Off track or…Posted: June 25, 2013
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Derailed by an earnings announcement
On April 10th, 2013, I wrote a lengthy posting (here) discussing MER Telemanagement Solutions, a publicly traded company, and its equity, MTSL, with a focus on establishing a target price for MTSL.
In my posting, I briefly explained the speculative character of a run-up in per share price of MTSL since August of 2012 and detailed the complete (and expected) break-down of this run-up since March of 2013. Subsequently, I took a stab at determining how much revenues and earnings MER Telemanagement Solutions will record in 2013 and 2014.
With respect to these revenues I wrote:
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 [with Simple Mobile,] 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.
I also wrote that:
[u]nless 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.
As it happens the per share price did not go up in the period from April 10th, 2013, through the first quarter earnings release on May 9th, 2013. However, after a drop in the per share price in the days immediately following April 10th, 2013, the per share price did stabilize and climbed quite a bit, maxing out at $2.36 in the days before May 9th, 2013.
Whatever gain were made in the period leading up to the day of the earnings release, however, were eradicated when the company announced that results for the first quarter. It was not that the results were bad… far from it…. the company had positive results and grew its cash position by a whopping $1.1 million in the quarter.
In fact, the beef may have been with the earnings number, $0.07 per share, which on a year-over-year basis was unchanged and on a quarter-over-quarter basis had deteriorated $0.01 per share.
Now, in absolute terms there was nothing fundamentally wrong with the earnings results for the first quarter, but there was probably an expectation problem. 2012 , a somewhat bumpy year, had generated earnings of $0.30 per share, and, so, using calculations similar to those I put forward in my posting, there was an expectation that the company could head towards $0.60 in earnings, before, if you will, falling over the cliff in 2014 when the Simple Mobile contract could no longer be relied on.
Moreover, there may have been an issue with the perception of the revenue situation, since, for the third quarter, while the quarterly year-over-year revenues increased by from $2.98 million to $3.3 million, the quarterly quarter-over-quarter revenues declined from $3.48 million to $3.3 million.
I, for one, had expected that the revenues for 2013 would increase, reflecting, among other things, that there would be some professional services work related to the migration of the Simple Mobile customers, but, clearly, that does not appear to be the case in the first quarter. This year-long view may be right or wrong, but, certainly, it was not reflected in the first quarter.
Not helping matters, on the revenue side there is a significant revenue recognition issue with the managed services model, which had worked so well for the Simple Mobile contract, perhaps causing some problems in the first quarter in that the two new deployments have to get up to steam before they start throwing off revenues — and until they do so, they are costly, eroding the margin from the other revenue sources.
So, overall, for the first quarter, it looks like a double whammy: Increased expenses to get the two new deployments going and no significant increase in revenues.
Regardless of the reason, however, the market clearly did not like what it saw, and between May 9th, 2013, and today, the per share price has declined to $1.56.
The consequences of the first quarter
Effectively, the per share price of $1.56 places a market value of $7.24 million on MER Telemanagement Solutions. This number should be understood in light of free cash on hand of $5.26 million, no debt, and quarterly net income in excess of $300 thousand, pointing towards a net income of $1.2 million or better for the 2013 year. Assuming that there are no accounting games at play, these $1.2 million could be added to the cash at hand, for free cash on hand of at least $6.16 million at the end of 2013 (see an important caveat, below.)
Effectively, unless something dramatic happens, you can therefore — right now — buy $6.16 million in cash for $7.24, and in return for the balance of $1.08 million be left with a company, which, sans the revenue contribution from Simple Mobile, should generate at least $10 million in revenues in 2014 and, once the operational overhead associated with the Simple Mobile contract is gone (more about this, below,) should generate a nice positive cash-flow. Quite a deal.. And, here is the best part: It is the worst-case scenario.
If the company does achieve the additional migration-related revenues that I guessed would be forthcoming, and once the company finishes the deployment of the two new contracts, the top and bottom lines should improve dramatically, sweetening the deal for a buyer.
The sweetness of the deal, however, is somewhat contingent on two things. First, the company has to reduce its operational expenses almost immediately to reflect the revenue and cash loss that it will incur when the contract with Simple Mobile is effectively terminated. Second, the cash position is impacted by some oddity in the first quarter.
With respect to the expenses, the underlying question is clearly how the company will manage in the post-Simple Mobile world. This is, of course, a question of cost-control, shaving the company to a size that is appropriate as soon as possible and preferably before the Simple Mobile contract’s effective end-date. The question is dealt with in the earnings press-release, but, unfortunately, this is done in an opaque, almost, shy way, with the CEO stating that the company is: “.. closely monitoring our operating expenses and … will make the necessary adjustments based on the business needs and changes…”
What this means, I think, is that the company will rightsize as soon as possible, but, if that is the case, why not just come out and say it loud and clear? The Simple Mobile contract is done… The market has reacted… Now, anything that deals constructively with how the world will look in 2014 will be interpreted positively by the market.
With respect to the cash, it is important to note that during the first quarter of 2013 the company’s cash position increased $1.1 million on net income of $344 thousand. Assuming that there is no such thing as a free lunch, the net difference of $750 thousand, or so, has to be accounted for either in the future or in the past.
Using only the filed financial statements it is difficult to determine if, or how, this will happen. For instance, the company recorded a substantial increase in deferred revenues from fourth quarter of 2012 to first quarter of 2013, from $1.65 million to $2.1 million, a net change of $450 thousand, which could account for some of the cash received, but only the company’s insiders would know if this is the case.
Regardless of the source or origin of the cash, the issue, of course, is that drawing a parallel between cash and revenues (as I did, above,) is at best difficult and at worst a fool’s errand.
And, so, the situation is not clear-cut — except that it is clear that the company should do fine (or very good!) in 2013 from both a cash and revenue standpoint with a significant potential for upside, and that the company in 2014 probably should do fine, but exactly how fine is dependent on its ability to secure new orders in 2013, to finish the deployment of the two new contracts in 2013, and to right-size the operations during 2013. Moreover, almost regardless of how 2013 and 2014 plays out, the per share price of $1.56 is incredibly cheap.
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