Company Signs Three Major Contracts In Excess of Their Market Cap

NCI.V CURRENT PRICE: $0.16
NCI.V TARGET PRICE: $4.50
UPSIDE POTENTIAL: 2,713%
SHARES OUTSTANDING: 29,468,391


June 3, 2013 - NTG Clarity Networks (NCI.V) rose 68% to 16 cents on Monday after the announcement of a $3.8M contract that was awarded to the company for NTG Software Development Resources. The company's stock price has nearly tripled over the last three days thanks to that contract on top of a $4.2M contract for systems enhancements announced May 30th and a $1.1M contract signed May 21st for NTS Telecom in a Box. All of the contracts are for a leading mobile operator in the Gulf region and are to be completed within 6 to 12 months. NTG Clarity is a leader in delivering network, telecom, IT and infrastructure solutions to network service providers and medium and large enterprises.

At first glance a tripling of NCI's stock price might seem like a lot for three contracts, until you realize that there are less than 30 million shares outstanding. At 16 cents NCI has only a $4.7M market cap, meaning these $9.1M worth of contracts are nearly double of it. Reviewing the company's recent financial statements, one would view a $4.7M market cap to be greatly understating the value of the company even without the contracts.

NCI's 2012 results were released on March 28th. Highlights from these results include:

"Revenues for the year ended December 31, 2012 were $5,002,537 versus $5,172,176 for 2011. The gross profit margin was 50.8% in 2012 compared to 40% in 2011. The Company recorded a net income of $776,688 in 2012 as compared to $1,097 in 2011. The significant increase in financial performance was due primarily to our focus on more profitable projects with higher margins.

General and administration expenses were $845,627 in 2012 as compared to $854,371 in 2011. Selling and marketing expenses were $280,768 in 2012 as compared to $659,829 in 2011. Interest expense was $183,980 in 2012 as compared to $258,627 in 2011.

NTG Clarity was also successful in strengthening its balance sheet during 2012. Shareholders' Equity improved by 39% to $3.7 million and long-term debt declined by 51% to $82,986. As at December 31, 2012, NTG Clarity had positive working capital of $1,010,760."

A $777K net income for 2012 translates to a 2.6 cent EPS. Ignoring the contracts mentioned above, a 15 to 1 price to earnings multiple would justify a 39 cent stock price.

Someone might be worried that revenue was down slightly when comparing 2012 to 2011. However, when reviewing 2013 Q1 results released on May 28th we see that NCI had "revenues of $1,486,872 as compared to $1,060,471 in the same period last year (All amounts in Canadian dollars). This increase in revenue was mainly due to demand for our professional services and product licenses.

The Company reported a net income for the three months ended March 31, 2013 of $202,064, compared to a net loss of ($59,430), for the comparable period last year. This is mainly due to the increased sales of product licenses which are market oriented and highly profitable."

Revenue in Q1 2013 improved by 40% over Q1 2012 revenue and net income was $202K versus a loss of $59K. That's of particular note because their 2.6 cent EPS for 2012 includes this $59K loss so there is ample evidence that the company will achieve substantial financial performance improvement over the 2.6 cents EPS even when excluding the impact of the contracts.

When looking at all these pieces separately they each point to the company being tremendously undervalued. But when we attempt to combine them the undervaluation becomes ridiculous. Q1 2013 had a $261K improvement in net income. Taking a very conservative assumption that Q2-Q4 2013 will merely match the performance of 2012 we can estimate the net income for 2013 to be $1.038M or 3.5 cents per share.

Of the $9.1M in contracts, at least $6M of that revenue will occur by the end of 2013. The company's gross margin was just over 50% in 2012 so we can expect $3M in gross margin from these contracts for 2013. As far as salaries and other expenses, that is a little more difficult to estimate given that 2012 expenses went down. Using Q1 as a proxy the $426K improvement in revenue came with a $98K increase in expenses from $430K to $528K. $98K divided by $426K is 23% so applying that same ratio to $6M in revenue is $1.38M in added expenses. Subtracting that from $3M leaves the company with $1.62M in added net income associated with these contracts for 2013.

$1.62M in net income translates to an EPS of 5.5 cents. Adding that to the 3.5 cents the company was on pace to achieve in 2013 before these three new contracts and the total EPS for NCI would be 9 cents a share for 2013. Because this company is showing profits in the early stages and yet is still experiencing high growth organically and with these new contracts, a 50 to 1 P/E multiple is appropriate. Applying that to the 9 cent EPS and the TSX News target price for NCI is $4.50 a share. Even if you don't agree with using a 50 multiple, you must agree that the 1.8 multiple with a stock price of 16 cents is far undervalued. It is only an argument of how undervalued it is but most reasonable investors would agree that the stock is undervalued by at least 5 to 10 times when considering the recent financial performance and contracts. 

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