Trading at only 3.5x EV/LTM EBITDA, RRSat Global Communications Network Ltd. (NASDAQ:RRST) (“RRST” or the “Company”) is an underfollowed, growing, high free cash flow generating, dividend paying company with a predictable revenue stream, healthy balance sheet, attractive industry dynamics and a new CEO. In many ways, RRST reminds us of another Israeli company. ticker PERI, which we wrote up in mid-July and has performed well…although we believe RRST is a much better business and a much cheaper company, its near term growth is not as high as PERI’s.
This is an illiquid stock; however, we believe there are a significant number of shares available for sale by non-management shareholders. The stock is down meaningfully from its 2006 IPO at $12.50 per share. As illustrated below, we believe the stock is undervalued, even if one has to buy the stock at a premium to today’s price.
1) Attractive valuation – the stock trades at only 3.5x EV/LTM EBITDA which seems too low for an unlevered, high free cash flow generating, dividend paying company with a strong long-term backlog and favorable industry dynamics. For those of you concerned that management may waste RRST’s sizeable net cash balance (an unlikely scenario in our opinion), if you ascribe no value to RRST’s significant net cash, the stock is still trading at only 5.4x Equity Cap/LTM Adj. EBITDA.
2) Attractive dividend yield - Although there is no declared BOD policy regarding dividend distributions, during the past few years the BOD had declared semi-annual dividends usually at the amount of approximately 50% of the previous two quarters’ net income. During the first half of this year the dividend rate was higher. RRST’s capex requirements are dropping significantly, which may inspire the BOD to return more capital to shareholders. Annualizing the last dividend payment of $0.10 would imply a 3.6% annual dividend yield. The company generates more than enough free cash flow to pay this (or an even higher) dividend. This is an attractive dividend in today’s market and provides a strong incentive for people to hold the stock until the stock price begins to appreciate (aka “you are being paid to wait”).
3) Long term contracts provide strong visibility – Most of RRST’s revenues are derived from long-term contracts (typically 3 years), which provides strong visibility into the company’s revenue. For example, approximately $87 million of RRST’s total estimated 2012 revenue of $113 million were already covered by backlog as of the beginning of 2012. RRST’s backlog at June 30 was virtually the same as it was at the beginning of the year despite the negative impact of f/x and some anticipated customer losses (which did not prevent the company from reporting higher profitability).
4) Significantly reduced future capex – Going forward, capex will be significantly less than in previous years. Last year RRST completed a significant infrastructure upgrade. From 2008-2011, total capex was $65 million or $16 million on average per year. Now that the upgrade is complete, capex for the next few years should be significantly less, averaging $6 - $8 million per year, of which maintenance capex will be only ~ $2 million annually, with the remainder being growth capex. For example, included in the $6 - $8 million for 2012 and 2013 is a total of $4 million of capex for a facility consolidation (which will yield meaningful cost savings).
5) Healthy balance sheet – Net cash represents ~35% of RRST’s equity market cap and the company generates significant free cash flow.
6) Favorable industry dynamics – The global satellite tv industry is growing, with the total satellite tv channels projected to grow from 33k in 2012E to 48k in 2021. Another important trend is the increasing shift from Standard Definition to High Definition channels because high definition requires ~3x more satellite capacity which results in more revenue for RRST. Finally, broadcasters’ increasingly complex needs should result in greater outsourcing of their transmissions to specialized companies like RRST.
7) Flexible business model – because the company leases its transmission capacity, it has the flexibility to easily and quickly expand without incurring significant capital expenditures. Similarly, during times of reduced demand, RRST can reduce its cost structure more easily than if it owed the satellites.
8) Favorable payment terms – RRST’s long-term contracts are generally billed monthly in advance and are usually secured via a cash deposit for the last one to three months of service. As a result, the company largely operates with negative working capital.
9) Diversified revenue base - RRST has a highly diversified customer and geographical customer base. The largest customer accounts for only 4% of revenue (top 10 = 22%) and revenue is derived from Europe (43%), North America (28%), Israel (9%), Other Middle East (10%), Asia (8%), and Other (2%).
10) Improving operating results – Last quarter RRST reported its highest Gross Margin and EBITDA margin in almost 2 years, and we expect this positive trend to continue. Gross Margin has improved largely as a result of increased satellite capacity in the industry which enables RRST to lease capacity at lower prices. Since the company’s SG&A is largely fixed, any increase in revenue or gross profit largely will flow down to EBITDA. For Q3, management has guided to sequential revenue growth of ~2% and gross margins similar to the (high) margins generated in Q2.
The following table illustrates the implied EV/LTM Adjusted EBITDA based on various premiums to the current stock price. So, even up 50%, the stock still trades at only 6.2x.
1) New CEO wastes cash balance – It is possible that Mr. Cohen will spend RRST’s cash on something that will not create any shareholder value…but we doubt it. While he has not yet officially laid out his plans for the company, Mr. Cohen has struck us as a smart, responsible, and thoughtful person. Furthermore, RRST has 3 investors who collecting own 75% of the shares and control the BOD, so it is unlikely they would approve a risky or questionable transaction that was not be in shareholders’ best interests. Finally, even if the CEO were to throw RRST’s entire cash balance out the window, the stock would still be undervalued at only 5.4x LTM Adjusted EBITDA.
2) F/X – As the US dollar strengthens against the Euro and Israeli currency, RRST’s reported results are negatively impacted. This impacts its reported revenue, operating income, tax rate, net income, backlog etc. (as well as some non-cash items which the company excludes from its Adjusted Net Income).
3) War erupts in the Middle East – While this is always a possibility, there are many US listed Israeli stocks you can short to hedge out this risk (and most of them trade at much higher multiples than RRST).
1) On the last earnings call (which was the first for the new CEO) the company cut 2012 revenue guidance from $118 million (midpoint) to $114 million (midpoint). It is not at all unusual for a new CEO to cut guidance and reset the bar. Management blamed the reduction on worsening f/x issues and, to a lesser extent, a softening economy.
2) Approximately 75% of the shares are controlled by 3 holders, all of whom are on the BOD. While this creates illiquidity in the stock, it gives us comfort that the BOD and some large shareholders are motivated to create shareholder value. The large holders are Intergamma, which is publicly traded in Israel, (39%), Kardan Yazamut which is publicly traded in Israel, (24%) and David Rivel, former CEO (12%).
3) Although the company is based in Israel, it generates