Radcom: Analyzing Stakeholder Incentives

Summary

• Part of my investment strategy is investing behind A players whose economic interests are aligned with shareholders.
• Zohar Zisapel, known as the “Bill Gates of Israel,” scored a recent win with a reported $430 million sale of Argus Cybersecurity, a startup Mr. Zisapel funded and became Chairman.
• Mr. Zisapel has demonstrated a record of successful exits. Radcom appears set up for another good outcome for investors.
• Mr. Zisapel has provided $3.3 million in cash infusions on good terms for all shareholders in a 2013 PIPE ($1.1 million) and 2016 equity raise ($2.2 million).

I have written about the fundamentals of Radcom (NASDAQ:NASDAQ:RDCM) ad nauseam on the pages of Seeking Alpha over the last several years. There isn’t much new to report on that front, other than it has been about ten weeks since RDCM CEO Yaron Ravkaie indicated the company won a new Tier-1 multi-carrier operator on the Q4 earnings call. If you believe, like I do, that management is in the final stages of closing a formal contract, then the stock should be particularly compelling after the latest bout of share price weakness and ahead of a major fundamental catalyst to potentially improve the valuation.

Looking at the 2017 annual report, the company disclosed that AT&T (NYSE:T) contributed $24.5 million in revenue while North America in total contributed $25.1 million. The other $600 thousand in North American revenue is almost certainly Verizon (NYSE:VZ), a contract which is expected to ramp to over $5 million in 2018 as the customer moves more network traffic and functions to the cloud.

Moreover, Radcom reported $3.8 million in “other” revenue, slightly more than 10% of the $37.2 million total 2017 sales (up from $0.7 million in 2016). Given AT&T contributed $19.2 million in 2016, the $5.3 million delta between 2017 and 2016 is likely made up of expansion orders for the new Network Visibility packet broker product and some maintenance/services revenue.

It is unclear how the network packet broker and new MaveriQ deployments are priced, but it appears like the new contracts are subscription models that scale with traffic and number of functions monitored, but capped at a certain level so operators don’t continue to pay above certain thresholds as their networks expand.

That said, Verizon and AT&T were spending between $150 million and $250 million per year on physical probes, so it seems reasonable that Radcom customers would pay between $15 and $20 million annually for virtual probe software (capped). To that end, scaling Radcom involves (1) landing new logos and (2) adding new functionalities with the idea that each Tier-1 could eventually be $20-$30 million per year customers like AT&T.

If investors believe there is a path to $20 million per Tier-1 customer, then AT&T, Verizon (presumably) and this new multi-carrier operator should eventually contribute $60 million in annual revenue, plus around $15 million from smaller, emerging market customers, collectively $75 million. By my calculations, $75 million in annual revenue generates $1.25 to $1.50 EPS on 13.5 million shares outstanding, and this could happen as early as 2019 depending on how fast these deals scale. Applying a 30-40x multiple on that earnings stream yields a $40 to $60 stock price.

Ultimately, however, it is Zohar Zisapel who will determine the right price to sell the company. Mr. Zisapel is the largest shareholder, owning just over 3 million shares, and sits on the RDCM Board of Directors while his life partner, Heli Bennun, took over as active chairwoman in September 2015 and helped pivot the company into a pure-play NFV software player while rejiggering the management team and orchestrating two capital raises that leaves Radcom in a compelling financial and strategic position to land new customers and scale the company to a new level.

Coincidentally, Mr. Zisapel stepped down as the Chairman of Radcom at the same time he became Chairman of a private Israeli startup called Argus Cybersecurity. Mr. Zisapel led the angel investment round, and participated in Argus’s series B round in September 2015. I learned recently that Argus was sold to a German company called Continental AG for a reported $430 million. Given Mr. Zisapel’s preference for incubating, growing and selling his businesses to larger players, I think that will likely be the outcome for Radcom, but only at a price Mr. Zisapel feels that fully values the company and its market opportunity.

As I’ve suggested before, the winner-take-most player in the service assurance space has historically claimed 20-30% market share and Radcom’s addressable market appears to be around $1.4 billion-$800 million for virtual probes and $600 million for the virtual packet broker. Claiming 20-30% of that TAM would lead to $280 to $420 million in revenue, a significant revenue pipeline for a large incumbent like Cisco (NASDAQ:CSCO), Amdocs (NYSE:DOX), Nokia (NYSE:NOK), Ericsson (NASDAQ:ERIC) and others.

Given the size of that opportunity and Radcom’s current market leadership, it becomes easy to understand why Mr. Zisapel or the Board would not consider being acquired anywhere near the current valuation or even a significant premium, which likely wouldn’t fully value the company.

Conclusion

I believe Radcom is set up for beat-and-raise quarters given what appears to be happening in its pipeline relative to its initial $43 to $47 million in 2018 revenue guidance. Moreover, the incentives of the insiders at Radcom are well aligned with minority shareholders and the company is well-capitalized with an experienced, stable management team in order to seize its opportunity as NFV and 5G deployments accelerate in the years ahead. To that end, Radcom remains a well-managed, growing, profitable company in which Wall Street still hasn’t found interest, as evidenced by light trading volume and limited institutional ownership.

Analyst’s Disclosure: I am/we are long RDCM. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.