Description

In a stock market that seems inflated by all measures, we are enthralled to have identified a microcap stock that we believe has a reasonable probability of being acquired in 2021, ~1,000% near-term upside, strong industry tailwinds, underappreciated technological innovation, and an anticipated surge in business driven by the impending reopening of the global economy and increasing awareness of the company’s differentiated product suite.

SuperCom Ltd. (NASDAQ:SPCB) is a leader in Internet of Things (IoT) tracking systems, which are primarily applied to the electronic monitoring of prisoners under house arrest, and cyber security endpoint data protection solutions, which guard against corporate data loss and theft through content discovery and inspection, encryption methodologies, and comprehensive device and port control. We believe SPCB’s stock has ~10X upside in the near-term, as the company’s already positive cash flow and annual recurring revenue (ARR) grow materially in the coming quarters. Our price target of $11 per share implies less than 20X our 2021 EBITDA estimate of $11 million, more than double its artificially depressed $5 million annualized EBITDA run-rate in the first half of 2020.

Most of SPCB’s revenues comprise ARR and encompass a high degree of visibility. Contract awards for SPCB began to accelerate at the end of 2020, and we expect increasingly cash strapped municipalities and continuing COVID-19 outbreaks in prisons to result in an explosion of orders for SPCB’s Pure Security Suite, which offers government agencies and correctional facilities the option to move prisoners outside of physical walled facilities to residential-based virtual incarceration, generating significant cost savings for municipalities and reducing prison overcrowding. SPCB’s monitoring technology is also applicable to COVID-19 tracking, and recent initiatives in countries like China to employ electronic monitoring for stemming the spread of the disease could result in major new contracts for the company’s PureCare quarantine monitoring solution in 2021.

SPCB currently has a market cap of only ~$22 million. The company has >100 employees, 119 issued patents, and it has made a slew of synergistic acquisitions since its inception in 1988. The business has over 1,000 customers in over 30 countries and an expanding, innovative product suite. SPCB’s largest shareholder is an entity controlled by the operating family and owns ~28% of the business. As a testament to the operating family’s conviction in the SPCB story, CEO Arie Trabelsi increased his open market purchase program in March 2020. The company’s reins were recently handed down to Arie’s son, Ordan Trabelsi. Ordan formely led SPCB's business and operations in the Americas, and he has been with the company since May 2013 as the second U.S. employee. Ordan grew SPCB’s U.S. business to over $10 million in annual revenues and profitability, representing over 1000% organic growth. We believe that Arie would not have handed the reins of SPCB to Ordan unless he were supremely confident in the company’s near-term trajectory, especially in the U.S.

Changing public perceptions towards drug addiction and mental illness are motivating a move towards alternatives to incarceration approaches.  The increasingly pervasive view is that addiction and mental illness are social problems, which arrests and incarceration will not fix.  As a result, incarceration as a response to drug addiction and mental illness is increasingly being eschewed. There is bipartisan support for a response to drug addiction and mental illness that is compassionate and treatment-focused. Electronic monitoring includes a variety of technologies and software systems that monitor a person's location. Such technologies can include wrist/ankle bracelets, field monitoring devices, alcohol and drug testing devices, voice verification systems and global positioning systems. Electronic monitoring is employed as an alternative to incarceration, and it can be utilized alone or in tandem with other services such as outpatient treatment or day reporting, as well as on the back-end to monitor those released from prison or detention.

In the United States, it costs about $100 a day to house a federal prisoner, according to the Bureau of Prisons, and about $140 for a state prisoner, according to the Vera Institute of Justice, a think tank in Brooklyn, New York.  Modern electronic monitoring technology, such as SPCB’s Pure Security Suite, facilitates house arrests. In stark contrast to the expense of prison incarceration, SPCB’s Pure Security Suite has a daily cost of approximately $4 per device. As Covid-19 outbreaks proliferated through prisons in 2020, criminal justice systems around the world turned to electronic monitors as an alternative to incarceration. Coincidentally, courts in the U.S. and Australia began to experiment with the use of ankle monitors for enforcing quarantine orders.

The multibillion-dollar global electronic monitoring devices market had already been surging prior to the advent of COVID-19, as secular drivers like prison overcrowding and declining hardware and cellular connectivity costs drove increasing adoption. From 2005 to 2015, the number of people in the U.S. who were monitored using this technology increased 140%, from approximately 53,000 to 125,000. Reports show there are currently an estimated 2.3 million incarcerated Americans, and over 550,000 of them have not yet been convicted or sentenced. An estimated 450,000 of them considered are considered non-violent drug offenders for whom house arrests would arguably be more logical than prison incarceration. Bloomberg estimated that within a few months of the pandemic commencing in the U.S., worldwide electronic ankle monitor deployment surged by an additional 25% - 30%. Research demonstrates that electronic monitoring can lower criminal justice costs, decrease prison populations, and reduce recidivism. There have been COVID-19 outbreaks at more than 850 jails and prisons in the country, putting many of the over 2 million people incarcerated in the U.S. at risk of infection. At least 275,000 incarcerated people have tested positive for COVID-19, resulting in more than 1,700 deaths.

SPCB’s new order announcements have been accelerating, with an unprecedented 4 electronic monitoring contracts and one cyber security contract with the Israeli government reported in the month of December 2020 alone.  Although the aforementioned themes may be contributing to the company’s recent success, we believe SPCB’s technology advantage is garnering more widespread recognition. On December 1, 2020, for example, SPCB announced the launch of a new 5-year contract with the government of Latvia, valued at approximately $1.2 million, to deploy its PureSecurity Electronic Monitoring Suite. The project was won through a formal government-led bid process in which SuperCom was awarded the highest number of points for the quality portion of the RFP, including technology and solution, in addition to the overall highest score. SPCB’s PureSecurity suite leverages smartphone technology to provide GPS, cell tower and Wi-Fi location tracking. Its solution encompasses calendar management, offender term notifications and reminders, voice, text, email, video communications, portable breath-alcohol integration and bio-identification, including facial recognition, fingerprint, and voice.  Unlike many competing solutions, SPCB’s hardware also has a battery life that extends to 4 years.  While community prisons have increasingly embraced SPCB’s technology in the U.S., such deals are initially relatively small.  With the company's growing recognition in the U.S., it is becoming increasingly probable that SPCB could land a transformational state prison contract, which typically range well into the tens of millions of dollars.

The electronic monitoring market comprises approximately 10 players and has high barriers to entry.  There has been a flurry of M&A activity in the sector over the past decade. In 2010, BI Incorporated was acquired by GEO Group (GEO), a large private prison and mental health facilities company, for 5.8X EV/Sales. In the same year, Attenti was acquired by 3M Company (MMM) for 4.6X EV/Sales. Each such deal was a multi-hundred-million-dollar transaction.

In the 6 months ended June 30th, 2020, SPCB generated an annualized run-rate of $13.6 million in sales and $5 million in positive EBITDA. Its IoT products sub-segment experienced a 119% YoY growth, as more offenders were transitioned from prison to house arrest and the company’s new technology solutions to assist with quarantine compliance and combating of the spread of Covid-19 garnered increased adoption. We believe, however, that SPCB’s first-half 2020 results materially understate the company’s normalized revenue and earnings power. The company’s IOT services sub-segment revenue decreased by 43% YoY, as government restrictions in California and other geographies limited the its ability to interact with clients to provide full services and to add new clients to its monitoring programs given court system shutdowns. SPCB’s cyber security and e-Gov segments were similarly affected by COVID-19 related shutdowns.

SPCB’s elevated order activity and recent commentary indicate that business has bottomed and is beginning to pick up strongly. The company’s business model revolves around a land and expand strategy in which initial orders for IoT devices tend to grow materially over time, resulting in rising ARR even without new contract wins.  In its September 2020 earnings release, SPCB’s CEO said, "While we did see some monthly revenue declines with the spread of Covid-19 and government imposed restrictions, we believe we have passed the bottom and have been pleased to see monthly increases in active unit counts and revenues in recent months. The unexpected environment has forced us to adapt and quickly. We have implemented cost-optimizations that can persist and improve future profitability, launched new products to meet the rapidly changing and growing needs of our customers, enhanced our opportunity pipeline with great new prospects and projects, and learned to work better together to overcome even the most devastating of global shifts. We believe we are weathering the storm and at the end will come out stronger and improved". 

We believe that with the global economy starting to reopen and SPCB’s traction accelerating, the company could generate 2021 sales in excess of the ~$22 million it generated in 2018, resulting in ~$11 million in EBITDA (implying 50% EBITDA margins, which would be up from 36% in the first half of 2020, driven primarily by >70% contribution margins from new IoT deployments). We believe that a 20X EBITDA multiple is appropriate for this business given the company’s elevated margin structure, high recurring revenue base, and its increasing penetration in the rapidly growing IoT and cybersecurity markets. Applying this multiple to our $11 million EBITDA estimate would yield an EV of $220 million. We believe that SPCB has net debt of ~$8 million following its $3.2 million private placement in mid-2020 and several million dollars of additional EBITDA generation since the company last reported earnings results. There are approximately 18.8 million shares outstanding, resulting in a near-term price target in excess of $11 per share.

Catalyst

1) Accelerating order trends for the company's IoT electronic monitoring devices continuing from December 2020

2) Additional cyber security contracts following SPCB’s deal with the Israeli Government signed last month

3) A transformational state prison contract award for SPCB’s PureSecurity suite

4) Prison reform under the new administration resulting in increasing home incarceration

5) Continued violent riot activity in the U.S.

6) M&A