Description

Summary

Billing Services Group Limited (“BSGL”) is a micro-cap with market cap of £6.7m ($8.7m, note that they are listed in GBP but report in USD), 73% free float and average daily volume of c. 200k shares (c. £4k at £2p per share) over the past 12 months, so it is really an opportunity for PAs only.

The company has been going through a turbulent period over the past 2 years, with various litigations hitting the company which ultimately resulted in a $5.2m fine by the US Federal Trade Commission and some large clients not renewing their contracts with BSGL. These factors combined with a secular decline in the company’s main line of business (which effectively generates revenue out of landline call volumes) resulted in investors’ confidence vanishing and the share price collapsing.

In my analysis below I touch on the business description and overall dynamics, however the key to the investment thesis here is based on current pricing and the market correcting the over-reaction to the negative news over the past few years.

At today’s prices you are buying a cash generative business for less than its cash value, and in my view the main catalyst will be the publication of the next set of annual reports: the numbers will show that while the main business line is declining, the decline rate is decelerating, while Wireless revenues will continue to grow. By using very conservative assumptions, your target return in the base case would be c. 2x.

Business

BSGL is a provider of clearing and financial settlement services for the telecommunication industry in the United States; it was founded in 2005 with HQ in San Antoinio, TX, and employs 67 FTEs across the United States.

BSGL operates across 3 main business lines:

• LEC Phone Billing Solutions

• BSGL is the market leader in Local Exchange Carrier (“LEC”) phone clearing, billing and settlement services. It has relationships with >1,000 telecommunication providers including all major ones in the country

• The main service provided here is called “third party billing”: BSGL aggregates transaction information from multiple customers and submits it to LECs for billing and collection to end consumers

• The Federal Trade Commission fined BSGL for $5.2m for mis-charging end customers in the bills they managed prior to 2012. The fine relates to business units that are now discontinued and fully provisioned for, with 50% of the total fine remaining to be paid in quarterly instalments over the next 12 months

• BSG Wireless: leading provider of Wifi solutions including: Hotspot finders, applications & website adaption, payment gateway services, directory data services, and roaming services

• VoiceLog: inbound/outbound order confirmation, credit card / ACF recurring charge authorization, utility services provider charges, Medicare program enrolment

Over the past decade the phone billing business has been adversely affected by the secular decline in the volume of landline phone transactions; this is clear from the topline trend since 2009, with revenues declining at an average 20% per annum. Note that the rate of decline has been decelerating, down to -14% (adjusted for one-offs) last year from -28% in 2011.

In order to diversify away from a declining business, BSGL acquired Connection Services Holdings Limited, a UK-based Wireless services provider, and implemented an operational restructuring aimed at optimizing the cost structure, which resulted in a 2% increase in operating margins and a $1.9m decrease in operating cost in FY16 alone. As a result, EBITDA margins improved from 16.8% in FY15 to 18.9% in FY16.

Thesis

The share price collapsed at the end of May-17 following the announcement that a large LEC will stop using third party billing services for its customers. As a result, the company is now trading below cash, with a negative EV of -$7.1m. I believe that the market reaction was overdone, that the business is a going concern and that the share price will correct back to positive EV levels.

BSGL doesn’t provide a breakdown of revenue by business line; however it is clear that third party billing is still the company’s main business. We can interpolate various data points in order to estimate how much comes from wireless: they paid c. $5m for Connection Services Holdings Limited (later renamed BSG Wireless), and looking at the financial statements filed by Connection Services in the UK we see that they generated c. $1.1m of “current assets” (no further breakdown) in FY15 (the latest reporting available). The disclosure here is very high level here but other balance sheet items have barely changed, so most of this could be cash generation. Both an acquisition price of 1x sales for a small telecom business and a c. 20% cash flow yield for a small asset-light company seem reasonable, meaning that wireless sales should stand at c. $5-6m. Coincidentally, if you flat-line the sales decline from 2012 to 2017 at the 2012 decline level (c. -27% p.a., when the business was still mostly phone billing solutions), you get to $25m in FY16, which is exactly $5m below the actual number. This figure is of course contingent upon a huge number of assumptions, however what is clear is that wireless is still a minor business for BSGL.

Using the conservative assumption that VoiceLog sales follow a declining trend which is in line with Phone Billing, we get to the result that c. $25m was generated from these two business lines in FY16.

In FY16 BSGL lost a major LEC, and this combined with a general decline in landline calls volumes resulted in “only” a 17% sales decline.

In the nterin FY17 results that the company reported in October, the key financial highlights were as follows:

• Sales: $11m H1 17 vs $16.2 H1 16

• EBITDA: $0.8m H1 17 vs $3m H1 16

• Generated $0.9m of cash, cash balance as of Jun-17 is $16m

As expected third party billing was a big drag on results, while growth in direct billing and BSG Wireless and TPV is picking up; management expects revenue to continue declining as the latter cannot compensate for the former yet.

The withdrawal of AT&T from third party billing announced after the Summer is responsible for 32% of the revenue decline in H1 17, and Verizon is also scheduled to stop this business in 2018.

Because of the continuing shift to higher margin direct billing and wireless, gross margins increased by 5.7c to 58.2%. On the other hand, EBITDA margins are lower mostly due to the fact that the cost base hasn’t adapted yet to the decline in volumes, with SG&A exactly flat compared to last year.

The strategic review is ongoing aimed at refining the corporate structure; this could mean anything from a cost restructuring to a disposal or shut down of the third party billing services business.

Other than the above, there is not much more detail on the breakdown between the various segments and guidance for next year.

So far, doesn’t sound too great – but microcap value investing was never going to be an easy ride. The key pillar of the investment thesis here is valuation: at current levels the company is so cheap that the trade is quite asymmetric – even a small improvement in some operating metrics could trigger a big correction.

Valuation

At current levels, Billing services is trading at an EV of negative $7.1m: $8.7m market cap, $16m of cash, $200k of gross debt.

LTM Jun-17 EBITDA is $3.8m (vs$5.7m last year); let’s assume no improvement in the cost structure (which seems unlikely, given the ongoing strategic review) in H2 17, so my estimate is that FY17 EBITDA could hit $1.5m.

I have no idea what is the correct valuation multiple for a business at this point in its operating life cycle, but EV / EBITDA of 2.5x seems low enough to me, and this gets you to $3.8m of EV. Cash burn at this run-rate EBITDA level for H2 should be c. $2.5m (again, assuming no improvement in cost structure and no one-off items like in H1 17), leaving you with a cash balance of $12.5m at year end. This implies a market cap of $16m or 2.2x money.

There are of course multiple upsides but, given a base case of c. 2x money, we can ignore these.

In terms of downsides, the most obvious potential downside to the valuation above is the going-concern issue: the company could not be able to ramp up wireless and direct billing fast enough to cover for its cash burn. The stabilised cash burn at current levels excluding exceptionals is c. $3m (with SG&A of $5.5m), plus the remaining fines to be paid to the Federal Trade Commission ($3.6m), so you have c. 4 years of leeway right there. This is enough time to turn the business around in my mind, considering that both wireless and direct billing have already been up and running for a few years (at a very small scale though).

Catalyst

Disclosures / Earnings

Re-rating as dying business fades

Potential MBO