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Marty Chilberg
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I'm a retired CPA who spent the majority of his working career in technology companies. My work included management stints at Atari Inc, Daisy Systems Corp, Symantec Corp and Visio Corp. My last position at Visio (VSIO) was as CFO and VP Finance and Operations.
  • TSYS conference call follow up. 8 comments
    Nov 18, 2010 5:34 PM | about stocks: TSYS
    After relistening to the conference call and updating my model for TeleCommunications Systems I thought I'd do a quick update on my last blog.  My general impression was that the call had a little better content than my first reaction.  They still have a long way to go to improve the quality of the calls and guidance but overall it had more positives than I originally thought.

    The Sep-10 quarter met the consensus expectations for revenues and earnings per share.  Revenue mix was more favorable with commercial systems (LBS licenses and infrastructure) coming in higher while government systems were soft.  This should have helped the overall gross margin but the decline in government systems margins to only 6% made the overall impact negligible.  Management addressed the government systems margin in the Q&A portion of the call stating that it was primarily due to end of year pass through costs.  Tom Brandt the CFO stated he expected this to be somewhat better next quarter though not as bad as in Sept.  He stated that margins should improve after first of the year. 

    Dec-10 guidance was reduced.  Tom provided range guidance for the CY-10 in revenues, tax provision, earnings, shares, non-cash charges and ebitda.   The guidance for revenues and earnings were below previous guidance so analysts have been busy revising their forecasts downward. 

    The better news was that once the reaction to the guidance was out of the way I could listen to some of the content more carefully:
    - The company now has almost 65% of their revenues in recurring service revenues.  These revenues have much more predictability and linearity going.
    - LBS is continuing to be a big opportunity.  The Navbuilder inside strategy allows carriers to keep their relationship with the customer which is generating a lot of traction.  The strategy employed by Google and Nokia competes/eliminates the channel (wireless carriers) which is causing stress benefiting TSYS. 
    - The government contract vehicle for WWSS was originally pegged not to exceed $5b for all subcontractors.  This contract has awarded $3.2b of this amount and while the remainder has an expiration date of next August, the company expects this to be extended or rolled into a new vehicle.    TSYS has had considerable success winning government business under this contract.  Of the 74 opportunities they have bid on, they have won an admirable 53 times.  This bodes well going forward as the company continues to track 30 major government opportunities that are sized in total at a multiple of the $5b. 
    - While admitting that government defense spending in general will continue to be under pressure in C11, the company stated that SNAP and WPPL revenues which represent the largest portion of the company's defense business have ongoing funding and will be largely unaffected.
    - Management repeatedly stated that they have set goals to achieve a minimum of 15-25% growth in revenue and ebitda for the long term. In the Q&A they did soften this by suggesting it could be through either organic or external methods. 

    Despite a quarter that was clearly pressured to meet expectations, the company generated substantial cash.  Ebitda was approximately $17.5m or 17% of revenues. More importantly (to me) was free cash flow.  My method of measuring this company's cash generation is to take ebitda and subtract back out interest/other, purchased PPE and capitalized software development costs.  That resulted in $10.8m in free cash flow.  I measure that as a percentage of market cap and it came out to around 17% or about double the average over last few quarters.

    It also is worth noting that they drew down $10m on their credit facility  Per management their interest rate on this debt is 4.5% which in this environment I view as a positive sign.  This additional cash and free cash flow allowed TSYS to increase their cash and equivalents to $112.8m up from $76.4 only six months ago. 

    Finally, it is interesting to see the early forecasts from analysts (9) covering the company.  Predictably the Dec quarter is down across the board with all 9 analysts reducing their forecasts.  However, most are still upbeat about next year.  While 4 dropped their earnings marginally, 2 raised their with the rest standing pat.  Also it appears all raised their revenue growth projections based upon the conference call commentary.

    Clearly everyone should do their own due diligence but my view is that the valuation should be based upon their ability to generate free cash flow predictably going forward.  My take is that the current valuation is less than 5x C11 free cash flow.  Not bad for a company going on record with a 15-25% growth objective. 
    Stocks: TSYS
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Comments (8)
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  • So what kind of valuation would you peg this at now and 12 months from now assuming they meet guidines?
    18 Nov 2010, 06:26 PM Reply Like
  • Author’s reply » You can't do a valuation multiple in a vacuum so I need to look at the market. The S&P 500 is currently trading at around 15x forward earnings. That's based upon consensus forward earnings growth of about 22%. Revenue growth is less but I don't have access to the total. I also don't know what ebitda for S&P 500 is or what it's growing at so that's a round about method of not really answering the question. I just don't have enough access to what the analyst community is forecasting.

     

    The point of my valuation point on TSYS was that they continue to be valued at forward earnings on a GAAP basis. My problem with that is it ignores free cash flow which is the most important number I use when looking at earnings. I find it interesting to hear investors say that they look at tangible book value and GAAP earnings when doing valuation analysis. If that's the case, why do companies buy other companies and why is that bullish for the overall market? It doesn't make any sense when the accounting rules make you use purchase accounting rules which put enormous intangible assets on the balance sheet that then have to be amortized.

     

    Looking at the current quarter as a snapshot. TSYS generated operating cash flow of around $13.5m. Reducing that for capx etc, I use $10.8m as a more representative free cash flow number. Annualized that is about $45m or around a 17% return on the current market cap. I would argue for a reasonable rate of return 8-12% for a company with this risk profile, so you could easily argue for a 50-100% increase in stock price as justifiable. Just depends on how much of a discount you'd want to use for management credibility, government spending issues, or other execution risks.

     

    Next year this will be much easier. If they don't execute than no one will care. However, my bet is that this year should be viewed in the context of integrating 4 companies that have dramatically changed their future. Next year will be substantially easier and as they continue to grow the relative impact of amortization will decrease and the balance sheet will recover quickly given the cash flows. That should set them up for a nice multiple expansion.
    18 Nov 2010, 08:20 PM Reply Like
  • Marty, any comments on the impact of the legal expenses related to patents/IP on Q3, and the relative long term value of such investment!
    Please note typo on second to last paragraph, "their"!

     

    Thanks for the great job.
    18 Nov 2010, 07:09 PM Reply Like
  • Author’s reply » Thanks for the Q and catch. I don't have a problem with the fees associated with continuing to build and support their patent moat. It is something that I won't add back either as it is a recurring and an important part of their operating profile.

     

    On the other hand the patent portfolio is another reason why they should be at a higher relative multiple.
    18 Nov 2010, 08:23 PM Reply Like
  • How do you respond to what appear to be the main criticisms of this company:
    1) Revenues keep increasing but the bottom line doesn't
    2) Management is grossly overpaid
    3) A buyout is unlikely since TOSE controls too much of the stock
    4) Management doesn't care about the stockholders, but rather only about enriching themselves.

     

    Your feedback on these points would be very helpful. Thanks!
    19 Nov 2010, 09:47 AM Reply Like
  • Author’s reply » Hi Shalev Thanks for comment/Q's. My take is:
    1) Revenues vs bottom line is a direct result on the transition that is occurring. Service revenues have a lower margin than systems revenues. The Y/Y decline of SMS licensing has driven down the commercial gross margin from around 64% in 2009 to 51% this year. This margin should now be stabilized as the relative impact of SMS is now quite small. The company has indicated that SMS will contribute $40m in revenues this year with a mix a 50% licensing (high margin) and 50% maintenance. The maintenance side is continuing to grow and the licensing is projected to be flat next year. So if the street consensus is accurate for next year this trend is coming to an end. They are currently projecting around 15-20% revenue growth and roughly 100% earnings growth.

     

    2) I've heard this claim but never seen any facts to support it. As I mentioned in my earlier articles, the company CFO admitted that the incentive bonus plan for C08 and C09 was structured with accelerators based upon earnings as most are. Unfortunately (per him) these accelerators didn't have a carve out for unusual items. In 2008 the company recorded a tax benefit of over $30m. In 2009 they sold a patent for $15m. Both of these kicked in much higher contractual company bonuses payouts than anticipated. The
    board negotiated a lower payout than the contractual obligation but it was still very high. I haven't spent much time looking further into the comp structure as this explanation seems rational. The argument is similar to frequent claims about insider selling and when I looked into that the insider selling is minimal and consistent with a diversification strategy.

     

    3) This is true. Tose controls over 6.2m shares so unless he wants to sell the company it likely won't happen. I think his class B shares have 3x voting rights as well.

     

    4) Again a common refrain from shorts. No facts just emotion. As an example the company stated that their priority for next year is 1) Revenue growth, 2) ebitda growth and 3) eps growth. Many jumped on this as not caring about shareholders. If they took the time to analyze the situation they would realize that ebitda is another way of saying cash flow. Cash flow is essential for the company to pay off the debt they took on to pay for the acquisitions. So anyone who thinks the acquisitions were a good move as I do understands that the need to pay down the debt and eliminate the converts/warrants associated with it will eventually serve shareholders far more that short term eps growth.
    19 Nov 2010, 11:16 AM Reply Like
  • Thanks for your responses. Very helpful to read clear thinking analysis.
    Any thoughts on the trading by insiders currently being discussed on the yahoo message board? Do you think the sales mean much about management's confidence in TSYS?
    22 Nov 2010, 09:08 PM Reply Like
  • Author’s reply » I've tracked the insider selling for past 2 yrs on a quarterly basis. I haven't seen anything out of norms occur. Tom Brandt's sale that was just filed was the only activity that isn't part of what appears to be a recurring diversification plan. His sale was first in over a year and it was only around 8% of his holdings. Nothing that signals anything that I can discern.
    22 Nov 2010, 11:01 PM Reply Like
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