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Thursday, July 27, 2006

All CSG Systems Go

By William Trent, CFA of Stock Market Beat

Analysts are paid to be paranoid, and sometimes the paranoia gets the better of us. One example of this was last week’s observation about Watch List member CSG Systems (CSGS) when we said that two press releases in one week was unusual for the company. We worried that they were trying to flood the market with good news ahead of potentially bad earnings.
We needn’t have worried.

CSG beat analyst estimates and raised guidance, sending the shares up 3 percent. Even after the move the company is trading at an enterprise value of just 12.5x its trailing free cash flow, a capitalization rate that implies approximately 2 percent annual free cash flowgrowth, which ought to be manageable. In fact, the company is projecting it will grow 25 percent this year (though that is somewhat of an anomaly). The company announced another share buyback, having already reduced the average share count by 2 million shares (four percent) in the last year. These are not just buybacks to replace shares issued to employees on stock option exercise. This is honest-to-goodness reduction in the share count.

So we misread this one. To be fair, it isn’t like we were pounding the table to sell. We closed out our argument with:
Now, before you pull out your order book consider a few points. First, really bad news like losing a top five customer would probably have been announced already due to the Sarbanes Oxley rules. Second, the stock is already pretty reasonably valued on an enterprise value to free cash flow basis. Third, the nature of the companies business results in earnings and cash flows that are quite stable. Of course, that overall stability sometimes results in market overreactions to small misses.

In the end, we may be reading too much into two stories that just coincidentally came out this week. But they caught our attention, and we figured we would bring them to yours.
But let’s not whitewash it. The jist of the piece was clearly negative and clearly wrong, and we want to own up to those just as we crow about our successful calls.

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