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Pacific Internet (PCNTF): New Stock Recommendation

Posted on February 28, 2006

Investment Summary:
I believe that Pacific Internet (Nasdaq: PCNTF), at its current price of about $7.60, represents a low-risk Internet investment, with substantial upside price potential in the next year, as the company capitalizes on new growth opportunities, under the guidance of a new CEO. In addition, with the recent unsolicited buyout offer of PCNTF, the stock could see more upside if the company gets into play as an acquisition candidate. 

Background:

The current stats on PCNTF are as follows:
Current Share Price:  7.60
Shares Out: 13.5 million fully diluted
Market Cap:  103 million
Net Cash: 34.5 mm
EV (Enterprise Value or Value of company minus cash + debt):
$68.5 million
Last Year Sales: $103 million

Last Year Free Cash-Flow: $6 million

EV/Sales: 0.67

EV/FCF: 11.4

Pacific Internet (PCNTF) generates revenue from selling Internet access and other valued-added Internet services (i.e. VOIP) to consumers and businesses, in Singapore, Australia, Hong Kong, Philippines, Malaysia, Thailand, and India.  At year end 2005, the company had 115,550 Business Customers and 261,166 Consumer Customers for a total of 376,716 total customers. The company´s business customer base is expanding, while its consumer base is contracting due to a switch to broadband from dial up Internet access. Specifically, the company´s customer base declined by 20% in 2005, because of a decline in consumer dial-up, but the business customer base grew by 15%. Overall, PCNTF operates in an attractive industry with strong growth potential and good economics (i.e. recurring revenue model).

Why is the downside risk in the stock low?

As can been seen from PCNTF’s stats, the stock has low downside risk at the current price because:

• Horrendous Recent Stock Performance

PCNTF’s stock has barely moved in the last three years and is way down from its bubble highs of over $40 per share.

• A Strong Balance Sheet

Over 30% of PCNTF´s market cap is in cash, providing good downside protection. The company´s cash position should continue to grow througout 2006, because of continued profitability.

• Recent Acquisition Offer

On February 28, 2006, MediaRing, an Asian VOIP provider, based out of Singapore (see their website at: www.mediaring.com for more information) offered $8.25 per share for all the outstanding shares of PCNTF. Interestingly, MediaRing has been buying shares of PCNTF in the mid-6 range throughout 2005. Clearly, if an outside investor with substantial insider knowledge of PCNTF´s business is offering $8.25 per share for PCNTF, you can be comfortable buying the stock at current prices. As can be seen below, MediaRing is trying to get PCNTF at a bargain, so I think the $8.25 per share valuation is low.

• Low Valuation

As can been seen above, PCNTF is trading at a very low 0.67 EV/Sales. With a recurring revenue model and strong growth opportunities, and looking at similar companies in the Internet Industry, I think a proper value is actually at least 1X EV/Sales or $10.18 per share. Another way to look at is to say the company should trade at about 15X Cash-Flow + Cash or about $9.20 per share. In either instance, the stock seems undervalued and the $8.25 per share offer is a low-ball offer. In the worst case, assuming no further growth, the stock is probably worth about $6 per share, though it seems difficult to imagine the stock will trade there based on the $8.25 per share offer.

So why should you invest in PCNTF now and what is the potential upside?

Without being overly repetitive, the three main reasons to invest now are:

• MediaRing Offer

Acquisition offer at $8.25 by Media Ring, puts the company into play. Even if no other interested parties emerge, clearly PCNTF management must do something to increase shareholder value. They can´t just ignore the $8.25 valuation.

• New Chief Executive Officer

In early January, PCNTF appointed a new CEO, Mr. Teck Moh Phey. According to PCNTF (I have not verified this information, but the company seems quite open and honest, based on my readings of SEC filings):

"Mr. Phey has two decades of leadership and management experience in the information technology (IT) and telecommunications industries. He is currently with Motorola where he served in various senior roles in the Asia Pacific region over the last 10 years, including Asia Pacific Vice President and General Manager for its Government and Enterprise Mobility Solutions business. In this role, Mr. Phey oversees the business unit’s profit & loss, sales, marketing and product planning for Asia Pacific.

In the last several years, Mr. Phey successfully grew the government and enterprise sector into one of Motorola’s most profitable businesses. In doing so, Motorola enjoys a dominant position in this space. During this time, Mr. Phey also turned around Motorola’s wireless business in China and significantly expanded its presence into multiple cities. Mr. Phey has served as Chairman of the Board at Shanghai Motorola Telecom Products Co Ltd since 2003."

The bottom-line is that the new CEO has extensive experience and contacts in the Asia Pacific region. The experience and contacts should help PCNTF grow its business customer base.

• The Singapore Stock Market is Hot and Foreign Internet Companies are Hot

The Singapore stock market recently hit a six-year high, and I think it is obvious that foreign Internet shares, particularly those involved in the Asia Pacific, sell at extremely high valuations. So the macro-environment for PCNTF seems favorable.

What are the risks here?

Declining Consumer Customer Base in Dial-Up, for Consumers

PCNTF is in a similar situation to US-Based Earthlink and/or AOL. The company´s dial-up Internet business (the largest part of its business) is declining rapidly. So, if PCNTF can´t replace these customers quickly, the stock will remain at depressed levels for a long time.

Competition for Broadband is Intense

At the same time as PCNTF is losing customers, the competition for business and broadband customers is intense. PCNTF is a tiny company in a huge pond of larger competitors. Notably, the company´s margins are under pressure due to this competition. Specifically, gross margin for 2005 dropped from 55.1% to 52.9% primarily due to lower average revenue per user (ARPU) arising from competitive pricing pressure.

Other risks include:

Foreign Government Meddling in the Business (e.g. you never know what is really going on in Asia Pacific Countries), and

A Somewhat Strange Corporate Structure (e.g. a corporate travel subsidiary that has seemingly nothing to do with the current business, accounts for about 4% of sales, though I guess one could argue that business provides leads for the Business Internet division)

The bottom-line:

I believe that PCNTF´s current stock price already adequately reflects the risks mentioned above. However, should the company´s broadband and business customer segments accelerate in the year ahead, above current expectations, the stock has at least 30% upside from current levels. In addition, the recent bid from MediaRing should serve minimize the downside for now as PCNTF executes on several growth plans.

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This site may include market analysis and we may own shares in the stocks mentioned in our reports. 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.

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