CSG Systems (CSGS)
CSGS 3% convertible bonds are offered at 101 vs. 17.15 (JP Morgan). The issue is $150m with 4.6 years to maturity. Using a 500 credit spread, I get implied vol. of 27 and delta of 49. The stock has historically realized about 30 vol over the past few years if you take the outlier periods out. In the past two years, the stock has been as high as $21.34 (May 2011) and as low as $12.34 (October 2011). We will likely see more volatility in the next 12 months as CSGS has two large contracts that are coming up for renewals in December 2012 (Comcast 19% of sales) and March 2013 (Time Warner 10% of sales).
These contracts typically last for 5 years. Last time when these contracts were up to renewal in late 2007/early 2008, the stock went from $28 in June 2007 to $11 in March 2008 due to speculation about a contract loss. This time, either the overhang of the contracts uncertainty lifts and the stock trades much higher or the loss of the contracts will cause the stock to decline.
I see the stock trading to $24 (12x PE) in a bull case scenario or down to $13 (2011 lows) in a bear case scenario. I would put the trade on a slightly light delta of 45 delta because this will make the trade more balanced since the convert has a lot of points (31) to the upside. I also think that the most likely scenario is that CSGS will be able to renew the contracts at favorable rates in addition to winning other new contracts this year.
CSGS is rated BB by S&P. However, the convertible bonds are senior subordinated bonds and are not rated. The company has no other bonds other than the converts and only $178m of term loans due 2015. The company reports earnings on 8/7/12.
Company profile
CSGS provides outsourced customer care and billing solutions primarily to the cable and direct broadcast satellite industry in North America. In 12/10, CSGS acquired Intec Telecom Systems, which is focused on telecom carrier billing.
The top 4 customers account for 51% of sales. These are:
1) Comcast (19% of sales) – uses dual vendors with the contract split between CSGS (16m subs) and Amdocs (8m subs). Both contracts are up for renewal on 12/31/12
2) Time Warner (10% of sales) – uses dual vendors with the contract split between CSGS (5.6m subs) and Convergys (7.2 subs). Both contracts are up for renewal on 3/31/13
3) DISH – (13% of sales) Uses CSGS exclusively (13.7m subs). The contract runs through 12/31/17
4) Charter (9% of sales) Uses CSGS exclusively (6m subs). The contract runs through 12/31/14
Cable and Satellite customers account for 60% sales with the remainder coming from Telecom Providers (30%) and Utilities (10%). CSGS gets paid on average about $10 per customer per year although this varies depending on the level of services.
Competitors – in-house systems, Amdocs, Convergys (satellite and cable), Accenture, Comverse (wireless and wireline)
Credit Analysis
CSGS is a solid credit with low leverage and a high percentage of recurring revenues. Even if CSGS loses one or two customers, I believe that the company has a large enough base of other customers with long term contracts and recurring revenues to allow it to right size itself into the current capital structure. The negative is the company’s small market cap. CSGS is rated BB by S&P but the convertibles are senior subordinate bonds. I believe 500 credit spread for the convertible bonds is appropriate.
Cash $189m (plus $100m undrawn revolver)
Total debt $328m ($150m converts 3/1/17 and $178m term loan due 12/31/15)
Debt/EBITDA = 1.72x, Net Debt/EBITDA = 0.65x
EBTIDA/interest = 11x
LTM FCF = $111m
LTM Capex = $20m
Market cap = $607m
CSGS is a consistent FCF generator (see below) due to the company’s recurring revenues and low cap ex requirements.
| $mil |
2011 |
2010 |
2009 |
2008 |
2007 |
2006 |
2005 |
2004 |
2003 |
2002 |
| CFFO |
61 |
131 |
153 |
114 |
115 |
118 |
102 |
119 |
60 |
88 |
| Capex |
22 |
14 |
40 |
22 |
20 |
13 |
13 |
10 |
9 |
13 |
| FCF |
39 |
117 |
113 |
92 |
95 |
105 |
89 |
109 |
51 |
75 |
Covenants:
Debt/Ebitda < 4x (current 1.72x)
Ebitda/Interest > 2x (current 11x)
Equity analysis
At $17.40, CSGS stock trades 9x PE to 2012 estimated EPS of $2. This is below DOX at 11.2x and CVG at 19x. Part of the reason for the discount is uncertainty about the upcoming contract renewals, which includes not only getting the contract but the pricing of the contracts and the split between vendors.
I believe that the contract negotiations could create some large moves in the stock with the bull case being that CSGS stock trades up to $24 (12x PE) and the bear case going down to $13 (2011 lows). The stock has also had decent sized moves on earnings as shown in the table below.
| earnings date | stock reaction |
|
5/1/2012 |
9.4% |
|
2/7/2012 |
-6.1% |
|
11/1/2011 |
4.1% |
|
8/2/2011 |
-6.4% |
|
5/3/2011 |
-2.6% |
|
2/8/2011 |
-2.4% |
|
10/26/2010 |
8.9% |
Convert specific
Due to CSGS’s small size and leading position in the industry, the company could be a takeout target. On 45 delta, the breakeven takeout price is $22 (23% premium). I believe a takeout would be higher than $22 given the stock’s low valuation and market position.
Get the last coupon if converting before maturity.
Full dividend protection
Net share settle; 20 day averaging period