Description

Q Comm is a name that offers strong risk/reward characteristics. The stock trades at a remarkably low enterprise value, has apparently reached an inflexion point in its business, operates in a huge and growing market, has several potential short-term catalysts, has created a network which will generate reoccurring revenue, and offers significant upside. There is not much downside to the name, although it has a bit more of a growth component than most of the “deep” value names we are typically involved in.

QMM is in the business of purchasing and reselling primarily prepaid wireless products though point-of-sale retail stores in the United States. Originally, they used third-party software and equipment to support these sales, but in the third quarter of 2002 they introduced their Qxpress 200 terminals and the software used in Q Comm’s data center. There are currently about 3,000 terminals currently in use generating income. As the network is being established there is also significant opportunities for other prepaid services in addition to wireless.

The company has suffered though some starts and stops, but will be cash flow positive next quarter, and profitable by approximately the end of next quarter. QMM has approximately $2 share in cash, and $1.75 in cash fully diluted. They are currently burning about $100k per month. The stock trades at approximately 12 times our expectations for next year’s earnings. Most importantly, QMM represents a huge reoccurring revenue base, and trades at an extremely low enterprise value of only $15 million.

Without question, the prepaid wireless market is enormous, and growing rapidly. In Europe prepaid is considerably larger than in the U.S. The size of the market has been documented by organizations such as Gartner, Yankee Group and Igilliot. We also had extensive discussions with an executive in the wireless division of a major wireless carrier who confirmed that the prepaid market is enormous, growing very fast, and an important component of their and every other major wireless operator’s strategy.

Prepaid wireless is sold to individuals with credit difficulties or simply individuals who want to control the cost of their wireless services. However, the “hard card” system is very difficult to manage, represents great challenges in inventorying the cards, and there is quite a bit of theft. The industry has been craving an electronic solution, and QMM seems very well situated.

QMM’s solution is a simple one, which reduces costs for the brokers, retailers and carriers. Qmm replaces the hard card system by electronically distributing PIN numbers. The carriers no longer need to manufacture, inventory or distribute the cards. The distributors/brokers have lower service costs and inventory. The retailers don’t have to worry about theft. The transactions are done through an electronic funds transfer system so bad debt falls off considerably. The terminals are lined to a central data center in Utah which distributes the PINs, creates management reports, and maintains inventory controls.

The economics of the system are very favorable. According to company executives, each terminal generates an average of 16 transactions per week, with an average transaction of $24.5 or $1685 per month. The company generates 2.2% or $37 per month per terminal. They also get a rental fee of $21.50 per month on units that are financed, which is approximately 75% of their terminals. We calculate that QMM breaks even at about 4500 terminals, they say very conservatively they break even with 5000 terminals. There is currently 3000 in use, and at the beginning of the quarter they projected to have conservatively an additional 1-2k terminals in place by year-end. In Q3 they added 1200 terminals, and said that some significant sales they expected were being pushed into Q4. The business model is highly scalable and represents significant leverage, as new terminals are added the great majority of the revenue drops right to the bottom line.

There are several recent developments which indicate that they will be profitable very soon, and represent catalysts for the stock to appreciate. Importantly, a few weeks ago, USA 1 Rate a prepaid wireless service provider announced they were converting their hard cards to the Qxpress system. They have announced their intention to have their third party retailers switch and they were going to begin deploying the terminals later in the month. This would represent an additional 600 terminals, plus they are about to expand to the west coast.

In the past QMM has had difficulty meeting customer demands due to problems with their contract equipment manufacturer. These problems have been solved along with $16 million financing should assure them of getting significant numbers of machines produced.

Qmm has recently appointed Terry Kramer as interim CEO and chairman of the board. He is a very well respected wireless executive who came out of Vodaphone. His immediate emphasis is on sales and getting the company to break even along with creating more transactions on existing terminals. There will also be a new vp of sales, which will start in the second week of January.

We have spoken to some of the brokers in the chain, and they said that without question the QMM solution is the most attractive, and they anticipate several large customer orders to be signed relatively soon.

The main competition is the hard card market, and we feel the greatest risk is if a data processing company like First Data entered the market. We feel however, that QMM has a significant lead, and the market is so large that they will be a very desirable acquisition target at some point.

In sum, QMM seems like a very attractive risk/reward opportunity. Most importantly the company carries an enterprise value of only $15 million. There is approximately 1.75 per share, fully diluted of cash. They are in a huge and growing marketing, the company is on the brink of profitability and should be cash flow positive next quarter, they have several new large sales opportunities, the economics of the business are compelling, the business is highly scalable, and there is strong new management. While the story has a bit more of a growth element to it, than most names we own, we find the remarkably low enterprise value, opportunities for reoccurring revenue, and inflexion point of their business a powerful offset.

Catalyst

1) Enterprise Valuation of $15 million
2) Expect break even and cash flow positive Q1 2004
3) New managemennt team
4) Solved manufacturing problems
5) Begin to rollout to countries like India and Phillipines primarily prepaid customers
6) No major competitor
7) Scalable business model