Description

MCK Communications, Inc. (MCKC)

MCKC represents an outstanding investment opportunity in the despised and collapsing telecommunications sector. The company currently sells for less than 50% of its cash position, net of all liabilities! I know what you are thinking: the company must be burning cash rapidly. This is not the case. Cash burn in the past quarter was reduced to about $400,000 from $1.6 million in the previous quarter which is excellent for a company with a $44 million cash balance.

The company has been extremely well managed over the past year by its new CEO, Glenda Davis, an industry veteran. She is a tough manager who has religiously focused on profitability, optimizing sales channels and most importantly preserving cash. As she readily admits the market “throws her a different curve ball every day”. She has done an excellent job in anticipating the market trends and growing sales in an extremely challenging telecommunications environment.

Let’s review the fundamentals that make the company attractive:

Current Share Price: $ .82

Cash per share (Net of all liabilities) $1.87

Current ratio: 8.4

Long Term Debt 0


Recent Performance and Events

Revenue for the quarter ended July 31, 2002 was $4.5 million an increase of $1.1 million, or 33% compared to revenues of $3.4 million for the same period last year. Sales were flat relative to the previous quarter as good growth in the U.S. was offset by a slowdown in Canada. Net loss per share for the quarter was 2 cents per share versus a 25 cent per share loss last year. Obviously, cost reductions have also had a big impact on the company.

The company has not provided any guidance for the current quarter or the 2003 fiscal year. Based on my discussions with Ms. Davis, it is clear that we should expect continued good performance and improvement in the bottom line. The cash burn in the current quarter will increase due to one-time items including the cost of the company’s move and restructuring costs.

In September the company announced that the Board had approved a stock repurchase program. The company expects to release the details shortly.


Company Business Summary

MCK Communications is a leading provider of products that deliver distributed voice communications by enabling businesses to extend the functionality and applications of their business telephone systems from the main office to outlying offices, remote call centers, teleworkers and mobile employees over public and private networks. Business telephone systems consist of private branch exchange (“PBX”) systems and key systems (“KTS”). Whereas key systems are used in medium and small businesses or smaller locations within larger companies, PBXs are the most commonly used telephone systems in corporations. PBXs deliver such features as 3- or 4-digit internal dialing, conferencing, call transfer and call forwarding. PBXs also generally support a range of telephony applications such as voicemail, automatic call distribution, auto attendant, call accounting and interactive voice response.

The company’s EXTender and ConneX products cost-effectively deliver a unified enterprise-wide voice network by enabling the voice switch to function as a company-wide voice server that transmits call function and applications to distributed locations over the company’s existing voice and/or data networks. This enables a company to provide the same telephony functionality to all locations while reducing their total cost of ownership. Savings are achieved by leveraging current investments in voice and data equipment, flexibility of network choice for lowered communications service cost, streamlined network administration through the utilization of industry standard network management techniques and lowered training costs. These products also afford service providers the flexibility of combining the power of their network services such as data and/or mobile services with PBX/ KTS extension to expand the range of offers provided to their customers.

The company’s embedded gateway recording products are used within a variety of telephony-based applications (i.e., call center, contact center, security and client services applications) and enable our customers to convert digital PBX signals into standard analog audio output so that calls can be easily and cost-effectively recorded for future use. The company also provides a range of custom embedded gateway products for specific Original Equipment Manufacturer (“OEM”) partners.

In addition, the company’s “bridge the gap” products provide enterprises or service providers flexible choices for managing their path to the future by leveraging their current infrastructure investments while taking advantage of next generation “nextgen” telephony systems (i.e., CPE and/or hosted IP switches), applications (i.e., unified messaging) and devices (i.e., Internet Protocol (“IP”) phones, wireless devices) to provide employees enriched telephony experiences.

The company markets and distributes its products through an international network of distributors, resellers, equipment providers, system integrators, service providers and, to a lesser extent, through direct sales. Manufacturing is outsourced to two manufacturers. Customers include Avaya, Alcatel, Bell Canada, Bell South, Ericsson, Nextel, Nortel, Panasonic, Toshiba And Verizon. For the fiscal year ending in April no customer represented more than 10% of revenues.


Possible Cause for Recent share Price Weakness

Insiders hold about 27% of the company shares, which includes an 11.3% holding by Summit Partners as of the end of August. Summit Partners is made up of a group of limited partnerships that were set up by venture capitalist when the company was originally formed. Recently these partnerships have put significant pressure on the stock price as they have executed an automatic sell program that also occurred around the same time last year. Management believes that there is no fundamental reason behind this selling other than the fact that these funds need to automatically liquidate after some time period.


Summary

In summary, we have a well managed company that has succeeded in growing sales in a horrible environment that is selling for less than 50% of its net cash position (net of all liabilities). Recent venture fund selling provides some explanation for the weakness in the shares. In addition, management is singularly focused on preserving the company’s cash position. The market rarely provides opportunities to double your investment with such limited risk.


Catalyst:

This position may require some patience, but it is tough to go wrong buying dollar bills for 50 cents. The current under valuation may not last long:

1) The company’s repurchase program will support the stock.
2) The Summit Partners sell program will end.
3) An outside company/investors/management will make a bid for the company.
4) A market recovery will lead investors to rapidly recognize the out performance and under valuation of the company.

Catalyst

This position may require some patience, but it is tough to go wrong buying dollar bills for 50 cents. The current under valuation may not last long:

1) The company’s repurchase program will support the stock.
2) The Summit Partners sell program will end.
3) An outside company/investors/management will make a bid for the company.
4) A market recovery will lead investors to rapidly recognize the out performance and under valuation of the company.