"not easy growing revenue organically at 50%pa with such tight expense control.
Risk/reward quite favourable at these prices."Concur,
@mal85.
I think that the evolution in SKF's cost base, notably in relation to its closely tracking increasing Revenue in order to driver further increases in Revenue, is not well understood by the market, and which I sense tends to look mainly at the trends in the raw cash flows of the company (and EBITDA as a proxy for cash flows) and the market therefore says to itself, "So, yet another quarter of mere cash flow break-even; we'll look at it when it shows signs of turning the cash flow corner."
The problem with that somewhat myopic approach is that it overlooks the increasing latency in free cash flow generation.
By way of demonstration, the way I assess the path of the intrinsic valuation of the company, is to consider the free cash flow generation in 12-months time under hypothetical scenarios of:
1. The value of the company if it ceased investing in costs required to pursue further growth
and
2. The value of the company in an takeover scenario.
Starting with
Scenario 1: Suspending Investment in "Growth Costs"
Recurring Revenue is currently slated to be at a
$10m pa run rate.
(As an aside, I think that's a conservative assessment, because I observe around $0.5m per quarter, consistently for several quarters, of "Services Revenue" which relates to certain projects conducted by SKF on behalf of its clients. These are not one-off "set-up" or "implementation" revenues, rather they relate to specific projects requested by overwhelmingly existing clients, so I think they are more recurrent than the company has classified them. So maybe half of that service revenue, so $0.25m per quarter, i.e., $1m pa, could easily be considered to be of a repeating nature, in my view.)
By this time next year, even if the rate of organic growth in Recurring Revenue slows considerably compared to historical growth rates (which have averaged around 60%pa), Recurring Revenue run rate of around
$14m is conceivable by 30 December 2020.
(That would be 28% higher than my assessment of current Recurring Revenue run rate of $11m, or 40% up on the company's conservatively stated $10m...either way, the assumed growth is not out of kilter with precedent).
As it happens, the cost base of the business is currently tracking at a run rate of around
$14.0m pa ($8m for Staff, $2m on product manufacturing, $0.8m for Advertising, $0.5m for R&D and $2.5m for Admin and Corporate expenses).
So the cost base is roughly in line with the Recurring Revenues (no surprises there; that's they way they've managed the businesses so far, meaning that Free Cash Flow is zero. )
However, that cost $14m base can be viewed as having to discrete components:
1. A "stay-in-business" component (80% of those costs, so
~$11.2m)
2. Costs that are being incurred to drive revenue growth (20% of total costs, so~$2.8m)
Accordingly, under the "No More Chasing Growth" scenario, the Free Cash Flow would look something like:
Recurring Revenue = $14m
Less: Stay-in-Business Costs = $11.2m
=>Recurring FCF = ~$2.8m Because the company is sitting on the better part of $25m of retained losses, the tax impact on the company's cash flows will be zero for a long time to come, so all of that FCF will accrue to shareholders.)
Based on the current $54m EV of the company, that "steady state" scenario values the company on a
5.2% FCF Yield.
Which might not be a dripping roast, but it is probably a touch better than most small cap stocks, and is way more attractive a yield than the cash rate.
Of course, within 12 months time, if the exercise was to be repeated (all other things held equal) it would result in the following situation:
Recurring Revenue = $17.5m (assume 25% growth)
Less: Stay-in-business Costs = $12.3m (assume 10% growth)
=>Recurring FCF = ~$5.2m In this case,
FCF Yield = 9.6%, which is a lot juicier and on which the market should be basing its valuation in the company in around 12 months' time.
Scenario 2: SKF's Cash Flows in the hands of an potential acquirer.
One of the appeals of this company is that it is accumulating data about people (possibly a bit creepy, in a way, but that's what the modern world has become), and in this digital age, data is a very valuable commodity.
And that data might be worth even more to other players than it is to SKF.
So one scenario that can't be ruled out is that the company's founders and managers (who collectively speak for more than 20% of the shares on issue) might decide to cash in and nail a "For Sale" shingle on the company.
A prospective corporate acquirer, with its own head office, management team and directors, along with other fixed SG&A overheads, would see a large part of SKF's cost base a being redundant.
Conservatively, I suspect that at least 40% (and probably easily in excess of 50%) of SKF's cost base could be eliminated if the business was owned by another entity. But let's work with 40%, for the sake of being conservative.
The 12-month's prospective Free Cash Flow equation in this case becomes:
Recurring Revenue = $14m
Less: Reduced Costs = $8.4m (60% of $14m pre-takeover)
=>Recurring FCF = ~$5.6m FCF Yield = 10.5% (Of course, any would-be acquirer would need to pay a takeover premium, which would dilute this figure, but the point being made is that there is latent value there right now, and which is increasing over time.)
And if this discussion was being had in 12-months' time, the prospective figures under this takeover scenario would look something like:
Recurring Revenue = $17.5m (assume 25% growth)
Less: Reduced Costs = $9.2m (assume 10% growth)
=>Recurring FCF = ~$8.3m FCF Yield = 15% (!)CONCLUSION:
Needless to say, all of the above is merely indicative of a different way to assess this particular stock, which the market might be overlooking.
The scenarios considered above assume and presume a number of things, not least of which is the fact that the business has a product offering that is of sufficient longevity and that someone doesn't come along with a better mousetrap or some governing authority doesn't outlaw the scrutiny of people's activities and movements, even on a basis un-attributable to specific individuals.
But what the exercise does indicate - well, to me, at least - is that there is fundamental value in the stock, and that the fundamental value is increasing over time.
It's just that that fundamental value is not readily observable in the financial performance of the company, which is still not profitable.
But that's not because it doesn't have the ability to be profitable at present; instead it's because management simply chooses for it to not be profitable.
For good reason, I think, but one that is not immediately apparent.
Therein lies the opportunity, I think.
Not a sheer slam dunk opportunity, but a pretty decent one.
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