $12 million and IDT is currently trading at a low free cash flow multiple of 5.5 to 7.5. In terms of dividend coverage, the annualized dividend of $0.60 per share multiplied by the ~22 million common shares outstanding translates into a ~$13 million commitment. The current quarterly dividend seems well-covered and sustainable assuming normalized annual FCF of $28-$38 million. It should also be noted that IDT has 5.4 million shares remaining on its existing stock repurchase authorization, equivalent to 25% of all outstanding common shares. The company has plenty of cash on hand to buy back those shares, a possibility which should lend further support to the stock at current levels.
While continued pressure on gross margins is inevitable, management has sought to offset this pressure by growing revenue. IDT is working to expand retail distribution, most recently inking an agreement with Rite Aid to market prepaid calling cards in drugstores nationwide. The company's Boss Revolution prepaid calling service will expand into Europe this year, with hopes of launches in Latin America and Asia in the future. CEO Howard Jonas has ambitions to use the Boss Revolution platform for an expansion into the money remittance and payments business, targeting lower-income and immigrant customers in both developed and developing countries who are already natural users of the company's prepaid calling services.
Another wild card for potential growth at IDT is the company's Fabrix unit, which sells video-on-demand management solutions to cable television providers. Fabrix is no longer a development stage company, as IDT management has indicated that Fabrix' sales are accelerating and beginning to contribute to cash flow. During the March earnings conference call, CEO Jonas mentioned that Fabrix could generate $20 million in cash in 2012, and that the company has a goal for Fabrix to generate $40 million in cash in 2013. While the targets may be overoptimistic, any sizable contribution to 2012-2013 cash flow from Fabrix could transform the market's perception of IDT's growth profile. Certainly at $9, IDT stock does not appear to reflect the incremental cashflow potential of Fabrix.
Currently, the main risks of an investment in IDT appear to be of the legal kind. IDT's public filings disclose a number of long-running lawsuits and tax cases which could result in a material judgement against the company, and IDT's fiscal Q1 2012 loss was the result of an $11 million judgement against the company in a case brought by T-Mobile. Although the company has accrued for potential damages in cases where a negative ruling is likely, it has not accrued in all cases. Chief among these is a case brought by the Swedish tax authority potentially seeking nearly $30 million in back taxes, although IDT is publicly confident that the case will be overturned.
Given its liquid balance sheet, limited capex needs, low free cash flow multiple, sustainable high dividend yield, and under-appreciated growth possibilities - we believe that IDT would make an attractive addition to a value investor's portfolio. We have opened a position as IDT has pulled back from its mid-March spike, and intend to add more on further weakness.