SURG - Riding The Surge: SurgePays Could Be The Next Big Asymmetric Bet

2023-08-16 02:58:38 ET

Summary

• SurgePays is a micro-cap company that has not yet seen its stock react to its current boom period.
• The company offers telecommunication services to the underserved and underbanked population of the US, focusing on low-income customers.
• SURG is benefiting from the Affordable Connectivity Program, which provides discounts on internet plans and devices to qualifying families, leading to positive financials and potential future growth.

Normally, a good investor sees a catalyst coming, anticipates the market, and buys the stock before it soars on the exchange. Sometimes you arrive late and miss the train. Other times, as in the case of SurgePays ( SURG ), time is a gentleman: this company is already going through a boom period thanks to a precise catalyst, but the stock has not yet reacted in the stock market.

Recently, I have developed a passion for researching these high-potential micro-cap companies, finding some: I recently recommended Solid Power and Illumin stocks, but to me SurgePays is even more interesting.

The company is going through a period where everything is aligned. The business has become profitable, the growth rate is higher than ever, and the political wind is blowing exactly in the direction the company would like it to. Putting all this together, the stock should have already had a stellar performance over the past year, while in reality, it continued to go up and down on a roller coaster. I thank Mr. Market's irrationality for the opportunity and buy the stock taking advantage of the situation.

SurgePays' Business Model

SurgePays offers telecommunication services to the underserved and underbanked population of the United States. The unique aspect of this company is that it focuses entirely on low-income customers, with a business model entirely optimized to attract and maximize the economic potential of this market segment.

To begin with, SurgePays uses a very specific type of promotion: partnerships with convenience stores. Convenience store owners are incentivized to work with SurgePays to offer an extra, high-margin service to round off their income; underbanked population customers tend to use convenience stores a lot for their financial transactions (e.g., cash withdrawals) and telephony. This positioning is simply perfect, with benefits for all links in this chain.

Second, and even more importantly, most of the company's customers qualify for the Affordable Connectivity Program . The company saw the opportunity coming and quickly adapted the offering of its two commercial brands -SurgePhone and Torch Wireless- to fit this novelty.

The Catalyst: The Affordable Connectivity Program

The ACP is already a huge success, with over 20 million households already enrolled as of August 14, 2023. The functioning of this program is very simple:

• Families with an income below 200% of the threshold set by the Federal Poverty Guidelines qualify, and all those families in which at least one member has received at least one of the forms of social welfare provided in the ACP list (Medicaid, SNAP, WIC, pensions for veterans, etc.);
• Beneficiaries receive a $30 discount per month on their internet connection plan (one per household), which rises to $75 in the case of qualifying Tribal lands;
• In addition to the monthly discount, a one-time $100 discount is received for the purchase of a computer or tablet.

The federal government has allocated $14 billion to fund this project, which became law on November 15, 2021. It is specifically thought of as a "long-term" program according to what is reported on the Federal Communications Commission website, so it won't disappear anytime soon.

How SurgePays is Benefiting from the ACP

Imagine having a company that can sell a valuable service to its customers without them paying even a penny. And despite this, your company receives all the scheduled payments for the services in question. Are you literally selling your product for "free," yet still being paid for its value? Too good to be true? In almost all cases, yes. But in the case of SurgePays, this is precisely what's happening.

The company clearly sponsors an offer based on the APC, in which new customers are offered the chance to obtain their tablet and internet subscription in a single operation: they register at one of the affiliated convenience stores, and they receive the device and SIM at home in 5-7 business days.

Not only has this had a very positive effect on SurgePays, but also on the convenience stores offering the service. For this reason, the number of partners has grown exponentially in the last two years, from about 4,000 to a current pipeline of 25,000 sales outlets that the company expects to activate over the next 12 months.

Furthermore, the company is starting to test LCD screens inside the convenience stores so that customers can register independently. Soon, the partnership with LeadEx will also be active, structured in a very intelligent way as explained in the Q2 2023 earnings call . LeadEx provides software to 130,000 ATMs in the United States, and when these ATMs recognize a debit card, a card linked to a public subsidy, or a rechargeable prepaid card, they will display a SurgePays advertisement.

The Catalyst's Effect on Financials

In the fourth quarter of 2022, the company recorded its first quarter with positive GAAP net income ($3.0 million). Profitability increased over the next two quarters, with a net profit of $4.5 million in Q1 '23 and $6.0 million in Q2 '23 . Moreover, the company expects a "strong acceleration in revenues" in the second half of the year, thanks to the partnership with LeadEx, the increase in affiliated sales points, and the new screens for customers' independent registration.

According to SurgePays' projections, by the end of 2023, the customer base should have more than doubled from the beginning of the year. Also, they expect revenues of $190 million in FY 2023, which could mean over $20 million in net profit - no guidance was provided on this, but one can rely on the data from the last quarters. For a company with a market capitalization of just $68 million, this would be an extraordinary result and an excellent prelude to 2024.

Regarding the balance sheet, SurgePays closed Q2 '23 with $5.2 million in cash on hand and $10.3 million in accounts receivable. The company has only $23.4 million in total liabilities, but it is also true that $18.5 million are due short-term. This is the only small blemish in an overall very positive picture.

Looking Ahead

Given that SurgePays has an extremely low market capitalization, if the company indeed doubled its customers over the course of the year - maintaining its current profitability - the stock could skyrocket. We're talking about a company that would easily arrive with a net profit of $30+ million by the end of FY 2024, against a current market capitalization of less than $70 million.

It is not hard to understand why this could be the case. The company expects to more than double its customer base in 2023, which started with a solid profit of $10.5 million in the first half of the year alone. SurgePays is growing by just adding new points of sale, and there is no variable associated to customer acquisition or operating costs that can meaningfully reduce the profit margin in the short-to-medium term.

This means that we are on track for a $20+ million GAAP net income in 2023, before considering the expansion of the customer base during the second half of the year and into 2024. At the same time, SurgePays thinks that they will actually accelerate growth during this period: all other things being equal, more than doubling the customer base means more than doubling the net income. Even if this wasn't the case and the net income was to stay consistently around $6 million, that would still make the case for a deeply undervalued company.

Threats and risks associated to the analysis

The main problem with this whole analysis concerns the expected end of the Affordable Connectivity Program, which should run out of funds in 2024. By that time, however, we will be in the middle of an election campaign, and it's likely that, considering the number of voters benefiting from the tool, the government will want to renew the proposal. Moreover, 230 organizations have signed a letter asking for it to be renewed, so there is also pressure from companies in the sector that goes well beyond SurgePays.

Considering that today the internet is the basis for checking job advertisements, accessing training sources, and being productive, there's also a strong economic rationale for funding a program of this nature. Furthermore, it's not an entirely new measure: the ACP replaced the Emergency Broadband Benefit program, which had a very similar purpose.

Another concern may be the competition: AT&T, Xfinity (Comcast), Verizon, COX and Xtream all offer ACP plans. The main difference is that these companies were never focused on serving the underbanked and underserved customers and they are simply not focusing all their efforts on this market segment. In particular, they are not exploiting the potential of selling directly inside convenience stores, which remain the stronghold of SurgePays.

The combination of a strong focus on ACP and a network of 25.000 partners among convenience stores is unique to SurgePays. The market would also be big enough to fit multiple competitors: right now SurgePays reports a customer base of 250.000 people, but there are more than 4 million underbanked people in the U.S. and, as previously mentioned, more than 20 million households that enrolled into the ACP.

Conclusions: Is it Worth Taking a Risk on SurgePays?

The way I see it, the issue is very simple. The stock has not taken off on the Stock Exchange despite the results the company has had over the last 9 months, because investors are scared of the possibility that the ACP will not be renewed. At the same time, here's my view:

• The likelihood that the ACP will be renewed is high. It's impossible to be certain about it, but running this risk can be highly rewarding;
• Even if it were not renewed, the potential downside is limited;
• If it were renewed, we're talking about a stock that can have a performance of 100-200% by the end of 2024.

To me, this is the perfect recipe for an asymmetric bet. Clearly, with a small part of the portfolio, but I absolutely intend to buy SurgePays shares in the coming days.

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