Seeking Alpha Article: Tio Networks: After A Big Move Up..
Tio Networks: After A Big Move Up, It May Still Have Room To Run
Jan. 5, 2016 6:00 AM ET
Summary
Tio Networks has seen a rapid price appreciation in the last several months.
This share price rise has been matched by a rapid increase in profitability and a strong revenue growth rate.
Tio's growth has been driven both by increased revenue and by a weakening Canadian dollar.
Its Softgate acquisition is anticipated to close early in 2016 and, combined with a highly invested management group and strong operational performance, gives Tio plenty of catalysts going forward.
In the last three months, Tio Networks Corp.'s (OTC:TNCGF) stock has risen rapidly, appreciating over 100%. Prior to this time period, Tio was dramatically undervalued, despite having a business that was beginning to scale in profitability and an outsized cash balance. However, even after this share price run-up, Tio continues to be of value, as its operational performance has matched its shareholder returns.
Tio Networks is a cloud-based multi-payment processor, supporting bill payments for the telecom, wireless, cable and utility operators in North America, among others. The company helps to service payments by the so-called "under-banked" segment of society by integrating its software with the larger operators' businesses and allowing them to process payments made through non-traditional (i.e. banks) sources.
I spent some time in my first article in July 2015 on the market opportunity and the impact of its impending Softgate acquisition so I won't reiterate much of that analysis here.
However, since then, a lot has happened for Tio:
The share price has run up by almost 60% from that point (more on its Canadian ticker that has higher liquidity than the OTC ticker).
The company issued strong Q4 2015 and Q1 2016 earnings.
It continued to work towards closing the Softgate deal, including a management-only private placement at market prices.
The formation of a telecom-focused business unit.
It launched Express inSight, a SaaS tool to leverage the information gathered on customer payments to provide value-added info on customer payment patterns, churn etc. to Tio's customers. This was combined with a strategic investment and business arrangement with Statflo Inc.
Whenever the share price of a company has a big run-up, it is natural for investors to feel they have "missed the boat". In this article, I will review if this is indeed the case.
Share Price Rise
The rise in Tio's share price has been nothing short of phenomenal, especially compared to the TSX Venture, where most of the trading in Tio occurs. The TSX Venture has predominantly resource and energy issues on it, so its sell-off is not surprising, but it has often taken down non-resource issues as well. Not so far with Tio:
TNC Chart
The increased share price and market capitalization of Tio will help significantly in gaining coverage for the company. A lot of small cap funds will not look at micro cap companies below $100m, which Tio is now over. This could potentially drive greater institutional ownership position in Tio. This will also lead to obtaining a listing either on the TSX Big Board or on the Nasdaq, which would further increase the company's exposure to a greater shareholder base.
Tio's shares have made this advance despite the fact that the Softgate transaction still has not closed (it had been expected to close in 2015, but now appears to be likely in Q1). However, both its year-end 2015 and first-quarter numbers showed some substantial growth in both revenues and profitability, notably on the margin front:
As a reminder, in Q3 2015 the company changed its billing from a front-end load consumer fee of $3.00 per transaction that was split with its customer (but showed up as total revenue to Tio) to a smaller back-end fee paid directly to Tio. The net revenue (being paid by the biller directly rather than by the customer) dropped its revenue number in the quarter it changed, but increased its margins as a result. For this reason, the last three quarters of margins are the most comparable. In the table, above, the Q1 and Q2 2015 numbers can largely be ignored.
Most noticeable is the substantial revenue jump in Tio's most recent two quarters, with almost all of the increase going to the gross margin and down to EBITDA. This is largely due to the nature of the company's business model; once it has integrated the transaction processing systems in to its billing clients, the incremental cost of adoption becomes very low for each additional user. By keeping its costs in line, Tio is hitting critical mass with respect to profitability.
With the growing number of "underbanked" end-users, Tio's payment solutions are becoming required options for payment. The further integration of Globex and Changesmart is also helping to fuel its revenue growth.
The company's software solutions are "sticky" for its customers. As the solutions become entrenched with customers and more familiar to end-users, the cost of switching providers will become much higher. Tio's customers (and their customers) will trust its payment solutions to accurately process and manage their payments. Tio is further building on these relationships by designating a customer support group to solely focus on the telecom industry (one of Tio's leading customer groups) and by adding SAAS functionality to mine the data its systems collect, giving the company the ability to add value to its customers beyond simply facilitating payments. Both these are recent initiatives, but show how Tio is building on its existing relationships to make its business even more "sticky."
Tio's continued operational improvement is real; it is just even more elevated due to the weakness from the CAD dollar. With approximately 50% of its operational expenses currently in CAD, this currency hedge will continue to benefit the company while the CAD remains weak, although this has not always been the case. I expect it to continue in the near term with the eventual integration of Softgate as well. Softgate's revenues are predominantly USD-denominated, as are its customer support and technical functions. I would assume the back office admin and R&D costs will likely be in-sourced to the Canadian operations, simply due to this currency benefit. However, should the CAD dollar reverse course, this could prove a headwind for Tio down the road.
Its revenue base is also becoming more diversified. In Q1 2015, Tio's top 2 customers made up 61.5% of its revenues; this has now dropped to 34.5%, making the company less beholden to its two major customers, while diversifying its revenue base, including the following:
Tio is clearly starting to see the benefits of reaching scale, with its EBITDA trending up significantly, while still having a very large cash balance, even after factoring in the Softgate acquisition. However, the question remains whether this improvement has already been reflected in the big share price move up.
Valuation
It is worth looking at my model prior to the last 2 quarters and then the current model. I made the following assumptions:
Softgate's projected results are constant.
For the last 3 quarters, Tio's base business has grown revenues 6% q/q, so I continued that trend.
I assumed the improved margin of 51% for Tio's base business and the same for Softgate and carried this blended margin over in the upside projections.
I modeled the company's admin costs as relatively fixed for the coming year.
First, we look at the valuation from my first article:
With the run-up in its share price, Tio's enterprise value increased as well, but so did the projected performance of its base model, as its most recent quarterly performance substantially exceeded my expectations.
Despite a doubling of the share price and a 77% increase in its enterprise value, Tio's EV/EBITDA multiple has only increased from 7.1 to 7.6. Its price-to-sales, a common metric for comparing software companies valuations, jumped dramatically from 0.7 to 1.2. If we look at some comparable companies below, only Green Dot Corp. (NYSE:GDOT) is in the same range of price-to-sales.
Green Dot is the most similar with respect to these ratios (albeit in a more retail-focused business), but it has some customer concentration risks, a slower growth rate and has been issuing a lot of shares. (I recommend this article as a good summary of the upside potential of GDOT). An investment in Tio does not have these risks. With most of the company's top line growth flowing to the bottom line, I utilized an EV/EBITDA multiple of 12x, which is roughly half its current growth rate:
Tio also has a very invested management team and Board of Directors. This is evident from the disclosure it made around the September 2015 private placement:
Combined with the 25m shares held by Softgate's owners after that deal closes, insiders will control almost 46% of the combined Tio. Investing alongside management, especially with small caps, is never a bad thing.
Tio's management has not been shy about acquiring complementary and transformational businesses, as its recent acquisitions of Globex, Changesmart and Softgate clearly illustrate. I believe they are highly likely to continue on this track moving forward, especially with a decent-sized cash balance still available to it.
However, no investment is without risk.
Customer Concentration. Although this has improved, a loss of one of its major customers would be a large negative for Tio. However, Softgate's integration will likely further reduce its dependency on key customers, making Tio more robust from a customer loss perspective. The nature of its business makes the company's products very sticky with its customers, but there will likely be some contract losses in the future as new competitors try to break in to a very lucrative market, so this risk cannot be ignored.
Currency. The sharp decrease in the CAD dollar has been a boon so far to Tio; however, should this reverse course, some of the gains we have seen to its bottom line will likely erode, though not all.
Technicals. The recent rise in Tio's share price has been somewhat dramatic, largely from its strong performance as well as a very favourable article in the Globe and Mail, one of Canada's major newspaper outlets. This has resulted in some elevated technical levels:
The RSI indicates that Tio's shares (I am using the Canadian ticker TNC.V due to its improved liquidity) have been overbought so far. The MACD momentum indicator is also elevated. Both these are indicators that the momentum is quite high, so a pullback wouldn't be a surprise from these levels even with clear support from the 50-day moving average.
What is on Tap for Tio in 2016?
Looking forward to 2016, Tio will likely be busy in the first part of the year closing and integrating the Softgate transaction. Having been business partners with Softgate for some time (as well as taking on an equity partner), I believe the company has already been transitioning this, or at a minimum, preparing for the transition. While there will likely be some restructuring charges early on, I expect to see the accretive effects of this transaction begin early, especially with the cross-selling functionality that the two legacy companies bring together, along with their historic partnership.
Conclusion
Tio Networks has long been a very inexpensive growth stock with some strong long-term prospects as the number of under-banked people needing services rises. Its last two quarters are indicative that Tio's business is starting to hit an inflection point, as it is beginning to earn outsized returns from each additional sale. The recent rise in its share price has been matched by its operational performance, meaning you are still getting an inexpensive growth company here at comparable valuations. With further operational improvement, the impending closure of its Softgate transaction, along with other potential M&A transactions, Tio has several catalysts for growth going forward. Investors at these levels have not "missed the boat".
For continued discussion, please don't hesitate to comment below; I learn from your feedback. If you like what I'm doing, you can follow me by hitting the "Follow" button at the top of this article. Plus, you can follow me in real time by selecting that option. It might give you somewhat of a head start whenever I write an article, as to what actions I am taking and the reasons behind them.
Link: http://seekingalpha.com/article/3789246-tio-networks-after-a-big-move-up-it-may-still-have-room-to-run?page=2
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