Description

Comtech Telecommunication Systems provides communications equipment to commercial and government customers, predominantly for use in satellite ground stations and ruggedized applications for the military. The Company also provides emergency call handling software to state and local agencies, and boasts a collection of other assets relating to public safety, location technologies, and cyber security risk remediation. We think it is helpful to think of the Company as being made up of 3 business segments: commercial satellite (the "satellite business"), public safety (the "public safety" or "911 business"), and government solutions (the "government business"). Note that Comtech currently reports only 2 segments, "Commercial" and "Government," which we believe encourages an antiquated and inaccurate view of the Company, since the public safety assets have little or no shared resources with the satellite and government businesses. 

We believe the segments have the following rough profiles on an NTM forward: satellite - $215m of revenue and $26m of EBITDA; government -- $180 million of revenue and $23 million of EBITDA; and public safety $215 million of revenue and $43 million of EBITDA. 

Despite competing in attractive markets, Comtech has been a chronic underperformer when measured over almost any time horizon. Meanwhile, key peers in the satellite (Teledyne, Viasat, Gilat), government (Kratos, Mercury) and public safety / call center as a service or "CCaaS" (Everbridge, Motorola Solutions, NICE, Five9) markets have significantly appreciated. Comtech's Board and management seem to have been overcompensated, complacent and reckless. A few bullet points in support of this:

• The CEO, Fred Kornberg has been with Comtech for 50 years. He left the CEO seat for a brief period of 18 months from 2015 to 2016 but remained Chairman during that time. Fred makes $4 million / year in salary and stock and leases his warehouse to Comtech for $700k / year. For a time, Fred was under grand jury investigation for espionage and lost his security clearance (https://patch.com/new-york/halfhollowhills/report-grand-jury-investigating-melville-based-comtech). During this period, Comtech lost significant government contracts, including the BlueForce and Movement Tracking (BFT / MMT) programs that comprised 50%+ of its revenue and earnings at the time.  
• The COO and President, Michael Porcelain, has been with Comtech for 20 years. Mike was previously CFO, and is also the current IR contact for Comtech. Intriguingly given his role as IR and corporate communications head, at conferences and on quarterly conference calls, Mike has repeatedly expressed his interest in "jettisoning" Comtech's growth. Mike makes $2 million / year in salary and stock. 
• Until a recent announcement that Judy Chambers of Meketa Group would be appointed to succeed three retiring directors, the Board was composed of a 78 year-old private investor, an 84 year-old private investor, an 85 year-old CEO of Comtech (Kornberg), a 66 year-old self-employed financial advisor with 5 LinkedIn connections, an 88 year-old owner of a small broker dealer, and two SUNY professors aged 70 and 74. Average director compensation is $270k, about 20% higher than $20 billion market cap Teledyne Corp pays its Board. No surprise, the Board is staggered. 
• In 2014, Comtech ran a publicly disclosed strategic review with the stock in the high $30s but decided to remain a standalone and promptly plummeted.  
• Starting in 2015, under the brief tenure of CEO Stanton Sloane, Comtech engaged in a roll-up strategy to enter and then consolidate assets in the public safety market. We believe this strategy was sound, but Comtech executed extremely poorly, entering into the $430 million acquisition of Telecommunications Systems ("TCS") on an all-cash basis that endangered the consolidated balance sheet and forced a dilutive equity raise at $14, more than 30% below trading levels prior to the deal's announcement. Management characterized this acquisition as "cash-accretive" in press releases at the time, but it's hard to see how the process was anything but a debacle. 
• In late January of 2020, Comtech attempted to acquire satellite competitor Gilat for $530 million, of which $370 million was the cash component. The proforma leverage profile of the combined entity would have been well over 3 times even before COVID struck. As it happened, Gilat specialized in in-flight connectivity products so the deal could have even been fatal to shareholders. Comtech abandoned the merger and paid a hefty $70 million break-up fee for doing so. The day of the GILT deal the stock fell by 20% from the high $30s and continued plunging until Comtech secured the break-up.

Fortunately, while there is "room for improvement," we believe many of these items are past history and not reflective of where the business and stock are headed. From a business standpoint, several compelling growth drivers are kicking in for Comtech across its segments that should drive consistent growth in revenues and profits in the coming years.

First, in Comtech's commercial satellite segment, the ground station market is on the cusp of a surge in demand as LEO and MEO constellations stand to be built out by players such as SpaceX's Starlink. While many with deep industry knowledge have questioned the long-term economic viability of such constellations, these same skeptics have acknowledged that LEO / MEO constellations are being financed and will in all likelihood be built in the coming years, to the immense benefit of those "arms dealers" supplying the nuts and bolts of ground station connectivity such as antennas and modems. On its FQ3 earnings call in June, Comtech disclosed it had entered into a substantial frame agreement and initial purchase order to supply a large LEO constellation provider with ground station equipment. While the PO was modest ($13 million), Comtech suggests in its 10-Q filing that eventual orders could reach into the hundreds of millions over multiple years, while management has hinted to some large shareholders that the deal could in fact reach over one billion in sales. Our checks are that the win is with Amazon's Project Kuiper, which is certainly among the best account to have secured. Of course, there are unknowns as relate to the margin contribution, multi-sourcing, and other elements attendant to supplying such a large customer. Nevertheless, this win is promising and should help contribute to double digit top line growth in the satellite business. 

Comtech has also taken steps to reposition its technology portfolio to address a much broader market TAM. Historically, the Company has had a monopolistic incumbency in Single Channel Per Carrier (SCPC) modems for satellite connectivity, boasting north of 70% market share for these products, but has also neglected to invest in TDMA technology that is far more cost effective and now is used for the bulk of satellite connectivity use cases. This has historically left the Company confined to chasing very specific, niche use cases that require the high fidelity of SCPC while flailing to grow its business elsewhere at unattractive margins. More recently, however, Comtech has enhanced its satellite network management platform branded "Heights," and acquired for $30 million UHP Networks, which has a disruptive TDMA-based offering. While this strategic maneuver is undeniably overdue, it has positioned Comtech to grow the satellite business organically for the first time in decades, even absent the step function growth opportunity in LEO / MEO. 

Second, in Comtech's high quality and high margin public safety segment, strong demand drivers abound that should contribute to rapid top and bottom line growth going forward. Company-wide, Comtech's best quality and easiest to grasp growth opportunity is in the 911 business, where state and local agencies are actively seeking to modernize their public safety technology. Comtech, which is responsible for roughly 50% of emergency call handling nationwide, offers modern CCaaS solutions that are ideally suited for the next-gen or NG911 opportunity. Comtech has recently been awarded major RFPs in the space, including in Pennsylvania, Iowa, Washington, Massachusetts, South Carolina, Ohio, and Arizona, with multi-year contract values of these deals ranging from the tens to hundreds of millions. Frost and Sullivan recently recognized Comtech in its annual awards and rankings for the category (https://www.businesswire.com/news/home/20210722005931/en/Comtech-Telecommunications-Corp.-Receives-Award-from-Frost-Sullivan-as-Growth-Leader-in-Next-Generation-911-Technologies-and-Services). The total NG911 upgrade cycle has been estimated at around a $15 billion cost over 10 years, with a minority but still substantial percentage of this spend addressable by Comtech, and has been funded to date locally but now looks to be the recipient of significant federal aid dollars as a result of the Federal Infrastructure Bill. 

Comtech provides only anemic disclosures around this part of its business, nonsensically lumping all its revenues into the Commercial Segment alongside satellite products. However, we believe the 911 business to represent the healthy majority of Comtech's ~200m annual public safety and location technologies product line (management has at least said that public safety is "around half" of the Commercial Segment), and a decent amount of this revenue is recurring in nature and relatively fungible with the CCaaS revenues generated by players like NICE and Five 9s. Based on past financials disclosed by Intrado, a division of West Corp (bought by Apollo in 2017), we can also see that 911 is a high margin business -- Intrado's public safety segment boasted high 20% EBITDA margins. Accordingly, given Comtech's undermanaged nature, we expect that CMTL is posting lower but still healthy 20% EBITDA margins in its public safety business.

Outside of NG911 itself, the public safety business also has some other interesting assets. For example, there is a cyber risk training business that we believe to be growing rapidly, and where peers are being acquired at 10x+ EV/S multiples. There is no doubt that the public safety business is Comtech's crown jewel asset, and we strongly believe it to be worth more than the current enterprise value of Comtech as a whole. If satellite and goverment's $400 million in revenue and $40 million in EBITDA did not exist, at today's prices, we believe public safety would trade for <4x EV / sales and <20x EBITDA in a market where peers mostly command 5x sales or and 25x EBITDA. 

Third, in Comtech's government segment, the Company has continued to develop compelling and differentiated new products with niche usage such as its troposcatter solutions, where Comtech has been awarded or is competing on substantial RFPs from the US Army and Marine Corps and competes in a duopoly against Raytheon, who has an inferior solution. In addition, as publicly stated by management and noted in its SEC filings, Comtech stands to benefit from the refreshment of the US Movement Tracking system, which has an outstanding RFP for replacement of its 120,000 terminals. While Comtech lost share to Viasat on the BFT / MMT2 program due to price competition (and we believe Kornberg's security clearance issues did not help), management has conveyed optimism for Comtech's prospects on the MMT3 program, which will likely carry a total contract value of $1 billion or more. Combined with growth in troposcatter solutions, we think the government segment can resume growth in about a year's time, after lapping the significant comp issues currently being caused by the US Armed Forces' withdrawal from Afghanistan (which management helpfully warned shareholders about its material exposure to only months after the withdrawal was done, not while it was being telegraphed for years). Suppliers of niche technology to key government programs can certainly command high valuation multiples, as evidenced by high-teens to 20+ times EBITDA multiples currently being assigned to companies like Kratos, Mercury, Flir (bought by Teledyne) and Rada. Given its past execution issues in this segment, Comtech should probably explore selling the government division if not the entire Company.                   

In addition to the fundamental upside poised to come, we believe Comtech's stock is poised to benefit from a material improvement in investor relations efforts and from better disclosures. In recent weeks, we understand Comtech has hinted to shareholders that it may imminently retain an investor relations profesional, and that it may host an analyst day following the end of its Fiscal Year, at which point much better segment disclosure and medium term growth targets could be unveiled. Such an event would be very helpful for allowing the capital markets to fairly assess and value Comtech's disparate assets. There is a lot of low-hanging fruit here for example:

• Comtech provides a "non-GAAP" operating income number, but this number includes stock based compensation and intangible asset amortization and only backs out extraordinary items. We back out amortization (which is significant) and SBC (which is quite minor) from our EPS calc, as does the Jefferies analyst, which yields a massive $.90 boost to Comtech's annual EPS, making the stock far cheaper optically to the lay person than the current GAAP figure. 
• As discussed above, Comtech lumps in public safety with commercial satellite for no good reason, which significantly weighs on the multiple. 
• Comtech currently provides no medium-term guidance on how fast any of its end markets should be expected to grow. 
• Comtech pays a dividend but despite having an active share repurchase program, generating ample free cash flow, and trading at a wide discount to intrinsic value, has not utilized it in years. 

Finally, we believe Comtech may stand to benefit from better governance in the future, which could also yield a more substantive exploration of ways to remedy its persistent undervaluation. Our dligence suggests that interest in the asset exists from credible parties.   

Even using healthy discounts to peer valuation multiples and an additional SOTP discount of between 10 - 25%, we believe Comtech shares are worth anywhere from the low-to mid $30s in a bearish scenario, to as much as $70 in a bull case. With management having blown up and lowered the bar last quarter on Afghanistan, recent wins for LEO / MEO and in the 911 segment should setup for a relatively strong FQ4 outside of government. There are also signs of improving corporate governance at the Company with the new board appointment. All of which sets up Comtech as a table pounder.

Catalyst

Improved performance, retaining IR / Analyst Day, selling all or part of the Company, using the buyback.