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Why I Would Not Buy Stock

|Includes:CMCSA,, Inc. (SPRT)

There has been some chatter in the value investing and Magic Formula® Investing (NASDAQ:MFI) communities lately about (NASDAQ:SPRT), a recent micro-cap addition to the MFI screens. I've had several readers ask if it looked like an attractive investment at present.

Let's check it out, shall we?

Outsourced Technical Support's basic business is providing outsourced technical support to communications companies and retailers. The core product is its cloud-based Nexus Service Platform, which allows remote tech support with features like remote access, chat/telephony support, ticketing, analytics, and so forth. The company's services are generally provided through their customer's brand, using technicians who work from home to troubleshoot problems.

You can probably relate to one of the common scenarios the firm handles: device (PC/phone/cable box/etc.) setup, data migration to a new device, spyware or virus removal, wireless network connectivity issues, software updates, etc.

While support services comprise 85-90% of revenue, offers a variety of software products such as an anti-spyware package, registry repair software, and Cosmos, a package of utilities for optimizing your computer. Software is about 10-15% of sales.

A Quantitative Superstar

I can see why so many value investors are intrigued by the stock. Looking at the numbers, this stock should and does find its way into most value-based screens:

  • Over $70 million in net cash for a $141 million market cap. That puts the company's EBIT/EV earnings yield at 15.7%, which is solid value territory.
  • Yield on free cash flow is currently 14.6%, also a deep value figure.
  • It meets growth-at-a-reasonable-price (GARP) standards, too, with a 5-year compound annual revenue growth rate of over 38%!
  • ZERO debt puts near-term business risk at a very low level.

Furthermore, is playing in a growing industry. Electronic devices from televisions to phones have become far more sophisticated to setup and use, necessitating solid support functions from providers. Additionally, recently entered a new deal with Comcast to provide support for connected home devices, which many believe is the next big thing for consumer electronics.

Too Many Small Cap Bugaboos for Me

Alas, I don't consider as a contender for a Top Buy selection, for three primary reasons.

Customer Concentration

The first reason is a common bugaboo with small-caps: customer concentration. In 2013, relied on Comcast (NASDAQ:CMCSA) for almost 60% of revenue, and a second deal with OfficeDepot (NYSE:ODP) (which recently merged with OfficeMax) was almost 20%.

Two deals, 80% of revenue. That leaves in a precarious position. Since they have been so reliant on those two customers, their pricing power is poor, and this is a very competitive market.

In fact, Comcast's program changes at the end of last year are behind much of the stock's weakness this year. The effect of these changes has led management to forecast a 17% drop in revenues for 2014, and un-profitability for the year.

While expanding deals with DISH Network (NASDAQ:DISH), and new ones with DirecTV (DTV) and Sams Club (NYSE:WMT) should loosen the concentration risks going forward, they will still be there for some time to come.

CEO Stepping Down

CEO Josh Pickus is stepping down next week, to be replaced by Chairman Jim Stephens on an interim basis.

Executive turnover at small-cap companies is always a big concern for me. Small caps have more difficulty attracting executive talent than larger companies. The fact that operates in a competitive market and is facing a transitional period in their core contract exacerbates the risk. Furthermore, Pickus has been at the helm for a long time (8 years), and owns almost 5% of the company.

This uncertainty is another risk in the stock.

Unimpressive Profitability

Since 2006, has posted ONE year of operating profitability - last year. With the Comcast changes and ramp-up on new contracts, 2014 looks to be another unprofitable year. It makes me wonder - even if the company can continue growing revenue, can it do so profitably? It is a fair question.

On the other hand, 2006 was the year Pickus took over, so perhaps his predecessor could do a better job with costs.

Conclusion is undeniably cheap from a qualitative perspective, and has good opportunity to grow revenues. However, some very serious, acute risks, combined with an open question about just how profitable the company can operate make estimating a price target for it almost impossible.

This is one of those stocks that Warren Buffett calls "too difficult". As such, MagicDiligence is avoiding it.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.