Small Cap Stocks

It has been a little over a year since we first recommended shares of SupportSoft (SPRT). While the stock has not been a top performer, the year-over-year return has been quite satisfactory at about 30%. Normally, after holding a stock for over a year we would consider taking long-term capital gains, and transferring the proceeds into what we perceive as a better risk/reward opportunity. However, in the case of SPRT, we’re going to hold on quite awhile longer.

Our continued optimism is based on the fact that the company’s consumer offering, support.com, is just starting to get traction, as evidenced in the company’s the latest earnings release. In fact, the company’s first major revenue from this new service will only be recognized in the fourth quarter of 2007, with potentially huge growth expected in 2008.

In addition, and perhaps more importantly, the remote computer support industry, in general, is just beginning to gain wider recognition. Specifically, we think that starting later this year and into next, remote computer support will be marketed heavily by many large retailers and other service providers, helping to greatly increase awareness of these services with a wide base of consumers.

As the only pure public stock play in the growing remote computer support industry, SupportSoft (SPRT) shares could see a big boost once more consumers and investors recognize the potential of remote computer support and leading role Support.com is beginning to play in this still nascent industry.

The key question, of course, is whether the potential of Support.com is already reflected in SPRT shares and whether there is still room for some “irrational exuberance” as additional consumers and investors discover the stock. We think that at a current enterprise value of about $150 million (SupportSoft has over $100 million in cash), one can easily argue that the potential of support.com is still not yet reflected much in SupportSoft’s value.

While, we won’t go into details here, it’s important to remember that SupportSoft, as a whole, is not a start-up business. The company’s core enterprise software business is doing about $50 million a year in revenues, and also has interesting growth opportunities. While the enterprise business is lumpy, there surely are strategic buyers who would pay a decent multiple for this established business, especially as the company’s main competitor, Motive, continues to suffer from accounting and SEC issues.

This leads us to conclude that Support.com is still only a tiny slice of the SupportSoft’s current valuation and SPRT shares could increase significantly over the next 12 to 18 months, assuming revenue growth for support.com and the greater awareness of remote computer support, matches our expectations.

Please Note: We hold a position in SupportSoft and first recommended the stock at $3.95 in May 2006 . All ideas, opinions, and/or forecasts, expressed or implied herein, are for informational purposes only and should not be construed as a recommendation to invest, trade, and/or speculate in the markets. Any investments, trades, and/or speculations made in light of the ideas, opinions, and/or forecasts, expressed or implied herein, are committed at your own risk, financial or otherwise.

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.

Despite the negative reaction of the stock market, I believe that the new management team at SupportSoft (SPRT) is moving in the right direction with their new, albeit admittingly still somewhat underdeveloped, direct-to-consumer strategy, which CEO Joshua Pickus discussed in the company´s latest conference call. I encourage interested investors to listen to the call for an excellent overview of the company´s new business direction. 

Essentially, the new plan is an attempt to leverage SupportSoft´s enterprise software assets to create a mass market, customer-support business, that is somewhat similar to The Geek Squad (http://www.geeksquad.com/), a nearly $1 billion unit of Best Buy (BBY). The idea still has some small flaws, but I am pleased that the company is opting to invest a little bit of money on this type of growth path, rather than investing more heavily on the enterprise side. As I mentioned in my first write up of SupportSoft, I do not believe that the enterprise software business is very attractive for investors long-term, given the reliance on large one-time sales and in the case of SupportSoft a limited base of potential customers. However, a successful mass market technical business, though risky to start up and tricky to scale, offers potentially huge growth opportunities.   

Technology turnarounds, particularly in the software sector, can sometimes make for profitable investments. The reason is that assuming the "broken" company has a strong balance sheet and a decent product portfolio, with time, a good management team can reignite high-margin license sales yielding substantial and sustainable free cash-flow growth for quite a few years. At the same time, the downside for the business and investment is protected by recurring, albeit low-margin, service/maintenance revenue, assuming that the software is being used by customers.

Furthermore, investors generally ignore the fact that the
enterprise software business is very lumpy and as such they get too
optimistic when sales (on the license end) are booming and conversely become too pessimistic
when sales slow. The whole business is quite cyclical, though. Therefore, assuming the stock of such a "broken" software company is trading at a low multiple to service revenue and at a value which implies zero growth in new licenses, the stock usually offers a good investment "gamble" on a potential license or product "cycle" upturn.