Description

Sangoma Technologies (CVE: STC) is a neglected micro cap that operates in the high growth VOIP industry.  Sangoma is a consistently profitable firm (posting positive net income for 26 out of the last 27 quarters) that currently trades at nearly 2x earnings net of cash with a variety of catalysts to unlock value and increase profitability.

Business Overview:

Sangoma is an equipment provider to the telephone communications industry.  Their main line of business involves selling products that allow PC servers to communicate with legacy telephone networks and Wide-Area Networks (WAN).  The product lines include both hardware and software solutions.  Some of Sangoma's products include:

• PC network cards that  convert phone calls from legacy PSTN (Public Switched Telephone Network) to VOIP
• Software that telemarketers use to detect when a human answers the phone
• Transcoding cards that compress voice signals to save bandwidth

The largest growth opportunity for Sangoma is within the unified communications industry.  Products like Sangoma's Net Border Express facilitate the move towards PC-based telephony by converting phone signals into computer processed VOIP transmissions.  The value proposition Sangoma provides to this market is best understood through an example.  Suppose you are a startup business and need to form a call center to handle returns and customer complaints.  Rather than paying through the nose for a full service proprietary technology to handle your needs, you go to Sangoma and purchase an A104 card for $1,400 (amazon.com).  With this card you can turn any PC into its own call center, routing calls, playing hold music, and recording conversations for quality assurance.  Businesses can utilize a variety of applications like Skype to efficiently and cheaply manage these centers.

Financials:

Even if the potential growth prospects for Sangoma's products don't pan out, you are still paying very little for a reliable, profitable company.  A summary of the last six years are shown below:

Strengths:

Founder and chairman of board owns 20% of the company.  New CEO William Wignall was granted options to acquire 6% of shares out.  While this grant may be overly generous, especially since the options were struck at a favorable price, it certainly aligns his interests with shareholders.  In the past, Wignall has proven himself dedicated to maximizing shareholder value, as the last two companies he led were bought out.  He also helped initiate a normal course issuer bid for Sangoma less than 3 months after being appointed CEO.

Downside protection from book value - tangible book value is $14.4mm (of which $7.5mm is net cash).  Total liabilities of $1.5mm (including interest free loan of $100k from Canadian govt).

STC announced a buyback program to acquire up to 5% of the shares outstanding by Dec 2011.  In the first quarter of its instatement, the company repurchased 193k shares or ~14% of shares traded.

Sangoma has a few new products in which it has invested over the past few years that are just launching, and could provide additional revenue upside.  These include: NetBorder 3.0 and STC's D100 and D500 transcoding cards.

A potential opportunity for STC is their deal with HP.  In early 2010, STC announced they had entered into an OEM partnership with a "major computer networking supplier" to supply them with STC's NetBorder Express Gateway.  Sangoma announced they expect this relationship to "generate several million dollars of revenue over the next few years".  Although the specific partner/product had never been named, strong evidence points to Sangoma's products being used in the HP Blade (see http://blog.tmcnet.com/blog/tom-keating/voip/sangoma-and-hp-partner.asp).  This product's launch has been delayed due to setbacks in the release of Microsoft's Lync software (finally released in late 2010) and could provide additional upside when launched.

Risks:

• Revenues/profitability lumpy on a quarterly basis
• First 9 months of fiscal 2011 have been a little weak due to FX losses, increased R&D  (many new products have just been launched, the effects of which have not yet hit the top line significantly), and slightly light revenues
• Stock is very illiquid

Conclusion and Valuation:

Given management's shareholder friendly mentality and strong equity incentives, I think full credit for the cash is merited.  A fair valuation for the shares should be more along the lines of 10x $2mm earnings + $7.5mm net cash = $27.5mm market cap or over 120% upside from current levels.  Given the high growth industry they operate in and their strong competitive position, one could argue a heftier multiple is merited.  Downside protection is provided by tangible book value of $14.4mm, of which half is net cash.

Catalyst