Why George Soros Owns Comverse Technology (CMVT): Stock of the Week ~ market folly

Monday, March 12, 2012

Why George Soros Owns Comverse Technology (CMVT): Stock of the Week

Continuing our new feature at Market Folly, today's stock of the week focuses on why George Soros' family office owns Comverse Technology (CMVT). If you missed the inaugural stock of the week, be sure to check out why Carl Icahn bought WebMD (WBMD) as well.

The following is written by Tsachy Mishal, Portfolio Manager at TAM Capital Management. He provides background on the situation, as well as what he likes and dislikes about the company:

Comverse Technology (CMVT) was involved in an accounting saga that dragged on for years and cost well over a billion dollars to untangle. During that period, a who's who of hedge funds tried to catch the CMVT falling knife unsuccessfully. Currently, Soros Fund Management and Barry Rosenstein's Jana Partners own major stakes in Comverse.

There has recently been progress as Comverse's financials are up to date and Comverse announced plans to separate their businesses with a spinoff of their Comverse unit. After the spin-off, shareholders will own the Comverse operating business and eventually shares in Verint (VRNT). The full details are not yet available as they are trying to structure this in a tax efficient manner and are still in discussions with the IRS on exactly how to do this.

Comverse trades with a market cap of $1.356 billion. They own $755 million worth of shares in Verint, a publicly traded company. They have $393 million in cash on hand at the Comverse operating unit. They own a 65% interest in Starholme, which at a conservative valuation is worth $45 million. Once one removes these items, the Comverse business is being valued at $162 million:

Comverse market cap @ 6.22 a share: $1,356 million
less value of Verint shares @ $27.98 a share: -$755 million
less cash on hand at Comverse operating unit: -$393 million
less 65% stake in Starholme: -$45 million

equals implied value of Comverse operating unit = $162 million

Comverse creates billing software for telecom companies. The most comparable company is Amdocs (DOX), which trades at a very conservative valuation of 1.5 times revenue. Comverse has revenue of $700 million, which means that at Amdocs valuation Comverse would be worth $1.05 billion. That is a far cry from the current $162 million the market is currently valuing Comverse.

Comverse management is guiding to 10% operating margins, which means net margins will likely be 10%, as Comverse has billions of dollars worth of NOLs. Amdocs has net margins of 13%. On this basis Comverse should be worth about $800 million, still a far cry from from the $162 million the market is currently assigning it.

What I Like

- Owning a software company that is cash flow positive with revenue of $700 million and 10% margins for $162 million seems like a no-brainer.

- There are high switching costs, so Comverse is likely to retain its customers. This predictable revenue stream might make it attractive to private equity or a competitor that could squeeze out better margins.

- Given all the distractions, it's very likely that Comverse is being under-managed and there is room for operational improvement.

- The bad actors have been removed from the board and the new board seems to be acting in the best interest of shareholders.

- I believe that Verint shares are undervalued as they trade at 11 times current fiscal year free cash flow estimates and nine times next year's estimate. This is for a fast growing small cap software company. Part of this discount likely has to do with their association with Comverse. A clean split could be a catalyst for a better valuation.

What I Don't Like

- Comverse does not have separate financials for its Comverse unit as a standalone company. One has to trust management on the 10% margin number.

- For years Comverse has seemed one step away from putting the fiasco behind them, yet the end has always been elusive. The spin-off is supposed to happen in the second half of the year, but this is not over until it actually occurs.

- There is a level of complexity to the investment as there are quite a few parts. One cannot simply buy the Comverse operating business.

I recently purchased shares in Comverse, albeit a smaller position than I normally purchase. It is difficult for me to see how one loses at the current valuation, although I'm certain that's what the hedge funds that have fallen before me in this stock thought. The difference is that the financials are now up to date and an end is in sight. The complexity of the situation and the history have me cautious and are the reason I have taken a smaller than usual position.

The above was a contribution by Tsachy Mishal, Portfolio Manager at TAM Capital Management.

Stay tuned for a new stock of the week in seven days. If you missed it, be sure to also check out why Carl Icahn owns WebMD (WBMD).

blog comments powered by Disqus