TD Securities Update part 3 Update and Changes to Our Investment Thesis
Still in the Early Innings of the Upgrade Opportunity. Most support contracts acquired through NSN were
billed using bundled pricing far below typical market rates for software maintenance (5-8% vs. market pricing
of 15-18% of the license value). As Redknee transitions ownership of these contracts onto its own model and
shows customers the increased value of its offering, there remains a significant opportunity to increase support
revenue (and margins). Redknee said in some cases they are driving 30-50% more value as contracts are
renewed. One interesting point is that if all the support contracts were at market rates, the acquired recurring
revenue base would be 3x or about $300mm. It will be a multi-year process to upgrade the majority of the
customer base.
Integration is Said to be Ahead of Plan; Margin Expansion Should Accompany Upgrades. Management
said it is 95% complete its integration activities and will be finished by next month. Expenses are expected to
remain stable at Q1 levels. The company is delivering EBITDA margins in line with its original target of high
single-digits in the first year after acquisition. As the company continues to execute on upgrading its customer
base, EBITDA margins are still projected to ramp to mid-teens in the next year and ultimately to 20%+.
We Believe Redknee Remains an Effective Play on the Europe LTE Deployment Cycle. EMEA was 52%
of revenue in Q1/14. A GSMA report has estimated that nearly 20% of U.S. wireless connections would be
LTE at the end of 2013 vs. less than 2% in the EU. As Europe continues to play catch-up (we have heard other
companies comment that Europe is 1-2 years behind), the added bandwidth enables different usage patterns
and different charging models. This could see competitive displacement opportunities as carriers re-evaluate
their legacy billing systems and potentially opt to add cloud-based modules.
New Customer Wins Are Upside to Our Model. Management said that customers tell it that competitors
have “taken it easy” on development, and that Redknee often ranks ahead of larger peers in terms of its
technology (available in the cloud, virtualized options, social media integration, the ability to monetize video,
etc.). This is evidenced by two acquired customers that were on a path to transition to a competitive product
recommitting to Redknee. The company highlighted a high level of engagement with prospective new
customers. Some potential new wins are $50-100mm (they had previously mentioned “9-figure”
opportunities). We see meaningful new customer wins as a potential source of upside to current estimates.