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Investment Thesis
DATA Communications Management Corp. (TSX:DCM:CA) (OTCQX:DCMDF) (“DCM”) is currently engaged in a transformation from a ‘print first’ to a ‘digital first’ company. Not only is the business’ traditional marketing business beginning to see recovery from COVID, but its profitability will continue to expand as management implements its plan to cut costs. If management implements only its plan to reduce overhead costs by “an annual $11.4 million” and excludes the additional margin expansion that is to be gained from digitization, a prospective FCF yield of > 50% (based upon the company’s current market capitalization) can be achieved when one adds this figure to the company’s normalized FCF. Additionally, a calculation of the company’s normalized FCF with no margin expansion implies an FCF multiple of < 3 on the current stock price. While the company’s balance sheet is far from ideal, it has sufficient lines of credit to draw upon to meet any liquidity needs should they arise. When one takes into account DCM’s valuation, its recovery and future prospects, it becomes clear that it is potentially undervalued.
Background
DATA Communications Management Corp. (DCM) is a business communications solutions company that operates throughout North America. In addition to marketing, the company also provides warehousing and freight services. DCM’s marketing business was particularly afflicted by the pandemic, with lower revenues of 8.3% and 9.2% in 2020 and 2021, respectively. However, even in 2019 the company posted a revenue loss of 12.4%. The challenge of 2019 was largely due to the company’s failed launch of its Enterprise Resource Planning (ERP) system. This caused a “level of disruption on a day to day basis” that caused operational difficulties. What is notable, however, is that in the first five months of 2019, prior to the launch of the ERP system, DCM gained in excess of $45 million of lifetime contract revenue, reduced SG&A expenses and managed to pay down long-term liabilities. But these results were overshadowed by the post-ERP period. The company has since embarked on a turnaround effort to digitize its marketing business and cut costs.
Earnings, Revenue and FCF
Prior to the failed rollout of the ERP system and the pandemic, DCM’s revenue, while showing a decrease in 2016, increased at a rate of 5.2% per year. Revenue peaked at $322.77 million in 2018. While EBITDA decreased in 2016, it increased by a rate of 18.3% and 31.7% in 2017 and 2018, respectively. This not only shows the company’s increasing margins, but the operational leverage inherent in DCM’s business. The company’s FCF approximated $8 million from 2016 to 2018. However, the company’s FCF peaked during the pandemic in 2020 to $47 million. The company also managed to produce $25 million in FCF in 2021. While the company’s historical FCF was meager, its recent FCF brings the average to $15.7 million. These FCF gains have largely been a result of the company’s turnaround efforts to digitize its marketing business and cut costs.
Margin Expansion
While the company suffered during the pandemic, and its revenue decreased by 11% during the pandemic, its margins actually increased. In 2021, despite the lost revenue, the company’s gross margin improved by 1.4%. This was achieved primarily through “realizing the full benefits from the cost saving initiatives implemented throughout 2020 and 2021 [and] improved management of purchasing inventory and other direct costs” along with improved pricing. It should be noted that temporary and permanent layoffs sustained through the pandemic also buoyed margins in the midst of operational challenged brought on by the pandemic. While a 1.4% improvement in gross margins is not in and of itself evidence of a successful turnaround, it shows management’s commitment to cost cutting even in the midst of secular difficulties.
In the midst of the revenue shortfalls brought on by the pandemic, in addition to improvements in gross margins, the company also managed to improve EBITDA. Despite the aforementioned reduction of 8.3% of revenue in 2020, the company’s EBITDA increased by $13.42 million to $21.63 million even exceeding its 2021 EBITDA of $19.93 million. The company subsequently and predictably saw a modest EBITDA decline of $3.44 million in 2021 as the company’s business was primarily negatively affected by COVID in 2021. The company’s LTM EBITDA is currently at $26.38 million and management’s adjusted TTM EBITDA is $35.6 million. At the beginning of 2021 the company is “expecting to deliver an annualized $11.4 million in overhead savings,” which is yet to be fully realized. Assuming $11 million in overhead savings is realized, in isolation from the company’s anticipated increased revenue from digitization, when added to the company’s pre-pandemic FCF of $8 million investors would enjoy a FCF yield (based on the company’s current market capitalization of $43 million) of 43%.
The company’s LTM EBITDA is at a level that surpasses its reported figures at $26 million. The company’s EBITDA for Q1 was $7.87 million and $7.85 million for Q2. “This is the highest “clean” quarterly EBITDA we’ve reported for MANY years” according to management. On an annualized basis this would amount to $31.44 million. Given that the company’s capex from 2016 to 2021 averaged $1.8 million, the company’s interest expense is approximately $6 million and taxes of less than $4 million a year, if one believes the EBITDA figures produced in 2022 are sustainable FCF of $20 million could be within DCM’s capability to produce. However, DCM’s LTM FCF is only $10.8 million, largely due to changes in receivables and inventories. Additionally the company’s merger & restructuring charges largely seem to be a figment of the past as they “had ZERO restructuring expenses this quarter, and no other one-time, non-recurring costs or adjustments [and its] current outlook calls for ZERO restructuring expenses throughout the balance of the year.” However, to be conservative, even if FCF of only $15 million was achieved by DCM, investors would receive a FCF yield of 35% based on the company’s current market capitalization of $43 million.
Risks
DCM currently carries $61.35 million of debt. Additionally, it carries $49.84 million of current liabilities, which is offset by $60.14 million of current assets, $44.38 of which are receivables. Its net property, plant and equipment is worth $32.55 million as reported. However, DCM’s tangible book value is still negative, at negative seven cents per share. Management is explicitly committed to paying down debt, and its actions say as much. Since 2019 the company’s debt load has decreased by $49.6 million. While my conservative estimate of normalized FCF is $15 million, if DCM could reproduce FCF around that of 2020 and 2019, DCM’s debt could become negligible in less than two years. Additionally, DCM’s revenue could not return to pre-pandemic levels as its sales pipeline only approximates $10 million. as of Q4 2021. The transition of its marketing business could see further operational mismanagement similar to that of the failed rollout of the ERP system in 2019. While DCM’s turnaround appears to be succeeding, its debt, mediocre sales pipeline and further mishandled operational endeavors could threaten its business.
Valuation
The current market capitalization of DATA Communications Management Corporation is $43 million. Its average FCF since 2016 is $15.7 million and my most conservative estimate of its forward normalized FCF is $15 million. Additionally, the digitizing of its marketing business and successful ongoing commitment to reduce costs is set to further increase FCF. Its average unlevered FCF multiple (using LTM interest expense) is 4.9 and its normalized FCF yield is 35%. Were FCF to return to its average during the pandemic of $36 million, the FCF yield would be 84%. Simplistically, were revenue not to recover and margins not to expand further, DCM would be incredibly cheap, and were revenue to recover and margins continued to expand, investors could conceivably enjoy a FCF yield of > 50% on the company’s current market capitalization. While such figures seem unrealistic, when the undercovered nature of this security is taken into account, the reasons for this apparent mispricing become self-evident.
Conclusion
DCM is a communications business that has witnessed a decline in revenues since 2019 that was precipitated by its ERP system and continued by the pandemic. However, the company’s turnaround and pledge to go from a ‘print first’ to a ‘digital first’ company, in addition to cutting costs, appears to be successful. Not only have revenues begun to recover in 2022, but throughout the course of the pandemic margins had already been increasing. When the operational leverage of the business is taken into account, it is a reasonable assumption that such margin expansion will lead to asymmetric returns for investors. While DCM’s balance sheet is not ideal, management’s track record of paying down debt has made its debt load, while still large, unthreatening to the enterprise. Finally, DCM’s valuation is apparently unjustified due to the nature of its small market cap. In conclusion, the secular tailwinds by way of digitization, margin expansion and egregious undervaluation have all arisen from DCM’s obscurity to create what is, in my opinion, a massive opportunity.
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