They say every cloud has a silver lining. To be truthful, after a long look through Subex’s results for the last financial year, I see heavy rain but no bright spots. The Q4 numbers failed to show any signs of a turnaround, and were consistent with the rest of a bad year. Q4 sales were down 12% on Q3, and down 26% year-on-year. Annual sales were USD61mn, down 31% compared to FY12. Overall, the company made a loss of USD11mn.
Sometimes management teams try to rush through sales before the year end, in order to bolster weak annual numbers. With numbers this bad, you almost hope that Subex’s management team decided to play the opposite trick: pushing sales into next year, so they can concentrate the bad news in one financial year. Whilst these kinds of presentational tactics are commonplace, Subex’s current management has not blamed their predecessors for this year’s poor results. Rightly or wrongly, they could have. Former boss Subash Menon said Q1′s disappointing numbers were due to ‘changes in revenue recognition’ that would be ‘evened out’ during the year. The revenues reported in subsequent quarters were not consistent with this expectation. There is no sign of Subex receiving an accounting boost due to a changing pattern of when revenues are recognized relative to the work being done and cash being paid. On the contrary, Subex sales were down, year-on-year, for all four quarters.
There is a large exceptional bad debt provision of USD5.7mn, and Subex continues to dispute demands for USD6.6mn in back taxes and associated penalties, which relate to business activities between 2006 and 2009. No provision appears to have been made for the disputed tax bill, on the basis that current management believe ‘the demand is not sustainable’. A few days before the year end, Subex obtained a stay against the demand.
As they have in previous years, Subex has lowered costs in order to protect EBITDA. The problem with cost cutting is that any company will inevitably reach a point where lower costs means a smaller business, less sales and less growth potential. As an outsider, I cannot speculate as to whether Subex has reached that point. However, I think it is significant that the Q4 wage bill was down to USD7.7mn. That figure is just two-thirds of the average quarterly payroll that Subex had in FY12. At some point Subex’s management has to come up with ideas for growing revenues, not just reducing costs.
Recent press releases have highlighted Subex’s data integrity and asset assurance offerings. It is possible that some R&D has gone into both of these, but neither are new. Subex formerly had a strategy of out-developing its rivals, offering a comprehensive suite of products that others struggled to match, and seeking to break into new areas first. In contrast, more recent Subex PR hints that they have changed focus, with less investment in developing future products. Given that managed services was previously trumpeted as a key growth area for Subex, it is possible that their strategy has shifted from new installations in new customers to winning long-term managed service contracts with existing users of Subex software. This would be consistent with a perception that there are few greenfield sites still worth chasing, that expanding the scope of products is risky, and that there is an ongoing trend for telcos to reduce operating costs and headcount through outsourcing routine but non-core functions.
Meanwhile, Subex’s finance costs continue to creep up, reaching USD3mn in Q4, up 13.6% on the previous quarter. The rising cost was reportedly due to ‘higher interest on short term borrowing’. I find that explanation far from comforting, especially as the book value of short term borrowing rose to USD35.7mn at year end, up 56% over the year. This may indicate a worsening problem with liquidity. In fact, liquidity difficulties may be a symptom of recurring and fundamental issues with solvency, as Subex lurches from one financial restructuring to the next one. There is some comfort in observing the value of trade receivables has barely changed since the end of FY12. However, this comes after the exceptional bad debt provision. It also implies a drop in cash collection, given that sales are lower. Subex’s annual finance costs now stand at USD9.6mn, up 21.6% since FY12. These costs were more than enough to wipe out the thin pre-interest profits, leaving the company with a USD3mn loss for the year, before exceptionals and tax.
Given that the stock market currently values the company as being worth around USD20mn-25mn, the need for a turnaround plan is obvious. But there is little evidence that Subex’s management team has a turnaround plan. When companies stop having a strategy, it may mean that the current management team is expecting the strategy will be set by the team which purchases their company. At this time, the goal may be a trade sale. However, there is still a need to bolster performance in the short term, in order to attract buyers and improve the sales price. Subex has a large customer base, but the signs are that their base is neither profitable nor cash-positive overall. This means any potential buyer is going to need to find synergies in order to rationalize the money that would be spent purchasing Subex. Of course, any competent management team will have looked hard at short-term tactics to boost cash generation and profits. The difficulty is that such tactics tend to have limited application, and may have undesirable side-effects.
Despite the difficulties in engineering a short-term lift to sales or profits, I wonder if Subex has adopted the optimal approach. Suppose the company shifted to a strategy where it mostly seeks to preserve its current customers, and to convert them from paying license fees to buying managed services. This could lead to cost reductions, both in terms of more tightly-focused product development and maintenance, and a greater overlap between account management and sales. Because managed service contracts are long-term, revenues and costs would be more predictable, helping Subex to manage its liquidity. A strategy like this suggests Subex should stop caring so much about overall market share, and should seek to improve the bottom line relative to the top line, by ridding themselves of their least profitable customers, especially where there is no prospect of selling managed services.
In contrast, Subex management has continued to emphasize how the business still has a large slice of market share. Subex have chosen to cite analyst reports which say they are market leaders, even whilst their annual sales figures have fallen below WeDo’s. If management wants to concentrate on raising the company’s worth by maximizing market share, they should focus more effort on winning customers amongst the underserved segment of smaller telcos. The revenues generated by these customers will be small, but I see two benefits. First, it would concentrate development on ensuring Subex has a range of products and services which are light, cheap, and easily accessed over the cloud. These could be sold to cash-strapped customers, and leaves the option to upgrade them to Subex’s more comprehensive ROC offerings when the customer is ready. Also, to my mind, the low end of the market may be more likely to take a managed service option, once the initial worth of revenue assurance or fraud management activities are proven. Dedicated RA and fraud management staff are a greater proportionate overhead for smaller telcos. Smaller telcos also tend to work within tighter relative constraints on their capex spending. If Subex is able to attain the cost synergies of managing services on behalf of many customers, they should have an advantage in profitably serving smaller telcos.
Following the failure of Connectiva, there are bound to be some customers who will be nervous about Subex’s poor FY13 results. Confidence is also an important factor, both for upselling to current customers, and for winning new customers. Whilst their attention may be drawn elsewhere, Subex’s management still need to maintain confidence amongst existing customers. So whilst Subash Menon’s explanation for the poor Q1 results may have fallen short, the current management team should consider what messages they send out about the full year results. Whether they like it or not, what they say about Subex’s present also says a lot about Subex’s future. Saying little is not a good option, because even a trade sale of Subex would lead to potential disruption for existing and prospective customers. If an acquisition occurs, and the incoming management team want to change course, so be it. In the meantime, Subex’s current management team need to remember that there have been plenty of businesses that took longer to sell than was originally hoped. During that time, management still needs to plot a course for the ongoing business, and they should communicate it to stakeholders.