Description
Investment Summary
Inphonic (INPC) is a combination play on continued growth in the wireless industry, as well as the secular trend of retail moving from offline to online channels. Inphonic represents a compelling risk/reward at current levels trading around 7.7x 2006 EBITDA, and growing top line > 40% y/y and bottom line > 50%. Looking at a normalized 2006E EBITDA multiple, I put a potential range on INPCs share price of $24-$27, providing upside of 70-90% from current levels.
Business Description
INPC is the leading e-commerce provider for selling wireless services and phones via its own branded websites (Wirefly, A1 Wireless), over 6,000 private label partner websites such as Yahoo!, MSN, AOL Mobile, Buy.com, CNET, Google, OEMs such as Samsung and Motorola , and back-office technology offerings for Sprint, Alaska Telecom. The business is broken into three different segments:
1.) Wireless Activation Services (WAS) (~90% of Revs in Q2) – This is the core growth engine of the company, with inherent operating leverage in the business. INPC runs its own branded websites (Wirefly, A1, 1-800Mobiles, many others) which allow comparison shopping around Carriers (Cingular, Sprint, Verizon, T-Mobile, etc.) or OEMs (Motorola, Samsung). INPCs platform allows consumers to compare costs, features and service among the various options. It then streamlines the process of wireless activation by directly connecting with the Carriers back office systems to handle everything from activation, customer service, procurement to billing and expediting the order and adding the latest features. Inphonic’s web-based platform includes an automoated order processing and credit evaluation system that is linked into the wireless carrier’s systems. The consumer receives the cellphone seamlessly, and typically at an added discount to other channels.
Inphonic gets paid by the carrier roughly $300 / activation that occurs. Carriers like this customer acquisition tool because it is well below the $375-$400 on average that a carrier would pay to acquire a customer on its own. Inphonic at the time of purchase will buy phones (it does not carry inventory) from the OEMs at volume discounts and then resell them at a discount to the consumer, essentially having its own customer acquisition cost. Leverage at the Gross Margin level is inherent in the model because of two factors; as the company activates more cell phones, it gets paid volume bonuses and essentially more per activation. Second, as it purchases more cell phones from the OEMs, it receives larger volume discounts on its purchases, also expanding Gross Margins. There is additional operating leverage on the Operating Profit line, as the technology and infrastructure needed to run the business is essentially a fixed cost business. These tier bonuses are paid at the end of the year, which although gives the company visibility into the end of the year, does heavily weight Q4 with cash flow and earnings. The company has discussed renegotiating carrier deals to smooth out the annual earnings inherent in the tier bonus plans.
INPC has partnerships with most of the major US carriers including Verizon, Sprint-Nextel, Cingular and T-Mobile, as well as many 2nd tier carriers including Alltel, Triton. In addition, INPC has agreements with Motorola and Samsung to incorporate the INPC search engine into their websites, so if a consumer goes to the Motorola website, they can comparison shop the various phone models among carriers and search for the optimal offering for themselves. This is a valuable proposition for the OEMs, as it keeps consumers active on their websites, while also allowing them to purchase and activate a phone.
Similarly, partnerships with MSN, Google, Yahoo, Buy.com, AOL, CNET and over 6,000 others as well as an important relationship with Radioshack (themselves the 2nd largest activator of cellphones) are another customer acquisition tool for Inphonic, which has helped them to grow their business.
Inphonic is currently the 3rd largest third party activator of cell-phones, behind Walmart and Radioshack, having activated 750,000 wireless devicese in 2004, or 27% of the US online activation market. This gives them a unique competitive advantage in that, as discussed above, they get paid volume bonuses by the carriers as they continue to sell more carrier activations. The competitive advantage here is that they can continue to offer the best deals out in the market as they gain scale while not cutting into their profitability, thus putting newer entrants into this market at a distinct disadvantage because they can’t offer a competitive deal with Inphonic.
2.) MVNO/MVNE business – 8.5% of Revenues
INPC signed an agreement with Sprint in May 2005 to run its online customer acquisition program as well as running its branded website for online activations. Sprint will direct targeted marketing campaigns to a Sprint-branded website, powered by InPhonic. Additionally, Sprint will leverage InPhonic’s technology to improve the online purchasing process for the customers. Also in May, INPC signed a MVNE (Mobile Virtual Network Enabler) agreement deal with Hawaiian Telecom. INPC will handle all outsourced non-core functions including activations, network operations and billing. As additional MVNOs come to market (ESPN and Disney already announced the launch of these services), INPC will have additional potential customers which to target, and enable their networks. Brands and companies like ESPN will not have the know-how, nor the need to take these functions in-house are widely expected to outsource as much of the process, except for the branding and marketing, as possible. These two existing agreements leverage the core technology assets of INPC and provide additional margin expansion for the business, as little additional infrastructure is needed in order to run these types of businesses. INPC has alluded to the fact that it is working to sign up other Tier 2 operators and possibly another Tier 1 GSM carrier.
Separately, INPC runs its own pre-paid MVNO (Mobile Virtual Network Operator) which utilizes Cingular’s network, and is named Liberty Wireless. This was originally intended as a way to pick up un-creditworthy customers that would not be approved by the credit checks required by the major carriers. For example, a customer would go to one of Inphonic’s websites, attempt to sign up for Sprint, when they are rejected because they don’t have the credit characteristics necessary, they are automatically offered the pre-paid Liberty product, which does not require a credit check. This business has been declining, as INPC has in the past year deemphasized this product, and even mentioned spinning it off or selling it, which would increase the growth rate of the company, and focus the company on the service and retail model.
3) Data business ~1.5% of Revenues
Data services have been declining y/y and historically have sold products such as unified communications services that allow customers to organize and access email, voicemail, faxes, contacts through a website and telephone; wireless email services and mobile marketing which allows marketers to deliver wireless advertising and subscription based content services to wireless services.
The company has been preparing for the launch of additional add-on services, such as mobile games, ringtones and insurance which can bought at the time of purchase of the cell-phone. They have recently upgraded their systems which now allow for the simultaneous purchase of phone & content. This will be an important growth catalyst going forward. Research has showed that people are more inclined to buy games and content the first few months around a new cell phone purchase. Data services are becoming an important part of carriers ARPU as well. As noted in the Journal this morning, Sprint now accounts for almost $6 of their ARPU from data services.
Competition
INPC says that they believe they have around a 27% share as of 2004, Thomas Weisel thinks its closer to 30-35% of the online activation market. There are several other smaller private players in the market, as well as Best Buy and Amazon, which has a about a 10% market-share. While Amazon could be feared, they have been in this business for over 4 years, and have not made significant inroads, and do not appear to focusing on it. In the future, Amazon may actually decide to outsource their web activations to someone, making Inphonic a leading contender to get this business. The bulk of the rest of the market share, which has been decreasing, belongs to carrier activations on their own websites. Wireless providers have begun to receive more and more of their activations through 3rd party channels - that percentage has increased from 44% in 2003 to 50% in 2004, as they can acquire a customer at a lower CPGA and more efficiently. Inphonic has partaken in core acquisitions in the past, taking out a competitor – A1 Wireless in 2004. This acquisition took some time to integrate, as INPC had to run off several non profitable contracts and move the platform onto INPCs.
While other competitors could flood into the market, what acts as a competitive advantage for INPC is its underlying technology which seamlessly connects with all of the carriers back office systems. Also, as discussed above, the more INPC sells, the more the Gross Margin can expand as they generate more volume bonuses. INPCs market share has been increasing steadily, and will continue to do so as it can pass along a portion of volume discounts and bonuses to consumers, creating a competitive advantage over other online activators.
Growth Drivers
Growth in the WAS segment is coming from several different areas, both industry driven and company driven. The key macro driver of INPC is that wireless subscribers are expected to grow from 182 million in 2004 to 240 million in 2008, translating into 40-50 million activations / year (difference is carrier churn). The second important macro driver is that online activations of cell phones currently only represents 1.8% of all activations and is expected to grow to 3.0% by 2008, according to Roth Capital. Inphonic estimates it had 1.2% share of the entire US gross subscriber adds during 2004. First-time purchasers of cell-phones are unlikely solely utilize the online channel to buy their first phone, however as the industry matures in the US, more consumers will be repeat purchasers and will look online. Additionally, as movement between carriers becomes more ubiquitous because of number portability, more repeat purchasers of cell phones will be looking online for their cellphone purchase.
More controllable catalysts driving growth are the following: INPC has been discussing the launch of additional high margin services at the time of sale, such as ringtones, games, insurance and other things that will utilize the same technology infrastructure that is already in place, which will drive growth and margin expansion. Management has mentioned recently that they are likely to partner with a mobile content provider to offer these services, as opposed to making an acquisition in this space. Besides selling additional services for the mobile user, the company has leveraged its technology infrastructure for lateral moves and cross-selling opportunities. In April, 2005, INPC acquired VMC Satellite, a reseller of DISH network. The economics are similar with the cell phone model, except that during a DISH sale, INPC will not “purchase” the satellite system from an OEM, it is a pass through of revenues and thus margins are higher than the core wireless product. INPC has also recently announced a partnership with Vonage, to act as an additional channel to sell VoIP services.
As discussed above, the business scales as more subscribers are activated, increasing the growth rate and the contribution margin of an additional subscriber. Down the road, the company has expressed an interest in exploring international opportunities in the wireless activation market. Growth is also expected by continuing to increase the base of private label partners, such as Yahoo and Google. On the MVNE side, the company has been actively targeting other potential MVNO partners (Virgin, ESPN, Disney etc.), while also hoping to recreate the relationship they currently have with Sprint, with other carriers. The have alluded to the fact that they are far down the line with some tier 2 and possibly a tier 1 carrier.
The company announced in mid August that it has launched a $30 million stock buyback program. They commented at the time that "We believe a stock repurchase program is an attractive investment opportunity for the Company, based upon current market conditions and the confidence we have in our ability to scale and grow the business." At the time, the stock was about where it is now, around $14.10.
Financials and Valuation
INPC has guided to 2005 sales of $345-$355, EBITDA of $35-$37 and EPS (untaxed) of $0.75-$0.78. They have further guided to greater than 40% revenue growth in 2006, and greater than 50% EBITDA growth. They are in a seasonal business, so much of the profitability is weighted towards the back half of the year. In addition, the volume bonuses from the carriers typically come at the end of the year.
The company has no debt, and over $2 in cash / share
Capital Structure looks like this:
Stock Price: $14.12
Basic Shares: 35,308
Options via Treasury method 2,911
Total Shares 38,219
Equity Value $539,651
Debt 0
Cash & Marketable Sec. $83,210
Enterprise Value $456,531
Income Statement
2005 2006 2007
Revenues $353 $495 $615
EBITDA $36 $59 $90
EBITDA Margin 10.2% 12.0% 14.6%
EPS (untaxed) $0.77 $1.32 $1.97
EPS (fully taxed) $0.47 $0.77 $1.17
Multiples 2005 2006 2007
Revenue 1.3x 0.9x 0.7x
EBITDA 12.7x 7.7x 5.1x
P/E (Untaxed) 18.3x 11.2x 7.4x
P/E (Taxed) 29.8x 18.3x 12.1x
There are no direct comps to Inphonic, but I have looked at internet retail companies growing at comparable rates as a proxy for where Inphonic should be trading.
EBITDA Multiples 2005 2006
Monster 17x 13x
Amazon 24x 18x
Digital River 15x 13x
GSI Commerce 25x 16x
Blue Nile 25x 19x
Red Envelope 13x 16x
Average 19.8x 15.8x
Take a range of 2006 EBITDA multiples, 14x-16x, implies a valuation of INPC $23.87-$26.97, a premium of 69% - 91% over current prices. Even if you make a case that 14x multiple is too rich for this company, which I would disagree with, but none-the-less, the company is growing revenues from 2003 to 2007 at a CAGR of 45.7%, and EBITDA from 2005-2007 (2003, 2004 had negative EBITDA) at a 58% CAGR. INPC should be valued a multiple more consistent with its growth profile.
Using a DCF valuation, which I discount and am not relying on because of its wide range of long term and wide ranging assumptions get me a significantly higher range, somewhere in the $30’s.
Why the stock has been so weak?
Since going public in late 2004, INPC has been a favorite of short-sellers. The stock has a high short-interest ~15% of the float, and has traded pretty erratically around actions of the CEO, David Steinberg, who hasn’t exactly garnered the respect of the Street. He is quite a salesman for his company. During the summer, as the stock faltered in the $15-$17 price range, Steinberg had a 10b-5 program selling shares on a weekly basis. Granted, that he owns over 15% of the company, but it doesn’t give a good signal to the company that he is selling shares below the IPO price. After investors, including us, voiced concerns to management of a continued sale program, Steinberg eventually put the program on hold, and then announced the $30 mm stock buyback.
Then, just as things began settling back in, and the stock began gaining some traction, it sold off hard at the end of last week and the beginning of this week. They announced on Monday that they engaged Grant Thorton as their new accounting firm, and were replacing KPMG. Again understandably, investors sold and asked questions later. The stock tanked below $14. In conversations they reiterated that they were only doing this to save costs, that nothing fishy was taking place, and that they would save $1-$2 mm in cost / year by not using KPMG. After the stock tanked, they then released an 8-K with a letter from KPMG stating that KPMG had no disagreements with INPC, and vice versa, and that there had been no accounting issues at hand while they were auditing INPC.
While I recognize that this adds some volatility to the stock, if the company continues to execute on its plans, and continues to grow the potential market and take market share at the same time, the short interest will sort themselves out.
Catalyst
* A re-valuation of the company, as past external disruptions are put on the side, and investors focus on the continuing growth and execution of the company
* Further announced Sprint-type partnerships with Tier 1 (Cingular) or Tier 2 Carriers
* Announcement of data content partner and execution of data service roll-out
* Additional MVNE deals (such as Hawaiian Telecom deal) with newly launched MVNOs
* Additional Radioshack type partnerships, running the private label online activation platform of a retailer
* Strong net adds continuing from the big-4 domestic wireless carriers. Lehman just raised their estimates on subscriber adds for Q3 from 4.8 M to 5.1M based on strong sales momentum. Inphonic is sure to benefit from strong subscriber trends, as they have partnered with all of the top 4 wireless carriers.
* Continued execution of $30 million stock buyback program
* Continued integration and cross selling of other products, including VMC Satellite and Vonage partnership, additional deals to be announced
* Savings realized by auditor change - $1-2 mm / year not baked into my or sell-side analyst models
* Sale or spinoff of Liberty Wireless, the MVNO business