My long-term orientation doesn’t typically fare so well in short term stock picking contests. Nonetheless, I have decided to enter the blogger face-off over at SINLetter. You can check in to see which of us are making the best picks between now and the end of March.
My picks were long SMH, short Diebold (DBD) and long CSG Systems (CSGS).
My RealMoney article from December 7, 2007:
CSG Systems (CSGS) is a leading provider of customer care and billing services for cable operators, including Comcast (CMCSA), Echostar (DISH - Annual Report), and Time Warner Cable (TWC). Since July, when the company announced in a shortfall in cash flow from operations, the shares are down more than a third. The current price may be a good opportunity for investors to buy a stable cash flow generator.
The cash flow shortfall in the second quarter was “due to unexpected changes in certain operating assets and liabilities at quarter end” as was largely made up in the third quarter. But don’t get me wrong - there are plenty of good reasons to explain the recent share price decline.
Let’s start with customers - the relationship with Comcast has been touchy at times, stemming from lawsuits related to Comcast’s 2002 acquisition of AT&T (AT&T’s former cable assets). That relationship seems stable now, but things could always get dicey again.
Then there is all the talk about Echostar being taken over. A merger with a company like AT&T (T - Annual Report) that does not use CSG’s services could mean CSG loses its number two client.
Next, even without any mergers and acquisitions activity going on CSG stands to lose when its customers have fewer bills to send out. Increased competition from telephone companies like AT&T and Verizon (VZ - Annual Report), along with trouble related to the housing market, have led both Echostar and Comcast to cut customer growth estimates recently.
So, suffice to say there are plenty of reasons to be concerned about CSG’s prospects in the near term. Now we have to figure out whether today’s one-third-off sale fully reflects those potential concerns. I think it does.
The Positive Side
If there is one thing to like about CSG Systems, it is that the earnings are predictable. Consider the last 12 quarters, which I charted below.
Source: Zacks Research Wizard
The knock against predictability, of course, is that the earnings are going nowhere. They have been stuck in neutral at $14-$16 million per quarter for much of the last three years. On the other hand, the company generates tons of cash - $105 million worth of free cash flow (cash from operations less capital expenditures) over the last 12 months.
And it uses most of that cash flow to buy back stock. In the third quarter of 2007 there were 17.5% fewer shares than there were in the same quarter last year. As a result, the earnings per share are far from stagnant. In fact, the last 12 months of EPS were 16.1% higher than the preceding 12 months.
Now that the share price has come down, the buybacks are having a bigger impact than ever. At the current pace, the company could take itself private within six years.
Free Cash Flow Yield
With $95 million in free cash flow and a current enterprise value of $638 million, CSG is sporting a free cash flow yield of more than 16%. Even if the $65 million they spent on acquisitions this year is deducted, the free cash flow yield would still be a healthy 6.2%, offering a solid risk premium over Treasuries.
With that kind of risk premium, investors look to be well compensated for the risks I outlined.
Zacks Investment Research has provided Stock Market Beat with a complimentary trial subscription to Research Wizard.
The Economic Calendar is relatively light this week. Potential market movers include:
Earnings are another story. We are in the peak part of earnings season this week. A few of the stocks we follow:
Monday
Tuesday
Wednesday
Thursday
Friday
Enjoy!
Disclosure: William Trent has a long position in SMH.
With the end of the first quarter approaching, it is time to adjust the names in our Watch Lists. We will price all the new lists as of the close on Friday, March 30. Today we present our planned updates to the Small Cap Watch List (Track at Marketocracy).
Frankly, we were surprised at the amount of turnover in our screens. Only 9 of the original 29 names made the cut for the new list (which comes in at only 24 names.) Still, given the level of outperformance we saw in the first quarter (actually just two months) and the fact that much of those gains were achieved early, perhaps the turnover is warranted.
So without further ado, the names on the chopping block from the previous list are:
Silgan Holdings (SLGN - Annual Report); Steel Dynamics (STLD - Annual Report); NVR (NVR - Annual report); Middleby (MIDD); Vector Group (VCG); Sanderson Farms (SAFM); Downey Financial (DSL); Waddell & Reed (WDR); Wilshire Bancorp (WIBC); Harrington West (HWFG); Gamco Investors (GBL); Apria Healthcare (AHG); Papa John’s (PZZA); Cato Corporation (CTR); Meredith Corporation (MDP); CSG Systems (CSGS); Energy East (EAS); Dynamics Research (DRCO); Ingram Micro (IM); and Dade Behring (DADE).
The new watch list will be:
Small Cap Watch List (Track at Marketocracy) member CSG Systems (CSGS) issued its 10K last week. We haven’t had a chance to review it thoroughly, but did notice some comments from Jack Ciesielski at the Analysts Accounting Observer Weblog.
First, this mention of SAB 108 in Note 3: “During the fourth quarter of 2006, we adopted SEC Staff Accounting Bulletin No. 108, “Considering the Effects of Prior year Misstatements when Quantifying Misstatements in Current Year Financial Statements” (“SAB 108”)… Our adoption of SAB 108 did not have any impact to our consolidated financial statements.”
But that bland statement of business-as-usual is contradicted by this one in the MD&A:
Income Tax Provision. The following are the key changes related to our income tax provision from continuing operations between years:
• For 2006, we recorded an income tax provision of $38.4 million, or an effective income tax rate of approximately 38%…
For the fourth quarter of 2006, we recorded an effective income tax rate of approximately 42%. The higher effective income tax rate was primarily the result of a correction of minor income tax expense items from previous periods that were not considered material to the current or past periods, giving consideration to the SEC’s Staff Accounting Bulletin No. 108, and thus were recorded in their entirety in the fourth quarter….
Hello? The effective tax rate was higher for the fourth quarter by 4% because of an adjustment for the SAB 108 correction of tax items - but simultaneously, the “adoption of SAB 108 did not have any impact to our consolidated financial statements?”Which premise is correct? Not both.
Give them credit for taking the high road and not revising history through retained earnings - they’re one of the rare companies observed so far who have taken the SAB 108 corrections into earnings.
We decided to look at the numbers fo answer Jack’s question. And if the 38% tax rate had been used, income taxes would have been about 850,000 lower for both the fourth quarter and the full year. And that would have made a $0.02 difference in earnings per share (without SAB 108 EPS would have been $0.02 higher), suggesting that there was a material impact. With all of the tax accounting intricacies it is possible the tax rate would have been higher than 38% in the fourth quarter anyway, but the apparent discrepancy deserves more of an explanation than investors have so far received.
We asked, but no one answered. So we are taking our own counsel and breaking our Watch List into three portfolios: Small Cap, Mid Cap and Large Cap. Each will be tracked against the relevant S&P index going forward from their collective inception date of January 31 (priced at the close of market trading that day.)
For your viewing pleasure, the Small Cap Watch List (Track at Marketocracy) (to be measured against the S&P 600) follows.
In addition, we will provide a “quick and dirty” analysis of each name, with a goal of one such analysis per day. As the name implies, the quick and dirty analysis will be incomplete. We are hoping you will join in the debate and fill the gaps in our analysis.
CSG Systems (CSGS) provides billing services to large cable and satellite operators. It is a boring, slow-growth business, as evidenced by their latest earnings report:
Total revenues for the third quarter of 2006 were $98.5 million, an increase of five percent when compared to $94.1 million for the same period in 2005.
Now, given that we have been berating slow-growth companies left and right, you might think think we aren’t too pleased with this type of result. Au contraire! Unlike those other firms, CSG Systems is a cash cow, throwing off about $100 million in free cash flow each year. With an enterprise value of $1.16 billion, that means it is trading at about 11-12x free cash flow.
Seen another way, the cash available to give shareholders each year is about 8.5-9.0% of the company’s value. Since the company does return that cash (primarily in the form of share buybacks) it is fair to consider this an investment that will pay 8% or 9% return without any growth. Since we don’t expect much more than that from the market as a whole, this stock looks like the market is pricing it for no growth at all. That five percent growth they gave shareholders was free of charge.
Of course, it is possible that the cash flow will actually decline, rendering the above analysis moot. But the same could be said of any company, and CSG has strong relationships with its major customers. While we wouldn’t ignore the possibility, we don’t see it as being any more likely for CSG Systems than for Xerox, IBM or anyone else.
With all the crazy private equity deals being considered, it’s a wonder this company is still public. Of course, with its planned buyback program the company may just go private one share at a time.
Analysts are paid to be paranoid, and sometimes the paranoia gets the better of us. One example of this was last week’s observation about Watch List member CSG Systems (CSGS) when we said that two press releases in one week was unusual for the company. We worried that they were trying to flood the market with good news ahead of potentially bad earnings.
We needn’t have worried. CSG beat analyst estimates and raised guidance, sending the shares up 3 percent. Even after the move the company is trading at an enterprise value of just 12.5x its trailing free cash flow, a capitalization rate that implies approximately 2 percent annual free cash flowgrowth, which ought to be manageable. In fact, the company is projecting it will grow 25 percent this year (though that is somewhat of an anomaly). The company announced another share buyback, having already reduced the average share count by 2 million shares (four percent) in the last year. These are not just buybacks to replace shares issued to employees on stock option exercise. This is honest-to-goodness reduction in the share count.
So we misread this one. To be fair, it isn’t like we were pounding the table to sell. We closed out our argument with:
Now, before you pull out your order book consider a few points. First, really bad news like losing a top five customer would probably have been announced already due to the Sarbanes Oxley rules. Second, the stock is already pretty reasonably valued on an enterprise value to free cash flow basis. Third, the nature of the companies business results in earnings and cash flows that are quite stable. Of course, that overall stability sometimes results in market overreactions to small misses.
In the end, we may be reading too much into two stories that just coincidentally came out this week. But they caught our attention, and we figured we would bring them to yours.
But let’s not whitewash it. The jist of the piece was clearly negative and clearly wrong, and we want to own up to those just as we crow about our successful calls.
Summary: Services are holding up fairly well in the current market.
PPI data for telecom shows that recent mergers have resulted in a less hostile pricing environment:
Leading customer care and billing solutions provider CSG Systems (CSGS) reported an upside earnings surprise and promoted Mike Scott to executive vice president and chief operating officer.
Credit reporting agency Equifax (EFX) earned $69.6 million, or 53 cents per share, up 11 percent from $62.6 million, or 47 cents per share, during the same period a year ago. Excluding certain items, the company earned 51 cents per share. Sales rose 7 percent to $387.7 million from last year’s $363.4 million. Analysts were looking for earnings of 50 cents per share on sales of $388.4 million. Shares fell on concerns of slowing growth in the face of declining mortgage applications.
Fidelity National Information Services, Inc. (FIS), a leading global provider of technology services to financial institutions, announced financial results for the second quarter of 2006. Consolidated revenue increased to $1.02 billion, Net earnings increased to $66.0 million and Net earnings per diluted share was $0.34. “FIS generated another quarter of solid operating performance. Year-to- date pro forma revenue growth of 6.2% and EBITDA growth of 10.4% are in line with our original full year expectations,” stated FIS Chairman William P. Foley, II. “With strong sales growth in the first half of the year and the recent launch of our new item processing and BPO operation in Brazil, we are increasing our full year outlook to reflect pro forma revenue growth of 5% to 7% percent, EBITDA growth of 10% to 12% and cash earnings per diluted share of $2.06 to $2.12.”
Rent-A-Center, Inc. (RCII), the nation’s largest rent-to-own operator, announced a messy quarter but the stock rallied sharply on an increase to guidance. The Company reported total revenues for the quarter ended June 30, 2006 of $583.6 million, a $3.0 million increase from $580.6 million for the same period in the prior year. Reported net earnings for the quarter ended June 30, 2006 were $39.8 million, or $0.56 per diluted share, representing an increase of 7.7% from the $0.52 per diluted share, or net earnings of $39.6 million for the same period in the prior year, when excluding the benefit of the 2005 tax audit reserve credit. “Our second quarter same store sales continued a positive trend in 2006,” commented Mark E. Speese, the Company’s Chairman and Chief Executive Officer. “Our same store sales increased 1.1% for the quarter, which is primarily related to changes in our promotional activities as well as an increase in the number of units on rent,” Speese continued. “In addition, we believe our customer has adjusted to the current level of fuel costs. As a result of these factors, we are raising our fiscal 2006 guidance to $2.08 to $2.15 diluted earnings per share from $2.00 to $2.10,” Speese stated.
Other News
Standard & Poors downgraded Convergys (CVG) on fears that it will lose major customers.
The Watch List declined 0.83% this week, which trailed the S&P 500 again but provided a significant boost relative to the small and mid-cap benchmarks that are more appropriate comparisons. Landstar had a strange round-trip. CSG Systems had too much news for our comfort. Earnings season started with a bang.
Some other stories that didn’t make it to either an industry summary or their own post include:
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