Mind C.T.I.: An Undervalued Micro Cap Gem

| About: MIND C.T.I., (MNDO)
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MIND C.T.I. (NASDAQ:MNDO) is a small micro-cap gem. The company provides software solutions to various types of communications providers. It has a rock solid balance sheet, a low PE and delivers a high-yield dividend. The company’s activities are described as follows:

Mind C.T.I. Ltd. develops, manufactures, and markets real-time and off-line billing and customer care software for various types of communication providers. The company offers billing and customer care solution supports multiple services, including voice, data, and content services, as well as prepaid and postpaid payment models in a single platform. It also provides a workflow engine to support the creation and execution of business processes, such as order management, trouble ticket, and debt collection. In addition, the company offers an integral point of sale solution that comprises dealer, store, and cashier management and sales processes. Further, it provides professional services, primarily to billing and customer care customers, consisting of installation, turnkey project implementation services, customer support, training and maintenance services, customization, and project management. Additionally, the company offers call management systems, including PhonEX, MEIPS, and PhonEX-ONE, which are used by organizations for call accounting, telecom expense management, traffic analysis, and fraud detection. Mind C.T.I. Ltd. offers its products through marketing alliances with network equipment vendors, systems integrators, and resellers in the Americas, the Asia Pacific, Africa, Europe, and Israel. It primarily serves traditional wireline and wireless, voice over Internet protocol, and broadband IP network operators, as well as WiMAX operators, cable operators, 3G operators, and mobile virtual network operators. The company was founded in 1995 and is headquartered in Yoqneam, Israel.

The company focuses on providing its software solutions to tier 2 and tier 3 communications service providers. In 2009, MIND derived about 44% of its business in the western hemisphere, 47% from Europe, 4% in Asia and about 5% from Israel. About 65% of its revenues come from recurring services, and the balance-- 35%-- from the sale of licenses. In both 2008 and 2009, approximately 95% of the company's revenues were generated outside of Israel. Sales outside of Israel are made in more than 40 countries. MIND currently has sales and support offices located in Silver Spring, Maryland U.S. and in Reading, U.K. In addition, it has a technical and support team in Jassy, Romania.

Sales in the fiscal year ending December 2010 totaled $19.9 million, up 13% from 2008. Net income came in at approximately $5.0 million, down 74.6% from 2009. In 2009, MIND recorded approximately $19.8 million in net income. Of this, approximately $18.5 million can be attributed to income from an auction rate securities settlement.

In FY09, the company distributed approximately $14.8 million or $0.80/share in dividends. In FY10, the distribution dropped to $0.32/share. Over the past five years, dividends have grown at the rate of 5.9% per year. The current dividend of $0.32/share exceeds the company’s reported earnings per share of $0.26/share. It also exceeds the company’s free cash of $0.33/share. At the current share price, the dividend yield is about 9.3%. This dividend is not sustainable.

Over the past five years, sales have grown at an annualized rate of 5.0%. Net income has been growing at about 3.6% per year and EPS at the rate of 6.5%. We think this slow growth rate is reflective of a certain maturing in the telecommunications sector, plenty of competition from larger, better capitalized companies and a small footprint in China. MIND has a current PE of 13.2X, which is low for this segment.

The balance sheet is strong. The company has no debt but it does report about $20.5 million in cash and short-term investments. MIND has a current ratio of 5X, which indicates no problems with meeting its immediate needs. Total Liabilities to Total Assets is a low 21.3%.

We compare MIND to several other companies operating in this particular segment of the market. This list is not exhaustive and is presented for comparison purposes only.

Several of these companies are domiciled offshore. Three of the companies, including MIND, have no earnings estimates for 2011 or 2012. BroadSoft (BSFT) is currently losing money but analysts are expecting a strong turnaround.

We place a lot of importance on cash flow and free cash flow. At 25.42%, MIND reports a very strong showing for Cash Flow Return on Invested Capital. BroadSoft reports a very impressive 30.02% CFROI. Return on Equity is determined, in part, by a company’s capitalization structure. BroadSoft’s ROE of 68.4% is all the more impressive when we consider it has virtually no long term debt. MIND also shows a strong ROE at 22.8% and without long term debt. The current ratio is one measure that can be used to determine if a company can meet its immediate obligations. MIND is well covered with a CR of 5.0X. As a group, these companies are not highly leveraged. Only one, CSG Systems (NASDAQ:CSGS) reports Long Term Debt to Total Capital that is higher than we like to see. For the two companies reporting long term debt, free cash flow is more than adequate to cover.

MIND is selling at 13.2X TTM earning of $0.26. This is low when compared to other software companies and the market. Some people look to the Price Sales ratio for valuation. At 3.19X sales, MIND is selling at a premium to its sector and industry. The Price to Book ratio is a favorite for value investors. Here we find MIND selling at 2.64X book value, which is about what the sector and industry is selling for now.

EBITDA (Earnings before Interest, Taxes, Depreciation and Amortization) is often used in valuation. EBITDA is considered by some to be a form of cash flow. With an Enterprise Value to EBITDA multiple of 9.17X, MIND is not extravagantly priced. The median EV/EBITDA value for 194 companies classified as “Software and Programming” in the Reuters Research, Inc. database we use is 19.84X and the average is 57.22X. EV/Sales ratio is another useful metric used in valuation. MIND has an EV/Sales ratio of 2.3X. The sector median EV/sales ratio is 2.49X and the average is 4.45X. Finally, our favorite valuation is EV/Invested Capital. MIND has an EV/IC ratio of 1.91X. The industry median is 2.34X and the average is 3.99.

Based on these several valuation metrics, we believe MIND is undervalued. We have a target price of $4.57 based on our estimates of earnings growth, return on invested capital and debt to the market value of equity and debt.

As always, complete your own due diligence prior to making any investments.

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