Description

Intracom is a company whose earnings power and free cash flow generating ability are masked by a transformation in business focus.

Intracom is a Greece-listed company nearing the end of a transformation from telecom-related products to software and services. Though the company has undergone a major transformation in focus, its financial statements still largely reflect its legacy business. Specifically, depreciation is vastly overstated while interest charges are set to decline rapidly. On a run-rate basis this business trades for about 10x earnings and 6.5x adjusted EBIT and should resume growing (up to 10% per year) in the next year or so.

The company’s historic business was in selling parts (switches, etc) to telecom companies and its major customer, accounting for over 2/3rd of sales at one point was Greek mobile operator OTE. As OTE expanded in Greece and regionally, Intracom thrived. Of course with the bursting of the bubble, the company’s revenues from OTE have collapsed (all price related, as unit volumes have been relatively stable). In 2004, OTE represented over 1/3rd of Intracom’s revenues and in 2005 the company estimates that OTE will be just 1/4th of revenues. Outside of that business, the software and services business (which was obtained as a result of a 2002 merger with Intrasoft) has been growing and now represents the core business of Intracom. The company provides consultancy services to the government, is Greece’s largest defense related company, provides software solutions to the banking industry, and maintains a large presence in telecom services as well. As services continue to become a larger proportion of the group’s revenues, the company should begin to post consolidated revenue growth again. I have no insight into when the shift occurs, but the company expects to grow revenues this year by a few percent and then 10-13% beginning in 2006. The two businesses (products and software/services) are managed separately and there is little overlap between them so it is proper to think of them separately.

Based on 2004 data, telecom represented 62% of sales, less than half of which was parts, 13% came from government, 12% from defense, 10% from the construction industry, and 3% from financial companies. Margins ranged from a low of 8.5% in telecom to 23% in the financial sector. On a group basis, 40% of revenues were sourced domestically and 60% was sourced from the region in countries such as Bulgaria, Romania, and Hungary. Though scary sounding countries Eastern Europe is one of the last remaining areas of growth in the EU area. Intracom believes that its addressable market can compound at 13% per year for the next several years.

The most interesting thing about Intracom is that its income statement (and stock price for that matter) doesn’t yet capture the change that has occurred at the company. For instance depreciation is 50% overstated as the company no longer invests in the legacy assets. Depreciation of 48mn euro compares with the company’s capex forecast of 30mn in 2006. The 30mn includes some capex for the services business as well, so maintenance capex is even lower. Secondly, the company will have taken almost 40mn in operating expenses out of the system by yearend (28mn last year and 10mn this year). The full benefit of that won’t really anniversary until next year. Finally, the company recently had a settlement of a long-standing legal dispute and will receive about 80mn euro in July or August of this year. With that payment, with the value of its marketable securities and with the free cash flow generated this year, the company will have almost no net debt by yearend.

Price: 4.20
Shares: 134
Mkt Cap: 564
Net Debt: 24 (after netting out LT receivables and associates)
EV: 588
EBITDA 120
EBIT 90 (i.e. EBITDA-capex)
Net Income 60 (2005 run rate, adjusted for excess depreciation and assuming debt is paid off)

EV to EBITDA 4.9x
EV to EBIT 6.5x (i.e. EBITDA less capex)
P/E 10x (again assuming debt is paid down)
P/B .75x

Catalyst