Consensus Cloud: Cheap Spin-Off, And Developing AI Technologies (NASDAQ:CCSI)

Consensus Cloud Solutions, Inc. (NASDAQ:CCSI) has been providing secure information services since more than two decades, and currently develops AI and intelligent data extraction technologies. The company is a spin-Off company from Ziff Davis (ZD), and appears to work in many different countries with a significant number of customers. In my view, the ongoing repurchase of stock and recent reduction in debt could be a driver for the stock price, and also enhance future financial statements. In addition, previous free cash flow figures and the fact that a large part of the company’s revenue comes from subscription make free cash flow forecasting easy. In my opinion, as soon as more investment analysts review the company’s current valuation, and more discounted cash flow analyses are performed, demand for the stock could trend higher. As a result, I think that the stock price could increase.

Consensus Cloud Is A Spin-Off Company From Ziff Davis

Consensus Cloud Solutions, Inc. offers secure information services to close to 900k clients in close to 47 countries and various industries including healthcare, financial services, government, law, and education.

The origin of Consensus Cloud is a spin-off executed in 2021, which means that the company acquired know-how inside a larger organization that tested the business model for over two decades. The following text was obtained from the last quarterly report.

On October 7, 2021, J2 Global, Inc. completed its previously announced plans to separate into two leading publicly traded companies: one addressing healthcare interoperability and comprising the Cloud Fax business, which does business as Consensus Cloud Solutions, Inc., and one that will continue the Former Parent’s strategy of building a leading internet platform focused on key verticals, including technology & gaming, shopping, health, cybersecurity and martech, which will do business as Ziff Davis. Source: 10-Q

In my view, the client base is quite diversified. The company’s 10 clients represent only 7% of the total amount of revenue, which appears quite ideal. Some customers could leave without creating a large collapse in the net sales growth and FCF. Clients working with CCSI need communication and digital signature solutions with 100% secure information interchange. The company offers these services via fixed subscription plans or usage-based contracts.

I think that the most recent quarterly report included beneficial financial figures. Even if we are long term investors looking at the numbers delivered in the last 5-10 years, looking at the most recent quarterly figures would not harm. CCSI noted better than expected EPS of $1.45 per share and quarterly revenue of $87 million, which was also better than expected.

• Announce Date: 8/8/2024
• Quarterly EPS Normalized Actual: $1.45 (Beat by $0.13)
• Quarterly EPS GAAP Actual: $1.24 (Beat by $0.14)
• Quarterly Revenue Actual: $87.50M (Beat by $823.92K)

Business Catalyst #1: Recurring Subscription And Usage-based Fees

In my view, the fact that the company receives monthly recurring subscription revenue is quite ideal for free cash flow forecasting. According to the last annual report, 7% of the total amount of revenue came from subscription revenue.

Besides, the company noted that the services offered are critical to the customers’ business operations. Given these information, I would be expecting future free cash flow and net sales growth to remain stable over time. I did take into account these assumptions in my valuation model.

Business Catalyst #2: AI, And Intelligent Data Extraction Technology

In my opinion, the service Clarity combining artificial intelligence and machine learning with fax technology and the position of CCSI in the enterprise fax space could enhance future net sales growth. CCSI offers Natural Language Processing with AI allowing clients to send the right information to the right person at the right place and at the right time. Thanks to the technology used, there seems to exist an acceleration of patient treatment, but these technologies could also bring many more advantages to clients in other industries.

Consensus launched Clarity, an intelligent data extraction technology which uses artificial intelligence and machine learning to extract and, combined with other Consensus offerings, transform unstructured information in documents such as faxes into structured data such as HL7, FHIR, and DSM formats. Source: 10-k

Stock Repurchases And Debt Repurchase Are Stock Demand Drivers

The company approved a stock repurchase program, and acquired close to one million shares at an aggregate cost of close to $31 million. It means that the company acquired shares at approximately $31 per share. Today, we can buy shares at a price that is significantly lower than $31 per share.

Cumulatively as of December 31, 2023, 1,028,662 shares have been repurchased at an aggregate cost of $31.3 million (inclusive of excise tax of $0.2 million). Source: 10-k

It is also worth noting that CCSI promised to acquire debt. The Board of Directors authorized the purchase of up to $300.0 million. The total amount of debt appears quite significant. In my view, the company appears quite undervalued because of the total amount of net debt. Moreover, further reduction in the net debt will most likely lead to increase in the stock price and the EV/FCF ratio.

On November 9, 2023, the Board of Directors approved a debt repurchase program. The authorization permits an aggregate principal amount reduction of up to $300.0 million and expires on November 9, 2026.

Interest expense was $8.7 million and $12.8 million for the three months ended June 30, 2024 and 2023 respectively. Hence, recent declines in the net debt and lower interest rate are having a significant impact on the company’s quarterly net income. In my view, further reduction in the total amount of debt will most likely lead to large increases in future net income growth and FCF growth.

My Price Target, And Peers

For the design of future free cash flow expectations, I assumed further development of the company’s AI technologies and secure communications systems. In my view, the company’s investments in research and development will most likely improve future technologies offered to clients.

Besides, I think that ongoing stock repurchases and debt reduction could enhance future financial statements, and improve the cost of capital. In addition, it is worth noting that I reviewed previous free cash flow figures to make forecasts about the future. I did not really think out of the box for free cash flow forecasting.

I reviewed the company’s list of debt agreements because CCSI does seem to report a considerable amount of debt. The 2026 senior notes and the 2028 senior notes bear interest rate of about 6% and 6.5%. In addition, the company’s loans are linked to the SOFR margin plus a margin close to 1.75% – 2.50%. With these figures in mind, I assumed that assuming a WACC of close to 6% would be acceptable.

The 2026 Senior Notes bear interest at a rate of 6.0% per annum and mature on October 15, 2026. Source: 10-QThe 2028 Senior Notes bear interest at a rate of 6.5% per annum and mature on October 15, 2028. Source: 10-QThe loans made under the Credit Facility are subject to a Secured Overnight Financing Rate (“SOFR”) base interest rate plus aSOFR margin between 1.75% – 2.50%, with stepdowns subject to the total net leverage ratio. Source: 10-Q

My free cash flow expectations are in line with previous free cash flow growth seen in the past. I assumed free cash flow ranging from $114 million to $127 million, with cost of capital of 6% and a terminal EV/ 2031 FCF of 7x. My results include total enterprise value of $591 million, with an equity valuation of $649 million and a fair price close to $34 per share.

• NPV of FCF: $664.53 million
• NPV of TV: $591.65 million
• Total EV: $1,256.18 million
• Net Debt: $607 million
• Equity: $649.18 million
• Shares Outstanding: 19 million
• Target Price: $34.17

If we look at the company’s stock chart, the current price mark appears quite cheap. The company traded at close to $65 per share a few years ago. Today, we can buy shares at close to one third the valuation of the company in 2021 with a stock repurchase program in place.

It is also worth noting that CCSI appears significantly undervalued as compared to peers. CCSI appears to trade at 4x TTM GAAP earnings. The PE reported by peers is significantly higher than 4x TTM GAAP. The company’s Ev/ Forward EBITDA is also close to 5x. The sector median Ev/ Forward EBITDA is close to 13x.

Risks

The company invests in new products to address secure data exchange needs. However, if demand for the company’s cloud fax as a messaging medium lowers, I would be expecting a decline in the company’s future cash flows. In my view, one of the company’s most attractive products is the cloud fax signatures offered. There seems to exist ongoing efforts by governmental entities to create methods for electronically signing documents. If digital signatures continue to spread, I think that the demand for fax services would decrease, which may imply lower net sales growth and FCF growth.

The total amount of debt is considerable, and the interest rates appear to be linked to the SOFR rate. In my view, changes in the interest rates could bring substantial changes in the interest expenses, and deteriorate future net income growth.

In addition, the company may find certain difficulties in financing its operations. If debt holders decide not to prove financing, CCSI may not be able to finance future operations and R&D efforts. The company may also not hire new employees. As a result, analysts out there could lower the net revenue expectations, and the demand for the stock could diminish.

Risks From The Relationship With Ziff Davis

It is worth noting that the company was one part of Ziff Davis. It means that many valuable employees that once worked for CCSI are no longer working with the company. As a result, experts in similar market may no longer work for CCSI because they are working for Ziff Davis. Hence, CCSI may not have similar access to capital markets. In the last annual report, the company made several references about this fact.

As an independent, publicly traded company, we do not have similar operating diversity and may not have similar access to capital markets, which could have a material adverse effect on our business, results of operations and financial condition. Source: 10-k

The company also signed several agreements with Ziff Davis including separation agreements and intellectual property license agreement, among many other agreements. If Ziff Davis fails to perform in accordance with these agreements, in my view, CCSI could suffer a deterioration in its net income growth. The company may have to pay certain obligations and liabilities that were not expected when the separation agreement was signed. CCSI provided full explanation about these agreements and risks in the last annual report.

In connection with the separation, we entered into several agreements with Ziff Davis. We rely on Ziff Davis to satisfy its performance and payment obligations under these agreements. Source: 10-k

Risks From Goodwill Impairments And Current Book Value Per Share

CCSI reports a large amount of goodwill accumulated from previous transactions. In June 2024, goodwill represented more than 51% of the total amount of assets. In the future, accountants inside CCSI could assume that an impairment of goodwill is necessary. Under such circumstances, in my opinion, we could see a significant decline in the revenue growth expectations, and the stock price could decline.

It is also worth noting that the current book value per share appears to be negative. Many investors may fail to recognize free cash flow generation reported by CCSI. The demand for the stock may lower if CCSI does not increase its book value per share. I would also be expecting sale of equity or sale of properties in the coming years, which could lead to a deterioration in net sales growth.

Conclusion

With offering communication services for more than two decades, CCSI could receive significant demand in the coming years thanks to its AI and intelligent data extraction technology. The fact that the company is repurchasing shares and reducing the total amount of debt could also bring significant demand for the stock in the future. Given previous free cash flow delivery and recurrent revenue coming from subscription services, in my view, making free cash flow forecasts appears easy. Under my financial models and those of other analysts, CCSI appears undervalued at the current price mark. In my view, as soon as more investors review the company’s financial statements, demand for the stock could trend higher. The stock price could go to higher and more logical stock valuations.