“heads I win, tails I don’t lose much”

 

Code:                           NASDAQCM.SPRT

Market cap:               $50m

Enterprise value:     $0

 

Thesis

Support.com is a very average business that provides technical support for customers of Comcast, Office Depot etc. that has been losing money for years. The reason I think it’s interesting is because it currently has a market cap of ~$50m and net cash on the balance sheet of ~$50m – which means the business is currently being offered for free.

 

Now normally, this would be a melting ice cube, where the ongoing losses erode the cash and eventually the business is a zero. However, activist investors took the company over in mid-2016 and they just posted their first quarterly profit since 2013. The company has also accumulated ~$140m in net operating losses that provide a tax shield on any profits for the foreseeable future.

 

I believe the activists will look to sell the business and use the cash box and tax shield to create an acquisition vehicle. I also think that if they can generate any level of profitability, the market will stop valuing it as a cash box and instead value it on earnings: balance sheet to income statement investment. Typically, this type of business could be sold for 0.8-1x sales, which implies 100% upside from current prices, with fairly limited downside given we’re paying nothing for the company.

 

Business overview & history

Support.com was founded in 1997, listed on the market at the height of the dotcom boom and it has been downhill since. In 2006 a new CEO was brought in who established the core operations that exist today and the legacy business was sold in 2009 for $20m. While it may be a dotcom baby and the company sounds like a “tech” firm, it is really a cost-plus, people business.

 

What’s the bet?

Essentially, the bet boils down to two questions: can they stop the bleeding and if so, can they generate a meaningful return on sales?

sprt

 

The investment thesis is relatively simple. I believe a highly incentivised management team (the activist shareholders) can stop the bleeding and generate some value from the business – which is currently being valued at $0 by the market. I believe the management team will likely sell the existing business and then use the cash box as an investment vehicle to utilise the ~$140m in net operating losses the business accumulated over the years.

 

The investment could be profitable even if the business cannot be sold or turned around. They could simply shut it down, use the existing cash and tax shield to make an interesting acquisition. There are multiple ways to win.

 

Why do I think they can turn the business around?

Support.com has been a poor performing business for a long time. So, what gives me confidence that a new management team will have any success in generating a return on sales? In short, because so far, they have delivered on their promises and last quarter they generated their first operating profit since Q4 2013.

 

Activists gained control of the company in June of 2016 and since then they have reduced total operating costs as a percentage of gross profit from over 300% to under 95%, allowing the company to return to profitability:

sprt2.png

 

Importantly, the focus on reducing operational costs has not come at the expense of gross margins or sales, both of which, look to have stabilised:

sprt3.png

 

What’s the market missed?

Support.com is an orphan stock, long forgotten by the market. In the last five years, the stock is down by ~80% and it has fallen over 95% from its dot-com highs. It is not covered by any sell side analysts, only trades around $150k in volume each day and over 25% of the free float is held by its activist owners. This is a stock off the beaten track, far away from the attention of Wall Street.

 

When will the market figure it out?

I believe the market will cease valuing the business on an asset basis and move to an earnings methodology when it reports a few quarters of consistent profitability – the market tends to only value the progress of a turnaround once it shows up in the P&L. The company will likely report a loss for the 2017 full year (unless Q4 shoots the lights out) however, it is also likely to show the second consecutive quarter of profitability. Investors may annualise this performance for the year forward, leading to a re-rating.

 

What’s the downside and key risks?

This is not a risk-less investment:

  • The market is in decline as the customers shift more towards automated, self-help offerings for consumers
  • High customer concentration with Comcast and Office Depot accounting for 75% of revenues
  • The company is barely breaking-even
  • The cash may be used to make an acquisition and take advantage of the large NOL balance
    • Creates a risk that the acquisition is a poor one
  • Staff turnover is very high because the pay is poor and the job very unappealing
  • Unknown legal liability (see below)

 

Potential legal liability

In 2016, an investigative journalist uncovered that Office Depot was using support.com software to trick consumers into believing their computers were infected with malware. Essentially, a consumer would come to Office Depot when they were having technical issues, an attendant would run support.com’s software to check for the presence of malware and if it was found, they would offer a service to fix the issue for ~$180. The trick was, the software always found malware. Therefore, many consumers who did not have malware centric issues, were tricked into paying the additional $180 for it to be fixed.

 

Estimating the potential liability to support.com (if any) is a pure guess. However, I have attempted to do so in order to assess the potential downside:

Test per week: 6,000
Years program ran: 3
Cost per test: $180
Estimated % that did not have malware: 10%
Total liability: $17m
SPRT exposure: 50%
SPRT liability/fine: $8.5m

 

Therefore, to estimate my “bear case” or downside valuation, I assume the actual business is worth zero, the company is hit with an $8.5m fine and the remaining cash is distributed:

 

Business value: $0
Net cash: $50m
Less liability: $8.5m
Cash for distribution: $41.5m
Per share: $2.22

 

At current prices of ~$2.70 this implies downside of <20%

 

What’s the upside?

Businesses in this industry tend to generate operating margins of 8-10% implying a fair EV/sales multiple of 0.8-1x (based on EV/EBIT multiple of 10x). This is consistent with where the peer group is currently trading:

Company Operating margin EV/sales multiple
Convergys 8% 0.8x
Sykes Enterprises 8% 0.7x
TTEC Holdings 8% 1.2x
Teleperformance 11% 1.9x
eGain <0% 2.4x
LivePerson <0% 2.7x

 

Currently, support.com is generating around $60m in sales:

Sales: $60m
Multiple: 0.8x
Net cash: $50m
Shares: 18.7m
Per share valuation: $5.25

 

At current prices of ~$2.70, the upside is around 2x. Given our upside is ~$2.55 and downside is $0.48, there is an attractive risk/reward skew at >5:1

 

13 thoughts on ““heads I win, tails I don’t lose much”

  1. Very straightforward thesis and simply presented, makes me want to buy SPRT. Only thing I query is the lawsuit – not sure what a person contacts SPR for but I would have assumed the overwhelming cause was technical issues, not malware. Are SPRT customers ordinary people & their computers, or office workstations at businesses?

    E.g. what is the likelihood of a work computer (which is presumably not used for gaming, pornography, gambling, etc) actually catching malware vs having a technical issue due to not being updated or improper installation or whatever? For ordinary people’s computers the figure is probably a lot higher, but anecdotally from my own experience probably 80%+ of my computer problems in the last 15 years have been technical problems, not malware.

    Not sure I’m reading this right, but your estimate seems to guess that 90% of the computers tested had malware. Prima facie I would have guessed the figure to be more like 5% or less, implying a lot of false positives which could lead to a much larger legal bill?

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    1. It’s worth noting that the legal liability is my assumption, there’s currently no lawsuit or anything regarding the malware incident. SPRT supplied the software to Office Depot (similar to officeworks) who had the customers (mostly ordinary people) come to them with computer issues.

      My estimate is extremely “finger in the air” and from conversations with people more in the know than me, Office Depot is more to blame than Support.

      It’s a good question though and is probably worth digging into more before I commit a meaningful amount of capital to the idea.

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  2. Another well written analysis. Always nice to uncover these sort of asymmetric risk opportunities, how did you uncover this little business? Its a bit of a needle in a haystack search! Do you screen with specific metrics to filter interesting things to look into further?

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    1. Thanks for the kind words. I wish I had a simple answer for you, but as with most things in life “it’s complicated.” I do screen for stocks trading below tangible book value and negative enterprise values – then go through them one by one. I also have several word search alerts that notify me of “strategic change” or becoming an activist target etc. They really are needles in a haystack though and it really just requires a lot of trawling through annual reports etc.

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      1. No surprises there! Anyone who expects a simple answer or a quick formula is missing the point. I think investing is largely long periods of inaction filled with a lot of looking and learning! Out of interest, did you work out where the $50m cash came from? It seems odd for a company that apparently has been unprofitable all its life, to have managed to accumulate/retain such a large nest egg of cash!

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    2. I think they raised some money many years ago and they also sold a business for $20m. The cash pile used to be over $100m and has slowly dwindled away. The bet is that now they’re able to maintain at least break-even and the melting stops!

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  3. Are you able to tell us a little bit more about the “activist investors” you refer to ?
    What else did you find out about them ?

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    1. Being US hedge funds, it’s a little difficult to find much about them. They’ve been engaged in numerous proxy fights etc. before and have had some successes and some losses – like most of us. Speaking with people in the company, they’re supposedly shrewd financiers and despite the turnaround taking longer than expected, they remain committed to generating value for shareholders.

      Sorry I can’t offer much more

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  4. Great writeup, thanks! Couple additions: they are losing Office Depot as a customer but not a huge blow as it was <10% of revenue as of Q2. Regarding OD legal liability, I remember seeing there was a similar issue years ago but they were insured and the actual payment was small. Activist group is led by Viex Capital. Their deck: https://www.sec.gov/Archives/edgar/data/1104855/000092189516004870/ex10tdfan14a10114013_060716.pdf

    Looking forward to SPRT earnings!

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    1. Thanks mate. Yep Office Depot is gone as of Q3, however, I believe there will still be some sort of trail revenues for the next 12 months & you are correct as they were <10% of revenues. From memory, the legal liability they got hit with a few years ago amounted to ~$8m but that's off the top of my head.

      What I find interesting about the activist pitch deck is that they have completely 180'd in their thinking – they now want to try and monetize the SaaS product and are focussing on growing the business as opposed to selling it and using the NOL's as a tax shield for an acquisition vehicle.

      Finally, I reckon Q4 earnings will be pretty ugly because it will be the first qtr without Office Depot – therefore, unlikely to see much growth. They're also investing in training some new people to take advantage of increased work from Comcast, so possibly added costs too. I'm hoping it's ugly and sells off as it should present a great buying opportunity.

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