Concurrent Computer (CCUR) is positioned to take advantage of the secular change in content distribution and consumption. The downside is limited by the large cash balance, zero debt and high dividend yield. Capital appreciation should be driven by high operating leverage, margin expansion and increasing recurring revenue.
CCUR operates through two segments:
Video solutions, which consists of software, hardware and services for streaming video as well as collecting and analyzing media data. CCUR has served more than 50 million video subscribers through more than 212 global deployments.
Real-time, which consists of Linux operating systems, development tools and system software. These products are sold to companies demanding high-performance, real-time computer solutions in the military, aerospace, financial and automotive markets.
The best way to play the secular change in content distribution and consumption
While there are many ways to play this trend, few are as attractive as CCUR. Device manufacturers (e.g. smartphones, tablets, TVs) have relatively long replacement cycles (even the shortest is measured in years), low margins (except for Apple), high capex requirements due to rapid product obsolescence and the risk of misjudging consumer preferences.
Cable and satellite providers face the small but growing trend of cord-cutting, rapidly rising content costs (e.g. recent CBS-Time Warner battle) and growing subscriber frustration with constantly rising monthly bills.
There are fewer over the top content providers however these are either private (Hulu) or trade at extremely high valuations (Netflix). CCUR has lower risk as the current valuation assumes little will go right compared to higher valuations that assume nothing will go wrong.
Many of the above companies care very much how, when and where content is consumed (except for Netflix). However, CCUR is agnostic and only cares that more content is consumed. Moreover, the amount of total content consumed continues to rise (rather than simply switch from one device to another) due to the growing number of devices (e.g. smartphones and tablets) and greater broadband speeds. CCUR should benefit from the coming "arms race" as the rising number of content creators and providers increase spending in order to grow their subscriber base.
The flagship MediaHawk integrated solution delivers video services to subscribers simultaneously on any device and over any network. It stole market share earlier this year from SeaChange International after the largest cable provider in the U.K switched to CCUR.
CCUR is positioned to take advantage of four secular trends:
First, the ability to record and store content in the cloud benefits both customers and operators. Moreover, the trend of using the cloud as opposed to physical media should continue given the secular decline in DVDs and increasing popularity of over the top services such as Netflix and Hulu. Customers benefit as they no longer have to buy external hard drives* or pay for TiVo and can "binge view" their favorite shows from anywhere. Operators benefit as the highly scalable, software-based approach is more cost-effective at providing additional content than traditional appliance based solutions. For example, in August 2013, CCUR was awarded a patent for demand-based edge caching of video content, which significantly reduces network bandwidth demands. One of the reasons Netflix is so successful is due to the high spending to ensure content is delivered in the most efficient way possible so viewers spend less time waiting and more time watching. As a result, the operator no longer has to provide expensive DVRs or send out so many maintenance techs as service and upgrades can be performed at a central location.
Second, the data collected provides operators with actionable intelligence that can be used to better understand customer behavior (including trending content) and reduce churn through personalized video streams. CCUR is rapidly disrupting traditional measurement methods by providing real-time data on all of the customers compared to delayed data on only a small portion of them. Moreover, in September 2013 CCUR was awarded a patent that defines a process for delivering highly relevant and targeted advertising based on consumer viewing and purchasing habits. This focus on "pay for performance" advertising is one of the primary reasons Google, Facebook and Twitter receive such high advertising rates and valuations.
Third, the strong digital rights management features protect against piracy across all devices. This feature should not be overlooked as piracy effectively crippled the music industry.
Fourth, CCUR can provide solutions for content providers to offer their content directly to subscribers. While subscribers will still largely continue to pay for content in "bundles", the trend of paying for a la carte content is gaining momentum much faster than expected. HBO appears to be going this route (and joining over the top providers Netflix and Hulu) as evident by the latest deal with Comcast.
*This helps solve the problem of multiple black boxes and a mess of cables in crowded media cabinets.
A higher valuation is deserved given the attractive business model and operational improvements
CCUR currently enjoys high operating leverage as evident by the 14% revenue increase in the mrq that drove a 100% EPS increase. Moreover CCUR is "asset light" as shown by the low value of property and inventory. However the low value of property should not concern investors for two reasons. First, the primary growth driver is on the income statement side of the financials rather than the balance sheet. Second, the balance sheet is strong enough already given the high net cash balance.
Going forward, an increase in recurring maintenance revenue should result in higher visibility while an increasing focus on software should drive margin expansion and the core video strengths provide a cross-selling platform.
While gross margins remain in the high 50s, the high delta in the operating margin should act as the primary value catalyst.
Real-time segment is ignored due to focus on more "visible" video segment
While the video segment receives virtually all of the investor attention (and most of management's), the real-time segment deserves more recognition than it currently receives for three reasons. First, it accounts for ~40% of revenue. Second, this segment benefits from a diverse application and customer base (shown in the charts below) as well as rising demand for low latency solutions. Third, continued innovation and integrated solutions provide a competitive advantage in winning sales in fast growing areas such as automotive and missile simulation.
Source: Company presentation
An attractive takeover target
CCUR is an attractive takeover target for a strategic buyer given the low absolute and relative valuation, key patents and superior solutions.
ARRS is a natural acquirer given its growth through acquisitions strategy. Moreover, the deal multiples were significantly higher than the current multiple received by CCUR. For example, in September 2009 ARRS acquired Digeo for ~$20 million. The company was unprofitable and sold for ~4x revenue. In September 2007, ARRS acquired C-COR for $730 million or 16x EBITDA.
There are two similarities to the acquisition of BigBand Networks that support the merit of a CCUR acquisition. First, ARRS only paid a net $53 million as BigBand had a high cash balance with no long-term debt (just like CCUR). Second, BigBand had tax losses (just like CCUR although these may be limited due to IRS Section 382).
An interesting side note is that management specifically mentioned the "risk" of increased shareholder activism in the most recent 10-K. Management probably realizes that investors (current or prospective) will not allow the disconnect between the bullish fundamentals and low valuation to persist indefinitely.
Strong balance sheet
CCUR has no debt and ~$26 million in cash, which represents ~38% of the market cap. Less than 10% of its cash is in foreign accounts. This should not be overlooked as many companies have large cash holdings that are for all intents and purposes "trapped" overseas. Issuing debt to avoid paying taxes in order to access this cash is a solution though not ideal.
Moreover, in FY12 CCUR liquidated $7.6 million of short-term investments and returned the proceeds to cash as the "yield on these investments in the current market did not justify the costs of maintaining the investment accounts and the costs of fair value audit and disclosure".
There are two main takeaways. First, while this cash had been invested in highly liquid CP, agency/corporate bonds, these investments are "equivalent" and not identical to cash. For example, the chance of being unable to sell these investments for par is remote just like there was a remote chance LEH would declare bankruptcy. Management removed an unnecessary risk to the most valuable asset. Second, by evaluating the risk/reward for holding these investments, management proved that they pay attention to even the small details and not just the big picture. Again, this should not be taken for granted as many companies simply "outsource" their cash management needs to large banks and don't think twice about it.
Low implied value of NOLs should rise given recent transition from losses to profits
CCUR has significant NOLs in both the U.S. and overseas including U.S. federal NOLs of ~$97.2 million, state NOLs of ~$55.2 million and foreign NOLs of ~$32.3 million. These tax assets are being valued significantly below their potential as CCUR only recently became profitable due to a combination of rising revenue and a reduced cost structure.
Moreover, the high delta surrounding the value of NOLs in this situation often results in the market being conservative and assigning a significant discount. However there are encouraging signs that the NOLs will eventually be able to be used. For example, management now believes it will generate sufficient taxable income to fully utilize its U.K. tax assets after a recent change in tax law. Management said that Japan has a long history of profitability and expects to be able to fully realize its Japanese tax assets.
A rarity - growth with a high dividend
Although there is a growing trend of tech companies beginning to initiate or raise dividends, the yields are mostly in the low single-digit range. However, CCUR yields 6.5% and has a history of rewarding shareholders by returning excess cash. In December 2012, CCUR declared a special cash dividend of $0.50 and in June 2013 it doubled the quarterly dividend to $0.12.
Competition. In addition to other companies providing similar solutions, CCUR faces competition from computer hardware/software companies, content providers, television OEMs and internally-developed solutions.
Customer concentration. In FY13, Cox Communications and Time Warner Cable each represented 12% of total revenue.
Dependent on capital/defense spending. CCUR would be negatively affected by a decrease in capital spending by its video customers such as cable providers or lower defense spending by the federal government or prime contractors.
The target price of $8.58 is based on a 8x EBITDA multiple.
The stop loss should be placed below the recent consolidation around $7.00. The use of put options can further mitigate risk. The time frame is 12 months.
Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.