SuperCom: Funding Likely Presages Major H2 Contract Awards
Must Read | Jul. 21, 2015 7:46 AM ET | 2 comments | About: SuperCom, Ltd. (SPCB), Includes: GTOMY
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Disclosure: I am/we are long SPCB. (More...)
Summary
We believe SuperCom's recent follow-on was an effort to strengthen the company's balance sheet to provide comfort to national governments ahead of large (i.e. $50M+) contract awards.
Despite modest dilution, the shares trade at less than 10x CY15 EPS (ex-cash). Notably, insiders still have never sold a share, despite a 30x return on their investment.
With a 70% GM/40% OM model, there is tremendous earnings leverage. A single large new award would dramatically accelerate the company's growth trajectory.
We believe SuperCom represents a compelling risk/reward opportunity. There is limited downside given current program visibility, while a single substantial win could drive the shares significantly higher.
"The time to raise capital is when you don't need it."
- Investment Banking 101
On June 18th, SuperCom (NASDAQ:SPCB) completed a follow-on at $12 per share, raising $27 million, including the underwriter's over-allotment. For those unfamiliar with the SuperCom story, this transaction would seem something of a head-scratcher, given the company's solid cash position ($4.2 million at the end of 1Q, and $4 million in cash collection in April), strong anticipated cash generation, and low capital requirements. While we are not advocates of equity raises and dilution, we believe this capital raise was strategic and likely presages sizable contract awards in coming quarters. Specifically, we believe a stronger balance sheet will give more comfort to governments considering awarding $50 million, $100 million or potentially larger contract awards, especially when SuperCom is competing against multi-billion companies like Gemalto (OTCPK:GTOMY). We view the risk/reward as highly asymmetric, with shares at less than 10x CY2015 EPS ex-cash, with high revenue visibility, and with the potential for a single large contract award to drive shares dramatically higher. For example, a $50 million contract award would likely add approximately $0.40 to 2016 EPS (and similar in 2017). In the event of such a win, we believe 2016 EPS would easily be $1.50, which, at a 15x multiple, implies a $22 stock price - 90% above current prices. And we believe multiple such awards are possible in coming quarters.
SuperCom is a leading provider of Electronic ID solutions for governments. The company's current investor deck can be found here. The business is marked by long installation periods, high revenue visibility, and significant recurring revenue (approximately 20-30% annual revenues after completion of the original contract award). The company is also extending its offerings in the RFid segment, including areas such as ankle bracelets for prisoners, and e-money solutions. In fact, it recently announced a win in Europe for electronic monitoring of prisoners on probation.
The business model is also marked by lumpiness, with a single contract potentially significantly changing SuperCom's growth trajectory. For example, in 2014, the company received over $60 million of new project awards, with a modest amount implemented in 2014 and the vast majority of project modules to be completed in 2015 and 2016.
2014's wins helped drive 1Q 2015 organic revenue and EBITDA growth of 45.7% and 77.6% y/y, respectively. Post 1Q, the company reiterated guidance of revenue growth of at least 40% y/y, or at least $41.6 million, which implies significant sequential and y/y growth going forward, given 1Q's $7.7 million in sales.
Year-to-date, there has been little in the way of announced awards ($7 million was announced on June 10th). That doesn't mean a lot isn't in the works. In fact, management sounded extremely confident when they reported 1Q:
"So far in 2015 we have been notified by several government agencies that we have been selected as the bidder of choice for a number of these competitively bid contracts and we are in negotiations with potential customers now.
As a general practice we announce new wins once a new contract is signed and/or a significant milestone achieved grants us high confidence in future revenues. Taking a conservative approach announcing new wins is a best practice and helps us as a Company avoid risk should a contract be delayed or negotiations break down... I will say that as we move through 2015 our optimism has only increased and we remain confident in our ability to achieve our full year outlook."
- Ordan Trabelsi, President SuperCom North America 1Q transcript (bold added)
Mr. Trabelsi adds that the company is now focused on "developing countries and international tenders between $10 million and $200 million" He continues by stating that SuperCom expects 1-3 wins by the end of 2015.
We continue to be encouraged by the number, quality, stage, size and time of opportunities we have in our sales pipeline. Today we have a large amount of open proposals in various stages in many countries around the globe and we believe we are well positioned to achieve our stated goal to secure at least one to three new deployment contracts a year also in 2015.
- Ordan Trablesi, President SuperCom North America 1Q transcript (bold added)
The simplest explanation makes the most sense (Ockham's Razor)
We think the most logical reason for SuperCom's recent capital raise is also the simplest. In our view, the best explanation is that the company wanted to show financial strength to large governments - some of whom may have required significant working capital to give an award. According to our research, some countries want to see 25% of the working capital for a contract on the balance sheet before providing an contract. Based on this, SuperCom's recent capital raise would support the idea that the company may be close to receiving a contract as large as $100 million (to be fulfilled in 2+ years). The fact is that the cash on the balance sheet is something of a red herring, as projects are typically completed in discrete modules, with each module receiving payment upon completion, and carry high margins (60%+ gross margins at the outset, and 80%+ upon completion/maintenance). Thus, that much working capital is not necessary. Still, the idea of a significant cash balance would obviously provide comfort to a large government.
We are hard-pressed to find alternative reasons for the capital raise. Insiders did not sell stock. Perhaps some investors might believe that SuperCom raised cash for its balance sheet before an earnings blow-up (again, we point out no insider sales), but this is a business with extremely high revenue visibility. Our sense from management is that their stock is a precious commodity. They don't dole it out generously or without significant consideration. We believe that the company believes this is something that had to be done to position itself for game-changing contract awards. Our checks also suggest that management will try to raise debt or establish a credit facility, assuming the company wins meaningful awards, to avoid future dilution via the equity markets.
What happens next
We don't know if it's tomorrow or next week or next month, but we suspect that SuperCom will receive a $50 million, $100 million or larger contract award. And we believe the achievement of such an award will be the best evidence that more will come.
Assuming just a $50 million award at a 30% operating margin (target is 40%) implemented over 2.5 years (target is 2 years) implies almost $0.40 in incremental annual EPS for the first 2 years. Upon project completion, there would be 20-30% annual recurring revenue on the $50 million. Assuming $10 million annually (20% recurring) at a 45% operating margin would imply $0.30 in annual EPS.
Conclusion
We think game-changing program awards are a question of when, not if. We believe SuperCom will win major awards in 2015, perhaps tomorrow, or perhaps in a week or 3 months. And there could be, and likely will be, multiple awards both in 2015 and beyond. If we are correct, this is potentially a 70% GM / 40% OM company with high visibility, and EPS approaching $2 in 2016 (with a strong growth trajectory thereafter) versus the $1+ currently expected. If we're wrong, this is a stock trading at 10x earnings, ex-cash - perhaps $1-2 of downside. If our industry checks are accurate, and management's commentary is correct - they already have wins, and are now negotiating the details. We believe this could quickly become a 15-20x EPS story on an EPS number approaching $2. At just $11.72 per share, we find the risk/reward compelling.
