Telit Communications (LSE: TCM) released its annual results this morning and its shares rose as much as 16.5%, hitting 360p at point, although they have since fallen back. The company, which describes itself as “a global enabler of the Internet of Things (IoT)”, posted double-digit revenue and profit growth.
Chief executive Oozi Cats commented on the company’s “strong competitive positioning and global reach”. He added that “The IoT market is rapidly gaining momentum … We are very well positioned to address the numerous opportunities”.
Impressive
Telit reported an 11% rise in revenue, a 19.9% rise in adjusted EBITDA and a 21.7% rise in adjusted earnings per share. The latest results continue an impressive record of growth, as shown in the table below.
| 2011 | 2012 | 2013 | 2014 | 2015 | 2016 | |
|---|---|---|---|---|---|---|
| Revenue ($m) | 177.4 | 207.4 | 243.2 | 294.0 | 333.5 | 370.3 |
| Adjusted EBITDA ($m) | 13.1 | 17.3 | 26.9 | 34.7 | 45.3 | 54.4 |
| Adjusted EPS (cents) | 4.5 | 8.6 | 14.9 | 18.4 | 21.7 | 26.4 |
Even after today’s rise, the shares are on a P/E ratio of just 16.7 — a very cheap rating for a company on such a strong growth trajectory.
Odder still, Telit is easily the most heavily shorted company on the AIM market. Six institutions, with an aggregate short position of 10.7% of the stock, are betting on the company’s shares falling.
Not so impressive
I’m not privy to the reasons why these institutions have taken short positions in Telit but I can see why an investor might want to short the stock.
The table below shows some key numbers taken from Telit’s cash flow statement and some free cash flow (FCF) calculations that I’ve done.
| 2011 | 2012 | 2013 | 2014 | 2015 | 2016 | |
|---|---|---|---|---|---|---|
| Net cash from operating activities ($m) | 15.4 | 5.4 | 25.4 | 46.2 | 41.2 | 47.7 |
| Capitalised development costs ($m) | (3.7) | (7.7) | (9.9) | (26.1) | (26.1) | (30.8) |
| Other investing cash flows ($m) (excluding acquisitions) | (11.6) | (6.4) | (9.4) | (11.9) | (9.5) | (10.7) |
| FCF per share (excluding acquisitions) | 0.1 cents | (8.4) cents | 5.8 cents | 7.4 cents | 4.9 cents | 5.4 cents |
| Acquisitions ($m) | (23.4) | (5.3) | (10.6) | (2.1) | (0.4) | (15.4) |
| FCF per share (including acquisitions) | (23.7) cents | (13.6) cents | (4.3) cents | 5.5 cents | 4.5 cents | (8.0) cents |
| FCF per share at average annual acquisition ($9.5m) | (9.5) cents | (17.7) cents | (3.3) cents | (1.1) cents | (3.4) cents | (2.9) cents |
Net cash from operating activities looks good, having risen from $15.4m to $47.7m over the six years. However, capitalised development cost (deemed an investing activity) is open to management discretion (or, for the cynical, manipulation). Those of a cautious or sceptical disposition might be inclined to consider it an operating cost. In Telit’s case, it has escalated dramatically from $3.7m to $30.8m. If we were to treat it as an operating cost, the progression of net cash from operating activities would be a far less impressive $11.7m to $16.9m, rather than $15.4m to $47.7m.
Either way, though, capitalised development cost comes into the FCF calculation. For the latest year, my sums say FCF (excluding acquisitions) was 5.4 cents. As such, while the P/E ratio is a relatively cheap 16.7, the P/FCF is a very expensive 81.3.
Furthermore, it’s arguable that acquisitions are a routine part of Telit’s business activity. If we account for them as such, FCF is even worse (the second-from-last row in the table). Finally, as acquisitions are lumpy from year to year, we might use the average annual cost of $9.5m. This results in negative FCF each and every year (the last row of the table).
Bottom line
The bull case for Telit is that IoT technology is going to be huge and that the company’s revenue and earnings are growing fast. The bear case is that while multi-million-dollar acquisitions are producing large annual increases in revenue and earnings, Telit continually delivers little (at best) or no FCF.
I incline to the bear view that Telit is grossly overvalued on an FCF basis. As such, I have to rate the shares a ‘sell’.
