Last week, during the launch of Strategy Lab, I wrote an article explaining why I chose Apple Inc., the world’s largest company, as a growth investment. (Disclosure: I own Apple shares in my real-life portfolio.) This week, I’m sprinting back to the opposite end of the spectrum by looking at a small-cap Canadian company called Redknee Solutions Inc. (Disclosure: I own Redknee shares, too.)
But before I do, I’d like to touch on the concept of stock price and valuation for a moment. There is misconception among many amateur investors that a high stock price means that shares are overvalued. To believe this is an investing atrocity of epic proportion.
Apple trading at $700 (U.S.) has no bearing on its actual valuation. Why? Because it’s all a function of how many shares are in existence. Without looking at share count, the share price alone is meaningless. Just look at Berkshire Hathaway class A shares, which trade at about $130,000. Share price alone is meaningless. But for many investors, price becomes an emotional trap. Don’t fall into it.
When I tell you that Redknee trades at a buck and a quarter (as of this writing), you should now know that this fact, alone, doesn’t make it a cheap stock. But I do think it’s cheap, and that’s why I chose to invest in the company. My time horizon on this investment is several years. That said, I won’t complain if someone snaps up my shares as a strategic acquisition. In small-cap Canadian tech stocks, this has been a nice “problem” for investors to run into over the past few years.
Redknee makes software that helps wireless network operators generate more profit. Specifically, Redknee sells software to these operators so they can create new promotions quickly, track customer behaviour in real time, and properly bill these customers. In other words, Redknee software powers the revenue generation for wireless operators who sell cellular service to folks like us.
Billing is boring, but necessary. However, marketing and analytics are far more interesting to me. Most wireless carriers use billing solutions from larger companies, such as Amdocs. These older systems were not built to support the quick rollout of marketing promotions. Redknee not only solves this problem, but has proven its ability to deploy its software in the “cloud” and scale to support 250 million users – more capacity than any wireless operator actually needs.
I’m a growth investor, but I still appreciate value. Redknee’s market cap is $81-million (Canadian). It reports financial results in U.S. dollars, but with the two currencies close to parity, I’ll ignore this small difference. The company has $14-million (U.S.) in net cash and runs a profitable, cash-flow-positive operation. Last quarter’s earnings per share of 3 cents (the highest in three years) didn’t contain any significant unusual items, so on a run-rate basis this stock is trading at about 10 times earnings.
Revenue is on track for about $60-million this year, and the company is transitioning from a perpetual licensing business model to a recurring one. This is known in the industry as SaaS (Software as a Service). This transition means revenue growth probably won’t impress anyone in the next 12 months. Instead of booking large revenue at the time of a sale, the company will book smaller but recurring and more stable revenue, over the lifetime of the customer.
Inevitably this makes for a better business. But institutional investors will take a pass on the stock because it’s small, and they won’t look much beyond the revenue line. Yet, Redknee just signed a multimillion-dollar deal with a Tier-1 North American wireless operator. I think that’s evidence of the company’s cloud-based SaaS business model working. Redknee also has an order backlog of $56-million. Not too shabby. The company’s CEO, Lucas Skoczkowski, has been running the company since he founded it in 1999. I like that kind of management stability.
The wireless industry is growing rapidly. Yet the industry is in flux, moving toward more data services with less focus on selling voice plans. Wireless operators need flexible software solutions to create new plans, test their performance and measure customer activity for billing purposes.
Redknee’s software fits perfectly into this new world.
I like the odds on this stock.
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