Reverse Corp

This company may be familiar to deep value investors using quantitative filters in searching stocks, as on a few basic metrics no doubt stands out.

Reverse Corp is an unusual business comprising high levels of cash with potential to frank a lot of future dividends. It has a business that is likely to decline rapidly yet currently spinning off large profits versus the market cap, and then an online business selling contact lenses that has recently turned to a profit but which is difficult to forecast the future with much certainty. I have been buying at 12 cents recently giving a market cap of about $11 mill, which as I am about to explain is very cheap.

They are sitting on cash of about $6 mill (before a very recently announced small pending EBITDA positive acquisition of $750k) and then a stake in OTH worth a bit over $2.5 mill which is under takeover and should convert to cash soon. They recently bought this at lower levels and look likely to book a quick and very attractive gain on this OTH trade.

That means if we buy the stock we are paying about an EV $2.5 mill or a bit over 2.5 cents per share for the two businesses mentioned above.

The most recent financial year the mature business 1800 reverse represents nearly all of the EBITDA of nearly $2.5 mill. This is actually close to the enterprise value as described above. One issue though is this business has been predicted to soon decline sharply. Essentially what it is about, is when you have a prepaid phone and miss-manage things and run out of credit you can use this number for free and the receiver of the call pays. It should decline because due to legal changes made other competitors are allowed to compete in this space. Another factor is Reverse Corp gets more if they call a fixed line but obviously fixed lines are in decline. Also one would think so many people can use instant messaging and there is no need for calling. Yet this business still seems to hang on to its profits a lot longer than most had expected. The number has an established brand making it difficult to compete. And it seems parents are happy to give their youngsters phones but only with pre-paid credit. So what may be happening is even though kids could message their parents they are falling into the trap of wasting their pre-paid credit on surfing other useless apps and still using this number. Perhaps even this is a trend that can hold up the earnings of 1800 reverse more than most expect?

Yet assuming this business does decline sharply we are paying next to nothing for it. Revenues are probably falling between 15-20% but costs are being cut. Even assuming this continues and even if the contact lens business was worth nothing you can see from the figures above that you would soon spinoff a lot more cash than the enterprise value the next few years where a fair chunk can be paid back in franked dividends. They have over $5 million to pass on in franking still. Last year they paid out one cent and this could continue for some time. Of course if we are surprised and 1800 reverse earnings hang in there then that could deliver plenty of upside to the share price.

The issue with these situations is the risk management waste the cash. Mitigating this I feel is that they do have some skin in the game and I wouldn’t say the remuneration is excessive. We also have Wilson Asset Management on the register to try and keep them honest. I give them the benefit of the doubt for a few reasons. They have been very patient with acquisitions only recently making a small EBITDA positive add on for the OzContacts business after sitting on loads of cash for a long time. They paid a very high yielding fully franked dividend last year and signalled their intentions to keep this up. Recently their decision on OTH has proved a smart move. Also they have now turned OzContacts into a profit. You can make a case the market should have a positive view on management, yet the share price is saying management do not have much credibility. Their patience shown so far to me indicates the large cash within the company will probably only get spent so long as OzContacts shows promise, and to the extent they can find small bolt ons to add scale. In the scenario that they cannot spend the money wisely to grow OzContacts, it wouldn’t surprise me if money is returned to shareholders via much larger fully franked dividends. I say that even though already the dividend yield is extremely high, because the dividend payout ratio is currently low.

Lastly I like virtually getting paid to own the OzContacts business. I am no guru at identifying great online businesses. However, when it comes for free and has turned a profit already, I don’t mind free upside. The base case is I don’t expect a great deal from this because it is a competitive space. Yet if they get it right who knows? Most are probably familiar with the business Dollar Shave Club. Don’t get me wrong I am not making wild predictions, just making the point something as boring as shaving blades or contact lenses can stop to be boring when the money comes in. In the event that the OzContacts business shows a little bit of promise and modest profits but doesn’t set the world on fire, it might be a target for a dominant player. In that scenario if the Reverse Corp share price remains undervalued it probably makes a lot of sense for a leader in the online contact lens space to buyout Reverse Corp, so shareholders may get a premium to the price in that scenario also.

Risks

– 1800 reverse declines VERY rapidly, like revenues absolutely collapse in the next year or so.

– The OzContacts business cannot make a decent return on investment, yet management can’t accept this and spend the cash on acquisitions destined to fail.

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