MIND CTI is now more reasonably priced but still has risks

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SPIRIT CTI (NASDAQ: MNDO) is an Israeli company that develops CRM software for small and medium-sized telecommunications operators.

In a previous post from February 2022, I commented that MNDO was aware of the threats in the telecom markets, in particular due to consolidation. The company is trying to break into new business segments through acquisition.

MNDO made two accretive acquisitions in 2019 and has $15 million in cash in 2Q22. The company regularly declares its intention to acquire another company, but has been slow to do so. In my opinion, this signals the prudence of the management of the company, a desirable characteristic. With significant insider shareholders, there is an alignment to do the best for the company.

MNDO’s revenues were down slightly from 2021 records, but did not deviate from normal. Over the past 10 years, the company has averaged net income of $5.2 million and paid out most of it in the form of dividends. Trading at a market cap of $44 million, the company looks cheap. However, in my opinion, the risk of losing customers is still there, and therefore the shareholder should ask for a higher return.

Note: Unless otherwise noted, all information has been obtained from MNDO’s filings with the SEC.

Competitive Characteristics

MNDO sells various CRM solutions to small and medium telecommunications operators. These include billing, e-commerce platform, onboarding, customer service, and more.

For a small and medium-sized operator (referred to as Tier III and II respectively), purchasing software from MNDO is cheaper and easier than developing in-house. While it may also be cheaper for a large carrier, the benefits diminish with scale.

The main problem facing the MNDO is the continued consolidation among telecommunications operators. Carriers need consolidation because fixed investments are high and fragmentation leads to rivalry. In addition, Tier I operators (those with national or continental scale networks) are incentivized to acquire downstream, get closer to end customers and capture more value.

For example, MNDO derives 60% of its revenue from European customers. Europe is known for protecting competition in the telecommunications sector and for avoiding multinational consolidations. This creates a landscape with small countries with many carriers each, instead of the continent-sized carriers in Asia or America. But this situation can change, and it does not depend on the MNDO. A Reuters article from February comments on Europe’s changing attitude towards consolidation, in hopes of attracting investment in fiber and 5G. Some companies like Vodafone are trying to test this changing regulatory attitude by engaging in consolidation.

The risk is not that MNDO finds itself in bankruptcy in the short term. The company’s activity is recurrent, with licenses that last more than a year. The problem is that the trend is towards fewer and fewer customers, who are not replaced by new carriers.

In terms of supply, MNDO hosts its R&D operations in Romania. It’s a price-conscious decision, comparing an average salary of $800 in Romania to an average of $3.5,000 for Israeli workers. This likely helped the company stay competitive and profitable.

Looking for new business

MNDO management has repeatedly stated that the company is looking to acquire business in other software segments. The company also has a cash reserve of $15 million which it plans to use for this purpose.

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Data by YCharts

While many companies would have rushed to acquire any business at any price just to promote a new business segment, MNDO took it easy. To me, this signals positive characteristics of management, seeking to protect the company’s long-term prospects rather than pumping the stock on the basis of promises.

I think it has to do with the position of management in the company. In particular, the company’s president and CEO, Monica Iancu, is the largest shareholder with 16.5% of the shares. This means that the company’s chief strategist has a lot of skin in the game. This again helps to align interests.

The above gives me confidence that when and if MNDO acquires another company, it will certainly be beneficial to MNDO shareholders.

For example, MNDO’s acquisition of two mobile messaging solution developers in Germany in 2019 proved highly accretive. Bought for just $3.2 million, the companies already generate half of MNDO’s revenue and up to 25% of its operating profit. More information was provided in my February article.

Recent neighborhoods, calm before the storm?

Information published by MNDO since I published my last article on the company has not changed my understanding of the situation.

The FY21 20-F annual report showed that the Telco CRM segment was not losing momentum yet, and mobile messaging was growing its revenue rapidly, reaching half of that year’s business. MNDO pointed out that part of the revenue from the messaging segment was non-recurring and therefore should be expected to decline.

In 1H22 the situation has not changed either. Revenue was down slightly in 2Q22 compared to 4Q21 (from $6 to $5.2 million), as was net income (from $1.5 to $1.2 million per quarter), but that’s not something that is outside of regular economic cycles, as shown in the chart below. Indeed, MNDO was able to renew contracts and resell licenses to two major customers in the telecom sector.

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Data by YCharts

But this relative calm should not make investors forget that the real risk, that of a slow but almost certain disappearance of customers in the telecom segment, is still there. This risk can only be mitigated by regulatory measures against the consolidation of telecommunications operators (eg in the case of Vodafone in Europe) or by the growth of MNDO in different segments.

Another risk, mentioned by Donovan Jones in a recent article on MNDO, is the company’s exposure to Europe. As the situation on the continent shows sign after sign of weakness, one wonders if the MNDO could be affected. My view on this issue is that the messaging industry may be negatively affected, but the CRM telecom industry may actually be favored by a crisis in Europe.

Messaging is displaced by advertising and customer interaction, this segment can certainly be affected if there is less money to spend on advertising or if customers are less active.

In contrast, CRM activity is displaced by the number of subscribers of each operator, and it is unlikely to decline too much during a crisis. The risk of a carrier switching to in-house developed software is also lower, as this transition would require investments in software and training which are less likely in a financially strained situation. The carrier cannot function without CRM and is therefore more tied to MNDO’s products.

Is the price cheap?

Since I recommended a hold rating on MNDO in February, the stock has lost almost 27%, compared to 17% for the Russell 2000 and 16% for the Israeli TA AllShares.

Today, the company trades at a market capitalization of $44 million, against an average annual revenue of $5.2 million. MNDO’s ADR price of $2.21 promises an annual dividend yield of 9% after taking into account a 25% Israeli withholding tax.

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Data by YCharts

Another possible benefit is to participate in the expansion of the company into new segments through accretive acquisitions. The problem with this advantage is that it is highly speculative. While I am convinced that MNDO’s management exercises judgment when evaluating potential acquisitions, betting on them finding one based solely on good intentions does not sit well with me.

In my opinion, MNDO could very well continue to generate the same level of profits that it has generated for much of the past decade, but that is beyond its control. Their future results depend on Europe not moving towards the consolidation of telecommunications operators.

The situation would be different if mobile messaging represented a larger share of their business, or if they had already diversified into other segments.

I prefer to watch from the fences in this case. If MNDO can grow the mobile messaging segment, and especially if it can make a promising acquisition, it might get more interesting.

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