Tuesday, May 24, 2016

I missed Zoom's big move

I wrote this post from Sept 15 - 17, 2015 when ZMTP was trading at about $0.80.  I placed an order for ZMTP on Sept 11, 2015 for something like $0.75.  It was a limit order for maybe 5 cents below market...man was I stupid.  I was trying to catch a low price rather than buying what I knew was cheap.  Costly mistake on my part but a good lesson to have.  When something fits just buy some then as time goes on you can try to get it cheaper.  Just as I finished my blog post ZMTP woke up and doubled then kept going higher, it now sits at $2.40 and I missed a triple.  I hold no shares.  I have had a limit order in off and on ever since but it has been fruitless.  I'm an idiot



Anyhow I wrote this whole thing and am just sick of looking at it sit unpublished so what the hell.  Might as well publish it.

ZMTP might be a buy now.  It still could double or even go higher but it's no longer the screaming buy it was.

Dan

current disclosure: never have had ZMTP shares and still kicking myself
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Zoom Telephonics (ZMTP) is a micro cap manufacturer of cable modems and related products. They have high insider ownership, no debt, and a ~$7M market cap. TTM EPS is $0.02 and book value per share is $0.26.

The big opportunity for Zoom was announced in a press release on May 18, 2015: they have signed an exclusive licensing agreement for the Motorola brand name.  Arris currently has the rights with Zoom taking over on Jan 1, 2016 for 5 years.  The market soon realized the significance of this deal and PPS shot up from about $0.19 to $1 in a couple weeks. The price has since dropped back down to around $0.80.  Bottom line is if the company executes anywhere near their predictions then this stock will be worth a whole lot more than the current price, so let's have a deeper look.  

We should start with the history of Zoom.
Zoom was founded in 1977 by Frank and Patrick Manning.  Frank has been CEO since day 1.  Terry Manning joined the company in 1984 and is now VP of sales.  Zoom designs, builds, markets, and sells cable modems and related product.  From the FY 2014 10-K:
Zoom Telephonics designs, produces, markets, sells, and supports broadband and dial-up modems, Wi-Fi® and Bluetooth® wireless products, and other communication-related products. Our primary objective is to build upon our position as a leading producer of Internet access devices sold through sales channels that include many of the largest US high-volume electronics retailers, and to take advantage of a number of trends in communications including higher data rates, increasing use of wireless technology for transmission of data, and increasing use of smartphones and tablets.
Zoom's largest market is the United States, accounting for 97% of FY 14 sales.  Their number 1 product is cable modems and gateways, accounting for over 80% of sales (according to the 2015 annual meeting conf call).  Zoom also sells DSL modems and mobile broadband products which "which provide or distribute a high-speed connection to the Internet that uses a cellular phone service provider’s network".  Dial up modem's were Zoom's largest source of revenue from the mid-80's to 2010 but are in decline, accounting for 18% of Zoom's sales in 2013 and 13% in 2014.  Zoom also sells WiFi and Bluetooth products.

For FY2014 ZMTP had sales of $11.9M and an EPS of $0.02.  Of this $11.9M we have about 11.9*0.13 = $1.5M dial up sales.  And about 11.9*0.8 = $9.5M in cable modem sales.

Cable Modems:
There are two market segments for cable modems: retail and provider.  During the 2015 Q2 conf call the CEO said he thinks the total US market for cable modems is probably over $1B while the retail market is around $150M.  ZMTP operates completely in the retail space.  Retail modem sales are online or at Best Buy or wherever.  The retail market is for someone who wants to own their own modem rather than renting from their cable service provider.  The provider market is much larger as most people would rather just rent the modem from their service provider who will then install and set it up for them.  These are two different markets requiring a different sales force, marketing, etc.

As far as the provider market, ZMTP's CEO has said the problem is low margins.  There are hundreds of providers and Zoom is not interested in going after the top two.  The CEO says they are interested in going after #3 and below.

Arris:
Zoom's biggest competitor is Arris (ARRS).  Arris sells many different types of products and cable modems are only a small piece of the pie.  They do not break out cable modem sales but ZMTP's CEO believes their retail cable modem sales are $50-100M.  Arris is the market leader for cable modems thanks to it's licensing deal with Motorola.  Arris bought Motorola Home from Google in 2013.  A few notes from Arris' most recent 10-K help to shape what Motorola means in the industry (all emphasis mine).

On the acquisition of Motorola Home:
Following our acquisition of the Motorola Home business from General Instrument Holdings, Inc., a subsidiary of Google, Inc. in 2013, ARRIS experienced significant growth in global scale and customer base and benefitted from an augmented engineering capability and product portfolio. As a result of the acquisition, ARRIS more than doubled in size and capitalized on many of the synergies between the two companies. 
Arris, with Motorola Home, is the worldwide leader in cable broadband products:
ARRIS has been a leader in the DOCSIS EMTA product category since its inception, and through the acquisition of the Motorola Home business, ARRIS is now a leader in the supply of all types of broadband CPE including DOCSIS, DSL, and FTTH. According to Infonetics Research, Broadband CPE Quarterly Worldwide Market Share and Forecasts for Third Quarter 2014, ARRIS was the leading worldwide provider of cable broadband CPE products in the third quarter of 2014 with approximately 36% worldwide share of revenues.
Motorola Home had more than double the revenue of Arris at the time of acquisition:
In April 2013, we completed our acquisition of the Motorola Home business, which was significantly larger than our business prior to the Acquisition. For the year ended December 31, 2012, Motorola Home had net sales of approximately $3.3 billion and total assets of approximately $2.5 billion, compared with our net sales of approximately $1.4 billion and total assets of $1.4 billion for the year ended December 31, 2012. 
Losing the Motorola brand name is listed as a risk item:
In connection with our acquisition of Motorola Home, we were granted the right, as extended, subject to certain conditions, to continue to use the Motorola brand name on certain products for a period of two years after the acquisition. We sell those products in geographic regions and through distribution channels, especially retail, under the Motorola brand where the “ARRIS” brand is not as recognized. 
Shelf space in retail outlets can also be impacted by how recognizable a brand is by customers. If we are unable to successfully rebrand those products, our sales in those regions and channels may decrease. Further, the loss of the use of the “Motorola” brand may result in a lower amount of shelf space, or space in less desirable areas, which may impact our sales. 
Arris most recent 10-K shows total annual revenue of $5.3B.  They are huge.  Their on Customer Premises Equipment (CPE) segment did $3.7B in 2014.  Unfortunately they don't break out cable modems or even retail sales so we'll have to take the ZMTP CEO's word for Arris' retail cable modem business being $50-100M.

The Motorola license for ZMTP:
So let's talk about what this new deal means.  Zoom has the rights for 5 years starting Jan 1, 2016.  ZMTP currently has annual sales of about $12M.  The Motorola brand name does $50-100M annually in retail cable modems so this deal will have a huge impact on Zoom.

ZMTP's CEO held a conf call in May 2015 after announcing the deal.  ZMTP has exclusive rights to the Motorola name in the US and Canada for cable modems, gateways, set top boxes, and telephony products.  Perhaps there's more but these are the major items.  Telephony would be a new development for Zoom but the CEO says they "hope to have some products with telephony."  Zoom says their margins should stay the same or increase and there should be "significant after tax profit in 2016 and beyond" "perhaps 8% of sales or higher."  ZMTP does not currently make set top boxes but will investigate the market, these go through the provider so it's a difficult market to enter.

New products for ZMTP:
Zoom has a few new things going on.  In May 2015 the CEO said they have a major push into AT&T and Verizon certified products (cell modems and LTE routers) which they plan to start shipping in FY Q4.  In August 2015  they announced FCC certification of a cell modem with GPS that they intend to submit for AT&T certification in Sept 2015.  The cell modems would be used in a M2M context such as Apply Pay.  LTE routers with wifi could be a good low cost solution for homes. 

The company has talked about a multi sensor which sounds interesting. It would connect to your phone through the cell network and has internal sensors for temperature, humidity, acceleration, light, and sound. They say it could be a DIY security system and I could see it being used for many other little projects. Hard to know what sales will look like though. Zoom expects to start shipping in Q1 2016. 

Zoom has also recently commissioned a new production factility in China.  Zoom is very excited about this new plant and the improvements it will bring.  It received a glowing review from Motorola prior to signing the lisensing deal.  This plant will supply the majority of cable modems, as well as other products.  

To me, the main point with these new products is Zoom's interest in expanding upon themselves and growing through R&D.  I don't know enough about any of these to estimate sales.  

How did Zoom get this Motorola licensing deal and will they keep it:
How did they get it?  Why did Arris lose it?  I've asked Zoom's CEO and they are not quite sure why Arris lost the deal.  One big issue between Motorola and Arris was the co-branding. When Arris sells cable  modems in retail  they are branded as both Arris and Motorola. That's a problem for Motorola as it dilutes the brand. When Arris sells to subscribers they use only the Arris brand. So it seems Arris was using the Motorola name to build their own name rather that letting Motorola stand on its own. 

I asked Zoom's CEO how they will keep the Motorola relationship going and he says they have a great relationship.  They work well together and Zoom will do everything they can to keep it that way.  Zoom will not be co-branding as Arris did, all products sold with Motorola's name will be Motorola only.  Zoom's CEO told me he thinks it's unlikely that they lose the Motorola lisense after 5 years.

Zoom's CEO told me Motorola has already approached Zoom with two trademarks extensions since May.  Zoom passed on both but moving forward the companies will look for ways to extend Zoom's use of the Motorola name.

On the Q2 earnings call in August Zoom's CEO gave an update.  They are on track for January 2016 with new cases designed which highlight the Motorola brand, not Zoom.  They have 6 different products with the Motorola name coming out.  they are working well with the Motorola lisensing team.  Zoom's initial focus is cable models while the mutual longer term focus is to expand.  Zoom's CEO said he believes they can do $50-100M in revenue at an 8% net margin on retail.

In Oct 2014 Lenovo bought Motorola Mobility from Google for $2.9B.  This includes Motorola licensing so Zoom is actually dealing with Lenovo now.  This could be a boost to the Motorola cable modem market as Lenovo will be marketing Motorola cell phones while Zoom is working with Motorola to create complementary modem case designs.

Financing:
Zoom will need money to expand.  Zoom filed an S-1 at the end of May 2015 to announce a secondary offering which would fund the expansion.  Offering price was estimated at $0.46 while the share price was $0.54.  Soon the share price shot up to $1 and Zoom amended the offering to increase the price to $0.90.  At this price Zoom was set to raise a maximum of $3.7M with their 8M outstanding shares.  Unfortunately the share price drifted down to around $0.80 so they did not get as many takers as they would've liked.  The offering sold 198k shares to raise $268k.  The CEO Frank Manning and co-founder Patrick Manning each bought $120k worth so the other sharesholders only put in $28k.

I had asked the CEO about insiders exercising their offering rights and he said they were low on cash.  It's good to know the two co-founders think enough of the company to exercise their rights at $0.90 when they could have bought on the open market at $0.80.  On the other hand they each only exercised about 1/10 of their shares.

The CEO told me that they still intend to raise $3-4M and are in talks with investors for a private placement.  Had the secondary been fully subscribed they would have enough money and the share count would have doubled.  With the secondary not providing enough shares they will now likely have to dilute more than they would have.  The sale price for the coming private placement is one of the big variables in this investment.

At the conclusion of the secondary in August the CEO said they have enough money for working capital and intend to raise the rest of this money later this year.  I asked the CEO if there will be a need for further funding beyond the $3-4M they are trying to raise now and he said no, the profits from this deal will be enough to fund significant growth if things go to plan.

How much revenue will Zoom capture:
Arris currently does $50-100M in retail cable modem sales with the Motorola name.  In the quotes from Arris' 10-K above you can see how important they believe the Motorola name is in retail cable modems sales.  Zoom's CEO has said that the retail cable modem sales are more dependent on the brand name than anything else.  He said Zoom has the cheaper product so they know that the lowest price does not bring high volume.  Zoom's CEO says they believe they can do $50-100M.

I don't know how to figure out what Zoom's revenue will be.  I think the best I can do is take the lower end of their own estimates.  The CEO has said he thinks they'll do at least $50M whenever he's asked.  Personally I agree with them that the biggest driver in retail cable modem sales will be the brand name and right now Motorola is the biggest name.

Conclusion and valuation:
So what does this all mean?  Well the big story for Zoom is the Motorola licensing deal.  Zoom now has annual revenue around $12M.  Before the recent financing Zoom has 8M shares outstanding and it's now more like 8.3M.  After the private placement I think there will be at least 16M.  The CEO has said they will not change the capital structure so the company will remain with only common stock and no long term debt.  Next year they should have at least $50M in revenue.

Some things I like about ZMTP:
  • CEO and co-founder together own about a quarter of the current shares outstanding
  • Company has no long term debt
  • Company is set to be the dominant player in a small industry

Some risks:
  • High customer concentration
  • Heavy dilution is coming
  • If the Motorola deal doesn't work out then the share price will dive back to $0.19

Let's run through some scenarios.  In the table below I calculate a share value based on the variables highlighted in yellow.  I try to come up with a range of values to encircle

  • revenue:  Zoom thinks they'll do $50-100M with the Motorola name and last year they did $12M as Zoom.  
  • net profit margin:  Zoom says they'll be around 8%
  • money to raise: Zoom said they intend to raise $3-4M and got $268k from the secondary
  • price per share for the coming private placement:  This will depend on what the share price is when the deal is done.  The CEO said they are in contact with potential investors and intend to get the money later this year.  
  • PE multiple:  What multiple would you give this company?  I am going with fairly low multiples because we have a 5 year contract with Motorola.  I think there's a very good chance the relationship extends past that but who knows.  



One issue with Zoom is that it's hard to nail down a value.  This one is going to come down to execution on their part.  How well will Zoom do with the Motorola name?  Will they do $50M or $30M or $100M?  Will net margin be 8%?  To me the stock looks cheap but we won't know how cheap until next year when we hear how the new business is going.

I would give ZMTP a value range of say $1-$4 right now.  Let's see how they do










2 comments:

  1. The first paragraph sounds so very familiar. Oh, yes, I know why. I have said it so many times during my years of investing. Essentially, the same choice of words. Idiot was definitely in the mix many times. So many low ball orders on good companies, just a little below the current price of a thinly traded security. Never got a fill and refused to chase the stock higher, thinking it is only a temporary rise. One day realize the stock is up over 50-100% and realize I missed the ride because I tried to save 3%. Psychology works against you once you miss the opportunity at a lower price. And yet, if you got shares at the lower price and then the price goes up, you often have no problem adding more shares at the higher price. Psychology again at play. The problem is I still keep making the mistake even decades later, although maybe less frequently.

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