First, we firmly believe at this stage Pareteum is a growth story rather than an earnings story so we are especially curious with the 2019 revenue guidance from management (we'll cover earnings at the end of the article nevertheless).
In principle, this should not be too hard as the company has been accumulating 3-year backlog at a tremendous pace. This backlog stood at just $147M at the end of 2017, and it has grown to almost $700M at the end of February 2019. This hasn't gone entirely unnoticed:
This backlog should provide a considerable deal of visibility, depending on how fast and at what pace it can be transformed into revenue and that visibility is normally something investors appreciate very much.
There could be up to 180 days between the signing of a contract and the first revenue recognition, although management is trying to reduce that to 30-90 days with the help of the new batch of engineers from the acquired Artilium and iPass.
In general, the chairman Hal Turner has given an indication of how to think about the conversion of the 3-year backlog into revenues. From the 2018 letter to shareholders:
Service Deployment and Implementation occurs on average over a 60 to 180 day period, dependent upon many factors such as number of connections and subscribers being migrated, complexity of the software integration with the customer's existing software and hardware, and the amount of custom tailored development work needed to satisfy the specific customer. Another variable is the availability of project and program managers, in country, to oversee the service initiation. Our targeted implementation times are shorter, ranging from 30 to 90 days, However, in some of the early agreements, the added element of customer readiness may have impacted the go live dates.
So, let's use a hypothetical example of a $3 million, 3-year Cloud contract. The approximate revenue recognition of customer's 36 month agreement, most often occurs as follows:
- Year 1 at approximately 15% coming from implementation and initial connection pricing;
- Year 2 at approximately 30% monthly recurring revenues based upon number of connections;
- Year 3 at approximately 55% monthly recurring revenues with a ramping of the number of connections;
Applying that formula would, especially after the recent explosion in backlog, give a tremendous amount of revenue for the coming years. You can find here a spreadsheet with all the monthly backlog calculations and revenue from iPass and Artilium added in the mix and you get a very sunny picture.
We're not quite there yet, which is why we're so eager to hear what they have to say in terms of revenue guidance for 2019 (if any). Why we're not completely convinced? Well, there are two other datasets:
- Analyst expectations, which are usually considerably lower.
- The company's own guidance, given in a presentation for investors for the iPass acquisition November 13, 2018.
Here is the relevant slide from that presentation:
You see that the analyst estimates are much lower, followed by the company's guidance and the highest future revenue figures come from transposing backlog into revenues roughly according to the formula given in that 2018 letter to shareholders.
Now, we think that the shares of Pareteum are undervalued whatever revenue scenario one takes (out of these three), but what we would like is some indication of which of the three is most likely to materialize. T
So the 2019 revenue guidance is the most important thing we will be looking for in the earnings and guidance, as it will give an indication which scenario is the most realistic:
- The moderate scenario ($100M-$110M) by analysts.
- The company's scenario ($144M) from the iPass acquisition presentation.
- The bull case ($150+) from backlog conversion calculations.
There is a somewhat curious gap between analyst expectations and the company's projection from last November in the iPass acquisition presentation. That gap has a couple of elements that are easy to explain:
- Some reports are older and do not include the iPass acquisition and the revenue ($40M in 2018).
- We suspect that the company projection is pro-forma while the analyst numbers that include iPass will exclude the first 7 weeks of the year as the acquisition only closed well into February this year.
But the latter effect is small, a couple of millions, which still leaves a really substantial gap between what the company projected and what analysts think (not to mention calculations based on conversion of backlog), and is exactly the reason we're quite eager to know which scenario is more likely.
For the growth trajectory of the company, it makes quite a bit of difference whether we'll start from $140M+ or from $100M-$110M.
Keep in mind that even if we start off from the lower analysts' numbers, the shares are still very reasonably priced at a little under 4x sales.
There is something to be said for the bull case. In the recent letter to shareholders, chairman Hal Turner said this:
Our growth will continue from our current customers who continue to buy more from us. We will also see many new customers enter our client rosters, and because of our iPass acquisition, we have opened completely new market segments in the enterprise sector... Attain (and exceed) our revenue target in 2019, through faster conversion of the 36 month contractual revenue backlog (36MCRB)
That is, there are several ways the company could speed up revenue growth:
- Faster backlog conversion. This might be possible with the help of the batch of engineers that came from the two acquisitions.
- Selling more to existing customers. In Q3, the company basked in a dollar net retention rate of 147%. That is, for every dollar stipulated in the initial contract, customers on average contract 47 cents more, but these additional sales show up in increases in backlog.
- Backlog has increased by 40% since the company made that iPass acquisition presentation (only last November!) which contained that $144M 2019 revenue guidance. Backlog was $500M then, it's almost $700M at the end of February.
- A new enterprise sales segment mentioned by the chairman.
That enterprise segment came with the iPass acquisition, which had a legacy enterprise customer base.
While that business was declining (mostly because iPass itself lacked scale), there are still some 500 corporate customers in that business and with the much more comprehensive offerings from Pareteum (and Artilium, acquired in Q4 last year), the company might be able to retain these and cross-sell to them.
In fact, this is what might be happening already. In their February PR with new backlog wins, the company announced a whopping 20 new customers (20%+ of their total), several of which were corporate customers (our emphasis):
- Full Deployment of SmartConnect™ mobile connection management solution with Wi-Fi connectivity to a US-based Fortune 1000 enterprise.
- SMS (Short Message Service) and voice solution for an Asian Voice over Internet Protocol (VOIP) Global Standard for Mobile (GSM) manufacturer.
- SmartConnect™ mobile connection management solution with Wi-Fi connectivity to a US-based Fortune 2000 enterprise
This could be a very significant development, but it's a little early to say, which is another reason why the Q4CC on Tuesday will be so interesting.
While we think earnings are not terribly relevant at this stage, let's nevertheless look at the possibilities here.
Recently acquired Artilium and iPass were loss-making, but management suggests that it could gain $6M (up from $4.8M in their first estimate and $4.1M was already achieved at the time of the Q3CC) in synergies from the Artilium acquisitions and $15M from iPass (much of it in fairly short order, see below), that is, $21M in total. Here are these iPass acquisition cost synergies:
These are especially necessary as iPass made heavy (GAAP) losses, to the tune of $4M+ a quarter. Artilium generated just a 269K euro loss in 2017; it was financially much sounder (and growing) as it had positive adjusted EBITDA in 2017 (558K euros).
This suggests (but not more than that) that the cost synergies could move the overall company into a small profit. This isn't factoring in any revenue synergies from cross selling, nor any leverage from growth.
We've seen various 2019 EPS estimates from different sources:
- $0.15, from Taglich Brothers, on revenues of $113M.
- $0.08, from Northland, on revenues of $107M.
- $0.38 on revenues of $144M, from the company iPass acquisition presentation.
- The average analyst estimate is $0.05.
But most observers expect profits this year, which should really underpin a substantial sales multiple of at least 5, in our view, and quite possibly higher than that.
If we come anywhere close to that $0.38 EPS this year that the company put in their iPass acquisition presentation, bottles will be opened by shareholders, needless to say. Given that a fairly modest 20x earnings multiple and the shares will be off to the races.
One might also keep in mind that their business model contains impressive leverage. Revenue per employee rose from $277K in Q3 2017 to $492K in Q3 2018.
It's almost like the company hooks the customers up and then sits back and collects the rent. The neat picture will have been muddied quite a bit by the two acquisitions, but when these are sorted out this force is likely to reassert itself.
There is much to look out for in the upcoming Pareteum Q4 figures, most notably the 2019 revenue, and to a lesser extent earnings guidance from management.
The company, which was growing gangbusters on its own, has acquired two other companies in short order and it will be interesting to see what the consequences are for the growth and earnings trajectory.
It's not surprising that estimates vary quite a bit. It seems logical to think the acquisitions come with a fair amount of revenue and cost synergies but how substantial these are remains to be seen.
However, even in the least optimistic scenario with 2019 revenue guidance a little above $100M and roughly break-even, the shares are still selling on a low sales multiple of less than 4.
Disclosure: I am/we are long TEUM. 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.