Oh no, it is worse… MTSL takes another $561 thousand torpedo

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.

…. And, if you find yourself enjoying this posting, consider supporting the blog through a donation. For your convenience, PayPal links are provided to the right and at the end of the posting.

USS John Young

In a recent posting (here) I wrote about the fourth quarter and full fiscal 2013 year earnings announcement by MER Telemanagement Solutions, an Israel based company that I have followed for quite a while.

I noted that the company had announced (1) a new high in cash (and cash equivalents) on hand almost exclusively on the strength of a very profitable contract with Simple Mobile, a West-coast based MVNO whose managed services contract with MER Telemanagement Solutions had generated a guaranteed $300 thousand in revenues and cash every month throughout MER Telemanagement Solutions’ fiscal 2013 year; and (2) the end of this revenue and cash stream, effective as of December 31st, 2013.

The termination of the Simple Mobile contract in itself was a disaster, but, unfortunately, things were even worse, with overall revenues and operating profit down significantly year-over-year and net income down $1 million to $1.4 million year-over-year when accounting for a one time $1 million tax charge in the company’s fiscal year 2012.

In my posting I included a computation table, trying to assess the impact of the Simple Mobile contract loss on the 2014 results based on previous results, and — oh, boy! — it was not pretty (here is a direct link to the table,) projecting a revenue drop of $3.6 million (or 28.5%) in 2014 and a net income drop well into the red.

Today, the company filed its 20-F filing with the Securities and Exchange Commission, and, unfortunately, things went from bad to worse. While I, in my table had estimated the Simple Mobile revenue contribution for 2013 to be 28.5%, it showed to be a staggering 33%.

As the company wrote in its very first qualitative statement in the 20-F filing:

If we do not replace the revenues generated by Simple Mobile LLC our operations and financial condition will be adversely affected.

Our principal customer during the three years ended December 31, 2013 was Simple Mobile LLC, a U.S.-based mobile virtual network operator, or MVNO, for whom we provided hosted billing services. In 2011, 2012 and 2013, sales attributable to this MVNO accounted for approximately 16.4%, 22.8% and 33.3% of our revenues, respectively. During 2012, Simple Mobile was acquired by TracFone and in 2013 TracFone migrated our hosted billing services to its own platform and did not renew its agreement with us, which ended in December 2013. If we are unable to replace the revenues generated by Simple Mobile LLC, our operating results and financial condition will be adversely affected.

Not exactly encouraging stuff.

The difference of 4.5% or $561 thousand between our previous estimate and the new announced results is significant enough in itself, but, unfortunately, there is more.

First, this means that the revenue contribution that has to be backed out of the 2014 projections are higher…. arghhh!…. leading to even more loss, in fact an additional loss of $453 thousand for a projected worst-case loss of $1.8 million in 2014.

Second, the significant increase in the Simple Mobile revenue contribution means that MER Teleamangement Solutions’ revenues that were not attributable to Simple Mobile declined a full 17.5% in 2013… a disaster of the highest magnitude.

Here is the updated table:

(c) Per Jacobsen, 2013 and 2014. All rights reserved

(c) Per Jacobsen, 2013 and 2014. All rights reserved

Oh, by the way, this worst case scenario, may not, in fact, be the worst case, since it assumes that the non-Simple Mobile revenue will be stable in 2014. If, instead, the drop in revenues continues, then we need to clear the decks for a much worse worst case.

Now, I hasten to say that there were some good news in the 20-F filing, albeit not much.

First and foremost, the company has reduced its payroll, laying of a large part of its staff. This, of course, was something that I knew had to happen, but that the company for some reason saw fit to not tell its shareholders was happening (read more about this and the company’s puzzling and, in my opinion, warped communications with its shareholders in my previous MER Telemanagement Solutions postings… you can use the nifty XREFs section to get them.)

The reduction is force is deep, but it does not make up for the loss off the Simple Mobile contract (to be fair to the company, almost nothing except a full scale roll-back of staffing in the very early part of 2013 could make up for the catastrophic loss of the Simple Mobile contract) and the extensive cost of winning and launching new managed service of cloud business. So, in spite of the lay-offs — a case of too little, too late — things are definitely looking bad.

Moreover, there were more somber language about the PFIC classification and its potentially adverse impact on United States based shareholders (read more about this here.) As I wrote I this earlier posting, the cash hoarded from the — now dead — contract with Simple Mobile may, in a ironic twist, become a poison pill for United States based holders of shares in MER Telemanagement Solutions.

Interestingly, today, on the tail-end of the filing of the 20-F, when investors (if they could — and cared to — read) should be heading for the hills, the company’s equity exploded. This could, of course, be caused by anything, including investor stupidity or leaking of information that the company is getting sold or having gained another customer, but it certainly does not mean that the company is doing well.

With respect to the potential for the gain of new customers to change the fundamental situation of the company, it may be worth thinking deeply about the depth of the problem to be plugged. As I wrote in an earlier posting (here) where I discussed an, in my opinion, less-than-reputable and poorly researched article by Mr. Sujan Lahiri, a self-confessed post-for-profit contributor to Seeking Alpha:

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.

So, new customers are definitely not a valid reason for a surge in the per share price of MTSL.

We’ll soon see what gives, I guess.

Donations, please….

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Breaking, pre-open news — MER Telemanagement in near extremis

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.

…. And, if you find yourself enjoying this posting, consider supporting the blog through a donation. For your convenience, PayPal links are provided to the right and at the end of the posting.

??????????????????Breaking pre-open news

Yesterday, after the close of the market, MER Telemanagment Solutions, an Israel based technology company whose equity is traded on Nasdaq, reported its fourth quarter and full year results for the company’s fiscal year 2013, and, frankly, in my opinion it is not looking good.

As the reader of this blog will know I have followed MER Telemanagement Solutions and its equity MTSL, for a while now, noting since the outset that the loss of the Simple Mobile contract constitutes a clear and present danger to the company and its shareholders. If you are new to this issue, you can start reading here and go backwards or you can use the nifty XREFs section to here.

Revenues and operating profit are down significantly year-over-year and net income was down $1 million to $1.4 year-over-year when accounting for a one time $1 million tax charge in the company’s fiscal year 2012.

The $1 million one-time charge in fiscal year 2012, which somewhat masks the enormous drop in net income in fiscal year 2013, was described in the company’s 20-F filing for the 2012 fiscal year:

Taxes on Income.

We recorded taxes on income of $736,000 for the year ended December 31, 2012, compared to taxes on income of $10,000 for the year ended December 31, 2011. Our taxes on income for the year ended December 31, 2012 are primarily attributable to a $1,050,000 charge related to the tax assessment from the Israeli tax authorities relating to an Israeli court’s decision with respect to our 1997 to 1999 tax years, net of a deferred tax asset recognition of $371,000 based on an estimate of future taxable profits and losses in the tax jurisdictions in which we operate, which is expected to be utilize in the foreseeable future. Our low level of taxes on income for the year ended December 31, 2011 is primarily attributable to the utilization of deferred tax assets by our subsidiary in Hong Kong and the state income taxes in the U.S.

Moreover, in the current earnings release the company confirmed that the fourth quarter marked the end of the revenue contribution from the all-important Simple Mobile contract, so, going forward, each fiscal quarter will have $900 thousand, or so, less in revenue and perhaps $450 thousand less in net income, which most probably will result in a loss in each quarter.

Also, with the loss of the contract revenue and its high margin there is now, I believe, a substantial risk that the company will be considered a PFIC by the IRS of the United States with serious tax implications for common shareholders in the United States. As the company wrote in its 20-F filing for its 2012 fiscal year:

We may in the future be classified as a passive foreign investment company, or PFIC, which will subject our U.S. investors to adverse tax rules.

Holders of our ordinary shares who are United States residents face income tax risks. There is a substantial risk that we may become a PFIC. Our treatment as a PFIC could result in a reduction in the after-tax return to the holders of our ordinary shares and would likely cause a reduction in the value of such shares. For U.S. Federal income tax purposes, we will be classified as a PFIC for any taxable year in which either (i) 75% or more of our gross income is passive income, or (ii) at least 50% of the average value of all of our assets for the taxable year produce or are held for the production of passive income. For this purpose, cash is considered to be an asset which produces passive income. As a result of our relatively substantial cash position at the time, we believe that we were a PFIC in certain periods over the last few years under a literal application of the asset test described above, which looks solely to the market value of our assets. We do not believe that we were a PFIC in 2012. If we are classified in the future as a PFIC for U.S. federal income tax purposes, highly complex rules would apply to U.S. Holders owning ordinary shares. Accordingly, you are urged to consult your tax advisors regarding the application of such rules.

The company’s earnings release contained no indications of cost-control measures or new deals, relying rather on the tired we-see-opportunities approach that we have seen from previous quarterly announcements and that I commented on in an earlier posting (here):

In fact, ever since the termination of the Simple Mobile contract was announced it has been clear that the company … is heading directly for exsanguination.

To avoid death, immediate action is needed on two simultaneous fronts: New sales and cost control.

The instinct in a tech company is to overcome a revenue crisis by bringing in new revenues. However, given the sales cycle time for enterprise software sales and the trailing revenue curves for managed services sales, the company’s areas of expertise, the pursuit of additional revenues alone is not going to solve the problem. Rather, the company has to immediately reduce its expenses while, at the same time, building up its sales effort.

Instead of addressing the situation heads-on in its first quarter earnings announcement, the company engaged in some sort of combined danse macabre and tap dance, which I certainly did not find reassuring.

It is hard to give the casual reader a sense of just how catastrophic the loss of the Simple Mobile contract coupled with the company refusal to reduce cost and it hell-bent pursuit of new business at great expense and risk is (read here about how bad it can get when you engage in what I consider to be reckless pursuit of new deals instead of buckling down down and controlling expenses,) but perhaps this table — greatly simplified and making sweeping assumptions where information is not available — can provide some insight:

(c) Per Jacobsen, 2013 and 2014. All rights reserved

(c) Per Jacobsen, 2013 and 2014. All rights reserved

As you can see, the Simple Mobile contract’s revenue and margin contribution was integral to the company’s performance and without it, the company will be hemorrhaging.

Acknowledging this imminent distress, which is now so obvious that no amount of voodoo or fancy leg-work will make it go away, the company closed its earnings announcement by stating that it is considering M&A options at this point, which I interpret to mean that either a fire-sale or a last-ditch clutching on to another company for buoyancy may be imminent. Either way, focusing on M&A — which, as we, know is associated with huge transaction costs and enormous risks — is bad news for the shareholders, I think.

The company did not offer any details about an upcoming earnings call in its earnings release.

Given the excessive — and completely unsubstantiated — speculative run-ups that have taken place over the last year (read more about this by starting here,) there is absolutely no way to predict what will happen to the per share price of MTSL in the very short run, but I am fairly certain that in the near and medium term, once whatever silly movement the market will make today and over the next week has completed its cycle, we will see another substantial drop in the per share price.

I would be remiss if I did not issue an early warning as well. Based on historic developments, I am fully expecting another SeekingAlpha article to arrive soon with unpredictable results (read about the previously published MTSL-centric SeekingAlpha article by Mr. Sujan Lahiri (here) — in my opinion, a prime example of bad research, wrong conclusions, and biased research aimed at generating a short-term run-up in the per share price of an equity.)

It appears that it is time to fire those emergency flares.

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Chicken coming home to roost

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.

…. And, if you find yourself enjoying this posting, consider supporting the blog through a donation. For your convenience, PayPal links are provided to the right and at the end of the posting.

1a34430vAs a general rule, I do not allow myself to be possessed by the common market maker conspiracy theory, the rampant paranoid notion that market makers manipulate stocks for their own gains.

Likewise, I don’t allow myself to be carried away in the pump and dump hysteria, where any momentum in a stock is followed by amateur speculators, traders, and investors yelling foul.

However, I do believe that there are equities that are extremely susceptible to manipulation, such as MTSL, the equity of MER Telemanagement Solutions, which I have written extensively about in this blog (refer to the XREFs section for more information about MER Telemanagement Solutions.)

The epicenter for such manipulation is frequently SeekingAlpha, because, as I wrote in a recent posting about a particularly unfortunate SeekingAlpha article that appears to have had a pumping effect on MTSL (here,):

…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.

The bumpy road for Mr. Sujan Lahiri

My posting was not written in a vacuum. I had been commenting on the SeekingAlpha article, which had been written by some hapless fellow named Sujan Lahiri, pointing out that the article was factually wrong on a number of counts. Mr. Lahiri, in turn, had initially attempted to respond in a calm and objective manner, but eventually got exasperated and started accusing me of being a bear.

Here is Mr. Lahiri’s last response to my probing comments:

You seem to be very bearish about MTSL. Instead of me writing a new posting, why don’t you write your own article and get it published on this website? If done well, SA might pay you $150, and shares MTSL could drop. Let the market decide.

This comment is extremely interesting — not just because of its infantile nature, which collides head-on with Mr. Lahiri’s attempt to come across as a mature value investor, performing in depth analysis, but also because it reveals that Mr. Lahiri is focused on writing for money, apparently banking on receiving the $150 per article that SeekingAlpha guarantees plus whatever reader-count based commission he can get.

In my posting about Mr. Lahiri’s article, I had shown him the courtesy of not assuming that his intent in writing the article was less than honorable (as I have written about in the past, as a matter of universal truth, when you see people doing or expressing something that is obviously wrong, then the only question is one of whether you are dealing with a crime or stupidity,) but, frankly, his comment about the $150 coupled with an earlier observation in his article, stating that he had taken a position in MTSL before publishing his SeekingAlpha article, makes me feel not so sure as to what side of the criminal/stupid seesaw he belongs to.

As I showed in my posting it is relatively easy to demonstrate that Mr. Lahiri’s SeekingAlpha article is less than a master-piece, and in my comments on SeekingAlpha I had pointed out four things that, right of the bat, were factually incorrect in the article:

  • MTSL is not the leader in the space of companies that serve MVNOs. Far from it i, in fact. Ask ourself who services Traq, or, for instance the large Italian MVNOs. MTSL is a bit player in the MVNO/BSS space.
  • The price did not slide from +$5 because of the tax issue, but, rather, because of the loss of the ONLY MVNO contract it had, and, also, the one contract that provided substantially 25% of the revenues and ALL of the margin.
  • Addition of more MVNO/managed services contracts will not swing the company to some incredible EPS immediately, even if these contracts are withe large MVNOs. In fact, it will take years for the contracts to provide material contributions and, in the short to medium term, they will actually hurt the margin — perhaps even considerably.
  • The marque customers quoted are on the TEM side, a business segment that, at best, is static, and, in fact, according to the company is declining. Moreover, to mention these companies is like Dunkin Donuts announcing that it has sold one donut to an employee in GE.

These factual problems where never addressed by Mr. Lahiri in his comment section, and, in fact, in his comments he addressed precisely zero of the deficiencies that were identified by readers of his article.

What he did do was pull a Halo Effect out of his hat, claiming that the — highly speculative — market’s reaction to his posting was prima facie evidence that his article was accurate:

I guess the market agrees with me, shares are up 25% since publication of this article.

This is, of course, abject nonsense, mostly similar to a pyromaniac setting a house ablaze by pouring 20 gallons of gas on the structure and lighting a match and then claiming that the resulting wholesale destruction of the house demonstrates that it was a fire-hazard. Just plain idiotic.

The article’s aggressive pumping (clearly visible even in the article name which included the terms “Low Downside, Multi-Bagger Upside”) did indeed result in a significant jump in the per share price. However, as it is always the case when the market reacts to shaky information, the chickens did eventually come home to roost, and as of 11:30 a.m., EST, today, Januar 27th, 2014, the per share price of MTSL is, in fact a full 10% lower than it was on November 19th, 2013, the day that Mr. Lahiri posted his ill-intended or ill-thought-out article.

So, with some glee towards Mr. Lahiri (but no prejudice or malice towards MER Telemangement Solutions, MTSL, or investors in MER Telemanagement Solution,) I allow myself to stoop to an infantile level and say: I guess the market agrees with me, shares are down 10% since publication of Mr. Lahiri’s article.

Back to MER Telemanagement Solutions

The drop in per share price accelerated when MER Telemangement Solutions recently announced that a three-year commitment contract from third quarter of 2013 had been terminated (read more about this in a recent posting, here.)

This event, the taking-on of a service contract that, apparently, was highly risky should give the company’s board of directors pause. For, as I wrote in the posting in which I dissected Mr. Lahiri’s article:

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.

Customer acquisition is a difficult discipline, but it gets somewhat easier if you abandon all risk management. However, as any operating executive will tell you, once you abandon risk management in order to increase the pace of bookings, you are set up for a serious beating.

For MER Telemangement Solutions, the first round of the beating is already being doled out, but there may be more beatings to come.

First, it is not yet clear if the termination of the three-year contract constitutes a clean break with each party owing the other party nothing, and, second, it is not clear whether MER Telemanagement Solutions has to make adjustments to its results to account for the terminated contract.

The first question is at its roots probably a question of contract law and who did what to whom and who was hurt by whom… Hopefully, it will be an amicable dissolution. If it is not, the two companies can end up in some nasty litigation.

The second question is on of how the deal was treated in the results for third quarter, I think, since (and I am going from memory here) the deal was struck in September of 2013 and announced in October… Hopefully, the deal was treated in a straightforward manner and the accounting impact will be minimal.

These two questions unfortunately goes to the heart of two other matters. The first matter is how much unrecoverable expenses MER Telemanagement Solutions took on to win and service the deal. The second matter is whether or not the securities class action lawyers will begin circling around the company once the fourth quarter results are announced.

One thing is for sure. The company has to be more careful about who it signs up for its managed service offering — particularly given the fragile state it will be in after having lost the Simple Mobile contract, potentially affecting perhaps 25% of its revenues and more or less all of its gross margin and net income.

And now for something completely different…

The above is pretty heavy stuff, so, while we are on the subject of chickens, I invite you to visit an earlier posting in which I discussed chicken crossing the road à la Hemmingway, Niccolò Machiavelli, and Jacques Derrida (here.)

Participate, please….

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Grundsaudaag — It is happening again

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.

…. And, if you find yourself enjoying this posting, consider supporting the blog through a donation. For your convenience, PayPal links are provided to the right and at the end of the posting.

6689617351_f9e5f4f9c2_o

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.

Participate, please….

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What is wrong with ClickSoftware?

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.

In this posting I ask the, perhaps, seminal question of what is wrong with ClickSoftware, referring to ClickSoftware Limited, a software organization headquartered in Israel, whose equity, CKSW, is traded on the Nasdaq exchange.

The question is valid because the equity of ClickSoftware, a company with revenues of $100 million per annum; annual revenue growth of 15%, or so; consistent profitability; regular dividend payments; a very strong product catalog; and a stellar balance sheet, is experiencing exceptional, sustained volatility, with CKSW’s per share price’s 52 weeks high and low swinging between $6.81 and $13.07.

As I will explain in the following, the answer to the question of what is wrong with ClickSoftware is everything… and nothing. This answer constitutes, of course, a dichotomy, and, therefore, the question is interesting. Moreover, as we will also discuss in the following, this dichotomy explains why traders and investors engaged with CKSW are increasingly becoming entrenched in their view of the equity, exhibiting, in a sense, textbook examples of cognitive dissonance.

Dichotomy?

The answer to the question, nothing… and everything, is similar to the cryptic answer that the Baron Balian of Ibelin got from Ṣalāḥ al-Dīn Yūsuf ibn Ayyūb in William Monahan’s fictionalized account of the surrender of Jerusalem on October 2nd, 1187, when he attempted to value the invaluable:

Balian: What is Jerusalem worth?

Ṣalāḥ al-Dīn: Nothing. [walks away]

Ṣalāḥ al-Dīn: [stops, turns around, spreads out his arms] Everything!

BalianofIbelin1490Ṣalāḥ al-Dīn’s fictive answer is, of course, cryptic primarily because it is a deliberate dichotomy, thrusting two world views against each other.

In the one view, that of Balian, a pragmatist and rationalist, Jerusalem’s value lies in its location, its land, and its treasures. In the other view, that of Ṣalāḥ al-Dīn, a spiritualist and nationalist, Jerusalem’s value stems from the belief that it has been exalted above all other places by God and from the fact that it can act as a lightening rod for a nationalistic movement, enabling him to achieve hegemony over a diversified Islamic empire.

By casting his answer in Baladin’s context first and applying his personal value system to this context, by which Jerusalem, of course, is worth precisely nothing, and, then, immediately afterwards, casting the answer in his own context and value system, by which Jerusalem is worth everything, Ṣalāḥ al-Dīn bridges the cultural cliff between himself and Baladin, a necessary step in the process to end the cycle of violence.

ClickSoftware – A primer à la Rochelle Jenks

Rochelle JenksMs. Rochelle Jenks, a member of an investment club, has published a comprehensive article on ClickSoftware on Seeking Alpha, and, so, in the interest of time, I will allow myself to extrapolate and extract from her article in the following.

Ms. Jenks describes ClickSoftware as a provider of mobile workforce management software and solutions to service-oriented businesses and notes that workforce management applications offer automated solutions to challenges such as shift management, schedule optimization, route recommendations, workload forecasting and performance measurement.

She notes that, in its fiscal year 2011, ClickSoftware recorded $87 million in revenues with earnings of $0.53 per share, and she notes that, in its fiscal year 2012, ClickSoftware recorded $100 million in revenues with earnings of $0.31 per share (a decline of 42% in earnings on a 15% increase in revenues.) Moreover, she notes that ClickSoftware is projecting 20% growth in revenues for 2013, but, at the same time, is projecting earnings per share in the range of $0.24 to $0.30 (at the high end, a further decline of 3% in earnings on a 20% increase in revenues – and, at the low end, a further 23% decline in earnings on the same revenue increase) and notes that “… [i]t’s hardly an optimal signal when revenue grows and earnings decline.”

In her article, Ms. Jenks proceeds to provide an explanation of why the earnings decline is happening, which hinges on a bet that the company is undertaking based on a perceived paradigm shift in service organization. This bet has required significant associated investments that, at the end of the day, has caused ClickSoftware to end up in a situation where, even though its year-over-year revenues have grown at an impressive pace, its operating income margins have decreased significantly. Specifically, ClickSoftware’s bottom line has taken and continue to take hits because of heavy investments in research and development and sales and marketing related to this bet. Between 2011 and 2012, for instance, the research and development spend increased 46%, sales and marketing expenses increased 36%, and the number of employees increased 25%.

Ms. Jenks proceeds to lay out a succinct view of important developments for ClickSoftware and its equity in the company’s fiscal 2012 year, a period where the company’s equity, now trading at a price of $8.20 per share, declined from a high of $13.07 to a low of $6.81. I will let Ms. Jenks speak for herself:

February – ClickSoftware reported year-end 2011 earnings and provided 2012 revenue guidance at $100 – $105 million.

April – ClickSoftware shares fell 16% when it announced first quarter 2012 revenues would come in below expectations. At the same time, it reiterated 2012 revenue guidance at $100 – $105 million.

May – The actual earnings report was published and share price fell another 8% even though revenue came in slightly ahead of the projection in April and full year guidance of $100 – $105 million was reiterated a second time. The actual miss was with earnings per share (EPS) which came in at $0.04 instead of the estimated $0.05. The next quarter’s estimates were estimated at $24.5 million for revenue and $0.11 for EPS.

July – When the second quarter was reported, revenue for the first six months was $44.3 million which was equal to 44% of the low-end of the full-year projection. Not only was that number in line with ClickSoftware’s historical trends but it was in line with industry trends of IT software investments. Even though ClickSoftware was fully confident in delivering another $44 million by year-end, it did conservatively lower full-year revenue guidance to $98 – $103 million. Again, the concerning miss was with earnings which came in at $0.03 instead of the projected $0.11. The share price fell another 14%. Analysts now projected full-year revenue at $101.8 million and EPS at $0.52 and third quarter revenues at $25.4 million for revenue and EPS at $0.07.

October – Third quarter reporting was finally somewhat of a bright spot for ClickSoftware. Revenue came in at $27.3 million and EPS came in at $0.11 beating the estimates of $25.4 million and $0.07. Still, earnings trailed the previous year’s same quarter by 36%. Estimates for the final 2012 quarter were now at $29 million for revenue and $0.12 for EPS. Full year revenue estimates from analysts fell to $98.8 million and EPS estimates were cut almost in half to $0.27. Click Software reiterated revenue estimates at $98 – $103 million.

February, 2013 – The conclusion of a challenging 2012 was summarized. Year-end revenue finished at $100 million and EPS finished at $0.31. Meeting the $100 million revenue milestone was the intentional target of ClickSoftware’s multi-year plan just as much as the decrease in earnings per share was. ClickSoftware purposely augmented and matured its products to meet industry needs, enhanced its marketing engine to generate leads and enlarged its sales force to drive revenues. The expenses of such are projected to continue through the first half of 2013. But, the benefits of higher profit margins are expected to begin to accelerate in late 2013 and continue improving in 2014.

In a rather unusual twist for Seeking Alpha articles, the point of Ms. Jenks’ article is not clear, but a conclusion appears to be that the time to invest in ClickSoftware, zero hour, if you will, may be the time when the company’s revenues demonstrate the double-digit pace, margins begin expanding, and earnings per share commence a sturdy upward trend. As Ms. Jenks points out, this point in time may be a while coming since:

[b]oth the company’s and industry’s history show cyclic buying from customers of 45% of annual revenues in the first two quarters and 55% in the last two … [and] … expenses for the transformation will continue through the first half of 2013 .. [and] …ClickSoftware’s tax status … will be a costly impact in 2013 and beyond … [and] … [c]arry-forward losses from the past are depleted … [and] … government exemptions are … fully consumed.

My involvement with ClickSoftware

CKSWI have previously invested in ClickSoftware’s CKSW equity, benefiting from a sustained growth in ther per share price from $6, or so, in 2010 to $12.50 in 2012, when, a couple of days before the company’s release in March, 2012, of the full year results for its fiscal year 2011, I liquidated my position.

My exit, which proved to be exceptionally timely with the company’s per share price dropping $2, or 20%, in the days immediately after the earnings release and an additional 30% in the months thereafter, was dictated by two factors. First and foremost, by fundamentals analysis that showed that at $13, ClickSoftware, which I was estimating to have lower than expected earnings, was over-priced, and, second, by my expectation that the market would react strongly to the miss on earnings.

If you had performed a fundamental analysis of ClickSoftware in 2002, or so, as did one of my fellow contrarian, common-sense investment acquaintances — a self-confessed investment dumpster diver, you would have been sitting pretty, having experienced a near 20 fold return on investment over the past decade, handily outperforming Warren Buffett and Charlie Munger.

Unfortunately, I missed that boat, primarily because I was heavily committed elsewhere. In fact, my entry did not occur until 2010 and was mostly prompted by the company’s filing of a shelf-registration in April of 2010 and the usual adverse, knee-jerk reaction by the market, which dropped the per share price 25% on what is essential a neutral event.

Shelf-registrations
Shelf-registrations are early-warning registration statements filed with a regulatory body. They are generally not well received in the market — mostly because their fundamental nature, an indication that the company may at some point in the future exchange some of its own paper equity for a share in another equity, is not understood for what it is, namely a non-dilutive mechanism for growing a company in a non-organic way.

The rationale for shelf-registrations is quite simple. They allow companies to move faster in raising capital once such companies find acquisition targets, since the preliminary filings have already been undertaken, and, also, reduce the scope of the category of objections by the seller that relates to the liquidity of the buyer in a merger and acquisitions scenario.

The market’s lack of understanding of shelf-registrations is partly a question of education and experience, but, also, a consequence of the fact that companies tend to be more tight-lipped about shelf-filings than they are about most other things. This tight-lipped behavior is in most cases related to the fact that when a company files a shelf-registration it is already in advanced talks with a seller and, therefore, there is a concern that any public information regarding the shelf-registration will adversely impact the talks.

The general idea, of course, is that the filing company intends to use its equity — rather than it cash — to acquire another company. Presumably, the value of the company being acquired will be equal to or exceed value of the equity being expended, and, thus, the event is non-dilutive to the common shareholder.

Thus, from an educated fundamentals investor’s standpoint, shelf-registrations are good signs, since a shelf-registration indicates that the company is seeking acceleration of its growth and, importantly, that the company considers its shares to be undervalued by the market. Most importantly, however, because of the market’s ignorance and general paranoia, the filing of shelf-registration introduces a near-immediate drop in the per share price of the filing company, providing the fundamentals investor with a discount for entry. All good stuff.

As it happens, ClickSoftware’s shelf-registration was not executed upon, and the company did not undertake an acquisition. Moreover, the shelf-registration will, I believe, expire in April of this year. So, in effect, the only thing that the market achieved with its knee-jerk reaction was to allow me entry to CKSW at a 25% discount, substantially adding to my return on investment. Good for me, bad for lots of people caught up in the turbulence of market stupidity.

But I digress… Back to the question at hand and the dichotomy of the answer.

What is wrong with ClickSoftware?

5372590938_e898f8d9be_oSo, back to our original question and the answer, that nothing and everything is wrong with ClickSoftware at the same time.

A clear dichotomy, which, as it was the case with the Jerusalem answer, can only be understood by viewing the question through the prisms of those mostly concerned with the performance of ClickSoftware and CKSW: Traders and investors.

A trader’s view

From a trader’s perspective, i.e. the perspective of an individual or institution that has a short-term view of his, her, or its position in CKSW, almost everything is wrong with the company and its equity at this stage.

Principally, the company appears to have a year-long, or even multi-year outlook, colliding headways with the outlook of traders, which is, at best, monthly or quarterly; a non-linear revenue achievement curve; a genuine and blatant disinterest in the interests of traders; a somewhat experimental and/or tinkering approach to the markets for its product; and a built-in belief that the company’s principals know better than the market. and, in a sense, that the market does not matter.

The company’s year-long outlook and revenue-up, earnings-down trend and their impact on traders are particularly interesting to watch and, lately, has become almost amusing for me. The company insists of making yearly forecasts, which are just that — yearly forecast, and traders insist on interpreting these in a quarterly manner, in spite of strong causal evidence that they should not, viewing each of the first three quarters of the fiscal year as failing to achieve the allotted 25% of the annual revenue guidance, leading to an assured quarterly, post-earnings release depression in per share price.

An investor’s view

From an investor’s perspective, i.e. the perspective of an individual or institution that has a long-term outlook on his, her, or its position in CKSW, almost nothing is wrong with the company and its equity. The company’s operation management success is nearly unparalleled, and historically the company has managed to strike a good balance between investment in future opportunities and consistent delivery of strong results.

Moreover, the company has demonstrated an ability to achieve and manage rapid growth, to undertake significant product development while maintaining positive results, building and maintaining strong and highly liquid balance sheet, and, importantly, the company has controlled its acquisition strategy carefully, limiting the significant exposure inherent in mergers and acquisitions. Indeed, given ClickSoftware’s consistent year-over-year revenue growth, equally consistently positive earnings, and the decade long price performance of CKSW, the company has demonstrated to investors that notwithstanding short-term equity pricing fluctuations, primarily, of course, caused by traders, an investor can have strong confidence that his, her, or its investment will result in an excellent return.

The dichotomy lives

5817572653_f9dcd7d745_oAnd, so, the dichotomy can exist in the world of ClickSoftware. For, for the trader, the opportunity to make a return with ClickSoftware and CKSW lies solely in the elusive timing of the market, and outside of getting this timing right every single time, trading in CKSW is an unpredictable science, and, therefore, since the company’s management appears to be doing whatever it want, without regards to traders desire for the next quarter to be the surprise quarter, where the company’s earnings growth resumes, everything is wrong with ClickSoftware. For the investor, however, there can be a high level of certainty that, when viewed over a multi-year period, the increase per share price of CKSW will be significant, easily outperforming the major indices, and, so, nothing is wrong with ClickSoftware.

The dynamics between the two parties are interesting. On the one hand, traders with their short term view and this view’s collision with ClickSoftware’s management year-long horizon consistently create a discount that investors can capitalize on. On the other hand it is investors that maintains a bottom on the equity, which ensures that a trader does not lose everything when his, her, or its trades in CKSW eventually goes wrong, as they must assuming that the tenet that consistently timing the market it impossible.

The investor’s position, by the way, is not clear-cut. Without a doubt, the company has engaged in a multi-year bet, investing heavily in new products and increased market and sales reach, trading of short- and medium-term earnings growth for sustained revenue growth and — eventual — long-term revenue growth. Should this bet, which is not, by any stretch, proven, fail to pay off in a reasonable time-frame, the company would in all probability scale back its investment and reduce its workforce, and the company would almost certainly suffer a significant loss in market capitalization, possibly setting investors many years back.

And a bet it is. Although the emotions among CKSW’s traders and investors alike are running high after the earnings release for fiscal year 2012, somewhat clouding the facts and impeding rational discourse, the facts are straight-forward: The company is making a substantial investment in the hope that it will provide a large return at a later date, the investment constitutes a — largely unproven — bet on an expected paradigm shift in enterprise mobility technology, and the bet comes at the expense of short- and medium-term earnings.

Moreover, the investor must embrace the volatility of CKSW, and must be armed with a near-infinite time-horizon on an investment in ClickSoftware, lest he, she, or it will simply revert to being a trader. If, for instance, you had invested in CKSW in April of 2011, then your CKSW position would now, in February of 2013, have increased precisely zero per cent (that’s 0%, people,) reflecting a per share price fluctuation from $8 over $13 via $7 to $9 back to $8. An amazing, but, ultimately, at least in the short- and medium-term, unprofitable journey — during a period where the major indices grew 15%.

What to do

7985815593_b9ee0e1252_oSo after all this, clearly the question is what to do.

Depending on how the company’s bet turns out, ClickSoftware may or may not show to be a “bad” company, but its common equity, CKSW, is certainly a stock that is exhibiting characteristics that should make anyone think hard before investing or trading.

From P/E to volatility

Let’s take a look at the P/E situation for ClickSoftware.

At a current P/E of more than 35 for ClickSoftware, CKSW ain’t cheap, and with a significant baked-in annual dilution it ain’t getting cheaper, even if the per share price does not move up, unless, of course, net income goes up radically over the next quarters, something that the company has been explicit in telling the market will not happen.

Moreover, when all is said and done, the harsh reality is that year-over-year earnings declined from $0.38 per share in fiscal year 2011 to $0.31 in fiscal year 2012, causing the per share price of CKSW to drop, and driving up P/E.

A funny thing about the P/E for ClickSoftware is that the only way to rapidly make a return now is for the P/E to grow even more into the stratosphere or by the company being acquired. So, if one is looking for a return in the space of, say 9 months or less, the question should be as simple as whether or not one believes that the revenue growth will significantly outstrip the expense growth or the company will be acquired within the next quarters.

If, over the next quarters, the per share price grew to, say, $10, while the earnings per share declined, then the P/E would grow to the other side of 40, probably making the P/E a somewhat meaningless measure, because a P/E in excess of 40 for an equity representing a company that is declining in net income is, in itself, at best, plain silly and, at worst, potentially dangerous.

Growth companies are certainly different than, say, income companies, but they are subject to laws of physics, if you will (or, perhaps more appropriately, subject to the laws of economics,) and the law that governs here is the law of volatility. Simply put, in my view, the higher an equity price climbs without earnings for the underlying company growing correspondingly, the more potentially volatile the equity becomes, and, unfortunately, the issue with volatility — as we saw with the drop from $13.07 to a low of $6.81 in per share price — is that it has potential to cause swings that moves faster than investors — or traders — can.

Hijacking — Financial style

3121126114_72c2f048fb_oPerhaps surprisingly — and having worked and invested in publicly traded companies I can attest to this being a distinct possibility — such volatility can manifest itself in a much more direct and harmful way than that of rapid, erratic movement of per share prices, taking the form of financial hijacking.

Hijacking can happen when the company’s management reaches the point of feeling that the market’s valuation of the company, as measured by its capitalization, is out of line with the intrinsic or true value, creating a company culture dominated with discontent with its investors, eventually leading to a hijacking of the company by the management, taking the form of either a privatization transaction, LBO, or forced sales — all, of course at a price that represents a significant discount to the intrinsic or true value of the company, but a smallish premium to the, then, current price.

If, for instance, volatility drives the per share price CKSW to drop to $5 in 2013, sentiment may build among the company’s management that a sale — in some manner — for, say, $6 per share should be undertaken, causing long-term investors to be under water, and, effectively, having no way to recoup their investments.

The probability of such hijacking scenario playing out stands in proportion to the ownership stake of the management of the company and the entry point for this ownership stake. If, for instance, in the above scenario, the company’s management team has a significant number of options or RSUs that have a strike price of $2.50, then the probability of a hijacking scenario is higher than it would be if the options or RSUs had a strike price of $10.

Financial hijackings are not unusual, and, in fact, are on the rise. When you work within a publicly traded company, you can actually see these hijacking coming, with an early warning sign being that the sentiment expressed by the company’s management about investors in in-house conversations results in these investors being referred to as — and pardon my language here, I am simply quoting — shit-heads.

Arguably, Mr. Michael Dell’s recent offer to leverage out Dell, for instance, could be viewed as an example of such behavior, and since the burden of proof for malfeasance is very high, most such hijackings, conducted in full daylight, will probably succeed. I plan to explore Mr. Dell’s apparent blatant attempt to hijack Dell (using, it would appear primarily Dell’s own money to finance the caper) in a future posting. Stay tuned!

In case you were wondering, the company’s Chief Executive Officer and other parts of the company’s management team control approximately 20% of the outstanding shares, a significant number of options are outstanding at an exercise price vastly below the current per share price of $8, or so, and the company continues to issue stock-based compensation at a high pace in spite of the fact that the company’s net performance, measured in earnings per share, has deteriorated over the last years.

There is, of course, other form of financial hijacking, including consistent issuance of diluting incentive equity to senior employees who does not need it. For ClickSoftware, for instance, Mr. BenBassat — in one form or another — controls close to four million shares, amounting to 12%, or so, of the total number of outstanding shares, and, yet, the company’s Board of Directors, lead by Dr. BenBassat, insists on issuing more than 100,000 options on an annual basis to … you guessed it… Dr. BenBassat.

Should the company be sold at some point in the future at a per share price of $15, Dr. BenBassat’s shares (or, rather, shares controlled by Dr. BenBassat) will be worth a staggering $60 million. On this scale of compensation, I, for one, do not see how the addition of 100,000 options annually really increases Mr. BenBassat’s incentive to achieve such outcome.

So, an important point in this nothing versus everything discussion, is that the imbalance between earnings growth and price is something to take into consideration and that both investors and traders needs to understand that this sort of imbalance causes the overall system to become volatile and potentially unstable.

And so?

All this being said, I really can’t suggest any sensible path for traders when it comes to ClickSoftware and CKSW.

Frankly, with the last years’ developments, I would have thought that traders would have sought other pastures, simply viewing CKSW as too volatile and too unpredictable, particularly since it has a management team that may or may not meet traders’ and the market’s expectations — and probably won’t lose any sleep over these expectations, but, contrary to my expectations, the traders appear to still be around shorting, longing, and optioning CKSW as much as ever. Go figure.

If forced to trade, I would probably lean on the side of the short trade for the next quarters, engaging only when the quarterly results are almost in, gambling (1) that the company’s revenues across the quarter would be lumpy relative to the annual guidance. However, this strategy is definitely not strong since it relies on the company not achieving a prorated 25%, non-lumpy revenue growth in the first quarters, and, critically, relies on other speculators to build up the per share price by going long before earnings — something that, of course, there can be no guarantee will happen. The alternative, however, to go long, is not great, since the company has a track-record of being punished for lumpy earning around the first quarters of the fiscal year.

From an investor standpoint, this is an interesting time, because, as Ms. Jenks indicated, it does not appear to be zero hour yet, with the company clearly telling the market that its pace of investment will continue in fiscal year 2013 and providing guidance that show a further deterioration in earnings for that fiscal year. So, effectively, the company is saying to any investors that, short of revenue growth and pipeline increase, there should be no expectation of improvements in the company’s fundamentals in fiscal year 2013 — not exactly an encouragement to invest now.

Moreover, if history is bound to repeat itself, the company current guidance for fiscal year 2013, which points to revenues of $120 million, or so, will be interpreted by the market to mean that the company will record revenues of $30 million per quarter; the company’s results will be somewhat less than that for the first quarters; and the market will punish the company for missing these unilaterally imposed quarterly objectives, driving the per-share price further down.

So, if Ms. Jenks’ point is that a wait-and-see attitude is appropriate at this time, then she is probably right if nothing monumental is in the cards.

Unfortunately, however, there is some probability that a monumental event will happen. It is possible that ClickSoftware’s bet will begin to pay off in fiscal year 2013, and there is even a possibility — however slim — that ClickSoftware will be acquired by SAP or someone similar during the fiscal year — two events which I predict will happen without much prior notice by the company and, given the level of attention that the equity is getting from traders, will cause a rapid and violent increase in the per share price of CKSW, possibly shutting a wait-and-see investor out.

There are a number of good reasons why ClickSoftware and/or CKSW may take off in fiscal year 2013. First and foremost, the enterprise mobility market appears to be accelerating and, critically, the acceleration appear to be sustainable, which should lead to increased business, increased margins, and increased mergers and acquisitions activity in the space. Second, for an enterprise software company, ClickSoftware has now reached a quite advanced age of 15 years, a point where, normally, something have to give. Third, the company’s Chief Executive Officer, and principal principal, if you will, Dr. Moshe BenBassat, is just around 65 years old, an age where retirement is normally considered. And, finally, fourth, there is the issue of hijacking of the company, as discussed in the above.

Perhaps a recent poster on the Yahoo Finance Message Board said it best when he wrote that:

[t]here are a lot of conservative investors like Rochelle who are not comfortable investing until they see the financials move first. Wall Street dumpster divers like myself prefer to buy at a much deeper discount… which is before a full turnaround shows up in the financials.

Put simply, perhaps for ClickSoftware and CKSW we are closing in on the time where the investors have to acquire some of the speculative nature of the traders if they wish to secure a position at the table. The irony of this should not escape us.

Cognitive dissonance

On the tail-end of ClickSoftware’s radical per share price swings over the last year and the non-blockbuster earnings for fiscal year 2012, emotions are running high, involving near-shouting matches around the nothing/everything dichotomy. Rather unusually, it is the investors that are most vocal, resorting increasingly to ad hominem attacks against anyone who question the value of ClickSoftware.

However irrational this behavior is, it is understandable. The latest evolutions in earnings and per share price has lend credence to the contention that ClickSoftware is worth nothing, which conflicts head-on with the investors’ viewpoint that ClickSoftware is worth everything, leading to cognitive dissonance, a feeling of discomfort when simultaneously holding two or more conflicting beliefs.

In line with cognitive dissonance theory the investors’ response is to seek the reduction of the dissonance by reducing the importance the dissonant elements, leading to the increasingly aggressive behavior against naysayers.

Arguably sound investment practices start with asset protection. From an asset protection standpoint, where the paramount objective should be to preserve capital by pinging actively for any signs that one’s capital base is endangered, cognitive dissonance is exceptionally dangerous, since it will cause one to ignore facts that are adverse to one’s belief system, and, often, engage in directly self-destructive behavior.

Just saying….

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