Untangling Comverse's Quarter

I recently posted on MarketFolly my explanation for purchasing Comverse Technology. I will not rehash my entire argument but at the current market price of $6.45, the underlying Comverse business trades at $140 million or less than .25 times its $700 million in revenue. The reason the value has gone down, even though Comverse stock has gone up is that the value of their stake in Verint has increased.

Since I wrote up Comverse there have been some important developments. Convergys sold a business similar to Comverse's to NEC for nearly 1.4 times revenue. At that price the Comverse business would be worth nearly $1 billion versus the current valuation of $140 million. Comverse's largest competitor, Amdocs, trades at 1.5 times revenue so this seems like a reasonable price for an acquirer. Management has indicated they are reviewing all strategic alternatives so a sale is very possible.  However, in order for a sale to occur Comverse must first spin off its Comverse unit, which its in the process of doing, and then wait 6 months for a sale to be tax free. Those hoping for a sale are likely looking at waiting at least a year. I am buying this business for peanuts so the wait seems worth it to me.

My biggest fear has been that Comverse will burn cash between now and the time they could sell their business. Today's earnings announcement has gone a long way in allaying my fears. The Comverse business generated nearly $17 million in cash this quarter. They spent $18 million settling a shareholder lawsuit, which is now behind them. They spent an additional $20 million on restructuring and getting their financials in order. These costs are set to dramatically decline and eventually disappear. There is an end in sight to these extraordinary costs and burning cash is now much less of a worry for me.

Investors are dumping Comverse today on a disappointment in new orders. I believe it is much more important that Comverse finally has its cost structure in line and is able to generate cash. Comverse is on track to release its financials for the spin off in the next month or so. In order to make good money on Comverse at the current price one does not need a beat and a raise. All one needs is stabilization, which is what I believe we have seen. I was holding a small position in Comverse but have turned it into a significant position today.

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