Mike McDermott (Rounders):
Generally, the rule is, the nicer the guy, the poorer the card player.
And these guys, despite being cops, are real sweethearts.
In my opinion, a recent two-part bearish series of articles penned by Sonya Colberg of The Streetsweeper on Radcom (NASDAQ:RDCM) is a real sweetheart of a short thesis.
Quite frankly, Ms. Colberg's criticisms of Radcom are about the weakest I've read for a short-biased article although her highfalutin headlines and loaded language within the narratives [see, for example, "ripping to double-digit-levels," "investors went mad," "insiders dumping shares," "teeth-shattering fall off the cliff," and "a chart that predicts collapse" et. al.] suggest otherwise. In my opinion, her work is rife full of questionable, yellow journalism tactics and I think she needs to be taken to task.
In fact, after reviewing Ms. Colberg's arguments, I'm more bullish on Radcom given her rudimentary analysis and weak criticisms. If the critiques described therein are all she could muster, I suggest street sweeping for dirt elsewhere.
1x1 Meeting With CEO David Ripstein
As serendipity would have it, I had the chance to sit down for a face-to-face meeting with CEO David Ripstein this week in Los Angeles with two other investors, who, collectively, including my stake, own more than 1% of the equity. We left the meeting feeling quite bullish about Radcom's prospects and visibility over the next several quarters.
I doubt Ms. Colberg's research included speaking with the management team or performing channel checks to ask questions which would easily have cleared up any concerns she may have had. That lack of research could lead to significant problems for her employer's disclosed short position over the next several quarters.
Recall that one of the central tenets of the long idea for Radcom is the quality of the management team and proven track record of the Chairman of the Board, Zohar Zisapel, to incubate, build and sell businesses. I firmly believe that thesis remains intact for Radcom.
I found the meeting with Mr. Ripstein to be particularly enlightening. He is unpromotional and conservative in his guidance [a good quality in a CEO, in my opinion] and is candid when discussing lessons learned from previous execution missteps in challenging economic environments.
He further outlined the strategy to bring the MaveriQ solution to market within its existing 70-client customer base, which includes adding additional services in new verticals. For example, the recent contract win with a Tier-1 telecommunications customer in APAC featured add-on customer experience management services on top of Radcom's core network service assurance solutions. In other words, there are ways to layer on new services to grow the business even before competing for new RFPs among other telecommunication customers.
Now, to my rebuttal of Ms. Colberg. For congruency, I'll offer my rejoinder to the arguments one by one.
Insider Stock Sales
Insider stock sales, especially when minor relative to a total economic interest, do not portend trouble. I'm not worried one iota about Mr. Ripstein's minor stock sales for four reasons.
First, Mr. Ripstein is responding to rational economic behavior by exercising soon-to-be expiring in-the-money stock options and selling modest amounts in the open market while being cognizant of the liquidity for Radcom shares.
Second, his sales were designed to keep his ownership position in the company at relatively the same level, around 2.5%. He has appreciable skin in the game.
Third, Mr. Ripstein participated in the June 2013 PIPE deal [pitching in $50,000] which was conducted because Radcom was in temporary breach of certain covenants of a loan. Given the rapid transformation of the business over the last 18 months, the company is on much firmer financial footing with rising cash balances and mostly unencumbered by debt and related covenants.
Fourth, Zohar Zisapel the Chairman of Radcom's Board of Directors, and his brother Yehuda, collectively own about 40% of the stock and have not sold a single share after the price moved appreciably higher. Note that Radcom filed a shelf in the summer of 2013 allowing them to sell a chunk of shares, although they haven't done so. Because of that, I'd guess Mr. Zisapel thinks the shares are worth substantially more to a strategic buyer, a valuation approach he has considerable experience with after selling numerous businesses.
Mr. Zisapel also kicked in $1.1 million as part of the June 2013 PIPE. Given Zisapel's track record of incubating, building and eventually selling businesses, I view this as particularly bullish. In addition, Mr. Zisapel is getting older [65 years old], so I believe there could be a push to sell more of his Rad Group businesses so he can focus on other endeavors, including Radcom. Speaking of Radcom as an M&A target, the service assurance sector is also in consolidation mode with Netscout (NASDAQ:NTCT) recently acquiring Danaher's (NYSE:DHR) network communication businesses for $2.6 billion.
Simply stated, I like to assess the landscape of the industry and economic incentives. All the actors in this narrative are highly incentivized to create value for all shareholders.
Predictive Stock Chart
We can stop right there. Quality investors who rely on assessing the underlying fundamentals of a company don't worry much about stock charts especially when asked to go back 4 years to review price action. In that time, Radcom was exposed to difficult macroeconomic conditions in its core markets, underwent a restructuring to its cost base and is now firmly profitable after reporting four straight profitable quarters.
Fear-mongering journalists, especially those whose employer has a short position on a relatively illiquid small capitalization stock, on the other hand, might find a volatile stock chart to be quite useful for inspiring readers' emotional fear/greed proclivities and to push an agenda.
I believe that contract wins [like the recent win which is the largest I can remember at $4.3 million], execution and time should allow intrinsic value to express itself.
Intense Competition, Equity Raise
Ms. Colberg argues Radcom will need to raise cash in order to invest in R&D and SG&A to win more contracts in the United States. That is a confounding criticism given Radcom's cash balance is up nearly 3-fold since the beginning of the year and the company has reported 3 straight quarters of positive cash flow. On the most recent conference call, management did guide to investment in the sales force in Q2 2015. It should be a modest investment in a small sales force and should be well covered by Radcom's growing cash flow. I view this as a high ROI activity.
Even more confounding is the fact that Ms. Colberg suggests Radcom can't compete in the United States. That would be interesting, except for the United States only makes up 5 to 10% of Radcom's revenue stream and Mr. Ripstein has stated numerous times that the company is targeting Asia-Pacific and Latin America. It seems like a smart strategy to me for Radcom to focus on less competitive, but still substantial markets relative to its size. For a company the size of Radcom, the service assurance and customer experience management market opportunity remains vast.
Here is a breakdown of revenue by geography:
With the likes of Netscout, IBM (NYSE:IBM) and Oracle (NYSE:ORCL) trolling the US market for contract wins, I think it is a smart strategy for Radcom to focus on emerging markets where 4G, LTE and VoLTE rollouts are ramping up. Given these large players all acquired their service assurance solutions, it stands to reason that Radcom could itself become a target with its footprint in the emerging economies.
Analyst Target Prices
Again, astoundingly irrelevant. Investors should not blindly follow price targets set by analysts, especially those who are asleep at the wheel. Radcom reported GAAP earnings 200%+ higher than the sole analyst following the company, and I'm guessing the same analyst is underestimating Radcom's earnings power again this quarter. Correlating the skill [or lack thereof] of an analyst to underlying business value is laughable, if it weren't so destructive to pawn this correlation off as some sort of zinger to influence people's decision-making.
As it relates to price targets, for Q4 I'm estimating ~$7 million in revenue at a gross margin between 65 and 70%, suggesting $4.5 to $4.9 million in gross profit dollars. Given the depreciating Shekel against the US dollar, Radcom should benefit from currency translation. I'm estimating about $3.3 million in operating expenses, leaving $1.2 to $1.6 million in earnings, or between 15 and 20 cents EPS. I think that earnings stream annualized, is worth far more than the HC Wainwright $7.50 target for Radcom shares.
Zohar Zisapel's Other Companies
Ms. Colberg appears to be afflicted by a selective and blurred memory with respect to Mr. Zisapel's track record to project what might happen to Radcom's share price. I find this particularly absurd.
The Rad Group is a collection of different businesses, with different economics, levered to niche sectors with different competitive and product lifecycle dynamics. Some of the examples Ms. Colberg cites to discredit Mr. Zisapel, RiT Technologies (NASDAQ:RITT), for example, are irrelevant. Mr. Zisapel sold his control stake in the business in 2008 and hasn't been involved since. To that end, Ms. Colberg is misrepresenting the facts and making an incredible apples-to-oranges comparison which carries little, if any, weight.
Let's talk about some of many Mr. Zisapel's massive successes.
Mr. Zisapel played a key role in the $230 million sale of Radvision to Avaya in March 2012, a buyout that occurred at a 57% premium. Mr. Zisapel was Chairman of the Radvision Board of Directors, and his 27% ownership amounted to about a $63 million windfall to him, meanwhile benefiting all shareholders.
Silicom (NASDAQ:SILC), a business Ms. Colberg cites as a "bomb" for investors, has consistently grown sales [$73 million in 2013 vs $20 million in 2009], cash flow and earnings [$2.40 EPS 2013 vs $0.42 EPS in 2009] over the last five years. I would call that a pretty successful ramp of the underlying business. The recent share price decline only demonstrates investor irrationality.
Keep in mind that Mr. Zisapel sits on the board at Amdocs (NYSE:DOX), a ~$7.5 billion networking technology company that could be a potential sales partner or a potential strategic acquirer of Radcom. In addition, Mr. Zisapel owns a ~9% stake in Allot Communications (NASDAQ:ALLT), a $300 million Israeli network services business for which Radcom has a strategic alliance, which is another solid relationship and potential synergistic sales and/or acquisition partner.
Stated differently, Mr. Zisapel is the wrong guy to point a finger at for underperforming over the course of his career. Quite the contrary, he is an entrepreneur and dealmaker as evidenced by the number of successful exits from his numerous ventures.
All the evidence suggests Radcom has reached sustainable profitability and the company is playing in a sexy industry with tailwinds. Given management has guided investors to - and made good on - gross margin levels moving directionally higher than 75% on the back of MaveriQ's software economics, I think this business has the potential to feature 25% to 30% operating margins to patient investors [Q3 was 12.9%].
If we assume Radcom delivers ~$28 million in 2015 sales [~15% higher than my 2014 estimate], normalized earnings power would be about $8 million, or roughly $1 per share.
Place whatever earnings multiple you think is appropriate on a software company in a growing sector which is ripe for consolidation, but I think 15x to 20x is reasonable and that a strategic player would pay that price.
Ms. Colberg is myopically focused on the past and recent share price performance, but fails to make a cogent short argument. A backward looking analysis is the easier argument to make because hindsight is 20/20, but we know equity value is about the future, which is becoming brighter for Radcom after each quarter of consecutive profitability.
Make no mistake, the future is inherently uncertain but the company is clearly executing better than it has in the past, sports a clean balance sheet and the company is consistently generating cash. It's hard to see any material reason for a drastic decline in the share price.
Disclosure: The author is long RDCM.
The author wrote this article themselves, and it expresses their own opinions. The author is not receiving compensation for it (other than from Seeking Alpha). The author has no business relationship with any company whose stock is mentioned in this article.
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