LCHTF - Text: Temporary Problems And An Unusual Dividend Yield Of 6.5%

2024-01-20 05:33:50 ET

Summary

• Text is a customer service platform that offers live chat support, multichannel communication, chatbots, analytics, integration, customization, and security.
• In an update reported at the beginning of January, the company showed a worsening in key performance indicators such as churn rate or ARPU.
• I think this slowdown in growth is temporary and was impacted by the macroeconomic situation and the change in revenue recognition.
• Currently, the P/FCF Ratio is 14x, and the dividend yield is 6.5%, making it a very attractive investment opportunity.

Investment Thesis

Text (LCHTF), formerly LiveChat Software, experienced a challenging year with its stock price declining by nearly 30%. Various issues, including slower growth, an uptick in subscription cancellations, and concerns surrounding artificial intelligence, have dented confidence in the company.

In this article, I aim to delve into the company's business model, its product offerings, and a thorough analysis of its financial statements. Additionally, I will provide my perspective on the challenges faced and explain why I believe these issues are temporary, presenting Text as a current investment opportunity.

Business Overview

Founded in 2002 in Poland, Text develops software used to manage text communication with customers, both in the business-to-consumer (B2C) and business-to-business (B2B) sectors. The purpose is to improve customer experiences and allow businesses to interact with their website visitors in real-time. Here are some of the products developed by the company:

1. LiveChat represents 91% of the revenue and serves as a tool for quick contact between customers and companies through a chat integrated into the company's website. This feature enables businesses to offer live chat support, allowing customer support representatives to engage with website visitors, answer questions, and provide real-time assistance. Essentially, these are the chat windows that appear when you enter a website, facilitating the process of resolving doubts, displaying important information, and enabling companies to provide excellent customer service.
2. ChatBot allows the creation of conversational chatbots for customer service teams, providing automation features such as handling routine queries. Automation improves response times and efficiency in managing customer inquiries.
3. KnowledgeBase is designed to help businesses create and manage a centralized repository of information. Customers can access it to find answers to common questions, troubleshoot issues, and get self-help support. It functions similarly to the famous "FAQs" sections but is automated.
4. HelpDesk is designed to assist businesses in efficiently managing customer inquiries, support tickets, and communication channels. It allows customers to leave messages outside of business hours, enabling customer support teams to organize and prioritize requests effectively.

In summary, Text helps businesses manage customer interactions from various platforms within a unified interface. It enables them to track and analyze customer interactions, streamline workflows, and prioritize security to protect sensitive customer data, ultimately enhancing the overall customer service experience.

This understanding explains the annual increase in the number of active clients for the company. The products offered by Text address a critical aspect for any business, which is customer service. Therefore, discontinuing the subscription to access these products would be considered illogical. This results in a consistent and predictable income stream for Text.

Key Ratios

Since 2013 (fiscal year 2014), the company has experienced an extraordinary annual revenue growth of 34%. However, there is a concerning trend in decreasing margins year after year. This warrants close monitoring, as it could indicate intense competition, prompting Text to lower prices to stay competitive. This impact on gross margins may subsequently reduce the EBITDA margin, which would be explained because while Text's products are indispensable for customers, it is challenging to establish clear differentiation in this market segment, so price wars become more common.

Despite facing challenges with competition, the company has maintained a prudent capital allocation strategy. 100% of its operations have been financed with the cash generated by the business. No debt or shares have been issued, resulting in a robust financial position . Currently, the Net Debt/EBITDA ratio is negative, indicating that with the available cash on the balance sheet, the company could fully pay off its total debt.

This financial stability is crucial, especially considering the constant need for innovation to enhance products and the evident intensity of competition. Avoiding excessive debt ensures a lower financial risk for the company.

The company has exclusively utilized its capital to invest in internal business operations, fostering the creation of new products . Noteworthy examples include the launch of KnowledgeBase in 2017, ChatBot in 2018, HelpDesk in 2019, and most recently, in 2022, the introduction of OpenWidget-a tool designed to enhance websites. This strategic allocation of capital ensures the expansion of the product portfolio and continual improvement of existing offerings.

A curious aspect is that over the last five years, 77% of the capital has been directed towards dividend payments. This might seem unexpected for a rapidly growing software company. The dividend has experienced an annual growth rate of 32% over the past decade, constituting approximately 80% of Net Income.

Considering that the company has not stopped releasing and improving products in recent years, it would seem that they are generating more cash than necessary to reinvest in the business and since they have no debt either, they decide that remunerating the shareholder is the best option, which is an extra benefit for shareholders

Another highly positive aspect is the company's exceptional profitability, evident in the Return on Capital Employed , which currently stands at an impressive 226%. Over the last decade, it has consistently averaged 125%, showcasing sustained high performance.

This not only indicates an asset-light business model with high-profit margins but also reflects the success of capital allocation and investments in developing new products. With such a track record, there's an expectation that the management will continue this trend in the coming years.

Valuation

To add to the positive outlook, the company's valuation appears highly attractive. A projection of 15% annual growth over the next five years, maintaining current margins, and applying an exit multiple of 15x EV/EBITDA suggests an expected return of 16%, in addition to the current dividend yield of 6.5%.

This attractiveness is underscored when considering the current valuation multiples:

• PER 13x
• EV/EBITDA 12x
• Free Cash Flow Yield 6.6%.

Notably, if Text were a U.S. company, its valuation could easily be at least double the current levels, given its robust ROCE, margins, and growth trajectory. But, considering that it is an unknown Polish company with a $600 million market cap, these types of inefficiencies are more common to occur.

Risks and Concerns

As evident from recent share price trends, the company has faced challenges in recent months, and it's crucial to address key concerns:

1- Slowing Growth: A recent update on key performance indicators revealed a modest increase of 2.2% in Monthly Recurring Revenue (MRR) compared to the previous year, and 0.3% compared to the preceding quarter. This slowing growth is a noteworthy factor.

2- Average Revenue Per User (ARPU): The LiveChat product's ARPU decreased to $156.4 USD from $160.7 USD a year ago, while ChatBot's ARPU increased to $132.4 USD from $115.1 USD. LiveChat's declining ARPU raises concerns about its revenue generation per user.

3- Churn Rate Increase: The company witnessed a modest increase in the total number of customers, adding only 19 clients this quarter. However, the churn rate has escalated, reaching around 3.5%, significantly higher than the average 3%.

We have rather symbolic increase in the number of customers because this quarter has added just 19 clients. This is something disappointing to us. The churn for this quarter has increased much higher than the average 3%. It was closer to 3.5%.

In my analysis, the sluggish growth can be attributed to two main factors . First, the adverse macroeconomic environment may have led some small clients that are in risk of going out of business to cut expenses, affecting their subscription to the platform-a potentially temporary situation. Second, a significant factor is the recent change in the revenue recognition policy, impacting how revenue is accounted for. Here's an example of how this has changed:

With the recent change in revenue recognition, the company, even with the same revenue generation, might appear to be yielding less in the final report. While this impacts short-term results, it's important to recognize that this shift aligns with the more accurate and commonly used practices in U.S. companies. In the long term, this change is considered a prudent decision.

This alteration in revenue recognition likely contributes to the observed decrease in Average Revenue Per User. So, although the company is experiencing a slowdown in growth due to the economic environment, it's crucial to acknowledge that this deceleration might be also attributed to the artificial impact of the revenue recognition change. Looking forward, the next year should provide clarity, indicating whether this adjustment was a short-term challenge or a more sustained concern for the business.

4- Artificial Intelligence: A widely discussed topic in recent months, AI's potential impact on the company has raised questions about whether it could spell "the end of Text. "In my opinion, this concern is unfounded. While AI is a powerful tool, it requires implementation by someone because AI doesn't independently seek potential clients to offer its services (at least not currently). Companies like Text will play a crucial role in implementing AI in businesses through their existing software, as demonstrated in the case of Chatbot.

There had been quite interesting things about ChatBot that took place this year. A new ChatBot which is available for all the clients and it has our AI model within the product. It has been very well received by the client and the results we are seeing are quite good.

5- Capital Allocation: While share buybacks may not directly impact business performance, they can instill confidence in investors. Given the company's track record in developing new products and its practice of using remaining capital for dividends, it's worth considering the potential benefits of aggressive share repurchases. This move not only signals confidence in the business but could also counterbalance low earnings growth.

For instance, if the company generates $10 USD in profits with 10 shares outstanding, the earnings per share is $1 USD. However, if they repurchase 1 share, the earnings per share would increase by 11%, showcasing the potential impact of strategic share buybacks on earnings per share.

Final Thoughts

In conclusion, my assessment of Text involves weighing various factors. While the company automates and improves critical areas for its customers such as customer service, concerns arise due to the perception of limited differentiation between Text's products and other chatbots. The company's prudent capital allocation has resulted in a debt-free status, but declining margins and the choice between share buybacks and dividends present considerations for investors.

However, I believe the challenges of low growth, currently reflected in a 14x Free Cash Flow valuation, are temporary. The upcoming wave of artificial intelligence is poised to benefit Text in the years ahead. Despite ongoing aspects to monitor, the current valuation is compelling and already accounts for somewhat negative scenarios. With a substantial dividend yield of 6.5%, I consider Text a ' buy ' at its current valuation.

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