RE:RE:TD re-affirms buy w $5.50 targetPart 2:
Details
When thinking about further declines in recurring revenue, remember that Redknee has not lost a
single customer since the NSN acquisition (in fact it has gained at least one back). Mar. 30 will mark the
two-year anniversary of the transformative acquisition of the NSN billing and support systems (BSS) business.
Management emphasized that it has not lost any customers since the acquisition nor has any customer given
notice of an intention to transition off the platform – an indication that both the service improvement and R&D
investment have been well received. America Movil was a customer lost five years ago by Nokia (both the
billing and the network hardware). We heard that this customer was unsatisfied with its alternative billing
vendor and has resigned with Redknee. There are two known customers that should complete the previously
announced migration off the legacy NSN system in Q3 and Q4 – and recurring revenue should bottom then at
around $24mm.
Stage one of the stock price recovery should be that stabilizing of recurring revenue and more
confidence in cash flow – look for this by the end of FY15. Redknee has recognized $22-$23mm of
restructuring charges and has just started to see the benefit – expenses were down $3.7mm Q/Q in Q1. We
expect expense reductions to drive a 14.7% EBITDA margin in FY15 (the stated target is "mid-teens") or
$35.9mm (consensus is $38.0mm). CFO is expected to cover the cash restructuring costs and the near-term
earn-out owed to NSN (each about $14mm), but balance sheet management remains a key watch item over the
following quarters. Net cash at Q1 was $54mm.
Stage two is the stock being seen has having opportunities for organic growth (in a variety of verticals) –
which could lead to a significant revaluation. The stock currently trades at 8-9x EV/fwd EBITDA. This is in
line with high cash flow but slow growth telecom comparables like Amdocs, CSG Systems and Comverse.
Contrast this with broader enterprise software stocks trading at 12-17x fwd EBITDA (with mid-single digit
organic growth). In our view, Redknee has the following calling cards that make us confident in the growth
potential:
There seems a significant opportunity just for upsell into the installed base. Arguably lost in all
the handwringing of the near-term cash flow is the fact that Redknee acquired 130+ tier 1 carriers who
were suffering with a system allowed by NSN to atrophy. The new Redknee Unified platform is the
combined NSN platform with the Redknee end-end monetization and customer care solution.
Management believes that a $250mm+ license revenue opportunity exists for upsell within the base.
Redknee is arguably ahead of competitors on offering a virtualized solution, and has completed
the first virtualized platform within Vodafone group. Redknee has transferred over 40-60mm
subscribers at Vodafone Germany to a virtualized instance of its platform – said to be the first
virtualized platform within Vodafone (the second largest operator group in the world). One of the
growth vectors for the Redknee is customers looking to simplify their data centre infrastructure by
using virtualization.
Redknee can follow customers outside of the telecom vertical – we think the early (earlier than
the market had thought) successes in IoT legitimize non-telecom as a growth angle. While we
would characterize this market as developing, we see the IoT potential as an underappreciated
opportunity to leverage billing/customer care R&D and expertise beyond the mature telecom market
(i.e. telematics, transportation, healthcare, smart energy, connected homes). Redknee has so far
announced three non-telecom deals totaling $20mm+ in revenue (attractive term license revenue) over
seven years.
As networks are upgraded to LTE we believe there will be more opportunities for new customer wins
related to data monetization. One subtle change within Redknee seems to be less of a narrative around large
new customers that will be displacements of competitive solutions, and more around selling additive solutions
to work alongside legacy systems. Our view remains that LTE is the kind of technology change that will lead
to new data services opportunities for carriers – and new reasons to talk to Redknee. According to the GSMA
in Oct/14, less than 5% of operator connections were LTE. We have seen numbers such as Ericsson saying that
85% of North American subscribers (50% in Western Europe) will be LTE by 2019.