Dirty little thing called growth and why I think this small cap is good value
Like in most market downturns, small cap growth stocks are being punished hardest by a market that now views growth as a dirty word. This is great news for investors, as it creates opportunities to invest in businesses whose share price decline is due to changing sentiment rather than deteriorating fundamentals. In this climate, one company we think deserves investor attention is Symbio Holdings (ASX:SYM).
The Symbio share price has dropped from around $7 in October 2021 to around $4 today. To be honest, I don’t think it was expensive before the pullback. But getting re-classified as a tech company in late 2021 seems to have been a red flag for some investors.
Symbio is a telecom system and services provider, with a twist. It provides services to customers directly and to other telcos to help them run their networks, just like normal telcos do. But it also provides services to a new breed of telecom network user, via CPaaS and UCaaS solutions. That’s the tech part. Don’t worry if you don’t follow the fancy tech jargon-orientated descriptions below, or Symbio’s website description.
UCaaS (Unified Communications as a Service) is a software orientated cloud-based service delivery of key telecom functions – voice, video, conferencing and messaging. CPaaS (Communications Platform as a Service) is a software development platform with pre-built services, that makes it easy to integrate telecom related services into another IT environment.
Two use cases for Symbio’s solutions
Simply put, telecom networks we have today were designed and built long before the Smartphone-enabled future was considered. And that Smartphone has given rise to (unforeseen) business models that want/need access to these old-world legacy telecom networks as part of their customer proposition in ways that were never envisaged. Symbio’s CPaaS tools enable that access and connectivity.
And that’s a game changing growth (that dirty word again) scenario. You see, when Zoom needs to offer voice access to a video call conference it needs to be able to seamlessly join that call to its Zoom stream and have the audio terminate on the traditional telecom network. In Australia, Symbio’s software helps do that. When you are trying to find your ride-share driver, you don’t want them to have your number and vice versa, but you do want to place a call to find out where that driver is. Symbio’s software helps do that. These are just two of the many and growing use cases for Symbio’s solutions.
These customers, and many more like them, want seamless access to the existing legacy telecom network, and they want it to work without human intervention, natively from inside their own technology stack. They want to be able to do this without having to work through a large technology project with every telco in every market they want to operate in. Moreover, they want to be able to evolve their technology stack, as that’s where their competitive advantage lies, without having to continually re-work connections to all these telcos every time they make a change. Symbio takes care of maintaining the connections to the telcos, and makes available the services on those networks as lines of software code which are easily embedded into the core technology stacks of their customers.
Zoom and Ride Share companies are in the business of helping you work from home and get home from the pub, not building and maintaining non-core technology links with many telecom companies in many markets. Symbio’s tools let them focus their efforts on their core proposition.
The numbers behind Symbio
Now let’s deal with that dirty word. Growth. Well actually it turns out in Symbio’s case you don’t have to. You see our net present value (NPV) model says you need to believe in precisely zero growth forever and still make a return north of 10 per cent per annum with Symbio on its current share price. That’s worth a bit of explanation.
Symbio delivered $15.7 million of free cash flow in FY21 – yes, Symbio is profitable, growing, free cashflow generating, and investing costs and capex for growth (but don’t let that put you off).
If you assume free cash flow of $15.7 million per annum, with no growth, at 10.7 per cent (weighted average cost of capital) WaCC (see calc below) you get $4.13.
WaCC assumptions – Symbio had $51.6 million of net cash on its balance sheet at 1H22 (Yep, no debt – Symbio has $63 million of undrawn facilities, Symbio is bankable). So let’s use that inefficient capital structure against them in our WaCC calculation, and let’s assume the entire business remains equity funded. Australian 10-year bonds at 3.5 per cent (almost today), equity risk premium (ERP) 6 per cent (what we have always used) and a beta of 1.2. Historically it’s been sub 1 for Symbio, but we are trying to make this a discussion about how obviously cheap the current cashflows are and not about what beta we choose to use that illustrates that. Those inputs get you to a Cost of Equity of 10.7 per cent, which, if we assume zero debt forever, means WaCC = CoE, in this case 10.7 per cent.
Put another way Symbio at $4.13, FY21 free cash flow (FCF) grows at 0 per cent forever, but the net present value (NPV) model says will give you a perpetual return of 10.7 per cent per annum. For those that are more inclined to look at short-term earnings metrics, Symbio is on 8.4x F22 (June 22, i.e. last year) EV/EBITDA, and 7.6x consensus F23. Cheaper than the market at almost 10x.
CPaaS and UCaaS are growing markets and Symbio’s business has been growing with that. Consensus has Symbio growing EBITDA at 12 per cent CAGR, faster than the bottom-up consensus market EBITDA growth expectations of 7 per cent over the same period (which is unlikely to happen in our view, but that’s another story).
Symbio’s medium-term growth strategy
We haven’t invested in Symbio because it’s pricing zero growth; that’s just a nice to have. And we aren’t investing in Symbio for next year’s earnings. We are there because we think that medium-term growth strategy looks plausible. Let us explain.
Symbio is a dominant provider of CPaaS services in Australia, and has an enviable client list of global technology and consumer facing growth businesses. Those businesses offer telecom related features in their services in Australia and, as discussed above, Symbio enables that capability. In other markets in Asia, it’s not so straightforward for these customers to turn up and gain access to the local telecom markets, and those customers want a SYM like player in those markets. That’s Symbio’s medium-term growth opportunity.
Symbio has laid all this out, identifying six Asian markets as 2022-2025 growth regions to enter – Singapore, Malaysia, Taiwan, Japan, South Korea and Vietnam. Management’s 2030 vision is for 100 million phone numbers – the unit revenue driver for CPaaS. This compares to 6.4 million numbers Symbio hosts in its Australian CPaaS today. That’s a giant shift in addressable market.
The unit economics of this move in our view should be compelling, as Symbio’s toolset is software based, it should scale well, as this is not a heavy infrastructure capex build story. To help size this potential opportunity, Symbio’s CPaaS business made $18.6 million of gross profit in 1H22 – that’s an annual gross profit of just over $6 per annum per number. There will be some/lots of overhead as Symbio enters these markets, and we can’t be sure the unit economics above will be the same. But there is a lot of room to compensate for that and for error in 100 million numbers x $6 GP per number per annum = $600 million gross profit per annum versus Symbio’s current EV of $295 million.
Clearly a lot has to happen before the market will price in a $600 million gross profit per annum scenario from this Asian growth strategy. It’s early, but Symbio is getting some runs on the board having just gone live in Singapore with 10 clients (1H22) won already, and has plans to enter Malaysia this year. Do we think it’s all going to go smoothly? No. Is it going to take more time than Symbio plans? Probably. Can we tell today if 100 million numbers is a realistic opportunity? No. But neither is paying the costs and capex of market entry and getting nothing for it as the share price implies today. Plus this Asian Growth strategy is lower risk than a normal move to find overseas growth by an Aussie company as it involves servicing many of the same clients Symbio serves in Australia today – yep, its Symbio’s clients that are pulling them into these markets. This isn’t build it and they will come; many of those clients are already operating there, but without telecom access capability, and they want it built.
In any case you aren’t paying for it. Zero is priced in for growth of any kind, let alone an opportunity to address a market more than 10x what Symbio successfully addresses today.
In more “normal” markets you would expect to pay for the underlying growth you are getting today (which isn’t the zero the parsimonious NPV assumption-driven calculation suggests) and you would put some option value for the Asian growth strategy. That same NPV tool suggests Symbio’s Asian growth strategy succeeds is worth many many multiples of the current share price if it gets delivered.
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Gary is the Portfolio Manager of the Montgomery Small Companies Fund – a small-cap Australian equity fund investing in 30 to 50 high quality, undervalued small and emerging companies with strong growth potential. The fund invests outside the ASX100.