WidePoint Corp (WYY)

[Methinks]

Catalysts For WidePoint In 2021: More Profitable, ETF Inclusion, A Takeover Target And More

https://seekingalpha.com/article

Summary
A look at some of the catalysts for WidePoint in 2021.
Fundamental and technical analyses remain bullish. The "cup and handle" breakout suggests another big move is in the works.
WidePoint is on track to be added to ETFs and Indexes and why the inclusion could keep shares soaring.
EPS targets raised, a look at short interest and why profitability will drive the story in 2021.
We reiterate our BUY rating on WYY and update our price targets. Bull Case: $30 (107% upside). Base Case: $20 (38% upside). Bear Case: $11 (24% downside).
Not even a global pandemic could slow WidePoint (WYY) down as 2020 turned out to be a monster year for the company.

WYY, a leading provider of technology-based management solutions, has seen revenue soar 106% during the first nine months on a year-over-year basis, with EBITDA also up 84% during this time frame. With no debt, the company continued to grow its cash position from $7.1M in Q3 2019 to $11.4M in Q3 2020. The company is expected to report fourth-quarter and full-year 2020 financial results in March in what will cap off a historic year for the company.

There was a number of catalysts in 2020 that led to the surge in share price, such as the company winning a $500 million U.S. government contract, management raising revenue and EBITDA guidance twice, managed services - the company's high-margin business - increasing 37% to $33.8 million, as well as the addition of the 2020 Census project that helped fuel top-line growth.

After shares soared nearly 150% in 2020, many investors might think that WYY's best days are over. But we don't believe that is the case and feel the party is just getting started. This article takes a look at several catalysts that could send shares higher.

We are also updating our 12-month price targets. We are raising our bull case to $30 (107% upside), upping our base case scenario to $20 (38% upside), and our bear case to $11 (24% downside). We'll go into more details about each of these scenarios later in this article.

More Profitable + Raised 2021 Estimates
Profits, profits, profits.

During the last earnings call, as well as at recent investor conferences, management has noted that one of its top priorities in 2021 is to focus more on delivering higher margins and increasing its bottom line. For us, those goals seem very attainable this year and the company is already off to a great start.

As we detailed in our previous article, "WidePoint: The $500 Million Contract, Updated Price Targets And Why We've Never Been More Bullish" the U.S. government contract win was based on "best value" as opposed to "lowest cost" as it had previously been. This meant that price wasn't as big of a factor this time around with performance and other factors taken more into consideration. With the company being the incumbent, and having proved itself over the past six years, WYY had leverage to be able to ask for better margins and did just that.

For us, the award was never a matter of "if" margins are going to be better, but rather by how much. That is why during the question and answer portion of the Needham Conference, we asked WidePoint CEO Jin Kang for more color on the margins regarding the $500 million award from the Department of Homeland Security ("DHS").

Here's what he had to say:

"The good news is that we won the contract and the great news is that all of the customers (DHS Components) are onboard already as well. We won't be losing any steps in terms of continued revenue generation. This time around, FEMA, is signing on from the start (we get the whole piece). FEMA was a small piece in the previous contract and is much bigger this time around. ... In regards to margins on the new contract, the company did restructure the pricing so that we would be more profitable. There are certain categories of work this time around that is of higher margin. We are going to continue to push those pieces of it. To sum up, we see DHS contract being more profitable than it was before."

While we don't know the margin specifics - as companies don't want to reveal what they bid due to competition - even slight margin improvement will make a big difference. Based on the $500 million award, even if margins improved by only 2% or 3%, we are still talking about tens of millions of dollars. For a company that is currently valued around $120 million, that is a very big deal.

Investors should also note that since new management took over in 2017, the company has consistently delivered revenue growth with a 33% compound annual growth rate ("CAGR"). Management has turned the company around, delivered on its promises and the outlook for 2021 is very bright.

Look no further than analyst estimates which continue to be raised. The two analysts covering the company recently changed their 2021 earnings per share ("EPS") estimates from $0.19 to $0.38 (midpoint) now. We feel those estimates are really low and believe EPS will most likely come in around $0.60 this year.

In our article back in May, we noted that shares could triple and that EPS would likely hit $0.40 in 2020. Shares have nearly tripled already and our EPS target is on track to get passed as well. Wall Street analysts had the company earning just $0.10 in EPS at the time, before upping their figures to $0.27 a couple of months ago. However, these estimates are still way too low because the company has already delivered EPS of $0.33 through the first three quarters and will likely finish the year with EPS around $0.43, which is just above our forecast that we predicted nine months ago.

Profitability will also get a boost as the 2020 Census project starts to wind down. The project provided a boost on the top line, but didn't move the needle on the bottom line with margins coming in around 2%-3%. This is why the company's margins have dropped from 17.5% during the first three quarters in 2019, to just 10.5% in 2020. WYY should still see significant revenues come in during Q1 of this year, however, revenues are expected to drop off after that. Management added that revenues will continue to trickle in over the next 12-18 months, but that it won't be significant as it was before.

With the Census project winding down, combined with higher margins on the recent DHS contract and the company moving more into the commercial space (higher margins), WYY is setting itself up nicely for a big year. And while margins for the Census project were extremely low, the company expects a big payoff from it as it shows WYY's scalability and ability to tackle large and complex projects for prospective clients. According to management, the project is also the largest and highest profile managed mobility services contract in the country and will serve as an excellent case study to land new business going forward.

Profitability will drive the story in 2021 and shareholders should be excited as it is a welcome change from years of breakeven or negative EPS. Here's what WidePoint CEO Jin Kang had to say when asked about the plan to fill the revenue hole from the 2020 Census project.

"We are not going to concentrate on back filling all the low-margin revenue (from the 2020 Census project). What we are concentrating on is profitability, net income and bottom-line improvements. In 2021, we look to be better on the bottom line. We look to beat the figures that we set in 2020 and we are going to beat that in 2021."

Lastly, during the Q2 earnings call in August, Kang noted that the company already has things in its pipeline that will help fill some of the Census revenue and that there is a great chance that managed services - the company's high-margin business - will still see an increase in revenues once again.

WYY Nears ETF & Russell 2000 Inclusion
One of the biggest catalysts of the year will be whether or not, WYY gets picked up by ETFs and indexes. With the company's rise over the past year, WYY has dramatically increased its chances of being picked up, which will only fuel another big rally in our opinion.

With some many ETFs out there, we are going to focus on one specifically: The ETFMG Prime Cyber Security ETF, otherwise known as "HACK." This exchange traded fund ("ETF") is a portfolio of companies providing cybersecurity solutions that include hardware, software and services. The reason we picked this one was because of its history with WYY, and provides a great case study as to what will likely happen again.

But first, here's a quick background.

In 2015, shares of WYY soared from $12.90 to $23.00 over a three-month span. This huge run in share price was mostly due to the company being picked up by HACK. During this time, the ETF took an 11.2% stake in the company with more than 9 million shares.

However, due to a perfect storm - as we outlined in this article - things changed quickly as the ETF ended up having to sell all of its shares which sent the stock tumbling. This was due to a global market meltdown as well as a disappointing quarterly earnings report. These factors dropped the share price which then forced HACK to sell everything because WYY fell below its requirements in that companies must maintain a market capitalization of at least $100 million.

Fast forward six years later and we are in a very similar situation. Shares are currently trading around $14 per share and the company is on the verge of being picked up by HACK again.

But here's why things are a different this time around.

First, WYY is in a stronger financial position today than it has ever been. Second, the company's outlook is very bright and more stable than it was in 2015. So just how bright and stable is the future you might ask? With no debt and a growing cash position, management has noted that it has been actively looking at making an acquisition - if it meets all of its requirements (the deal being immediately accretive and only for a profitable and growing company). Add the fact that the company recently won a five-year government contract worth $500 million with DHS - which currently accounts for just over half of its total revenues - and a lot of that risk is now removed for investors and clears the company's path forward for years to come.

We bring all this up to show investors that the company shouldn't have a repeat performance of 2015, when the fund was forced to sell all of its shares due to its $100 million market cap rule. Looking at the eligibility requirements, the $100 million market cap rule is still in place, however, based on WYY's current trajectory, it shouldn't have that problem again.

So when will WYY have a shot at rejoining the HACK ETF?

Each year, the fund has its quarterly reviews in March, June, September, and December. The composition of the index and the constituent weights are determined on the second Friday in March, June, September, and December. Component changes are then made after the market closes on the third Friday of those months, and go into effect on the next trading day. Based on this, the soonest WYY could be included is in March.

WYY currently meets all the requirements and we feel it will be included when March comes around. Here's a look at what could happen if that takes place.

If HACK decides to take another 11% stake in WYY again, and with the company having a float of just 8.5 million shares, the ETF would pick up roughly 935,000 shares in what would be a relatively short period of time. We believe the impact of this would be massive and the buying pressure would likely push this to 2015 highs ($23.00). The 11% stake wouldn't be a lot for HACK either as it would come out to less than $14 million based on WYY's current share price ($14.49). Again, this would be a drop in the bucket for the fund that has $1.7 billion in assets under management (AUM). Below is a look at the Top 10 holdings for HACK as of Friday.

Obviously, HACK is just one of more than 2,000 ETFs in the United States, including nearly 100 micro ETFs, that specifically buys stocks in companies in the $50M to $300M range. Any institution or ETF that adds to its position or starts a position, will only add to the momentum going forward in our opinion.

Russell 2000 Index
Another big catalyst for the company is the opportunity to be included in the Russell 2000 index. For anyone new to the Russell indexes (Russell 1000, Russell 2000 and Russell 3000), approximately $9 trillion is benchmarked to these U.S. Indexes.

This means that funds and ETFs that track the Russell 1000, 2000 and 3000 indexes will buy and sell stocks based on whether or not they are included. For those companies who are included, it's a big deal and provides a lot of positive momentum for shares going forward. In 2020, roughly 150 companies were added and just over 200 were taken out. Below is a look at the different Russell indexes.

So when would WYY be eligible to join the Russell indexes? Below is a detailed guide on the process, the eligibility requirements as well as a look to see how WYY stacks up against the competition.

Each May on "Rank Day" (May 8th of last year), companies are ranked from largest to smallest based on market capitalization. The largest 4,000 companies that satisfy all of the eligibility requirements become members of the Russell indexes.

In the first week of June, preliminary lists come out with updates provided over the next three weeks. The newly reconstituted indexes then take effect at the end of the month in what is usually one of the most highly-anticipated and heaviest trading days in the U.S. markets.

Eligibility requirements:

Location: Must be considered a U.S. company
Size: Must have a total market cap larger than $30M.
Price: Shares must be trading above $1.00 to be considered for inclusion
Float: Must have greater than 5% of shares available in the marketplace.
Liquidity: The Average Daily Dollar Trading Value (ADDTV) must exceed the global median (130,000 in 2020)
Note: Stocks below $1.00, ADRs, preferred stocks, closed end funds, REITs, and LLCs are excluded from the Russell indexes.

With over 2,000 companies in the Russell 2,000 index, there is quite a range in market capitalizations as you can see in the image below. Looking at the historical average, the smallest companies included usually have a market cap of around $150 million. In 2020, however, the smallest U.S. company that was included had a market cap of just $94.8 million. It was the first time since 2009 that the index had a company below $100 million.



Image Source

The big dip in 2020 was most likely due to the COVID-19 crisis and the subsequent market meltdown that happened last spring. While the stock market recovered and has since made new highs, the global pandemic recovery has been uneven with stay-at-home plays like ROKU (ROKU), Netflix (NFLX), and Zoom (ZM) soaring, while travel and other related industries being crushed. Luckily for shareholders, WYY has benefited from the pandemic and capitalized on its opportunities.

We are currently forecasting that the smallest company added to the Russell 2000 index this year will likely be in the $120 million range, similar to the type of jump that happened in 2010 after the financial crisis in 2009. We feel very confident that if WYY goes into "rank day" with a market cap above $150 million (around $17.50 per share), it will be included in the Russell 2000 index.

Another Breakout Is Coming
In our last article, we highlighted that a breakout was coming. After shares soared on the $500 million contract in November, the stock took a breather and entered a consolidation phase for nearly two months.

During this phase, the $9.20-$9.30 range became strong support with shares then forming a symmetrical triangle with lower highs and higher lows. Another great sign was that shares rose on higher volume and sold off on lower volume, signaling that buyers were accumulating shares.

As we outlined, we expected shares to breakout - which they did. Our forecasted price target on the breakout was $16.50.

On the initial breakout, shares soared more than 30% to $13.50, before pulling back ($11.50) and trading sideways for several more days. While it hasn't reached our $16.50 target yet, we expect it will be getting there relatively soon.

The breakout move also brought another bullish pattern into the mix with the cup and handle. This bullish continuation pattern marks a consolidation period followed by a breakout.

As its name implies, there are two parts to the pattern: the cup and the handle. The cup forms after an advance and looks like a bowl or rounding bottom. As the cup is completed, the handle starts to form. Most of the time the handle resembles a short downward trend. This is due to profit taking after a quick rise, and also gives buyers one last opportunity to get in before the rise.

WYY is a good example of the "cup and handle" pattern and checks all of the boxes (uptrend, "U" shaped, etc.) as you can see in the image below. Shares were in an uptrend prior to the construction of the base which is a necessary component of a cup and handle. Shares then formed a cup over the past two months and with the recent breakout, the chart has equal highs on both sides. The handle was then formed and on Friday, the breakout ensued.

We have been calling out the cup and handle pattern for some time now and on Friday, shares broke out of the handle on strong volume. Shares climbed 11.5% with volume just under 800,000. This is well above the average 10-day volume of 421,000, signaling a true breakout.

The projected advance after a breakout on a cup and handle is estimated by measuring the distance from the right peak of the cup, to the bottom of the cup. We estimate that WYY's price breakout will be around $17. Here is how we calculated it: $13.00 - $9.00 = $4.00. Then $13.00 + $4.00 = $17.00.

The current 52-week high is $15.89 and we believe a new high will be made shortly. We currently have a base case price target of $20.00 on WYY, with our bullish case being $30.00. With the Fear of Missing Out ("FOMO") craze that is in the stock market right now and combined with strong fundamentals, great technical indicators and a low float, we wouldn't be surprised to see shares hit our base case scenario before shares take a breather.

Recent Government Hacking And Riots Show The Need For WYY's Services
Over the past month, government hacking and riot incidents have taken place that we believe could give WYY more business opportunities going forward. In December, a massive and sophisticated cyberattack on the U.S. government was unearthed involving tens of thousands of customers.

According to The Cybersecurity and Infrastructure Security Agency ("CISA"), the hackers behind the attack used network management software made by SolarWinds, to breach the government networks. Tens of thousands of SolarWinds Orion customers downloaded a software update that contained a backdoor, which the hackers used to gain access to the networks.

CISA believes the hacking took place as far back as March, giving hackers nearly a year to access top-secret government networks and data. Roughly 18,000 victims were identified in early December with new victims coming forth every day.

Then in early January, The U.S. Capitol was overrun by rioters who wanted to disrupt the confirmation of Joe Biden as the next U.S. President. Members of Congress were ordered to shelter in place as rioters stormed the building with others were taken to a secure location. All of this took place as rioters freely roamed throughout the Capitol complex, including the Senate chamber. All this took place right as Congress was counting the Electoral College ballots. Luckily the ballots were gathered before rioters made it to the Senate floor.

These incidents left us wondering about WYY and future business opportunities in the commercial and government space. The company already plays a critical role with the Department of Homeland Security and its components (TSA, Secret Service, etc.); however, its product would also work well for all government officials when it comes to protecting sensitive information and mobile security.

In the rush of a lockdown, government officials could have left phones and other devices on the senate floor as they ran for cover. Rioters were already looting the place and who knows what they would have done with sensitive information. In fact, one woman is accused of planning to steal a laptop from House Speaker Nancy Pelosi's office during the riot and sell it to Russia.

We feel the latest government incidents show the need for more of the WYY's services. The company does a lot with mobile management and security with its TM2 solutions as you can see in the images above.

Notably, the company has the ability to remotely wipe devices that contain sensitive material. In the case of the rioters, if anything were to be stolen from government officials, WYY would be able to wipe the devices and keep sensitive information private.

Already working with DHS and its agencies, we believe it's possible for the company to gain even more market share with its services based on recent events, especially with the glowing reviews the company has received from DHS over the years. WYY already manages more devices for the federal government than any other organization and we feel recent events provide the company with another opportunity to promote its services. This applies to all state and government officials whether in Washington D.C. or elsewhere.

Lastly, the COVID-19 pandemic has shifted a lot of work remotely, with more companies becoming more reliant on a mobile workforce. This plays right into one of WYY's strengths with its mobile offerings.

As management continues to note, the company is "in the right place, at the right time" and will continue to benefit from the "new normal" amid a growing shift in the mobile workplace. As the images above indicate, the mobility management market continues to soar as companies look for new/better solutions for remote work.

Conclusion
After management confirmed higher margins on the $500 million DHS contract and provided more color about the deal - as well as its profitability outlook for 2021 - we are making some adjustments and raising our price targets once again. Below is a look at our bull case, base case and bear case.

Bull Case: $30 (107% upside)

We have raised our bull case scenario to $30 (from $25), mainly due to the company's brighter outlook for 2021. Recent results have also been impressive as the company reported record-breaking third-quarter earnings in November which saw revenues, EPS figures and its cash position come in higher than our own street-high estimates. We have been very bullish on WYY since May and the company continues to exceed our own expectations.

It also helps that Wall Street has come around to the company as well. Sentiment has turned positive - although it took a bit longer than we expected - as management has delivered on all of its promises so far. With WYY's market cap now at $120 million, the opportunities to be included into indexes and ETFs has risen significantly. Also, as we outlined earlier in this article, the company looks like a lock to be included in the HACK ETF which will bring a lot of buying pressure in March.

The company is also making strides with its SYNNEX (SNX) partnership to expand sales of its TM2 solutions, and we're also optimistic that WYY will be included in the Russell 2000 index as well. With a low share float (8.5 million), and with institutional ownership continuing to grow each quarter, we believe shares could very well hit our bull case target by the end of the year.

Base Case: $20 (38% upside)

We have upped our base case scenario to $20 (from $18), for many of the same reasons mentioned already above. However, the biggest difference from our bull case, is that our base case scenario doesn't assume the company will get added to the HACK ETF, or Russell indexes. While we do believe that WYY will be included in these, our $20 base case scenario is strictly on fundamentals alone.

To sum it up, management has turned the company around the last three years and WYY is now arguably in its strongest position ever. The company is also making great strides to expand into the commercial space (higher margins) and continues to pick up more contracts in Europe as well through its subsidiary Soft-ex Communications.

Lastly, most companies in the information technology sector trade anywhere from 1-to-3 times forward sales. Our $20 price target currently has WYY trading at the very low end of that range with a forward P/S of 1.1.

Below is a breakdown on how much shares would be worth if the company traded at 1X, 2X and 3X forward sales (2021). Also, these projections don't even factor in a profitable and immediate accretive acquisition which management hopes to do this year if the right opportunity comes along. As you can see, Wall Street is still severely underestimating the company at the moment.

WidePoint Share Price
1X Sales (2021) $18.24
2X Sales (2021) $36.47
3X Sales (2021) $54.70
Bear Case: $11 (24% downside)

With the company recently confirming higher margins on the $500 million DHS contract and more color about the deal - as well as its profitability outlook for 2021 - we are moving our bear case scenario to $11 (from $8). This implies 24% downside from current levels.

Honestly, the bear case doesn't have a lot going for itself, which is probably why short interest is still under 2%, despite shares more than doubling in the process over the past two months. Below is a look at how the latest short interest figures.

Date Short Interest
12/31/2020 161,500
12/15/2020 148,500
11/30/2020 61,200
As we've noted before, WYY's business model is nearly bulletproof, incredibly stable and continues to grow even despite a worldwide pandemic. Last but not least, recent events have all but eliminated any downside risk for the foreseeable future. The $500 million DHS contract accounts for more than half of the company's total revenues right now and with a new five-year contract in place, this award takes a lot of risk off the table for investors and clears the company for growth for years to come.

The only concern going forward for investors is whether or not the company can continue to grow its high-margin business (managed services) for the foreseeable future as it expands more into the commercial space. With the current trajectory, as well as the things that are in place (partnerships, etc.), we firmly believe the company will be able to do so. The only other scenario is if the company decides to do an acquisition that the market doesn't like, or a massive market selloff ensues like we saw back in March. However, because WYY doesn't trade with the overall market most of the time, a 10% correction shouldn't have as big of an impact compared to stocks that closely follow the indexes.

Lastly, despite the rise in share price, we still feel WYY is undervalued at current levels and believe the company is becoming more of a takeover target with each passing day. It's no secret that WYY competes in a very competitive market and we expect consolidation will continue to take place. And while management is actively looking to make an acquisition this year, they may very well find themselves receiving a buyout offer this year as well.

Risk Factors
With a market cap of $120 million, WYY currently falls into the micro-cap sector. Companies in this range come with a higher degree of risk compared to more well-known and established companies.

Because WYY competes in a competitive market and against both private and public companies, some competitors are able to offer more scale, which can enable them to significantly discount their services in order to maintain market share. If the company has to resort to deals with lower margins, profitability would suffer.

Lastly, WYY's revenue from government contracts is quite large. A change in government spending policies or budget priorities could cause the company to lose revenues. The loss of any contract would also have big implications for the company.

Past Articles
WidePoint: The $500 Million Contract, Updated Price Targets And Why We've Never Been More Bullish

WidePoint Q3 2020 Earnings Preview: What Investors Need To Know

WidePoint: The Party Is Just Getting Started

WidePoint: Why Shares Could Triple

WidePoint: Upcoming Catalysts And Why Shares Are A No-Brainer

WidePoint: Q2 Earnings Preview And Why The Future Has Never Been Brighter

WidePoint - Wall Street's Hidden Gem

WidePoint: New Price Target, Raised Guidance And A Possible Acquisition

Disclosure: I am/we are long WYY. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.