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Comtech: Legal Battle Over Gilat Pushes Shares Down, So It Launches $100 Million Buyback Plan (NASDAQ:CMTL)

Comtech Telecommunications (NASDAQ:CMTL) dropped 60% during the sell-off back in March, and the stock has never recovered. The company is in the middle of two acquisitions which have yet to close, but the company’s core businesses are strong. The stock appears to be a bargain, and the company is taking advantage of that fact by announcing a $100 million stock buyback.

Comtech provides satellite communication-related products and services for two segmented businesses: Commercial Solutions and Government Solutions:

Source: Q4 Presentation

As can be seen in the graphic above, the Commercial Solutions is the largest of the two segments, and while the US government is a big customer, Comtech’s international revenue accounts for 23.5% of the total. So, the business is nicely diversified and has several large tier-1 customers.

Two Acquisitions

In January, Comtech announced an agreement to acquire Israeli Gilat Satellite Networks (GILT) for $532.5 million. Israel-based Gilat is a global leader in the satellite ground station and in-flight connectivity markets and has expertise in operating large networks.

The plan to acquire Gilat came after Comtech announced a much smaller deal to acquire Canadian company UHP Networks for ~$40 million in November of last year. UHP has developed an innovative technology that is disrupting and transforming the Very Small Aperture Terminal (“VSAT”) market.

Of the two deals, clearly, the Gilat deal is the more impactful. CMTL stock dropped almost 20% in January when the deal was announced. After all, a $532.5 million acquisition would be a relatively big matzo ball for Comtech to swallow, considering, at the time of the announcement, it had a market cap of an estimated $925 million.

In addition, there are some complications with both deals regarding assets in the Russian Federation. These were itemized in the Q4 presentation, and the graphic below shows all the acquisition-related developments:

Source: Q4 Presentation

With respect to UHP, the main talking points are a reduction in the purchase price of ~24% and an agreement that either company can terminate the agreement if approvals (including from the Russian Federation) are not received by year-end.

The Gilat deal also requires approval from the Russian Federation. In addition, Comtech began litigation seeking a judgement regarding because it believes Gilat has suffered a “Material Adverse Effect”, and therefore, it is not obligated to complete the deal. Gilat has counter-sued. As a result, Comtech has suffered “significant” legal expenses, while the Delaware Court is expected to fast-track the legal battle and render a judgement by October 29, 2020, the date that either Comtech or Gilat can terminate the merger agreement.

Earnings

Meantime, Comtech announced its fiscal Q4 and full-year 2020 EPS report last week:

Source: Q4 EPS Report

As can be seen in the graphic, Comtech got hit with a one-two punch – significantly lower revenues (primarily the result of COVID-19 impacts to its businesses) and sky-rocketing “acquisition plan expenses”. In the Q4 release, Comtech said:

To-date, during the first quarter of fiscal 2021, the Company has incurred approximately $14.2 million of acquisition related litigation expenses. Acquisition plan expenses are expected to continue through the Company’s second quarter of fiscal 2021.

$14.2 million is obviously a big expense, considering Comtech’s full-year 2019 net income was only $25 million. As a result, the company’s Q4 EPS dropped to $0.04/share from $0.25/share in the year earlier quarter. For the year, earnings fell to $0.28/share: down 73% from the $1.03/share the company earned in FY2019.

As for Gilat, note its stock has plummeted after a big pop in January when the deal was announced:

Gilat’s Q2 EPS report was very weak, swinging to an operating loss of $3.5 million compared to operating income of $4.9 million in Q2 2019. Adi Sfadia, Gilat’s interim CEO, said:

The COVID-19 pandemic continued to affect Gilat’s second quarter 2020 results, as we continued to see postponements and delays in orders. However, during the second quarter we began to see and are continuing to see a recovery in most of our areas of operations which is demonstrated by a significant increase in pipeline opportunities. We believe that as a result of these trends, coupled with the cost reduction initiatives we have executed and are continuing to execute, the second half of 2020 will be meaningfully better than the first half, for Gilat.

Since then, Gilat has logged some multi-million dollar cellular backhaul deals (see here and a $10 million 5-year deal here).

Clearly, the market doesn’t believe the deal – for which Comtech agreed to pay $10.25 per Gilat ordinary share (70% will be paid in cash and 30% in Comtech common stock) – will get done. At least, not at the $10.25 price.

Going Forward

Despite the legal entanglements, there are signs of strength in the underlying businesses. Comtech’s backlog at year end was $620.9 million, and the company said,

“When adding Comtech’s backlog and the total unfunded value of multi-year contracts that Comtech has received and for which it expects future orders, its revenue visibility approximates $1.0 billion. A number of large potential contract awards are pending.” CMTL also expects 2021 adjusted EBITDA will be slightly higher than in fiscal 2020.

Indeed, after the close of the quarter, Comtech has announced several large orders, including:

  • A $20 million contract with a tier-1 carrier as part of their 5G implementation.
  • A $20 million contract with the US Army to provide VSAT support (additional funding on a previously announced $223.4 million contract).
  • An $8 million contract for mobile satellite equipment (additional funding on a previously announced three-year $124.2 million contract).

The bottom line is, the backlog is relatively strong, and order flow continues to be strong and steady.

The balance sheet: as of July 31, 2020, Comtech had $47.9 million of cash and cash equivalents and had lowered its total debt outstanding in FY20 by $16.2 million to $149.6 million.

Share Buyback

As a result of the stock’s drop and the company’s ongoing operations, Comtech announced a $100 million stock buyback plan last week. All things being equal, $100 million at Friday’s closing price of ~$14 equates to roughly 7.1 million shares, or an estimated 28.5% of the average numbers of total outstanding shares at the end of Q4 (25.06 million).

Chairman and CEO of Comtech said:

Authorizing the use of our strong balance sheet for share repurchases demonstrates our confidence in the underlying value of our stock and our commitment to providing long-term value for our stockholders.

The new stock repurchase program replaces the CMTL’s prior $100 million stock repurchase program that had $8.7 million and has no specific time frame. Note that, despite the previous stock repurchase program, shares outstanding at the end of FY20 were actually higher than at the end of FY19 due to stock compensation and other factors.

Valuation

Adjusted EBITDA for FY20 was $77.8 million or 12.6% of consolidated net sales. GAAP operating cash flow was strong at $52.8 million.

Comtech’s enterprise value is (market cap + debt) = ($349 million + $150 million) = $499 million. That puts the EV/adjusted EBITDA ratio at 449/77.8 = 6.4x.

Summary & Conclusion

The Comtech/Gilat deal is a classic case of an acquisition gone bad where, in the interim, neither company is benefiting more than the lawyers handling the legal battle. That said, Comtech is trading is at considerably less than a 10x multiple on EBITDA – as though it was a company in decline. Yet if one disregards the short-term legal expenses, the company expects to grow EBITDA this year without the acquisitions. Meanwhile, the fast-track legal decision is expected to come before the end of the month. Either the deal gets done (and remember, Comtech expected it to be accretive), or it doesn’t get done (and the market should give back what it took away). In either case, it would seem as though the stock has been punished much more than the legal fees rationalize. Even if the legal fees and acquisition costs double to, say, $50 million by the time it’s all over, that’s a short-term one-time expense that equates to ~8% of annual revenue. Yet the stock is down 60% this year. My guess is that the deal with Gilat gets done, but at a renegotiated price – something perhaps half-way between the original $10.25 agreement, and Gilat’s Friday close around $5.25.

Either way, Comtech is a BUY because it has been so badly punished by the market. CMTL could easily trade back up to $20/share – 50% higher than Friday’s close, but still down 30% from where it started the year. Without Gilat, even at $20, the EV/adjusted EBITDA ratio would be an estimated 8.6x, still a relative bargain, in my opinion.

Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

Additional disclosure: I am an engineer, not a CFA. The information and data presented in this article were obtained from company documents and/or sources believed to be reliable, but have not been independently verified. Therefore, the author cannot guarantee their accuracy. Please do your own research and contact a qualified investment advisor. I am not responsible for the investment decisions you make.

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