Commander Communications Limited (CDR) Share price free fall!...

Commander Communications Limited (CDR)

Share price free fall! Cheap but for traders now!

Recommendation 20070914: Speculative Buy
Investment Rating
CDR has successfully transitioned from a telco hardware supplier to an all-round IT hardware, network, and services provider. Brand strength and management capability combined with the favourable recurring revenue should make CDR a strong proposition. The acquisition of Volante in April 2006 extends CDR´s reach into larger enterprise and government sectors, with the move to franchise selling targeted at the previously under-serviced SME sector. CDR is suitable for investors seeking access to a growing sector.


Event

CDR shares have continued to freefall post-downgrade as institutional shareholders, in particular Perpetual and AMP, sell down their significant stakes in the troubled IT provider. Most recent concerns involve liquidity issues. Has CDR sufficient cash to remain afloat at current low operating profit levels and could the banks foreclose on existing debt?

Full Event Analysis

Impact

Our FY08 and FY09 forecasts remain unchanged. We assume no dividend in FY09. Our Intrinsic Value reduces 10cps to $1.25. Our view has not changed since our last report - 29/08/07 SCG33 - and we still believe CDR is cheap at these historically low levels. We believe at 50cps the upside potential looks greater than downside. This said, it could blow-up. Unfortunately it’s a murky situation, that’s why the stock price is so low.

The extent of the freefall below 80 cents has surprised us however. Speculative investors can Buy but keep in mind the high risk. Those with low risk tolerance can reduce positions. We expect volatility to subside somewhat post the dramatic PPT and AMP’s sell-off.


Recommendation Impact
(Last Updated: 20070914)
Recommendation is a Speculative Buy


Event Analysis
Share price free fall!
CDR shares have continued to freefall post-downgrade as institutional shareholders, in particular Perpetual and AMP, sell down their significant stakes in the troubled IT provider. Most recent concerns involve liquidity issues. Has CDR sufficient cash to remain afloat at current low operating profit levels and could the banks foreclose on existing debt?

Our FY08 and FY09 forecasts remain unchanged. We assume no dividend in FY09. Our Intrinsic Value reduces 10cps to $1.25. Our view has not changed since our last report - 29/08/07 SCG33 - and we still believe CDR is cheap at these historically low levels. Some parts of the company are decent and can make quite good profit if they are run properly. There has been a big stuff-up no doubt. The board will likely change management. Hopefully new management can make better use of the business. They will need to uphaul and fix Volante. We believe at 50cps the upside potential looks greater than downside. This said, it could blow-up. Unfortunately it’s a murky situation, that’s why the stock price is so low.

The extent of the freefall below 80 cents has surprised us however. Speculative investors can Buy but keep in mind the high risk. Those with low risk tolerance can reduce positions. We expect volatility to subside somewhat post the dramatic PPT and AMP’s sell-off.

High capex and acquisitions have driven CDR gearing to high levels, with net debt at $230m at FY07 year end. CDR expected to paydown debt quickly post the Volante acquisition until operations took a major stumble, beginning with the initial June earnings downgrade and most recently with a soft FY08 management outlook at the full year result. A cautious management outlook suggests a lack of visibility with management seeming still unsure of extent of 4Q07 billing problems and the switch to the franchise model. The continued skew of earnings to the last quarter of the financial year compound the problem. The question is Can CDR stay in business? Should CDR get through FY08 without needing to raise large amounts of capital then share price should recover somewhat.

FY08 management outlook is for EBITDA of $67 - $75m, up only 0-12%. Cash from operations has typically run below EBITDA. Finance costs of $26m for FY08 suggest an interest cover of around two times.

CDR’s current capital structure is unsustainable at current low profitability levels given (1) high debt at higher interest rates (2) considerable capex and working capital requirements, and (3) possible losses from sale of inventory. All three severely crimp free cash. We forecast free cash of $8m for FY08, increasing to $20m for FY09. Either EBITDA needs to return to $95-101m earlier guidance levels or capex needs to fall from current $35mplus levels for substantial free cash to be generated. Management has suggested it may be able to remove government-related assets from balance sheet, doing away with some capex requirements. Whether EBITDA can return to higher $100m levels – this was earlier guidance - depends on the extent of customer losses and brand damage.



CDR renegotiated debt covenants on the basis of new FY08 guidance. Concern is the more the share price continues to fall the greater the risk of contravening loan covenants with now more risk averse Banks. It is now more difficult and expensive it to raise equity capital for a perceived high risk situation. CDR has a revolving debt facility of $360m, up from $340m. At June 30 2007 $247m was drawn-down suggesting $113m is still available.

CDR has incurred serious damage to its brand. We now have a lower run-rate of revenue as typical maintenance and service revenue to which ICT hardware sales are a lead will be lost. The extent of these losses will not be known until 4Q08 and potentially 4Q09, and relies on CDR convincing customers to retain their services.

The move to franchise model is still risky and key to reducing labour costs and rebuilding margins. Six franchises remain unsigned in a target of 41, but management sees this as less important than the performance of existing ones.

Management assures us that problems with the Volante billing system have been fixed with no capex spend required. Poor performance could lead to asset write downs of Volante with a $147m price adding $115m of goodwill to CDR’s balance sheet. At the full year result CDR ensured investors an independent review conducted since the earnings downgrade did not result in a write-down of Volante. Inventory of around $10m remains on CDR balance sheet because of the 4Q07 transactions blow-up, but management say very little of this needs to be written off.

Corporate activity is unlikely while operations remain a mess. Pressure from the board has emerged to change management.

Both PPT and AMP are no longer significant shareholders after intense selling on Tuesday September 11, with around 35m shares or 15% of total shares outstanding traded. Part of the recent sell-down by PPT and AMP is likely to do with CDR coming out of the ASX200 and its now higher risk profile. Given the debt and management issue, and the complexity of the business issues, we would rate the stock as only for traders at present. The history of the company is not indicative of a quality business or a quality management.