This morning FiberNet Telecom (FTGX) reported outstanding results for the third quarter of 2006. Notably, Fibernet reported free cash-flow (defined as EBITDA minus interest minus cap-ex) of nearly $1 million on $10.4 million in sales. Sales jumped 20% year-over-year and EBITDA rose 160% as compared to 2005, showing once again that the company’s business model has excellent operating leverage.
Blog
Archive for October, 2006
SupportSoft (SPRT) is Still Our Top Software Pick
Tonight SupportSoft (SPRT) released Q3 2006 results which were basically in line with expectations. The company reported a cash-flow positive quarter on nearly $12 million in revenue, with license fees growing from the second quarter of 2006, maintenance revenue remaining stable, and the cash pile growing slightly to $122.5 million. Overall, it definately appears that SupportSoft’s enterprise software business has stabilized and that new growth initiatives should start to generate additional top-line increases for the enterprise business in 2007.
New Stock Pick: Fibernet Telecom (FTGX)
FiberNet Telecom (Nasdaq: FTGX). FTGX, is a highly-leveraged, micro-cap company, based out of New York City, that provides broadband transport and co-location services to over 240 clients. The company’s stock currently trades at about $4.30, down from a five-year high of over $100, and a two-year high of nearly $10. We believe the company is in the midst of a successful and sustainable turnaround in operations, and given the low valuation of its shares relative to recent M&A multiples in the sector, we think investors should be aggressively buying stock at current price levels or lower.
Financials Are Improving Dramatically
We’ve been following FTGX for quite some time, and we finally became interested in the company following the last quarterly earnings report. In the quarter, EBITDA was $1.2 million, up 207.2% from $0.4 million reported in second quarter of 2005 and up 30.6% from $0.9 million for the first quarter of 2006. Furthermore, in looking at the company’s 10Q, it appears that FTGX broke even on a cash-flow basis, after taking into account capital expenditures and interest expenses. We saw what happened to Internap’s stock when the company started turning the corner on a cash-flow basis, and we think that FTGX is now in a similar position to where Internap was about a year ago.
Valuation is Cheap
What makes FTGX even more interesting is that the company’s market valuation is still low when one takes into consideration industry valuations based on the recent M&A activity in the company’s industry and valuations given to FTGX’s competitors. With the stock trading at an over 50% discount to our expected value, we think the shares are very attractive at these levels, despite a recent run-up from $2. It is also worth noting that the company’s tangible book value on a fully diluted basis is about $6.00 per per share. It’s not often that we find a company in a hyper-growth industry, with improving company-specific financials, trading beneath tangible book value.
Upside Potential Far Exceeds Downside Risk for the Shares
Overall, we think that the supercharged industry backdrop, including recent acquisition activity, a generally positive outlook for bandwith transport pricing over the next year, and the continued financial improvements that we forecast at the company over the coming quarters, more than compensate for FTGX’s high debt level and dismal past operating performance.
We believe that as the company continues to report increasing EBITDA and cash-flow growth over the coming twelve months, Wall Street will finally wake-up to this developing turnaround story, and send the stock soaring. In a worst case, should the stock remain at low levels, we would expect management to put the company up for sale to a larger competitor. Any sale would likely be at significantly higher prices, making the stock a worthwhile investment at current levels or lower.
ActivIdentity (ACTI) Wins Big
Congrats to subscribers who have held on to ActivIdentity (ACTI). We recommended the stock on CasinoCapitalism.com, back in March 2006, at $4.37, and after alot of volatility were finally rewarded today with the announcement of a huge HSPD-12 government contract. Specifically, the company announced
a major contract win with the U.S. Department of Defense (DoD), U.S. Army and
U.S. Air Force for ACTI’s smart card desktop client software to enable their move to next-
generation HSPD-12 certified Common Access Cards for 3.5 million military personnel and
contractors around the world.
New Stock Pick: PMA Capital (PMACA)
PMA Capital (PMACA) is an insurance company that has been undergoing a turnaround since 2004. We think that over the next twelve months, investors will finally feel comfortable that the worst is behind for the company and the focus will shift towards renewed growth opportunities for PMACA’s core workers’ compensation business, which has been operating since 1915. As investor sentiment changes towards the company, its shares could rise by 50%+ over the next two years with limited downside risk for investors.
Though the company still faces some risks, we think that with the shares currently trading at a discount to book value, and considering the company’s solid core business, the current valuation more than adequately reflects these risks. It is important to mention that PMACA’s shares are very thinly traded and that interested investors are advised to use limits when buying/selling the stock. The limited liquidity also provides opportunity for investors, since it has been possible to buy shares on temporary “liquidity” drops in the stock. In the full interest of disclosure, we began buying the stock for clients at an average price of $9.
Reinsurance Diversion Almost Sinks the Company
So what went wrong with PMACA? Simply put, the company diversified out of its main workers comp business, into re-insurance and other non-core insurance-lines. Growth was of course good at the start, but as is common in the insurance industry when companies venture out of their core markets, the company underestimated its loss reserves (i.e. Liabilities established by insurers and reinsurers to reflect the estimated cost of claims payments that the insurer or reinsurer believes it will ultimately be required to pay in respect of insurance or reinsurance it has written).
Starting in late 2003, the company began recognizing significant charges to increase the loss reserves for the reinsurance business for prior accident years. Following these charges announcement, A.M. Best Company, Inc. (“A.M. Best”) reduced the financial strength ratings of PMA Capital’s subsidiaries. Ratings downgrades present serious, and at times terminal, problems for insurance companies. After the downgrade The PMA Insurance Group’s ability to attract and retain workers comp. business was severely constrained and the company lost many key customers.
The Developing Turnaround
As a result of the above negative developments, PMACA brought in a new chief executive officer, changed its corporate structure to “separate” the reinsurance and workers’ comp. businesses, and decided to cease writing reinsurance business beginning what is termed a “run off” of the reinsurance business. In November 15, 2004, after approving of these dramatic corporate changes, A.M. Best restored The PMA Insurance Group’s financial strength rating. The rating restoration enabled the company to increase new business written and business retention rates in 2005. In 2006, the company has continued to wind-down the run-off re-insurance business, reinvigorate the core workers comp. business, while continuing to grow fairly new Third Party Administrator business.
Back to Growth
Now that PMACA is finally “back in business”, and on more stable financial footing, there are numerous things that can now go right for the company over the next two years.
Firstly, the company will likely continue to be able to extract capital from its run-off reinsurance business and return that capital shareholders. What is happening is that PMACA has been able to “buy out” many of their major insured parties from the run-off reinsurance business via what is called commutation transactions. In a commutation transaction, the insured agrees to settle their claims in advance against PMA in exchange for an upfront payment which is at a discount to the potential liability. These types of transactions significantly improve the financial profile of the run-off operations by decreasing liabilities and increasing excess capital. Interestingly, on May 3, 2006, the Pennsylvania Insurance Department (the “Department”) approved an extraordinary dividend in the amount of $73.5 million from the run-off operations, which PMCA used to reduce debt. We expect continued special dividends from the run-off business in the coming two years. This will help the company pay down debt and ultimately re-instate the common stock dividend.
With regards to the core workers comp business, it is important to note that even though this is a mature and highly competitive industry with little growth, PMACA could still show above-average premium growth since it still has a ton of business to regain. Before the ratings downgrade in 2003, the company had grown to about $512 million in net written premiums for its core workers comp insurance business. Net written premiums in the same line of business were only $335 million in 2005. Clearly, with time, the company can regain a significant portion of this lost premium income. At the same time, the company has a fast-growing Third Party Administrator (TPA) business which will also add to profits in the coming years. The TPA provides various claims administration, risk management, loss prevention and related services, primarily to self-insured clients under fee for service arrangements. This business allows PMACA to expand and diversify its revenue base to include services that do not provide for any insurance risk.
Conclusion
Overall, we think that despite the fact that PMACA does not have the huge potential upside that some turnarounds in technology provide, we think the stock offers solid appreciation potential with much more limited downside and risks than our usual tech recommendations. This is not a company that faces any terminal risk due to the possibility that its product will become obsolete. We like to add solid financial businesses at cheap valuations to our portfolios since they mitigate some of the volatility and risk associated with an otherwise strong weighting towards technology names. And sometimes boring can be quite profitable.
New Stock Pick: Isolagen (ILE)
We think that Isolagen (ILE), an early-stage biotechnology company focused on the skincare market, offers investors an extraordinary opportunity to invest alongside a proven management team with significant experience in Isolagen’s core market. Though the company still faces substantial operating and financial risks, we believe that the odds and potential upside for the company’s stock price, assuming certain scenarios, is high enough to warrant buying shares in ILE at current prices or lower.
For a variety of reasons, Isolagen has had a few tough years, and shareholders of the company have suffered, with the stock declining to a low of $1 from over $8 in 2005. However, in June 2006 the company brought in Nicholas L. Teti to turnaround the company. Mr. Teti was the former CEO of Inamed Corp., a healthcare company that developed aesthetic products, and was sold to Allergan for $3.2 billion in 2005. Under Mr. Teti’s tenure, Inamed’s revenues nearly doubled to $440 million and its stock increased nearly fourfold to $84 per share. Notably, Mr. Teti has already brought in two other high-level executives from Inamed, to help restructure Isolagen.
It appears to us that the main problem for ILE in the past, had been that it did not have the right people in place with the proper experience in FDA Protocol Design, Manufacturing, and Marketing to really position this company for success, despite what appears to be an extraordinary platform for skincare therapy. The arrival of Mr. Teti and his team of proven executives, however, greatly increases the odds that Isolagen shareholders will finally see substantial returns on the company’s unique autologous cellular therapies for the treatment of wrinkles, burn scars, acne scars, and many additional potential applications.
We believe that the company under the new leadership of these highly-experienced executives will create a high-growth skincare company over the next three to five years with a combination of both FDA-approved procedures and high-end, scientifically-based skincare products. The business, if successful, would be highly profitable for the company and its shareholders. A quick look at the valuations afforded to companies in the aesthetic marketplace with FDA-approved products, is quite supportive of our investment case for Isolagen.
In sum, despite the fact that the company will likely face many more quarters of negative operating results, we think that the stock could move significantly higher over a longer-time frame as the company’s products move closer to FDA approval and the management team executes on several deals that could both increase the company’s revenue in the short-term, as well as, substantially increase the value of the company’s core technology platform over the long-term. We think that investors with a multi-year investment horizon would be wise to begin investigating Isolagen as a potential investment at this time.
Stock to Watch: Seitel (SELA.ob)
Note: Since this is a watch list stock, we have only provided an investment summary.
If you’ve been following our stock picks, you know that we occasionally recommend investments in M&A risk-arbritage situations. Specifically, we recommend taking stakes in companies that have an existing acqusition offer on the table and the stock is trading well beneath the existing acquisition price. PCNTF and STLW, two stocks that we recommended and continue to hold, were examples of this type of situation.
Additionally, if you’ve been reading our blog from some time, you also may know that we made subscribers a significant amount of money in the last year by recommending investments in seismic data companies. These companies offered the perfect combination of post-bankruptcy restructuring situations, favorable industry dynamics, M&A activity, and low Wall Street research coverage. Seitel (SELA.ob) was our top pick in the seismic sector and it rewareded us nicely.
We continue to hold Seitel (SELA.ob) and we want to remind investors that in August 2006, ValueAct Capital offered to buy the company for $3.65 per share. In the interim oil prices have plummeted and Seitel’s stock price has dropped beneath ValueAct’s offer. Without getting into detail here, we think that should the stock trade at a more than 10% discount to the offer price, or about $3.25 per share, the stock will start to offer an interesting trading opportunity. Can this happen? We’re sure that it can given the continued pessimism towards oil-related shares.
New Stock Pick: Autobytel (ABTL)
From our perspective, it’s not difficult to see where Autobytel has gone wrong and how a smart management team could easily fix this broken company and in the process greatly enhance shareholder value. Therefore, at current prices levels or lower we would be purchasers of Autobytel’s stock.
We believe that the company’s still solid balance sheet, valuable Internet property assets, and the low valuation of its shares relative to future business prospects, offer investors solid downside protection, as they wait for the company’s current management team to execute on new strategic corporate initiatives.
Specifically, it appears to us that Autobytel has failed to deliver satisfactory financial returns in the past because the company’s previous executive management teams have focused on building an online lead generation business, and other non-core auto businesses, while the real profitable action in the Internet industry was and will continue to be in the high-margin advertising business.
Our investment thesis is that the company, under the new leadership of several proven Internet executives, is finally beginning to allocate more financial and human resources to establishing a high-growth and high-margin online automotive advertising business. This strategy, if successful, would be highly profitable for the company and its shareholders. A quick look at the valuations currently being afforded to other consumer-driven, advertising-supported website properties, by both venture capitalists and public Internet companies, is quite supportive of our investment case for AutoBytel.
In sum, despite the fact that the company could likely face several more quarters of negative operating results, we think that the stock could move significantly higher over a longer-time frame as online advertising becomes a higher percentage of the revenue mix. As such, we think that investors with a multi-year investment horizon would be wise to begin investigating AutoBytel as a potential investment at this time, especially given the current positive investor sentiment towards consumer Internet properties.
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