Description

Long MNDO: a boring cheap microcap with a double digit dividend yield and improving fundamentals.

It is getting hard to find cheap stocks these days. While MNDO is not dirt cheap, I think it does represent a reasonable value with limited downside. The company is highly cash generative and has an aligned CEO who owns 20% of the stock. MNDO has a policy of paying out all of its cash flow as dividends (last three yearly payouts were $.24/sh). I think this limits the possibility of the stock being a value trap, and along with the undemanding valuation should allow shareholders to do well going forward.

MIND CTI Ltd. (MNDO) is an Israeli based “provider of convergent end-to-end billing and customer care product based solutions for service providers as well as telecom expense management (call accounting) solutions. MIND provides a complete range of billing applications for any business model (license, managed service or complete outsourced billing service) for Wireless, Wireline, VoIP and Quad-play carriers in more than 40 countries around the world.”

Basically MNDO provides billing software to tier 2 and 3 telecom carriers primarily in the Americas and Europe. The majority of MNDO’s engineering and support employees are based in Romania where labor is cheap. Margins and return on capital are good but growth is limited as small and medium telecom carriers are generally not growing, with the pool of carriers shrinking over time due to acquisitions. Revenue is comprised of many small accounts that churn over time necessitating at least a minimum number of new customer wins just to maintain flat revenue. The company generally receives an upfront licensing/implementation fee for its services and then a monthly maintenance fee based on customer metrics like the number of subscribers.

MIND is run by its original founder Monica Iancu, who owns 20% of the stock. MNDO has a pretty stable low-Capex, high-return (20%+ ex cash balance ROA), recurring revenue business that consistently generates cash. The company has been pretty shareholder friendly with normal and special dividends totaling $2.04 per share over the last 5 years. 2013 operating performance stumbled last year with revenue down 9%, a 4% reduction in gross margin, and a 51% decrease in operating income. However, due to a large increase in deferred revenue, CFO and FCF were actually up slightly, which allowed the company to maintain its dividend.

 If the company maintains its lower 2013 level of performance, the stock is close to fairly valued, but if it is able to recover some of its previous profitability (which I think it can), I think the stock has some upside.

The company has a gross dividend yield of 12.4%. If business stays at the depressed 2013 level of earnings, the $.24 dividend would not be sustainable from cash flow, and a dividend cut could occur, which would send the stock down. If CEO Iancu wishes to keep the dividend at the current level (her dividend income is larger than her yearly compensation), the company could cover the dividend with a combination of FCF and cash on hand for another 8 years.

 A note on the dividend:

MNDO pays a dividend once a year around March based on the previous year’s results. U.S. investors receive a 25% Israeli withholding tax on dividends. This would reduce the current 12.4% gross yield to 9.3%.

 Right now the company has $19M of cash and no debt, giving it an EV of $17M.  The company has a low tax rate and good cash conversion cycle, so EBIT is a good proxy for FCF. If business stays at the depressed 2013 level of earnings, it will be trading at 8x EBIT, not expensive but not very exciting. However, the stock gets pretty cheap if you use 2012 numbers (4x EBIT) or 3 year average numbers (5x EBIT).

 I think the business will recover in 2014 based on the increased in deferred revenues that propped up 2013’s cash flow. MNDO  received two new customer wins in Q413 which should increase 2014 revenue vs. 2013 and help operating income recover some of the ground lost last year. Quotes from MNDO’s recent press releases help highlight the likely 2014 recovery:

 Monica Iancu, CEO, commented: “As expected, 2013 revenues and profitability were lower than in 2012. However, in 2013 we signed the largest deal in MIND's history and in total the new deals and follow on orders committed to by our customers exceed any yearly prior bookings. The gross margins decreased to 57% from 61% in 2012. This trend is expected to continue since our engineering efforts are dedicated more to customizations for new and existing customers and to other service related tasks. We expect the significant wins of 2013 to have a positive impact on our 2014 results. We believe that our reputation of outstanding support and commitment to meet customer needs combined with our proven fully convergent technology will enable us to achieve our targets of internal growth and improved profitability.”

 “This significant win is a multi-million dollar deal and we expect to recognize its revenue during a phased implementation within the next eight to ten quarters.”

 Continued pressure on gross margins should be at least partially offset by a company stated expectation that R&D expense will decrease (although this could be pressured by Romanian wage increases) so increased revenue from new customer wins should translate to increasing y-o-y EBIT.

 Something to note is that the company’s financials have already started improving. Revenue and profitability fell off a cliff in Q1 2013 and have been getting better ever since. If the company is able to maintain this momentum, I think the stock will be able to increase (or at least stay flat while you collect a nice dividend yield).

Because of the company’s dividend history, I am fine with giving the company full credit for its cash balance. I think a 7x EBIT multiple is fair for a high-returning (ROA) cash generative company with low growth prospects. With that valuation framework in mind, below is how I think about the potential returns for MNDO:

While large returns are unlikely, so are large losses. It may take more than a year for EBIT to ramp back up to $3-4M+ as new contracts take a while to fully generate revenue, but if the new order momentum continues, cash flow could continue be saved by the growth of deferred revenues.

 If the business starts to detiorate from run rate Q4 levels, you could think about selling early next year before the dividend is announced, as a dividend cut is likely the largest risk/catalyst for a permanent loss in the stock at this point.  

 The CEO is 56 and might think about selling the company at a premium in the future. I doubt that is in the cards over the next few years though so I am not planning on that when thinking about potential returns.

 Risks:

The company could pursue a dumb acquisition with the cash balance. The company states that it is targeting acquisitions, but notes that “targets at reasonable valuations…are scarce nowadays”. I think a big dumb acquisition is unlikely but as always remains a risk for a company with a large cash balance.

 Business performance could continue to deteriorate and the dividend could be cut, sending the stock price down. A recession or market pullback could occur and MNDO’s price could go much lower due to its small size and liquidity. MNDO has previously traded at much cheaper valuation levels, but is protected by some degree by the $1.02/sh in net cash.

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