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The Last of the Undervalued Telecom Stocks
by Briton Ryle
As recently as 5 years ago, detailed analyst reports, earnings projections and sector-specific research were the lingua franca of the brokerage houses. To gain access to these sacred texts, investors had to cough up exorbitant broker fees, or be cozy with a big shot analyst. No more.
The Internet gives the average investor access to information that used to be verboten. I'm sure some insiders long for the old days when they held all the keys. Personally, I love it. That's because Taipan members are a breed apart. I know most of you venture out into cyberspace, call companies, and do some digging on your own.
Now, getting the skinny on some oil refinery in Tajikistan can be a little difficult. But overall, Taipan members have done pretty well by our recommendations, both the obscure and the mainstream. And your diligent approach to investing has given Taipan and its members a great reputation in the investment community.
In this era of instantaneous access to information, you'd think there'd be no undiscovered opportunities. (At least not this side of Tajikistan.)
Buying valuations
What if I told you there's a telecom equipment stock that's grown annual revenues at least 20% for the last six years, trades for less than 2x sales, less than 2x book, and has US$6 per share in cash? You'd probably think something must be terribly wrong. Telecom stocks simply don't trade at such ridiculous valuations unless there's a pending lawsuit or the company's equipment has been proven to cause sterility in lab rats.
Truth is, there's nothing wrong. In fact, the story gets better. An acquisition just completed will add US$90 million to the bottom line, and the company has also won a contract from the U.S. Military that could be worth US$418 million over the next 8 years.
So why does Comtech Telecom (CMTL:NASDAQ) trade at P/E of 13 while the industry average is around 60? It's a riddle, covered in an enigma, shrouded in a mystery, wrapped in bacon and deep fried. But mostly, I think it's a question of exposure.
Maybe you've seen the Nortel ads on TV, with the slogan "What do you want the Internet to be?" Or the Williams ads with the executive who doesn't know the difference between "telepathy" and "telephony". Cisco and Lucent both spend millions every year to make sure they stay in the consumer's consciousness. But why?
Consumers don't buy routers from Cisco. They don't buy power amps from Lucent, nor do they shell out thousands of dollars for Nortel's base stations. So why do these companies spend so much to advertise to people who don't buy equipment? The answer is simple — to sell stock.
Stock is, by far, these companies' most lucrative product. When a stock price is growing faster than sales, a company has no problem hiring and keeping the best people, making important acquisitions, funding new initiatives and so on. Stock is the life-blood of many tech companies. Without it, growth would be stunted.
Selling stock is crucial to the growth of some companies. But the little guys who can't afford a national advertising campaign, like Comtech Telecom, have to support their stock price the old-fashioned way. They have to run solid companies, aggressively pursuing new contracts and new markets. They have to remain on the cutting edge.
They earn it
Companies like Cisco and Nortel can, to an extent, dictate the market. Not so for a company like Comtech. Small players have to stay ahead of the market or get left behind. Pacing yourself with Cisco will only result in lost market share.
Comtech has been very successful signing up unnoticed and unglamorous customers, like the military and emerging foreign countries. The terms of the military contract may never be released. But you can bet those dollars will hit the bottom line. And most people won't care that South Africa is upgrading its satellite communications system. But Comtech will be glad to bank the cash.
Most stock prices are a combination of fundamental value and hype. Some, like Amazon, are pure hype. Others, like Comtech Telecom, are pure fundamental value. There are tradeoffs. Fundamental value companies don't jump 50% in a day. But they also don't lose 50% of their value overnight because the market has second thoughts about the valuation.
Based solely on increasing sales and earnings growth, Comtech Telecom stock will appreciate 40% over the next year — and is a screaming buy. And if even a little hype enters the mix, it's gravy. Ironically, I imagine the most probable source of hype is the low valuation. But, as you'll see, Comtech stock is about to jump a lot more than 40%.
The nuts and bolts
Comtech Telecom is a conglomerate, consisting of independently run subsidiaries representing three general product categories or segments. General product categories are: Telecommunication Transmission, RF Microwave Amplifiers and Mobile Data Communications Services. A fourth segment, the Wireless Local Loop, was discontinued owing to poor performance.
Incidentally, management showed great leadership in phasing out the Wireless Local Loop division. As an explanation, CEO Fred Kornberg said the division would need resources and time that could be better used elsewhere. Rather than burn a bunch of cash to turn around a lagging division that might never become profitable, Comtech decided to cut the deadweight and concentrate on the other divisions. Bravo.
The Telecommunication Transmission segment is, by far, the star performer in the Comtech family. This segment is made up of four subsidiaries that sell power amps, modems, frequency converters, satellite VSATs (very small aperture transceivers) and antennas, and over-the-horizon microwave communication products and systems.
The Telecommunication Transmission segment accounts for 60-80% of the company's sales. This segment is due for a sizable gain in revenue, which I'll tell you about later. The other two segments are also poised to see a substantial gain in revenues, and one may even supplant Telecommunication Transmission as the company's biggest division.
Introducing...
The other two segments of Comtech's business, each represented by a single subsidiary, are much smaller than Telecommunication Transmissions, but each has excellent growth potential. The RF Microwave segment makes solid-state broadband power amplifiers for the RF (radio frequency) and microwave spectrums. Applications include wireless communications, test equipment, instrumentation, and identification and jamming in defense systems.
Customers for RF microwave products include foreign and domestic commercial carriers, government agencies, and prime contractors. In fact, Comtech recently signed a US$1 million deal with Lucent to supply power amps for testing purposes. The high linearity of the Comtech product makes it possible to test equipment for both 2G (CDMA, GSM, and TDMA) and 3G (W-CDMA and EDGE) wireless networks. As wireless penetration increases, the need for test equipment will also increase. And Comtech has one of the most versatile products on the market.
Finally, there's Mobile Data Communications Services. This segment, represented by Comtech Mobile Datacom, markets a satellite-based data communications system developed through internal and government-funded research. The service uses GPS (the Global Positioning Satellite system) to provide asset tracking, two-way messaging, e-mail and telenetics. Comtech Mobile Datacom routes signals through leased satellite bandwidth. Customers in the transportation, remote sensing, utility and aviation markets can then access their data via the Internet.
Early in 1999, Comtech Mobile Datacom beat out a team of two other companies in competition for the U.S. Army's Movement Tracking System. The Movement Tracking System will be used by the Army to track its assets and allow real-time communication between fixed and mobile command centers. Comtech's team got the contract, which could be worth US$418 million over the next 8 years.
The contract is dependent on funding, which, if you choose to invest here, maybe be at least one good reason to vote for Dub-yah in the coming presidential election, though I still think Gore is the most tech-friendly candidate. Also, this contract opens the door for other government agencies in need of tracking and messaging services.
It's amazing to me that this company carries only a US$100 million market cap when revenues are literally about to explode. Its history of earnings growth alone should put the stock in the mid-twenties, at minimum. And the potential of the government contract should add another ten bucks. But incredibly, there's still another revenue catalyst that will triple sales in the Telecommunication Transmission segment.
Adopting Adaptive
On July 10, 2000, Comtech completed a deal to acquire the satellite equipment division of Adaptive Broadband (ADAP:NASDAQ), called EFData, for US$61.5 million in cash money. Adaptive has unloaded several divisions because it wants to concentrate on the broadband wireless market. This acquisition will add around US$90 million in annual revenues to Comtech's balance sheet. You'd think that would turn some heads on Wall Street, but I guess not.
This acquisition will open up markets for one of Comtech's most innovative products, the Turbo Codec modem. I can't tell you how, because I frankly don't understand how the contraption works, but the Turbo Codec uses less bandwidth and power to send more data than traditional satellite modems. Comtech has demonstrated that this modem can cut data transmission costs by as much as 40%. I bet Iridium could've used something like that.
You might think that integrating EFData into the Comtech family would pose problems. Except that EFData and the Comtech subsidiary it will fit into (Comtech Communications Corporation, or CCC) are both located in Tempe, Arizona. And, ironically, I understand that some former EFData people helped get CCC off the ground. Serendipity, kiddo. Integration should be a simple matter, without a lot of merger-related charges. Comtech is financing part of the deal through a loan, and part through cash on hand.
Here come the numbers
Consider yourself warned. It's time to get down to revenues, earnings, estimates and all that other boring stuff. At least, sometimes it's boring. I'm actually kind of excited about Comtech's numbers 'cause they're so bloody good.
As I said before, Comtech has been growing revenues at a minimum 20% clip since fiscal 1995, which was also the last year the company reported a loss. Net income has fluctuated a bit, but nothing out of the ordinary. I've broken down the total sales and income since 1995 in the neat little box above for your convenience. Fiscal 2000 just ended July 31st, so those numbers aren't included, which is too bad, cause they're simply smashing.
For the nine months that ended April 30, 2000, Comtech Telecom's sales were US$40 million, up from US$28 million for the first nine months of fiscal 1999. That puts fiscal 2000 sales somewhere in the US$53 million neighborhood.
Backlog for the second quarter of 2000 was US$38 million and dropped only slightly to US$35 million for the third quarter. R&D expenses for the first three quarters of fiscal 2000 were US$1.6 million, but Comtech managed to get customers to fund all but US$386,000. Not bad.
Until the EFData acquisition, Comtech's only long-term debt was lease agreements for various facilities. To complete the sale, Comtech borrowed US$40 million at 9.25% interest, payable in installments through 2005. They could've gotten away with borrowing less by using the proceeds of a recent secondary offering of 2.3 million shares. Comtech cleared around US$42 million from the stock sale, which, incidentally, went for US$17.50 a share. And when you consider Comtech is posting returns on investment and equity of over 20% (industry average 5 and 10%, respectively), borrowing the capital at 9.25% makes sense.
2001: An earnings estimate
Now for the "money shot," as they say in a particularly seedy biz. I'll lower the backlog to US$30 million, assume zero growth for EFData, use the low end of historical revenue growth (20%), and assume a minimal order from the government contract (US$10 million), and I still come up with 2001 revenues of US$163 million.
Telecom equipment stocks trade at some pretty high valuations. The industry average price-to-sales is 20, for instance. Comtech currently trades at around 1.8x sales. At current multiples, US$163 million in sales would value the stock at US$46 a share. That's 200% from where it is now.
I believe Comtech should trade at a higher multiple, but there needs to be more institutional support for the stock. 36 institutions hold 30% of the outstanding shares, but that only amounts to about 2.2 million. Insiders hold another 11%. Even with the 3-for-2 stock split last July, there are only 7.3 million shares outstanding, and another 6.5 million in the float. Comtech needs to have more shares out there for institutional investing to increase. With 30 million shares authorized, and only 14 million issued, I look for Comtech to announce another split in the near future.
Based on a pattern of growing sales, steady profitability, a potentially gigantic government contract and the acquisition of EFData, I rate Comtech Telecom a strong buy with a one year price target of US$46 a share.
I think we should be able to get in under US$15 a share, but I consider anything under the secondary offering price of US$17.50 a good entry point.
You can contact Comtech Telecom at 105 Baylis Road, Melville, NY, 11747. The phone number is (631) 777-8900, or you can e-mail them at info@comtechtel.com. Website: www.comtechtel.com
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2000 (est) |
1999 |
1998 |
1997 |
1996 |
1995 |
| Sales |
US$53 |
US$37 |
US$30 |
US$24 |
US$20 |
US$16 |
| Gross income |
US$13 |
US$11 |
US$8 |
US$7 |
US$6 |
US$4 |
| (All figures in millions) |
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