Grundsaudaag — It is happening again

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Phil: What would you do if you were stuck in one place and every day was exactly the same, and nothing that you did mattered?
Ralph: That about sums it up for me.
— Groundhog Day

The bodies are piling up and SeekingAlpha appears to be Patient Zero.

MER Telemanagement Solutions and MTSL

I have written about MER Telemanagement Solutions and its equity, MTSL, at length, primarily in relation to the company’s predictable loss of its single most important contract, a managed services contract with Simple Mobile, a California based MVNO; the company’s apparent refusal to warn about this event; and the market’s refusal to accept the event as a fact (to learn more, you can start reading here and work your way backwards.)

For reasons that I will not rehash here (again, you can start reading here,) the company’s equity exploded from a per share price of $1.50, or so, to a per share price of more than $5 in a very short time-frame in spite of it being absolutely clear that the company would lose the key contract with Simple Mobile and that this contract constituted the very basis for the company’s profitability.

After the company announced the loss of the contract, the per share price collapsed, with lots of optimistic and possibly extremely naïve investors being left with massive realized and unrealized losses.

SeekingAlpha

Subsequently, MTSL would, from time to time, experience very short-lived run-ups in the per share price, almost without fail linked to an announcement by the company and an article on SeekingAlpha touting the equity, the company, and their combined potential for immediate short term growth.

These run-ups have not only been speculative in character, but they have, in my opinion, in many cases been moved almost entirely by the SeekingAlpha articles, and, moreover — again in my opinion — a number of these articles have been written with the explicit objective of creating a run-up with the intent of creating an environment in which a position entered into prior to the creation of the article can be sold.

That this sort of run-up by design is possible around MTSL is primarily because of the equity’s low float, and, so, each share involved in the run-ups was traded multiple times. But the float is not the cause of the run-up, but rather the enabler. In fact, to achieve a run-up, we need information dissemination on a vast scale. Simply put, we need a channel — preferably one that provides indiscriminate and rapid access to mainstream online media.

SeekingAlpha, through its direct feed into other news streams, is such a channel. For instance, articles written on SeekingAlpha gets replicated in the Headlines section on the associated equity page on Yahoo Finance, providing not only near-instantaneous distribution, but also an air of credibility that alternative channels, such as investor and trader newsletters, cannot achieve.

Of course not all SeekingAlpha articles are written with malice. In fact, most SeekingAlpha articles are written by hardworking and honest investment professionals and amateurs for reasons other than luring victims to equities.

Unfortunately, sometimes these well-meaning professionals and amateurs write SeekingAlpha articles that are poorly researched or poorly thought-out and reaches unsubstantiated and erroneous conclusions. Moreover, sometimes these poorly researched articles resonate with what is best characterized as the lemming market, creating a short-term run-up that is virtually impossible to distinguish from the run-ups originating in articles written with malice.

MTSL again — this time courtesy of Sujan Lahiri

The day before yesterday a Mr. Sujan Lahiri joined the ranks of individuals writing optimistic and upbeat articles about MTSL and MER Telemanagement Solutions, when he wrote a SeekingAlpha article touting the company’s potential for being a “multi-bagger.” You can find the article here, but, as you will gather from this posting, I don’t recommend it.

We don’t know who or what Mr. Lahiri is. He appeared on SeekingAlpha in late August and has since then produced articles at the dizzying speed of one article per two weeks.

Although much, if not most, of the information laid out in Mr. Lahiri’s most recent article about MER Telemanagement Solutions was, in my opinion, factually incorrect, it created, I believe, a new run-up, which is currently playing out.

Let’s review, in detail, what Mr. Lahiri wrote.

Objectivity

First Mr. Lahiri establishes that he, prior to writing the article, had established a position:

For a couple of days we have been accumulating shares of MER Telemanagement Solutions (MTSL).

I don’t know who “we” refers to, but that Mr. Lahiri has been accumulating a smallish position is consistent with the last couple of days trading pattern, wiz that the equity, which, as the reader may recall, was headed for a per share price level somewhere far below $2 after the most recent earnings announcement (read about this here,) but its slide was halted through a couple of smallish, premium rate trades placed on days with very limited volume. I, therefore, assume that these premium rate trades were, substantially, attributable to Mr. Lahiri.

So far, so good.

Company description

In his article, Mr. Lahiri proceeds to describing MER Telemanagement Solutions and its business, saying among other things, that:

MTSL provides the most innovative and award winning cost-cutting technology to make this happen. MVNOs can rapidly gain a competitive advantage in the marketplace with MTSL’s comprehensive, end-to-end MVNE managed service solution that is specifically designed to align with their business objectives and meet the needs of their target market; regardless of their size, service offerings or business ecosystem. MTSL operates worldwide; a few known and reputable customers are Siemens, McAfee and Costco.

The first line is, of course, pure marketing fluff, shamelessly lifted wholesale from MER Telemanagement Solutions’ self-promoting marketing literature (I will ignore the obvious referral of the company, MER Telemanagement Solutions, by the way of its equity name, MTSL — a common error.) This lifting is, of course, very problematic, since, there really is no room for mindless regurgitation of company propaganda in an investment thesis.

The second line of this paragraph, a run-on line, is somewhat correct in that, at some point in time, MER Telemangement Solutions did probably have Siemens, McAfee, and CostCo as its customers (and, I guess, may still have these companies as customers, although it is hard to say, since, in the world of marketing, the line between current customers and past customers tends to get a little blurry.)

Where it gets complicated, however, is in the “tightness” of the line with the prior line in the paragraph, which implies, I think, that these customer relationships are centered around the MVNO/managed service or MVNO/SaaS/cloud service (read more about the distinction between cloud and managed services here,) which, as far as I know, they are not.

To the best of my knowledge, MER Telemangement Solutions’ relationship with these marque customers is or was, in fact, centered around the company’s TEM business line, a segment in stasis or decline (read more about the TEM segment here.)

Mr. Lahiri later discusses the MVNO business line’s prospects and the market position of MER Telemanagement Solutions’ MVNO/MVNE solutions:

According to Visiongain, a leading research company, the MNVO market will grow to $40 billion by 2016, with subscriptions doubling to $186 million. Click here for the detailed report. Its this gigantic and increasing potential customer base MTSL must and will tap into. Investors ought to know that MTSL is the leader in servicing this growing MNVO industry. On top of that, MTSL is also entering into new growth areas like mobile banking.

Well, not so fast, buddy! With the Simple Mobile contract, MER Telemanagement Solutions certainly established itself as a participant in the MVNO/MVNE supplier market, but, as Mr. Lahiri should have known, there are many other providers in the space, including, but certainly not limited to, Redknee, who recently announced multiple Tier-1 MVNO deals, and AMDOCS, which is a supplier to Effortel, a combined MVNO and MVNE provider whose MVNO subscribers alone numbers more than one million.

Virtually all the BSS players dabble in the MVNO space and the vast majority of these players have substantially more customers and deeper pockets than MER Telemanagement Solutions, and by no stretch of the imagination is MER Telemanagement Solutions a leader in the MVNO/MVNE billing support space or, for that matter, in the larger BSS space.

The reality, as far as I know, is, in fact, that during a three to four year period, MER Telemanagement Solutions had only one customer for its MVNO business segment, and only recently has it managed to pick up more customers, none of which, in my opinion, qualify as Tier 1 or, for that matter, Tier 2. Although, MER Telemanagement Solutions may have future, long term potential, it is currently, at best, a very small fish in a large pond filled with very large sharks.

The Simple Mobile and the “cloudy” issues

As I have written about in past postings, the issue at hand when discussing MER Telemanagement Solutions as an investment object is not whether or not buying MTSL is a strong long-term investment. It very well may be. Rather the issue is what will happen with the per share price of MTSL in the short to medium term.

The reader may recall that the key issue is that the Simple Mobile contract, which accounts for a huge part of MER Telemanagement Solutions’ revenues and substantially all of its margins, is scheduled to end in 2013, leaving the company only with its TEM contracts and a few, new, embryonic MVNO and convergent billing services contract, supplemented with one or two minor new, and also embryonic, mobile banking contracts. Moreover, these contracts may be licensed as cloud and/or managed services contracts, creating a deferred revenue stream and an adversely tilted margin profile.

I assume that Mr. Lahiri and most of the investors and traders involved in the current run-up are newcomers to MER Telemanagement Solutions and MTSL and have no more than superficial understanding of the company and its equity.

It is hard to explain to such newcomers how important the Simple Mobile contract has been and continue to be for MER Telemanagement Solutions in view of the static or declining TEM segment, but perhaps this (rather long) outtake from one of my earlier postings (here) will be helpful:

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.

So, in summary, the TEM segment is not great and the gamble is that the MVNO and convergent billing solution (and, perhaps, the mobile banking solutions) in the long term will provide an avenue for growth. However, in the short term, the issue is that the scheduled termination of the Simple Mobile contract will hit the company hard, eroding in excess of 25% of the company’s revenues and substantially all of the margins.

Moreover, by attempting to sell “cloudy” solutions (whether structured as a managed service or as a pure SaaS license offering,) the company is effectively: (1) deferring revenues for new deals; (2) increasing its short to medium costs without achieving a corresponding offset in short to medium term revenues; and (3) investing in its customers business ventures.

The investment issue is problematic, of course. A failure by the one or more of its customers can hit MER Telemenagement Solutions hard, leaving the company with a permanent loss on its books. Moreover, ironically, the success of a customer can cause a range of problems, including the well known problem of losing the customer because it gets acquired by a larger company.

However, this issue is somewhat in the medium term, so, perhaps, for now, it can be ignored.

The revenue deferral and cost issues are immediate and critical, acting as an amplifier to the already dramatic hit the company will probably take after the end of the year, when the Simple Mobile contract is finally dead.

And it gets worse… For one has to ask why it was not possible for the company to sell additional MVNO/managed services contracts or, for that matter, MVNO/cloud or mobile banking solutions over the last three to four years, and, then, suddenly, when the Simple Mobile contract is in the wind, deals starts pouring in. One possible answer, and it is a nasty one, is that the company has become less picky and more willing to, on a deal-by-deal basis, run risks related to the three dimensions that we spoke about above: 1) revenue profile, 2) costs, and 3) risk.

Simply put, the Simple Mobile issue is not simple. And the cloudiness of it all is making it even less simple.

Mr. Lahiri’s mono-vision

Here is Mr. Lahiri’s take on this complicated issue:

One reason we invested in MTSL is the company’s strong financial platform:

  • Market capitalization: $9 million
  • Cash: $5.7 million
  • Debt: zero
  • Cash flow: $300,000-$400,000 positive per quarter
  • Shares outstanding: 4.7 million

MTSL reported a net profit for the first three quarters this year of almost $1 million, which is $0.27 per diluted share on an annual basis. Shares currently trade for $2.00. MTSL has been generating a positive cash flow for years now. If you subtract the cash, the market seems to price their profitable business activities at just $3 million, which is far below fair value.

This neat — and extremely impressive — little summary completely ignores two material facts: 1) The cash-flow and net profit is predicated on the Simple Mobile contract, which, as it is presumably end-of-life (unless something changes in this, the 11th hour,) is a shaky foundation; and 2) the results for the third quarter showed a 10% revenue decline relative to the results for the second quarter ($2.96 million versus $3.10 million) and, critically, a 13% decline relative to the results for the same quarter in the previous fiscal year ($2.96 million versus $3.40 million,) and corresponding material declines in net income and gross profit.

The declines, in particular, are problematic. Not only for what they represents, a declining top line and increasing costs per revenue dollar, but also because they signal that the Simple Mobile contract is already winding down and the cost of launching new contracts is going up.

The issue is, of course, complex, and it may be unfair to expect Mr. Lahiri, who probably has never been an executive in a delivery role, to understand that delivery and operations entails costs, which has to be offset by revenues, and that, critically, cloudy license models pervert a company’s cost/benefit model in the short to medium term and add substantial risk in the long run.

However, regardless of how much slack we cut Mr. Lahiri, the fact is that his statements about the company’s operations are, at best, a little to simplistic, and, at worst, they are reckless.

One could, in fact, argue that the market, which is expected to evaluate an equity based on its future potential (and, increasingly, only on its short to medium term potential,) is entirely correct in reducing the per share price for the equity of a company that might very well swing into the red in the near future and that has very limited cash reserves to weather a storm (in particular, in MER Telemanagement Solutions’ case, if one goes back in time and lock at the rather shaky road the company followed before the Simple Mobile contract started gushing money (hint: cash injections by insiders and majority holders and reverse splits are involved) — something that, clearly, Mr. Lahiri neglected to do.)

On a side-note, it is no strictly correct that the company has no debt, since it carries substantial contingent liabilities related to the Israeli OCS, which must be satisfied.

Mr. Lahiri’s rather simplistic view continues throughout his article. For instance, he writes:

For instance, if MTSL were to land one large customer, EPS could easily grow from current $0.27 to $0.40 per share in the near future. Apply the industry average of P/E 15, and you have a $6.00 share. Another customer could mean $0.50 or $0.60, that’s a $7.50 or $9.00 share. Any extra customers directly add to the profit without a substantial increase in costs. The upside potential is therefore very large.

Well, let’s look at this. The assumption here is that a new customer would add something like $0.13 in earnings in the near future. In real terms this means yearly earnings (not revenues!) of $585 thousand or so, or just about $50 thousand per month. Assuming a liberal 20% margin, this amounts to $250 thousand in revenues per month.

With the Simple Mobile pricing a benchmark for per subscriber revenues, pointing to something like a quarter of a dollar per subscriber per month in revenues, this would mean that the fictive customer would have a subscriber count of one million.

MVNOs or MVNEs with 1 million subscribers are relatively rare, and, importantly, they don’t just emerge in one go (read about subscriber count in the MVNO world in an earlier posting here,) so I think that Mr. Lahiri’s projection of the “near future” earnings is… well… laughable.

But, it doesn’t end here. In fact, it goes on an on and is mostly of such quality that it is not worth spending too much time on. However, my regular readers would probably be on my case if I did not, in closing, point out the following two gems:

An obvious setback would be management failing to acquire new customers. MTSL is likely to remain profitable, which sets a floor, but shares won’t surge either. Two-thirds of the market cap is pure cash, so downside risk is limited. We think it’s unlikely this risk will materialize though, given the company’s acquisition history.

An viable risk that could push the share price lower is an existing customer deciding not to renew its contract. Revenue and profits would shrink. It happened before (Simple Mobile) but we regard this as an one-time event. The company’s history proves this is very rare so we do not expect the same happening again.

Let’s look at the first point. As it happens, the successful acquisition of new customers may actually be the risk, rather than a salvation, as explained in the above. The statement that the company is likely to remain profitable is, of course, completely unsubstantiated, and the note that the downside risk is limited and the reference to the company’s acquisition history is, at best, puzzling.

The risk is, of course, not limited. The new customers have a contractual expectation to be served and the cost basis from the hey-ho Simple Mobile days can quickly bleed the company out.

I am unsure what the company’s profitability has to do with its acquisition history, but, playing along, the company’s acquisition history is rather shaky with the recent acquisition of AnchorPoint, in an attempt to hold up the sliding TEM segment, leading to a rather costly intellectual property right lawsuit (on the order of $500 thousand to $750 thousand, a massive amount for a company in the ten million dollar class.)

Ok, ok… I assume that the the acquisition history being referenced is customer acquisition history (although I could be excused, I think, for not understanding this from the context and shoddy writing.) However, this does not really make much difference on the depth of the argument, since the customer acquisition track-record for the MVNO, convergent billing, and finance solutions is, at best, unknown, and, at worst, irrelevant. Again, remember that the company went for multiple years before it began picking up customers, that the value of this new stream of customers is unproven, and that, in a cloud/managed services area, customers are double-edged swords, carrying with them risk and expenses in the short to medium term.

The point of customer renewals, and in particular the sentence that the “company’s history proves this is very rare so we do not expect the same happening again,” is really odd. In fact, the company’s three to four year track-record when it comes to MVNO/managed services is one customer won, one customer lost, i.e. a 100% loss record, so almost the opposite point could be made.

Of course, my, now quite old, statistic teacher, would shake his head at any inference drawn on the basis of a sample set n, of one (n = 1,) but, I guess statistics and critical reasoning may not be Mr. Lahiri’s strong points.

So…

So there we have it. A substantially unsubstantiated and quite error-riddled story, which, for reasons more to do with legacy than merit, appears to have been able to move the market.

Short of one of two outliers (an acquisition or an extension of the Simple Mobile contract, both, I think, rather unlikely,) it is, I think, highly probable that the gas will soon go out of this, the latest, run-up, and MTSL will continue it decline towards its price equilibrium of somewhere between $1.50 and $1.75.

Personally, I continue to hope that the company will do the right thing, reducing costs before the black turns to red, but I have not yet seen any indications that this is the case.

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