Description

TransAct Technologies Incorporated (TACT) designs, develops, manufactures and sells transaction-based and specialty printers for the casino, banking, food service, oil and gas and lottery markets.  It has recently introduced four new products across its business units which each have the capability to materially improve revenues and profitability.  Should each of these new products win a reasonable level of acceptance over the next five quarters I believe TACT would trade at $46.57 per share, implying an upside of 419% over the current share price of $8.97 as of 9/9/2013.  This write up includes no benefit from the reduced share count from the recent repurchase of 470,000 shares at $8.75 by the Company, since it happened after the quarter.

Historical Business

TACT’s headquarters are based in Hamden, CT and its primary operating facility is located in Ithaca, NY.   Approximately 85% of TACT’s printer production is through contract manufacturers in Asia, while the remaining 15% of products are assembled in Ithaca on a configure-to-order basis using components and sub-assemblies sourced from contract manufacturers around the world.  TACT designs software and products in its Ithaca facility as well.  The Company has its casino and gaming sales and service headquarters in Las Vegas, NV, a European sales and service center in the United Kingdom, a sales office located in Macau and three other sales or administrative offices in the US.

In the gaming market, TACT is one of two companies that sells printers to the manufacturers and owners of slot machines and other electronic games for use in casinos.  These printers allowed casinos to eliminate the use of coins and improved profitability for casinos and game play for gamblers.  The ticket in / ticket out (“TITO”) market currently consists of approximately 1,000,000 machines of which TACT has about a 50% market share with an installed base of approximately 500,000 Epic printers in nearly 1,800 casinos.  At the peak of the TITO sales cycle in 2004, TACT’s stock traded for about $34 per share and over 20 times enterprise value to earnings before depreciation, interest, taxes and amortization (EV/EBITDA). 

This business is mature, however there are some recent events that lead me to believe that it may begin to grow at a high single to low double digit rate.  There is potential growth of printer sales from nearly 60k video-lottery-terminals “VLT’s” which are expected to be installed in Illinois, new US casino openings in Maryland, Ohio, Massachussets and Las Vegas, as well as international opportunities in the Asia-Pacific and potential new VLT deployments in Greece and Eastern Europe.  TACT just recently announced a new distribution partnership with Suzo-Happ who is the world’s largest distributor of casino gaming components.  The exclusive deal has effectively shut its largest competitor, FutureLogic, out of a large part of the market for TITO printing equipment and parts.

In its lottery business, TACT has an exclusive agreement to be the sole provider of printers for the lottery company G-Tech, which is world’s largest provider of lottery terminals.  These printers offer the ability to quickly print high volumes of lottery tickets with little down time for maintenance issues.  The business has lumpy sales volumes based on G-Tech’s ability to secure contracts in new or expanded jurisdictions.  For example in fourth quarter (Q4) 2012, G-Tech purchased $6.4 million of printers from TACT in that quarter alone, and $11.6 million in total for the year. 

The last part of TACT’s legacy business is its banking & point of sale (“POS”) division.  In the banking market, TACT sells printers to banks, credit unions and other financial institutions to print and/or validate receipts at teller stations.  In the POS market, TACT sells printers used by restaurants, hospitality and other specialty retail industries.  Unlike the lottery and casino segments, this part of the printer market is very competitive.  TACT lists seven competitors in its 10-K for the banking and POS market and TACT’s CEO has mentioned on many quarterly earnings calls that this segment has lower margins since it is essentially a commoditized printer.  Going forward TACT plans on allocating its resources more towards niche printer products that have fewer competitors and higher margins.

I believe that these historical businesses of TACT should generate $9.5million in annual EBITDA going forward not factoring in the potential of the Suzo-Happ relationship.  If we give the historical business a 8 times EV/EBITDA multiple, with cash of $8.83 million and 8.8m shares outstanding at the end of second quarter (Q2), this business equates to a value of approximately $9.75 per share, just above the current trading price of the stock.   

I utilized this 8 times multiple for valuation purposes based on the trading multiples of the two most closely related companies to TACT.  They are PAR Technology (PAR) and Zebra Technologies (ZBRA), which trade for 19 times and 9 times EV/EBITDA, respectively.  ZBRA designs, manufactures and sells various printers and related products.  Its products include direct thermal and thermal transfer label and receipt printers, RFID printers/encoders, other printers and supporting software.  PAR provides technology solutions to businesses in the hospitality industry.  It offers a mix of software and hardware products.  The hardware segment consists of order-entry terminals, self-service kiosks, kitchen systems, utilizing printers, video monitors, and a range of food safety monitoring and task management tools.  While these companies are not perfect competitors to TACT, Zebra is comparable to TACT on the printer side while PAR is comparable to TACT on the software and user interface side.  While I chose an 8 times EV to EBITDA to value TACT’s business, the niche markets that TACT is in compared to those of ZBRA and PAR have less competition and allow for better margins, and thus TACT could very well get a higher EBITDA multiple once the market notices and understands the company better.

The Opportunities for TACT

Food Safety

TACT has three new product lines that it has recently introduced.  The first product is a printer for Food Safety applications used in the restaurant and hospitality markets.  This printer was developed in coordination with McDonalds over the past few years, and recently the exclusivity period with McDonalds has ended.  The printer is called the Ithaca 9700 and has a MSRP of $1299 or $1499, for the single or dual-printer version, respectively.  The 9700 can individually or batch print the labels for newly opened items that need to be put back on shelves, refrigerators or freezers after a prep chef has used some of the ingredients, such as a bag of tomatoes.  It can also be considered as “use-by labeling.” 

This printer replaces the manual use of day dot stickers and other manual means and eliminates human error, which can create food waste and especially safety issues.  It also replaces handheld devices, similar to pricing guns, where for every item, the expiration date needs to be looked up and manually adjusted to be printed on the label, creating a lot of room for error and can be very time consuming.  Instead, with the Ithaca 9700, the employee can touch the screen with a picture of an item, and the expiration date for that product is automatically printed out quickly and accurately.

TACT’s Ithaca 9700, EcoLab and Avery Dennison food safety printers pictured in links below, from top to bottom

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All of a restaurant’s food items can be easily programmed into the terminal, especially the shelf life data. The 9700 terminal uses an internal clock to print out clearly and accurately the necessary information to maintain a safe food environment. In addition, the terminal can use English as well as other languages for both the screen and label printing. Finally, the terminal can print what is called grab-and-go labels for those items quick-service restaurants like McDonald's makes for sale. An example of that would be a parfait or cookie that is premade in its entirety and then has to be sold by a certain time. That is what TACT calls "enjoy by labeling."

Here is a link to a video showing the 9700 and how it works: http://youtu.be/ukJjUn1UCJ0

TACT’s food safety terminals have an active color touchscreen and a very small footprint designed especially for the hospitality market that has limited space. The terminals are simple to program, come with a TransAct software program that makes programming simple and is totally customizable.  So every restaurant, no matter who or where it is, can have a terminal that fits its exact need.  TACT has invested a lot time and capital into developing the software that is used on the food safety terminals, and has worked with each restaurant chain to improve the software, which creates a nice barrier to entry against new entrants to this market.

This past May, I visited the National Restaurant Association Show in Chicago and was able to see the Ithaca 9700 as well as competitive products such as the Avery Dennison (AVY, $43.12/share) FreshMarx and the EcoLab (ECL, $92.89/share) Prep-n-Print printers.   The Ithaca 9700 printer stood out compared to the other two.  The FreshMarx printer had an outdated interface, and to change the printer head, you had to unscrew what held them in place, put the new printer head in, the screw it closed again.  Not only did this take time, but it also created the risk of losing the screw or even potentially dropping it unknowingly into food items.  The 9700 had an easy snap-in snap-out label and print-head system.  The EcoLab printer, as you can see from the photo does not have a touch interface, and needs the user to scroll through different items to print out the labels.  This creates a lot of inefficiency compared to the other touch systems that can quickly navigate to food items and print the necessary labels.  Avery Dennisson is a label company that makes a printer to help boost the demand for their own labels.  Ecolab is a food-safety company.  TACT as a specialized printer company, who has partnered with Daymark which makes labels, decided to make the Ithaca 9700 agnostic to which labels the printer can use.  The experience of making high-quality printers for niche industries has helped TACT make a food-safety printer that stands head and shoulders above its competition.  AVY felt so threatened by the 9700 that it requested a preliminary and permanent injunction against TACT from selling the Ithaca 9700 printer. On November, 7 2012, the court denied Avery Dennison’s request and ruled in favor of TACT.  The case is currently being appealed by Avery Dennison, but after reading the court’s initial ruling it is my opinion that AVY’s case was solely intended to delay TACT’s entry into the food safety business.  This tactic has seemingly failed even though the case was brought in a jurisdiction that was friendly to AVY.

Now to take a look at the potential market size for the food safety printer, I have created the table below showing the potential US locations that the Ithaca 9700 Food Safety Printer can be used in:

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In the Q2 2013 earnings call, TACT CEO Bart Shuldman stated: “This is a very significant market opportunity for TransAct as we really don't see another product like the Ithaca 9700 in the market. And we can easily identify a worldwide opportunity of approximately 700,000 terminals. We're not expecting this market to ramp up overnight, so we want to make sure we remain conservative with expectations.”

The 700,000 terminal opportunities worldwide that Mr. Shuldman mentions seems to check out accordingly.  There are over 800,000 food-service locations in the US and I estimate that only about half of them are likely candidates for a food safety printer.  The one-off mom and pop restaurants likely would not find a great need for such a printer, since a food safety issue is not likely to make headline news that affects multiple locations.  Looking at MCD and YUM’s US versus their International location count, I think it’s fair to assume that the international addressable market is about the same size as the United States for TACT.  The 700,000 unit opportunity number used by Mr. Shuldman seems reasonable, and probably conservative based on a potential market of over 1.7 million locations.  Recently, TACT announced in the Q2 2013 earnings call that it has expanded the relationship with MCD to countries outside the US with its food safety printers.

YUM has approximately 18,000 locations in the US and 21,000 locations outside of the US.
Source: http://yum.com/investors/restcounts.asp
McDonalds has approximately 14,000 locations in the US and 19,000 outside of the US.
Source: http://geography.about.com/od/lists/qt/mcdonalds.htm

In the first quarter (Q1) 2013 earnings call, management stated that gross margin going forward should sit in the 42% to 43% range.  If on average, the Ithaca 9700 printer sells for $1000, assuming discounts for bulk orders and third party sales commissions, it should average a gross profit of $420 per printer.  If TACT can reach 50% of the total addressable market of 700k over a 5 year period, that will average out to 70k printers a year.  The table below shows the calculation of gross margin dollars generated each year for this product at this level of sales:

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Granted it will take some time for sales to ramp up to such levels, but I think that by mid-2014, this sales level is reasonable.  This estimate excludes the replacement cycle for this product which should start after a few years as the back of a restaurant is a particularly hostile environment for electronic devices.  These gross margin dollars will only be offset by some sales, marketing, warranty and support expenses, since TACT uses third party contract manufacturers and already has the staff and infrastructure to handle a much larger level of production.  Therefore, nearly all of the $29.4 million gross margin will go straight to the bottom line, after accounting for taxes.  TACT just began selling this printer in a material way for the first time in Q2 of 2013, so future quarters will benefit from this product.  At most, I estimate this segment would require incremental Selling, General and Administrative “SG&A” of $2 million per year to support it.  Valuing the new Food Safety business on its own with an 8 times EBITDA multiple to the $27.4 million, increases the value of TACT by $219.2 million for an increased value of $24.91 per share. 

Epicentral Print System for Gaming

Another exciting segment recently entered by TACT is the electronic gaming software market.  TACT has created an additional networking and software component that adds valuable coupon printing capabilities to the printers it already sells for the casino gaming segment.  The name of the product is called Epicentral.  It works in connection with TACT’s gaming printer, the Epic 950 and an additional piece of hardware that allows the printer to become networked, called ServerPort.  This software allows casinos to communicate with casino guests across the gaming floor by providing promotions, coupons and messages directly though slot machines and electronic games being played by those customers.  Coupons can be pre-programed to print under certain events and can either be printed in mass or by specifically targeting certain players.  The system allows the casinos to promote and market to both carded (registered with the casino’s loyalty program) and un-carded players.  TACT’s CEO has mentioned that one casino has said that it had a 30% increase in player enrollment and a big increase in average win per day due to Epicentral.

Another example that TACT’s CEO Mr. Shuldman mentioned in the Q1 2013 earnings call was that one casino told him that when a lower-tier player, whose average daily theoretical “ADT” loss was $15 to $20 per day, after receiving a coupon for free play of $10, will increase their ADT by another $15 to $20 that day.  That means their ADT increases by 100% on the day they receive this promotion.  The casino is so pleased that now during certain times of the day give it gives out promotions almost every minute, printing over 50 promotions an hour.

Looking at the value of TACT’s Epicentral product, it’s important to understand how TACT makes money from it.  The revenue model for this software in general is similar to Oracle’s, where the Company charges its customer upfront for the software in addition to a recurring maintenance fee.  According to Wikipedia.com, there are over 900 casinos located in the US and its territories.  I believe that it is likely that TACT can obtain recurring revenue of $20.2 million from casinos in the United States alone.  Casinos are always looking for ways to increase profitability, especially due to the increased amount of competition from the proliferation of new casino openings over the past ten years.  Once one casino in an area gets the Epicentral software and increases its revenue and profitability, the competitors will be heavily incented to get the software as well to keep up their market share.

TACT has now installed Epicentral and is live at 4 casinos, running in over 5,000 slot machines.  Epicentral software is now integrated with the gaming industry’s 3 leading slot management systems.  TACT expects to go live at 3 additional properties by the end of the year, bringing its total up to 7 casinos and 10,000 slot machines.  One of these installs is at Resorts World, the former Aqueduct Racetrack, one of the world’s largest slot casinos.

TACT’s competitor in the gaming segment, Futurelogic also has competing software that prints coupons.  However, Epicentral is able to connect directly to the casino’s player tracking system, allowing coupons to be given to specific players at any time, while Futurelogic’s system can only give coupons based off of pre-programmed scenarios.  For instance, with Epicentral, the casino can in real-time coupon a player with a buffet coupon saying, “Hi Jill, here is a 50% buffet coupon”, while FutureLogic’s software can , for example, only give a coupon after a player plays $20 on a game, which has been pre-determined by the casino.  This difference in the products creates a large advantage for Epicentral and thus this software is gaining more traction with casinos compared to Futurelogic’s software.

The success of Epicentral compared to FutureLogic’s coupon software seems to have led to TACT’s recently announced deal that it has reached an exclusive distribution agreement with Suzo-Happ Group, which is the leader in the worldwide gaming and amusement components and accessories market.  Below is a screenshot from Suzo-Happ’s website on 9/5/2014, which clearly shows that FutureLogic was working closely with them.  Now that TACT has become the exclusive provider of gaming printers going forward, this allows TACT to increase its market share and expand its global reach.  To sell a product to a casino, a company must be licensed in the individual state, and thus TACT and Futurelogic use distributors who have such licenses to sell their products.  Partnering with one of the largest worldwide distributors will allow TACT to have a greater reach of customers for both its Epicentral software and its Epic gaming printers.  As FutureLogic printers need replacement, they now become more likely to get replaced with TACT’s Epic printers due to this new deal.

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When I look at Epicentral’s value to TACT, I believe that it can obtain $20.2 million alone in recurring annual maintenance revenue within five years from casinos.  By the end of 2014, Epicentral should be generating around $7.6 million or approximately 40% of this opportunity.  The margin for software is generally very high at approximately 80-90%, and most of the revenue will drop to the bottom line after-tax.  The amount of incremental EBITDA generated from Epicentral would be $6.1 million assuming an 80% margin.  Software companies generally trade at high multiples of EBITDA, but if we give a consistent 8 times EBITDA multiple to this segment, that would come out to a value of $48.8 million for the Epicentral software segment. With 8.8m shares outstanding, this comes out to an additional $5.55 per share.

Oil & Gas Color Printers

The third leg of TACT’s growth strategy is providing high quality color printers to the oil and gas industry.  In August, 2011, TACT bought a specialty printer company called Printrex, whose printers are sold into vehicles and data centers to plot oil field and down-hole well drilling data in the oil and gas exploration industry.  The market also includes sales of wide format printers used to print test results in ophthalmology devices in the medical industry, as well as vehicle mounted printers used to print schematics and certain other critical information in emergency services vehicles.

To acquire Printrex, TACT paid $4 million in cash and a contingent consideration arrangement for 30% of the gross profit related to certain new products under development, for a three-year period beginning in January 2012.  Currently TACT has accounted for a contingent liability of $760,000 on its books relating to this transaction, as of June 30, 2013.

There are two new printers in this division that are very exciting.  Both of the printers are geared towards the oil and gas industry.  The first is the Printrex 980.  This printer is a desktop office printer that allows for continuous feed paper printing in a wide format.  This allows for extremely long sheets of paper to be printed out showing drill holes and wells in color so that they can be read easily and accurately.  More printer details can be found here: http://www.transact-tech.com/oil-gas/printrex-980

This business is a razor-razor blade revenue model and TACT has mentioned that it expects each Printrex 980 printer in service to generate annual recurring revenues of approximately $50k in consumables.  Many owners of oil and gas wells print logging reports 24 hours a day, 7 days a week, which is why the consumables for the printer can average $50k per year.  This printer uses proprietary inkjet cartridges, inkjet print heads and other items that can only be sourced from TACT.

Their main competitor for this printer is Neuralog.  From Neuralog’s website, here is the company’s profile:
“Neuralog was founded in 1991 to find creative solutions for problems in the petroleum industry through the application of advanced computer science technologies and client direction. Today Neuralog software solutions are recognized around the world as the best digitizing and exploration reconnaissance tools available. Currently, over 1000 customers in 70 countries use Neuralog products. These include majors, small independents, and many digitizing service centers. Neuralog has signed agreements with several of the world's largest computer-aided exploration software companies to be incorporated with, and enhance, their own software solutions. “

Not once does Neuralog mention printers in its profile.  That is because it is more of a software company.  On Neuralog’s website, when you look under products, software shows up first, then hardware.  TACT on the other hand, is at its core a printer company.  So if you are printing in very high quantities, which company would it make sense to go with?  Would you want to be spending much of your time fixing printer problems?  This is one of the reasons that TACT entered the oil and gas office market, since there is a need for an extremely reliable printer that could handle these unique types of printing jobs.

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The other exciting product coming out of TACT’s Printrex brand is the Printrex 920.  This printer is the first true rugged color printer for the oil & gas exploration market that is specifically designed for the trucks and rigs out on the field.  The printer utilizes specially coated thermal paper that TACT has the exclusive distribution rights for in the oil and gas market.  The 920 uses thermal technology, which unlike inkjet and other printing technologies, is more reliable in harsh environments.  The food-safety printer from TACT uses thermal technology as well, but it only prints in black and white.

Black and white thermal technology isn’t anything special, but the color thermal technology used in the Printrex 920 is impressive.  TACT partnered with ZINK Imaging on this printer.  In a recent press release from ZINK, it describes the technology:

“About ZINK® Zero Ink® Printing Technology
ZINK® Zero Ink® Printing Technology from ZINK Imaging is a revolutionary approach to printing that makes it possible to print in full-color without ink cartridges, ribbons or toner. The key to the ink-free system is the patented ZINK Paper®, an advanced composite material embedded with cyan, yellow and magenta dye crystals and with a protective polymer overcoat.  Before printing, the dye crystals are colorless making ZINK Paper look like regular white photo paper. The ZINK Smart App Printers™ use heat to activate and colorize these crystals. The result is full-color, high quality, long-lasting and durable images. ” Source:  http://goo.gl/ame9kJ

The barrier to entry for this business is that every set of paper for the Printrex 920 has slightly different composition, for which the crystals react differently which could potentially create printouts that are not consistent.  TACT has resolved this problem by having an RFID chip on every set, which identifies the paper’s composition, and sends the info to the printer when installed, so that the printer can calibrate itself accordingly to provide consistent printouts across different batches of paper.

The color thermal technology that TACT uses in the Printrex 920 printer is not only patented by ZINK, but also seems to be very difficult to actually execute.  I wouldn’t be surprised if TACT used the special technology used in this printer, and find other niche areas where the technology would be very beneficial.

Previously, TACT and other companies in the oil & gas truck market have made printers that are thermal and print only in black & white “B&W”.  When I look at a printout of B&W versus color drill hole, I noticed a lot of detail getting lost in the B&W image compared to the color one.  This is the same reason why in the office environment, these logs are printed in color instead of B&W, even though color costs much more.

TACT has mentioned on conference calls that Printrex 920 printer sells for $5k per printer, and that it expects each printer to provide about $5k in recurring revenue, in large part due to the specialty paper needed for color thermal printing.  This will create another recurring revenue source for TACT, to accompany the Printrex 980 and Epicentral software in new recurring revenue sources for the company.

When looking at how to value Printrex, since it is a razor-razor blade model, it is important to think about how many printers will be sold and being used in the market.  I think that there will be approximately 150 Printrex 980 printers in service by the end of 2014.  For the Printrex 920, I believe that TACT can have 2,000 in service within the same time.  Since Printrex already has over 10,000 B&W printers installed and in the field, I think that 2,000 color printers installed by the end of 2014 is reasonable.  This number of printers in service would provide $17.5 million in additional recurring revenue for TACT.  Assuming, conservatively that the consumables have the projected company’s gross margin of 43%, it amounts to $7.5 million in annual gross profit.  TACT would likely need a regional office in Texas to provide support and deliveries for this segment, which I believe would cost around $500k per year.   This leaves TACT with $7 million in incremental EBITDA from Printrex’s new products.  If we again assume an 8 times EBITDA multiple for this business, which is conservative in my opinion due to the recurring nature of sales for this business, the business is valued at $56 million.  With 8.8 million diluted shares outstanding, this equates to an additional $6.36 per share for the Printrex business from the new printers.  Also, don’t forget that by January of 2015, TACT’s agreement to give 30% of its gross margins away due to its acquisition of Printrex ends and TACT will then claim the full value of the business.

TACT still isn’t done introducing new products

TACT announced in its latest conference call that it is going to be launching two new products in 2014.  It will be interesting to see what TACT launches and how it can potentially create an additional benefit for TACT.  For the sake of projections, I have not included any additional revenues or profits from these products.

Valuation of Transact including the three new business opportunities

I have valued TACT using the sum of the historical business and each of the business opportunities.  I believe buying TACT today at $8.97 gives an investor three or more free call options that are being ignored by the market and an upside case if all of the options hit of over 400%.  The table below highlights the values.

Catalysts

As the new products that TACT has recently launched ramp up in quantity, we will see the benefits in the company’s financials.  I believe that the food service printer will be the fastest out of the gate, with the casino software and oil & gas printers close behind.

In addition, I believe that the food safety printer has really caught the attention of Avery Dennisson, as noticed by the lawsuit it has brought on against TACT.  It may be in its best interest to purchase TACT and its food safety business so that it can be the main provider of labels for that printer, instead of sharing the market with other label companies.  TACT’s current enterprise value is below $70 million and AVY could easily buy TACT for a large premium and justify it by the synergies with the food safety business and other labels that can be used within TACT’s current printer lineup.

Catalyst