MER Telemanagement Solutions’ worth in a post-apocalyptic world

As it is the case for all postings in this blog, my standard disclaimers apply for this posting.  However, since this posting discusses investments, I urge you to review the disclaimers laid out in the About section with extra diligence. Moreover, even if you have already reviewed these disclaimers in the past, you need to review them again, as they are subject to change without notice.  Do it now, and remember that whatever I say in this blog posting is simply my opinion — it is not science, it is not advice, and it is not an attempt to make you act in any way whatsoever.

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A quick summary of this posting

This posting is long, so I will break with the typical pattern for postings in this blog and briefly outline its content.

In this posting I discuss MER Telemanagement Solutions, a publicly traded company, and its equity, MTSL, with a focus on establishing a target price for MTSL.

First, I briefly explain the speculative character of a run-up in per share price of MTSL since August of 2012, detail the complete break-down of this run-up since March of this year, and explain how I had predicted the break-down since the run-up began on the basis of volatility of a key contract, which will terminate in 2013. Subsequently, I take a stab at determining how much revenues and earnings MER Telemanagement Solutions will record in 2013 and 2014, which can provide the intrepid reader with some ammunition for a fundamentals-based assessment of a current, 2013, and 2014 per share price target for MTSL. Rather than undertaking such fundamental-based assessment, however, I estimate the target per share price of MTSL using historic pricing and compensating for the loss of the key contract.

I then note a number of reasons why the speculative wave that lifted the MTSL price in the period from August of 2012 through March of 2013 is likely to re-occur (spoiler alert: The free float is low and speculators tend to be iterative, visiting the same trade repeatedly, even if they ended up recording a loss last time around,) and I conclude that, when taking speculation into account, a short to medium term price target for MTSL is likely to exceed the long term price targets set through analysis and, therefore, for the period from now until the early part of 2014, a current investment in MTSL may yield a very attractive return over the next 12 months.

Generally, I estimate that 2013 revenues will be approximately $14.5 million, for an increase of 10% over revenues for 2012, and earnings for 2013 will grow to between $2.4 million and $2.7 million, or $0.60 per share, a significant increase relative to 2012. From a value investor’s perspective these numbers are, of course, mostly meaningless since they are predicated on the terminating contract, but, since speculators care little about what the long term outlook is of an equity or the underlying company, I note that these numbers most likely will drive the per share price in the rest of 2013, starting with the first quarterly earnings announcement, through the early part of 2014. When seen in isolation and applying blinders in the manner that a highly speculative market might do, the numbers support a per share price of at least $6 for MTSL — a +100% premium to the current per share price.

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The speculation is over… now what?

In previous postings I have written about the speculative run-up in the per share price of MTSL, the equity of MER Telemanagement Solutions.

MER Telemanagement Solutions is an Israel headquartered company that provides Telecommunications Expense Management (TEM) solutions to enterprises and Mobile Virtual Network Operator (MVNO) solutions to communications service providers.

The company has also recently begun providing a mobile money solution for communications service providers and financial service providers.

In one of my postings I described the run-up, writing that:

… the company announced its second quarter results on Thursday, after the close of the market, and on Friday the company’s shares soared at the open … Trading volume for the MTSL equity was 661,271 shares, compared to an average daily volume of 12,333 shares over the last three months.

In summary, I classified this run-up as speculative because:

  1. the change in the per share price was based primarily on MER Telemanagement Solutions swinging from a net loss position to a net income position on the strength of a contract with Simple Mobile, a U.S. based MVNO carrier, and
  2. it was known since May of 2012 that this pivotal, high-margin contract, accounting for 22.8% of MER Telemangement Solutions’ revenues in 2012, and providing $300,000 in monthly guaranteed revenues in 2013, was at risk for cancellation or non-renewal since Simple Mobile was in the process of being acquired by América Móvil through TracFone Wireless, América Móvil’s United States subsidiary.

The speculative run-up that started at the market open on August 17th, 2012, was destroyed at the end of March, 2013, when MER Telemangement Solutions announced that TracFone Wireless had informed the company of its intent to migrate the services provided by MER Telemangement Solutions to Simple Mobile onto its own platform, and, therefore, it was unlikely that the company would receive significant revenues from TracFone in 2014. As the company said in its 20-F filing for fiscal year 2012:

During 2012, Simple Mobile was acquired by TracFone and in October 2012, we renewed our agreement with them to provide for minimum monthly payments of $300,000 during the year ending December 31, 2013. Recently, we were advised that TracFone intends to migrate the hosted billing services to their own platform. It is unlikely that we will receive significant revenues from TracFone in 2014, which will adversely affect our operating results.

MTSL Price ChartThe per share price, which had exploded from $1.60 on August 16th with zero shares traded, peaked out at $5.49, has now dropped to somewhere around $2.5 and shows no sign of stopping its drop.

In the aftermath of the run-up and the subsequent break-down, the question, of course, is what the true value of MER Telemanagement Solutions, as measured by its per share price, is. Determination of such magical per share price, the price equilibrium, if you will, is the focus of this posting.

You should be aware that, in attempting to determine this magical per share price, we will rely on a mix of available data and good old fashioned guesswork, assumptions, and estimates. You should carefully consider the validity of such mix when you read the following.

Data, data, data….

Since per share price is related to capitalization and capitalization should, at least on some level, be related to future, current and past revenues and earnings, let us first take a look the financial statements for MER Telemanagement Systems as reported in its 20-F filing for fiscal year 2012.

MER Telemangement Solutions’ total revenues from 2008 through 2012 were impacted mostly by two events: (1) the revenue addition achieved through the acquisition of AnchorPoint, a United States based Telecommunications Expenses Management (TEM) provider, and (2) the incremental guaranteed and earned revenues from Simple Mobile, which reflected Simple Mobile’s explosive growth from its launch in 2009 through 2012.

We can learn about these revenue groups and their relationship to and impact on margin and expenses from the 20-F filing.

First, we can learn that revenues from products and services:

… increased by 9.3% to $13.1 million for the year ended December 31, 2012 from $12.0 million for the year ended December 31, 2011. … Revenues from products and services from our wholly-owned U.S. subsidiary, MTS IntegraTRAK, increased by 15.7% to $10.3 million, or 78.1% of our total revenues, for the year ended December 31, 2012 from $8.9 million, or 74.2% of our total revenues, for the year ended December 31, 2011. The increase in revenues from products and services in 2012 is primarily attributable to the revenues from our agreement with Simple Mobile. We expect that our revenues will increase slightly in 2013.

With respect to the revenue from Simple Mobile, we can learn that in

… 2010, 2011 and 2012, sales attributable to this MVNO accounted for approximately 3.6%, 16.4% and 22.8% of our revenues

Using this information, we are able to form a view of MER Telemanagement Solutions’ revenue situation net of the contribution from Simple Mobile:

2010 - 2012 Revenues MTSL -- Adjusted

We see that without the contribution from Simple Mobile, MER Telemanagement Solutions’ revenues have decreased by 10% since 2010.

We note that the company has two segments: A TEM segment, targeting enterprises, and an MVNO segment, targeting telecommunications service provider. With respect to the revenue distribution between these two segments we learn that the majority of the company’s revenues:

… are derived from our TEM call accounting solutions, whose revenues declined each year from 2006 until 2012 and revenues for these products may not grow in the future.

This is substantiated in the filing, which notes that revenues from the company’s Enterprise segment:

… decreased by 2.2% to $9.0 million, or 68.7% of our total revenues, for the year ended December 31, 2012 from $9.2 million, or 76.7% of our total revenues, for the year ended December 31, 2011. Revenues from our Service Providers segment increased by 46.4% to $4.1 million, or 31.3% of our total revenues, for the year ended December 31, 2012 from $2.8 million, or 23.3% of our total revenues, for the year ended December 31, 2011.

We can also learn that cost of revenues from products and services:

… increased by 15.4% to $4.5 million for the year ended December 31, 2012 from $3.9 million for the year ended December 31, 2011. The increase in cost of revenues from products and services is primarily attributable to services associated with the growth of our hosting and managed services business. We expect a minor increase in our cost of revenues in 2013 compared to 2012.

This observation is consistent with the high-margin characteristics of the Simple Mobile hosting and service contract, which will increase significantly in 2013 (more about this below) before terminating, with the additional 2013 revenues carrying with them dis-proportionally small cost of revenues.

In fact, by making a basic assumption about the character of the increase in costs of revenues, we can conclude that the margin on the Simple Mobile contract is at least 32%, and, so, given the increased revenue contribution from Simple Mobile in 2013 (again, more about this, below,) we can guess that the maximum increase in costs of revenues attributable to the Simple Mobile contract in 2013 will be $200 thousand, or less than 5% of the company’s total cost of revenues during in 2012.

Furthermore, on the expense side of the income statement, we can learn that the company’s research and development expenses, which decreased in 2012, relative to 2011, are expected to increase in 2013:

Research and development expenses consist primarily of salaries of employees engaged in on-going research and development activities, outsourcing subcontractor development and other related costs, net of grants that were approved by the OCS. Research and development expenses decreased by 31.6% to $1.3 million for the year ended December 31, 2012 from $1.9 million for the year ended December 31, 2011. The decrease in research and development expenses is primarily attributable to a decrease in resources assigned to ongoing research and development projects. We expect that our research and development expenses will increase in 2013 compared to 2012.

For the uninitiated the OCS entry may be puzzling, so we will side-track for a moment, explaining what the OCS is.

The OCS, the Office of the Chief Scientist of the Ministry of Industry, Trade and Labor of the State of Israel, is an Israeli government function that issues development grants and support to Israeli companies. Under the the terms of research and development grants that MER Telemanagement Solutions have received from the OCS, the company is required to pay royalties on the revenues derived from products incorporating know-how developed with the grants, up to 100% to 150% of the dollar-linked value of the total grants, plus interest, at a rate of 3% to 5% per year.

The obligation to pay these royalties is contingent on actual sales of the products and in the absence of such sales, no payment is required. As of December 31, 2011, the company had a contingent obligation to pay royalties to the OCS in the amount of approximately $9.0 million.

Getting back to the revenue and expenses, we note that the company:

… employed 13 persons in sales and marketing and 33 persons in support as of December 31, 2012, as compared to ten persons in sales and marketing and 33 persons in support as of December 31, 2011, and nine persons in sales and marketing and 37 persons in support as of December 31, 2010.

We assume that the high support head-count is mostly attributable to the contract with Simple Mobile.

The increase in sales and marketing staff and the decision to increase the research and development burn in 2013 is probably appropriate given the anticipated terminal date of the revenue flow from the Simple Mobile contract, but it — as well as the size of the support staff — will become an issue if new sources of revenues are not secured by the sales force during 2013.

Guesses, guesses, guesses….

What will tomorrow bring?

Having looked at the data, we are ready to enter into the guessing phase.

So here, ceteris paribus, are my segmented prognostications:

  • From a revenues and earnings standpoint, 2013 will be a strong year for the company.
    • Revenue contribution from the Simple Mobile hosting and services contract will increase by $750 thousand. This estimate assumes a revenue contribution that is higher than the minimum guarantee of $3.6 million in revenue in 2013, and is based on an assumption of an effective subscriber count of 1.5 million in 2012 and no subscriber count growth in 2013.
    • Some revenue contribution will be obtained from migration related services, and on a highly speculative basis I set this amount to $250 thousand.
    • Revenue contributions from a new MVNO contract and a mobile payment solution will be $320 thousand in 2013 and possibly more in 2014.
    • In aggregate, assuming flat revenues from the TEM segment and no new deals that will materially impact 2013 revenues, 2013 revenues will be approximately $14.5 million, for an increase of 10% over revenues for 2012.
    • Earnings will grow to between $2.4 million and $2.7 million, or $0.60 per share, a significant increase relative to 2012, primarily attributable to the increase in revenues and the absence of tax charges, and assuming that no significant new expenditures are initiated. In computing this number I have offset some royalty payments to the OCS.
  • Unless significant new customers are secured or significant additional revenue-contributions are made by existing customers in 2013 and 2014, the company could, relative to the 2013 results, encounter a $4 million revenue drop in 2014 with a corresponding drop in net income of $2.7 million, which would lead the company to experience negligible earnings — or even a loss — per share in 2014.

Importantly, in the above, we have assumed that the revenue contribution from the Simple Mobile hosting and services contract will be a function of the subscriber count and, as such, will exceed the guaranteed minimum of $3.6 million for the year. If this is not the case, and, for instance, Simple Mobile migrates of the MER Telemanagement Solutions provided platform in the middle of 2013, then the revenue growth will be less than what we have projected, impacting, of course, on the earnings.

Finally, it should be noted my estimate of revenue increase may be different than that of the company, who in its 20F filing, in somewhat more bearish language, noted that it was expecting that:

… revenues will increase slightly in 2013.

The market complication

The above is speculation and guessing. It may be based on certain data, but it is still speculation and guessing, and, so, the reader should take it with a grain (or, better year, an entire boatload) of salt.

However, now that we have prognosticated, we can make some sort of guess to the per share price…. except we can’t really… well, maybe we can… I don’t know, so let’s just do it.

Normally, in valuing the opportunity inherent in an equity, a fundamentals investors would add up the underlying future potential earnings, assets, liabilities, etc. and compare the sum, adjusted by some risk computation, to the capitalization of the company. If the net out is sufficiently high, the value investor will buy and, presumably, hold until the capitalization catches up with the fundamentals.

This approach can certainly be followed with MTSL and MER Telemangement Solutions, but it will be heavily impacted upon by two factors. Primo, MER Telemanagement Solutions’ ability to use the remainder of fiscal year 2013 to capture new business – a relatively unknown. Secundo, the impact of speculators upon the per share price over the remaining eight months of the year — a near complete unknown, but, if an important factor, very much relevant to the timing of an investment.

Speculators aside

If we simplify and look at the future per share price as a non-speculator impacted measure, then, if, for instance, significant new sources of revenues are not secured in 2013 and 2014 and the company rapidly reduces its operating expenses once the Simple Mobile contract is terminated, one could — somewhat crudely, I admit — argue that the per share price should be similar to the per share price before 2010 plus a little something to account for some cash reserve, some revenue contribution from new and “newish” customers, and the value of some new technologies/solutions.

As a simple year average, I think it is fair to say that the per share price for MTSL was at — or below — the $2 level in 2009 when adjusted for a 1:2 reverse split in March of 2010, and, therefore, a per share price between $2.25 and $2.50, or so, may be reasonable.

An alternative — and far more harsh — approach would be to use the per share price for MTSL immediately before the speculative run-up adjusted fairly aggressively downward to allow for the termination of the Simple Mobile contract and, then, adjusted little bit upwards to account for some cash reserve, some new customers, and some new technologies/solutions.

With a per share price of $1.60 or so prior to the speculative run-up, a per share price of $1.25 may be reasonable.

Together these two approaches provides for a range from $1.25 through $2.50. Naturally, if the company does not manage to control its expenses after the effective terminal date of the Simple Mobile contract, then this range would be too high, and, likewise, if the company manages to secure significant new sources of revenues in 2013 and 2014, then this range would be too low.

Speculators on the inside

Rational estimates can be very valuable when it comes to establishing target prices over some long time-horizon. In the short term, however, the price tends to be ruled more by speculation and other ill-defined market mechanisms. The effect of these factors are interesting in general and may become pertinent for MTSL.

Generally, it is my experience that once an equity has been exposed to a speculative boom-and-bust cycle, it is susceptible to be so again, with the probability for repetition decreasing only slowly over time. I don’t really understand this phenomenon, and, in a very real sense, I do not have to. All I need to do is to acknowledge it.

The per share price for MTSL has tanked as the result of information that has revenue and earnings impact in year 2014, consistent with standard efficient market and pricing theory for equities. However, this information was also known before and during the speculative run-up, albeit less certain and not precisely timed, implying that speculation can thrive even when adverse fundamentals exist.

In fact, in a speculative environment, fundamentals matter little until such time that the speculative wave hits it apex, and, so, even when traders know for a fact that something is wrong with the fundamentals and perhaps even are reminded of this fact on a daily basis, the speculative wave will continue to rise. Again, I don’t know why this is the case, but my ignorance is not important.

To me, the fact that a speculative wave can rise in spite of the presence of adverse fundamentals imply either that traders are ignorant or that traders apply select blinders or temporary memory loss in order to participate in a rally — with the expectation that they will be able to exit at the expense of another trader, à la willing participants in a Ponzi scheme. I think the reality lies somewhere in the middle, with lots of ignorant retail traders being exploited by more seasoned or even professional traders.

I continue to be amazed by how cavalier traders are about losses that they incur as a consequence of having put capital in an equity solely on the basis of a herd mentality only to see the equity dropping in value. At StockTwits, for instance, I noted the following comments, which, believe me, are not atypical:

2.64 -.12 still buried deep in the dog house. Valuation cut in half in one week.

@septjet i got in on $MTSL at the 3s too. Losing big. I think i might sell. What do you think?

well i go from a $5000 gain to a $100 gain. lol. what a waste of time and money. had sell order last week twice never got filled.

reminding us why Israeli stocks trade historically at discounts. Cause you can’t trust management.Cut above China stocks

2.80-.41 freaking ugly off 3.70 hod. Wonder if the Super Hero world tour has been postponed after this rather large speed bump. Lol

got in @ $3.32 then took some loss, hope it bounces back to $4

Clearly, these people are almost proud of there losses, considering them to be badges of honor or battle-scars, which, of course, is an insane attitude. In doing so, they are, in fact, more akin to degenerate gamblers than traders, and, as they say in Vegas, Show me gambler who walked away from the table with a loss today, and I will show you a player who is back for more action tomorrow. So with this crowd keeping an eye on MTSL, my basic assumption is that if there is a slight upswing in the per share price, they will be back for more punishment.

When considering the possibility of recurring speculation in MTSL, it is worth noting that the very limited free float, one of the key factors in bringing about the first wave of speculation, is mostly unchanged since 2012. While float is generally the total number of shares publicly owned and available for trading, calculated by subtracting restricted shares from outstanding shares, free float is float adjusted by the known number of outstanding, but sticky shares, i.e. shares held by large position holders, company insiders, key employees, and long term non-institutional holders (today, unlike twenty years ago, institutional holders tend to have short-term positions, and, therefore, their holdings are not sticky.)

At approximately four and half million shares, the float of MTSL is low — the result of a reverse split in 2010. Of this float however, more than 55% is closely held, resulting in a free float of only approximately two million shares. The free float has increased by 500 thousand shares or so since August of 2012, as the result of one company insider eliminating virtually all of his position, but this number still constitutes one of the lowest free floats that I know of the reputable market, and clearly can be a major factor in setting the pace for a speculative run-up in the future.

Accordingly, I believe that it is quite possible that there, after the announcement of presumably very positive first quarter earnings results, will be a significant rebound in the per share price for MTSL. Moreover, if we apply speculation and ignorance induced memory loss about the Simple Mobile contract (a reasonable approach given the discussion above,) then, based on quarterly earnings of $0.15 per share on revenues of $3.5 million and some sort of middle-of-the-road price to earnings ratio, I would not be surprised to see the per share price leap towards its previous peak.

Such leap would, of course, not last long (in investor terms — in speculators terms it will last a life-time,) but it would be notable and would, I think draw in enough interest to ensure that the subsequent decline would be extended throughout a good part of 2013 and first quarter of 2014.

A possible path

I am not a trader, but I can’t help noting that, if I am right, then there is a significant opportunity to buy MTSL and hold it through a potential run-up in 2013 — possibly, ultimately, reversing the long position through the assumption of a short position before the announcement of first quarter results in fiscal year 2014. Certainly, bad news are now baked into the equity pricing and if you assume that the market’s memory is poor and/or any coming news from MER Telemanagement Solutions will be good news, then there is a strong opportunity here.

From a value investor’s perspective the earnings and revenue numbers for 2013 are mostly meaningless since they are predicated on the terminating Simple Mobile contract, but, when seen in isolation and applying blinders in the manner that a highly speculative market might do, the numbers support a per share price of at least $6 for MTSL — a +100% premium to the current per share price.

The problem at hand is, of course, the determination of the peak of the speculation, the apex, if you will, which will constitute the optimum point for an exit from the long part of the trade, and that is one area where I have now experience, and, so, I will not speculate on this.

Aside for the apex, this looks pretty good to me. But then, I am probably unduly affected by having predicted the break-down of the speculative wave, and, so, I may have gotten a somewhat inflated sense of my own ability to see clearly. Certainly, it would not be the first time that I fell victim to hubris, as you can read about here.

Please remember that my standard disclaimers apply for this posting. Most importantly, whatever I say in this blog posting is simply my opinion — it is not science, it is not advice, and it is not an attempt to make you act in any way whatsoever.

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