Monday, October 13, 2014

Evolving Systems ( Nasdaq - EVOL ) - Loads Up

Evolving Systems (EVOL $9.25) is a leading provider of dynamic SIM card activation systems used by large mobile phone carriers.  SIM cards contain all the variable information that goes into every phone.  In the United States most subscribers select from a small selection of plans.  In international markets, though, carriers offer a wide range of options covering minutes and services and other features.  Mobile phone carriers traditionally have stocked SIM cards with all those permutations in their retail stores, an expensive and complicated proposition.  Evolving Systems allows them to stock blank SIM cards and then program them when a sale is made.  The back-end software integration is difficult because the carriers run complex systems that Evolving Systems needs to work with.  So a large majority of carriers still rely on the pre-loaded model rather than struggle through a major software project.  The companies that have done it enjoy substantial recurring savings, though.  And the flexibility enables them to customize a broader variety of packages for their subscribers, which tends to enhance marketing and reduce turnover.

Evolving Systems also provides service activation systems for mobile phone carriers.  That's a more mature market that automates the entire customer acquisition process.  It also updates accounts when new phones or features are added by subscribers.  For example, most Americans who upgrade to an iPhone-6 probably are incurring new billing amounts, and a re-start of a 2-year plan.  More than 50 mobile phone companies uses the company's service activation technology around the world.

SIM card activation is the primary growth driver.  It can take as long as a year to install the software.  Once the product goes live Evolving Systems ordinarily receives a large payment covering a "tranche" of SIM card activations, that the carrier works off as new subscribers are signed and existing ones modify their service.  Once those run out the carrier is allowed to abandon the whole thing and return to its old pre-loaded approach. That rarely happens.  Instead, the carriers buy another tranche, usually at a lower per-user price (to encourage the repeat order), generating another revenue surge.  The first of those renewals occurred in 2014, following on from deals that originally were implemented 2-3 years ago.  Several more are coming close and likely will renew before long.  That recurring revenue base, combined with the mature service activation business, is likely to provide a solid foundation in the future.

New sales promise to accelerate growth.  Evolving Systems's most fertile markets are competitors to its existing customers.  Once the company breaks into a geographic area with one carrier the others tend to follow suit.  The technology allows greater marketing flexibility which is expensive to match using the pre-loaded approach.  The greatest challenge is actually getting into one of those new areas.  In the past Evolving Systems relied on reference accounts to persuade prospects.  Over the last year the company has engaged in several pilot projects to prove without question that its technology is compatible with the carrier's core systems.  Several of those could be converted into sales in Q4.

A new product, the "AppLoader," could reinforce expansion.  That line is slated for introduction in the December quarter.  The system will allow new subscribers to select the "apps" they want from a list presented to them at the time of sale.  Large software and data providers like Facebook and Disney spend millions trying to convince users to download their apps after the fact.  If they can get those apps loaded right in the store, the savings promise to be large.  Evolving Systems expects to split the "AppLoader" revenue with the carrier and any third party sales agents.  Each deal is likely to be unique but likely will include a payment to get on the list, a payment every time that list is shown to a new subscriber, a bigger payment if the subscriber selects the app, and a recurring payment if the app isn't deleted over some period of time.  Broad based adoption could support a major revenue advance.

We estimate 2015 income will improve 30% to $.65 a share on a 25% revenue improvement ($40 million).  Start-up costs associated with "AppLoader" might reduce profitability but Evolving Systems thinks revenue should quickly catch up with those costs.  New SIM card activation contracts will generate professional service revenue.  "First tranche" income might leverage performance further, although some of that could fall in 2016.  Renewals on existing programs are likely to build.  The mature service activation line is likely to remain steady, although a modest gain is possible.  A cloud based version of both products was launched in 2013 to address the small carrier market.  That could provide a modest lift, as well.

In 2-3 years income could reach $.75-$1.25 a share.  Applying a P/E multiple of 20x to the midpoint of the range suggests a target price of $20 a share, potential appreciation of 115% from the current quote.  Widespread acceptance of the "AppLoader" could support a higher valuation.  Evolving Systems pays a $.44 per share annual cash dividend.  In 2011 the company sold its then-core business (a phone number management system that allowed users to keep their number when changing providers) for $39 million.  That cash financed the current product lines.


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