There are many routes to becoming a successful company. The
standard one is to provide a desirable product to customers at a
profitable price. However, another highly effective approach is to
provide an essential service to other companies that are engaged in
the above action. CSG Systems International (
) has adopted the latter approach by handling the customer care and
billing services for a number of cable and direct broadcast
satellite markets, including such giants as Comcast (
) and Dish Network (
). Last year, the company also acquired Intec, a U.K.-based firm
that primarily services the telecommunications industry.
What drew my attention to CSG Systems, though, is its high
earnings power relative to its price. Setting aside certain
nonrecurring expenses, the company has an impressive earnings yield
of over 16% based on 2010 earnings, once its excess cash position
has been taken into account.
CSG's four largest clients are Comcast (24% of 2010 sales), Dish
Network (18%), Time Warner (
) (12%), and Charter (
) (10%), although with the Intec acquisition these percentages are
expected to decline. CSG has historically been successful in
renewing contracts, and last year extended its contract with Dish
Network in part through 2017. Even so, the degree of concentration
of customers is a risk factor that should not be ignored. The
Comcast contract expires at the end of 2012. The Comcast contract
was last extended in 2008 for four years. The contract with Time
Warner expires in March 2013, and the contract with Charter
Communications expires at the end of 2014.
Turning to the figures ... I mentioned earlier that the company
has an excess cash position. I calculate excess cash as total cash
and investments minus the extent to which current liabilities are
uncovered by noncash current assets. According to its latest
balance sheet, CSG Systems has $167 million in cash and
investments, $195 million in tangible current assets (consisting of
accounts receivable and income taxes receivable), and $209 million
in current liabilities. As a result, the company has $153 million
in excess cash. Subtracting that figure from CSG's market cap of
$585 million as of this writing, we get a figure of $432 million
for the market value of the company's operating assets.
In terms of earnings, I spoke earlier of certain nonrecurring
expenses that I will be adjusting for. These would be $12 million
in charges relating to the acquisition of Intec, and $20.5 million
relating to the company switching its data center to a new
provider. The data center switch also produced $15.5 million in
expenses in 2009.
So, in 2010, revenues were $549 million, operating earnings were
$74 million, but reversing the above nonrecurring charges and
taking into account a $14 million foreign currency loss brings the
figure to $93 million. The company also incurred $23 million in
excess depreciation. This produces a total free cash flow from
operations of $116 million. Interest expense that year was $7
million (although CSG Systems did issue a significant amount of
debt relating to the Intec purchase, so future interest expenses
will be higher). This produces pretax free cash flows of $109
million, which, at a 35% tax rate, produces an after-tax cash flow
of $71 million. Based on the above figure of $432 million for the
market value of the company's capital assets, that produces a free
cash flow yield of 16.4%, which I consider very attractive.
I should note that this figure differs from the company's
reported earnings for 2010 primarily owing to the noncash
amortization of the company's convertible bond issue, a loss taken
on bond repurchases, the company's interest income, and of course
the nonrecurring expenses previously mentioned. However, it is what
I consider to be a more reasonable estimate of the company's
sustainable earnings power.
CSG Systems Free Cash Flow 2008-2010
|Operating Income (net of nonrecurring items)
|Operating Cash Flow
|Pretax Free Cash Flow
|After-tax Free Cash Flow (35% rate)
The first quarter of 2011 is shaping up well. Sales were $183
million, operating income was $24 million, excess depreciation and
amortization was $10 million, producing $34 million in operating
cash flow. Interest expense were $4.3 million, leaving $29.5
million in pre-tax free cash flow, or $19 million in after-tax free
cash flow. Obviously, one should not make too much of a single
quarter's earnings, but CSG Systems is not a seasonal company and
this figure is at least consistent with (higher than, actually) the
company's historical ability to generate free cash flows.
In terms of debt, the company has outstanding $197.5 million in
term loans at LIBOR plus 3.75% due 2015, $150 million in 3%
convertible loans due 2017, and $25.2 million in 2.5% convertible
loans due 2024. The conversion price for the 2017 loans is $24.45
and for the 2024 loans it is $26.77. As we have seen, interest is
covered by cash flows nearly eight times based on the first quarter
of 2011's results and therefore the debt looks very safe. The price
of CSG Systems as of this writing is $17.88. However, if we apply a
10x multiple to the company's earnings, and estimate earnings power
at $70 million based on the 2010 figures, we get a value for the
firm of $853 million ($700 million for the earnings power plus $153
million in excess cash). Based on the 32.9 million fully diluted
shares, this translates to a price of $25.89, so there may be some
dilution from at least the 2017 bonds.
CSG Systems reports second quarter 2011 earnings on August 2.
that earnings will be 55 cents, marginally better than last year's
second quarter earnings of 53 cents. I will not comment on analyst
estimates, but it is probably worth keeping track of the date.
CSG Systems is a company with strong earnings power that has the
stability of long-term contracts behind it. The customer
concentration is a risk factor, although the Intec acquisition has
diversified the company's revenue sources. As long as the company
is capable of renewing its major contracts, I anticipate that its
earnings power will continue, and as it trades at a remarkably low
multiple to free cash flow, I can strongly recommend CSG Systems as
a candidate for portfolio inclusion.
I have no positions in any stocks mentioned, and no plans to
initiate any positions within the next 72 hours.
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