NMKT..one to consider...
Conversion of of preferred shares should be complete in about 2 1/2 weeks!
INVESTMENT THESIS AND RECOMMENDATION
Our analysis suggests that NEWMARKET TECHNOLOGY INC. is an interesting speculative play among micro-cap companies offering exposure to the investor on the widespread need for enterprise systems integration and IP packaged solutions. The investor enjoys the added benefit of being able to partake in geographic diversification with VoIP growth opportunities in emerging markets such as Latin America and China, where the technology is not well-known and the company prides itself in being able to consult with various enterprise customers to tailor solutions that will best suit them, while also introducing new technology to customers. Despite the size of the company it is already structured and positioned to provide diversity in more than one business segment to the investor, namely IP solutions and systems integration, VoIP and other telecom, healthcare and Homeland Security solutions. NMKT has begun to consolidate and optimize its general technology service business operations to include the divestment of unnecessary redundancies and streamline efficiency. NewMarket has acquired 4 general technology service business operations since 2003, which all hold tremendous promise for continued growth.
Both operating and financial risk involved in investing in a young technology company are typically high and should be considered by investors. In this case the risks are tied to the uncertainty surrounding competition and the speed and success of its international rollout. Due to the business model that uses brand name solutions that are packaged with new emerging technologies that are offered to customers, there is a risk to overcome the prevailing consumer resistance to new technologies, which if not achieved will raise marketing costs to launch new products or re-launch old products and to concentrate selling efforts. SG&A costs and infrastructure spending need to be managed well in order to achieve consistent profitability. Readers should understand that there can be no assurance that the company will be able to fast-track its intended path towards diversifying the client base, that will flow through directly to the top and or bottom line to build a consistent longer term profitable track record to enrich shareholder value.
We therefore only recommend investors that have a high tolerance for risk that are able and willing to forfeit either most or all of their capital in search for extraordinary returns, to consider investing in the shares. Also, in our view investors willing to commit capital to NMKT should do so with absolute minimum 2 year investment horizon, but preferably longer, to allow ample opportunity for growth to emerge until broader price discovery can materialize within the investment community that will allow the value behind the current acquisitions to be unlocked as new services to current and existing regions are added. Short term we expect an upward price bias in NMKT stock. There is some evidence of a meaningful short position in the security and the potential exists for a short squeeze scenario to develop should the stock price rise beyond the 45c level in quick fashion. In the medium term the major factor that may continue to result in share price underperformance is delays in moving the listing to a national exchange such as the AMEX and a restructuring of the capital structure to lower issued and outstanding shares (I/O) that has been identified as one of the major culprits of the share price appreciation not keeping pace with the major growth achieved in sales, profits and shareholder equity by NMKT management in recent years. We believe that the company will be able to make improvements on this I/O issue, that will ultimately lead to re-rating of the stock to better reflect what we believe is a more realistic reflection of the true worth of the company.
The goal of all publicly traded companies is to pay dividends and/or attempt to increase the value of their stock price. One of the core reasons which is pivotal to our bullish argument for upside in NMKT, results from our interpretation of the financial data and developments for NewMarket and added potential of its spin-off strategy for incubator companies that implies future equity dividend events. We see a value opportunity in NMKT stock for prospective and existing shareholders that can make tactical investment decisions, since management contemplates and targets spinning off the incubated companies from the main concern when the timing is right. This is the "the sum of its parts is worth more than the whole" argument. Based on recent outlook provided by management for FY 2006 for each of the respective units of the company, we expect financial performance to improve and begin to accelerate by middle of the this year (FY2006). We expect some improvement in the operating cost structure in FY2006 that will result in EPS increases of close to 100% on topline revenue growth ($50 million in FY 2005 to at least $87.5 million in FY 2006) of roughly 75%. Under the assumption that any further capital raising activity is well-managed to contain any further major I/O increases and positive cash flow from operations to be generated in FY 2006 as more progress is made to consolidate and synergize recent acquisitions, we are of the opinion that NMKT stock has compelling upside potential.
Given managements and our own independent forecasts, we are of the opinion that revenue potential of $87.5 million is achievable for FY 2006. Using our gross margin (44%) and operating cost (37.5% of revenue) assumptions we estimate a net pre-tax profit of $6.33 million for FY 2006, and forecast FY 2006 EPS of 4.2c (assuming 120 million weighted number of shares outstanding). We have not made allowance for 30% effective tax rate or tax expense of roughly $1.9 million in FY 2006.
Our view is that the shares are beginning to reflect the expected positive financial improvements we expect in FY 2006, but given the current low PE and Price to Book multiples, we argue that the market is assigning a low probability to the fact that high growth rates can be maintained off a larger revenue base and/or that the rating is negatively affected by the overhang of roughly 70 million shares that may be converted into common stock that will dilute the interest of ordinary shareholders.
We believe these concerns are exaggerated and that this negative dampening effect on the low rating of the shares will be reversed once the company is listed on the AMEX (AMEX peer companies trading at over 2 times P/S value), more institutional interest and position taking occurs in NMKT, and the fully diluted issued and outstanding reduction is implemented. The fully diluted issued and outstanding reduction will be achieved by exchanging preferred stock in NewMarket for securities in NewMarket subsidiaries. The company intends to complete and disclose the reduced fully diluted issued and outstanding in the upcoming annual report.
Using our FY 2005 and FY 2006 EPS forecasts and applying a forward 6 and 18 month PE multiples of 40x and 35x respectively, we arrive at forward share values of 80.7c and 97.7c going out 6 and 18 months. The PE ratios chosen are based on a blend of peer telecom and IT services comparatives and as a function of the expected growth rate, or PEG methodology. We have chosen a discount rate (k) of 31%, which is a function of the stocks beta measure, which is typically high for telecom issues relative to other sectors.
{k=Risk-free rate + (Market risk premium) * Beta}
We compute a present value of these two future values (forward price) by discounting and determining the average between these two present values (SEE TABLE ABOVE). This process yields a result of 89.48c which is our mathematical estimate of the value of NMKT under these assumptions. Given these calculations and our bottom up analysis which is more qualitative in nature, we set a 12 month target price for the security of $0.8950.
All factors considered, we anticipate a stake in NMKT still has compelling upside potential in the coming 12 months. Our 12 month price target also implies a forward Price to Sales ratio of close to 1.09x our FY 2006 Revenue forecast of at least $87.5 million, which is still well below that of with the average listed telecom services sector names and Internet and Software industry price to sales multiples of 2.09x.
We HIGHLIGHT to the reader that this forecast is made under the assumption that the company can attain our FY2006 revenue expectation of $87.5 million and a minimum of 4.2c positive EPS. Moreover, we believe that the present market for NMKT shares is far from efficient, does not fully reflect the leverage possible from the UniOne deal that will bolster growth in Latin America and secondly we believe that the potential healthcare acquisitions discussed earlier in this report, could dramatically change the future revenue composition of NMKT by growing the healthcare industry segment of the company to such an extent that it may dwarf the FY 2006 revenue forecast of this division of $7 million, in 2007 and beyond.
To summarize, we view that the share price and corresponding market capitalization does not adequately reflect the company's progress. The dynamics of the OTCBB is unlikely to consistently support true valuations based on financial performance. Financial performance similar to NewMarket's is supporting better share price to sales performance on national exchanges. In addition to taking measures to ensure continued fundamental financial performance, NewMarket is in process of upgrading its current equity environment by:
1) Achieving a listing on an exchange that attracts more institutional investors.
2) Pursuing institutional shareholder interest after this listing.
3) Obtaining financing for growth leveraged on financial fundamentals and moving away from equity only financing.
After reporting $2.3 million in revenue in 2003, the company expects to report over $50 million in profitable revenue for 2005. NewMarket's earnings and balance sheet metrics beat technology service sector averages for companies under $100 million in revenue listed on national exchanges (SEE ADDITIONAL INFORMATION that follows at the end of this report).
NewMarket's market capitalization value is currently less than half the average market capitalization value of these technology service companies. Once the company can achieve a listing on the AMEX exchange, which it has stated is part of its near term objectives, investor awareness and visibility of NMKT will increase which can raise the rating on the stock beyond our target price goal.
Under these assumptions we initiate coverage on NMKT with a SPECULATIVE positive rating, which is our highest category rating.
Risk to our recommendation include amongst other: failure of new marketing campaign(s) to its Chinese and Latin American customer base and landing of contracts in broadband and other solutions on municipality level, a slowdown in growth of current contract, service and product revenue streams that will lead to a contraction in forward PE multiple assumptions. New competition in regional markets, any stringent or bold regulatory changes impacting adversely on the US domestic and international VoIP, broadband, homeland security and healthcare systems and related telecom services and system integration markets, any inability to obtain necessary financing from capital markets when needed, to continue its business projects and/or major share dilution that can occur, if large quantities of shares are issued to extinguish debt or paid for services, are some additional factors that will counteract price appreciation potential or cause shares to decline in value.
Any failure to obtain adequate distribution of NMKT products/services to a large number of intended end users, the inability to achieve revenues in the future that depends in significant part upon NewMarket's ability to build upon existing relationships with, and provide support to, several large recognized branded communications suppliers can hamper share price performance. As a result, any cancellation, reduction or delay may materially adversely affect the business, financial condition and results of operations and additional risk factors that could adversely affect the attainment of our share price target include: market acceptance of NMKT products or services; consumer demand for, and acceptance of, products, services and follow-on products; the company's ability to create user-friendly applications and its unproven and evolving business model. Revenues and gross margins will depend significantly on the overall demand for IP Telephony products. Reduced capital spending budgets by NMKT customers caused by the ongoing industry downturn can lead to continued soft demand for products and services, which can resulted in decreased revenues, earnings levels or growth rates.
We would caution that given the size of the company (microcap) and risks involved, overall we advise private client positions be limited below 5% of the client's total portfolio size.
The research analyst, who upon request wrote this report, certifies that the views expressed in this research report, accurately reflects his personal view about the subject company. The analyst also certifies that he does not own or have any beneficial interest in shares of the covered company, also that no part of his compensation was, is or will be directly or indirectly related to the specific recommendation or view expressed in this report.
Based on the facts that were provided, the industry trends present and sources of information used to produce this report, it is my best opinion and reflection of what the company's rating and share appreciation potential could be once research coverage is widely adopted. Investors are urged to consider this report as only a single factor in making their investment decision. Information, opinions or recommendations contained in this report or research note are submitted solely for advisory and information purposes and we also do not accept any obligation to provide updates to this report in future.
Clients of the analyst firm collectively own less than 1% of total shares outstanding of the issuer. For securities recommended in this report the firm is not a market maker, but may from time to time provide bids and offers and may act as principal in connection with such transactions to facilitate trading liquidity or execution. The firm of the analyst does not actively seek to do investment banking business with the company covered in this research report. This independent analysis and judgment relies on material supplied by the subject company and other sources, such as SEC filings believed to be reliable. The analyst that prepared this report cannot guarantee the information contained herein for accuracy or completeness.
All information contained in this report is subject to change without notification. The information contained in this report is not intended to be, and shall not constitute, an offer to sell, nor solicitation of any offer to buy, any security. Investors are advised to consult their personal broker or investment advisor before making any decision concerning the subject company. Investors are also urged to do their own due diligence. In our opinion, only high risk oriented investors who can risk the loss of their entire investment should even consider a commitment to the covered company.
All readers are urged to peruse SEC documents relative to the subject company before making any investment decision. No reproduction of this report is permissible without the consent of the writing analyst. All rights reserved.
