Market cap: $50m
Enterprise value: $0
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?
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:
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:
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%|
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:
|Cash for distribution:||$41.5m|
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|
Currently, support.com is generating around $60m in sales:
|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