Israel-based Mind CTI Ltd. (MNDO, Financial) is a unique case for technology investors in terms of shareholder value creation. In our opinion, the share of the company can somewhat be compared to an ultra-high-yield bond with potential upside to the increase in the annual payment. Before we dive deep into numbers, let's take a look at the business background.
With a less than $50 million market cap, Mind CTI mainly provides convergent billing and customer care software solutions for communication service providers. The keyword "convergent" here means that through one single comprehensive platform, the end-user (i.e., telecommunication operators) is able to manage all subscribers (e.g., prepaid, postpaid) and all services (e.g., fixed telephone, mobile, broadband, cable, IPTV), which saves operational costs and enhances efficiency.
Billing and customer care are quite mission-critical to telecommunication businesses. Mind's platform can be deeply embedded into the client's day-to-day operations and even integrated with other parts of the technology ecosystem. Therefore, like many other business-to-business software providers, a high switching cost digs out the majority of the moat. This is reflected by financial data that shows margins and returns on capital have been mostly decent over the last several years.
In the 2019 annual report, management wrote:
"Customers that use many of the features of our products or use our products to support or enable core functionality for their applications may have difficulty or find it impractical to replace our products with a competitor's products or services, while customers that use only limited functionality may be able to more easily replace our products with competitive offerings."
To strengthen its moat, the company seems committed to investing in technology and product development. It typically spends nearly 20% of its total revenue on research and development. Given the size of the company, Mind may have difficulty leveraging a scale advantage here. But on the bright side, the business only focuses on tier-2 and tier-2 telecoms that are underserved by big software companies. What has been attractive in that niche is that those businesses struggle with competition from tier-1 players and, as a consequence, are eager to replace their legacy systems, which are often "non-convergent" and becoming obsolete, in order to maximize efficiency and protect profits. Nonetheless, this also comes at a price for Mind, as the total addressable market has been shrinking. Over the years, the company has lost revenue as a result of exiting businesses, market consolidation and cut budgets.
To counter this headwind, the company's management has been attempting to increase revenue out of the existing customers (e.g., platform upgrade) as well as looking for acquisitions to expand into adjacencies. Mind has seen some preliminary success in terms of the former, including two significant follow-on orders during the latest quarter. Be aware, however, that software orders usually lead to recurring revenue for maintenance and professional services over the years to come.
Regarding acquisitions, management has been exploring options in the enterprise messaging service domain and has already completed two deals (i.e., Message Mobile and G.T.X.) last year. The company paid over $3 million in aggregate for the two subsidiaries, which can contribute to additional annual sales of more than $8 million at this point, per our calculation. However, as the management admitted, these new businesses are low-margin. It is crucial how well the margin improves and the top line grows over the next couple of years.
Now let's get to some valuation numbers. At present, Mind is worth $46 million with no debt. Acknowledging its limited options to reinvest at a high rate of return, the company typically pays out an annual dividend amounting roughly to the free cash flow for the year, which ranged between $3 million and $7 million over the past decade. Assuming a modest level of $5 million in free cash flow moving forward, we come up with a free cash flow yield of almost 11%, which is already remarkable even if the business does not grow at all.
Furthermore, we noticed nearly $13 million cash and cash equivalents on the balance sheet as of the end of June. Theoretically, the company can afford to pay out all its cash reserves as it does not see any significant need for additional funding for working capital or capital expenditures. Hence, net of cash, shareholders harvest a yield of over 15%. Certainly, the management team will definitely want to keep that cash for additional acquisitions. Also in question is how much return those deals earn. For the past 10 years, the annual return on capital at Mind moved between 10% and 27%. So it is very likely management will allocate capital wisely from an owner's perspective to at least match the 15% hurdle rate of return. Notably, the founder and CEO of the company, Monica Iancu, owns almost 17% of the shares outstanding.
Lastly, two minor points worth considering. As the company is based in Israel, a withholding tax would be charged on dividends. Also, as the business is by no means a compounder, shareholders themselves would have to constantly look for reinvestment opportunities for any cash payout to generate a double-digit, long-term total return.
Disclosure: The mention of any security in this article does not constitute an investment recommendation. Investors should always conduct careful analysis themselves or consult with their investment advisors before acting in the stock market. We do not own share in any company discussed in this article.
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