Description

Overview

MiX Telematics is a growing telematics company with a good value proposition trading at less than 10x trailing owner earnings. Paying under 10x trailing for a net cash balance sheet company that should be FCF positive this year and could grow at 10% or more in the medium term seems reasonable when there is a good chance of both multiple and margin expansion for reasons I get into below. 

Catalysts / Why is it cheap?

MiX is cheap because it is a small cap South Africa domiciled company with somewhat obscured financials, but there are a few catalysts (becoming a domestic filer and completing the transition to a subscription model) that will help. Telematics for oil and gas customers is also about 25% of the business, which is clearly not ideal today, although these tend to be larger and better capitalized multi-nationals. 

Becoming a domestic filer

MiX became a domestic filer on April 1, 2020. This means that for now MiX will file both IFRS and GAAP financial statements. The stated goal here is to increase US investor awareness. Management has explicitly said that they would eventually like to reduce the IFRS filing burden by only filing domestically, in tandem with continued expansion in the US.

Transition from hardware sales to subscriptions

MiX is almost though a hardware to subscription model transition. This transition has distorted top line growth somewhat and depressed income and cash flow significantly, but we're towards the end of the transition, with 80% of new sales bundled. 

Overall revenue has a 10.4% CAGR from 2011, while subscription revenue, which is now about 90% of total revenue, had a 16% CAGR. Subscribers have grown in the low to mid teens as well. 

EBITDA margins declined in 2014-2016 in the earlier innings of this transition, hurt further by increased growth spending in the P&L, but they started to inflect in 2017, going from about 20% to 29% today. Markets noticed as well, and the stock quickly moved from $5 to prices in the high teens as people started to dream the SaaS dream.

EBITDA margin targets of 35%+ are realistic when you consider hardware gross margins of 27% vs. subscription gross margins of 69% along with the expectation of some operating leverage as the business grows.

Because MiX owns the in-vehicle hardware when they sell a subscription, that hardware is depreciated on MiX's books. In-vehicle hardware is also a cash outflow that MiX recoups over time. The net effect of all this is current profitability and cash flow are impacted through the transition, but you're moving to a higher lifetime value for the customer. These transitions are well understood by US investors in larger cap companies but probably less understood in companies like MiX.

Business overview

MiX has 812,000 vehicles under subscription, which are served by 17 offices and over 130 fleet partners globally. MiX serves a variety of verticals, although the exposure to oil & gas hasn’t helped lately. 

MiX competes in an underpenetrated and fragmented market. Telematics penetration in commercial vehicles is under 20%, and most telematics providers operate on a regional basis. In that competitive landscape, MiX clearly is doing something right. Subscribers have grown over 10% in the past five years, and these subscribers are high quality. Their recent presentation gives these facts on subscriber composition: 72% of subscription revenue is from fleet customers; 88% of fleet subscription revenue is from customers with 50+ vehicles; 66% of fleet subscription revenue is from customers with 500+ vehicles. Retention (highlighted below) is also decent, although I wish they provided more data on churn in their filings. 

Telematics has a strong value proposition: companies enjoy fuel savings, less theft, fewer accidents, easier compliance, and more. 

Functionality goes way beyond a dot on a map. MiX can integrate cameras (inward and outward facing) and other sensors and help fleet managers monitor most aspects of driver performance and behavior. MiX even gamifies driver data to let drivers compete over improving these metrics. I'd recommend checking out the MiX website and YouTube videos. Investments over the past few years have produced functionality that rivals any telematics company, and I think customer wins in large multinational companes proves this.

Smartphones and vehicle OEMs have been cited as threats to telematics. OEMs aren't a threat because fleet managers would prefer homogeneous telematics equipment across the fleet, which they can't have unless they standardized by vehicle. 

Smartphones are an enabling technology for the industry. MiX hardware lets users access cloud hosted vehicle data through smartphones. Compare this to telematics solutions of the past where desktops were required.

Valuation

Clearly calendar 2020 is going to be challenging, and MiX has pulled guidance for the year. For simplicity's sake, I'll talk about trailing multiples and thus I'm implicitly assuming that things get back to normal within a year or so. 

My biggest adjustment from reported results is in adjusting D&A for equipment put into vehicles. In a subscription deal, MiX buys/builds telematics equipment that is installed into a customer vehicle. MiX owns this equipment and the depreciation flows through MiX's financials. In-vehicle equipment is depreciated over 1-5 years, and if you look at it vs. beginning equipment at cost it implies 3-4 years on average. But, the equipment can last twice as long, and upon contract renewal MiX typically doesn't install new equipment in the vehicles. If you assume a 7 year life for this stuff, and if you assume a small amount of amortization is not economic, D&A exceeds what I consider economic D&A by about 6.5mm (21c/share). Working from this assumption alone, MiX trades at less than 10x trailing earnings and about 8.7x trailing NOPAT. This dynamic will become more apparent in the next couple years as the first big wave of subscription customers renew with MiX without requiring additional hardware investment.

I'm not going to call this a SaaS business and slap a SaaS multiple on it, but others have before and I think they might again. On my trailing numbers, multiples of both earnings and NOPAT should be about 50% higher, suggesting 50% upside on the stock. 

Public comps and deals suggest greater upside. Ituran (ITRN) trades at a similar multiple but Cartrack (CTK SJ) and Quartix (QTX LN) trade turns higher on any multiple and 2x-5x as high per subscriber. The acquisitions of companies like Pointer Telocation, TomTom Telematics, BSM Technologies, Fleetmatics, and Telogis were done at even richer multiples.

Management makes a credible case that we are coming out of an investment cycle and that we’re at an inflection in growth. I don't think we need this for the stock to work, but we are seeing evidence of it.

Even holding margins constant and assuming MiX grows as it has in the past makes for a cheap stock at these multiples, but we could get higher growth and margin expansion. 

Management doesn’t own as much stock as I’d like, but they seem competent. They’ve also bought back stock intelligently over time.

The graph doesn’t show it, but they spent 9.7mm in FY20. 

Risks:

South Africa exposure & currency moves.

Attempt to grow in the US fails. 

Catalyst

Increased US investor interest from recently becoming a domestic filer. 

Subscription economics mature and no longer depress P&L and cash flow.