Spok Holdings (NASDAQ:SPOK) stock is a name likely familiar with micro-cap investors. The healthcare communications company has been well-covered here on Seeking Alpha. COVID-19 notwithstanding, the story here hasn’t changed much since the last write-up was published on this platform (Jan 2019).
So, what’s the story? Formerly known as USA Mobility, for the past decade it has pivoted away from its legacy paging business and towards the healthcare communications software business. Via its Go and Care Connect platforms, this company is far from the slowly fading paging company some investors may still believe it to be.
Granted, after initial strong growth, sales for this unit leveled off in the late 2010s. And now, with COVID-19, software sales took a hit as hospitals postponed capital expenditures.
However, after the pandemic-driven sell-off, the gap between trading price and fair value is massive. With shares changing hands around $10 per share, now may be the time to enter a position.
Why? Firstly, while it doesn’t look cheap at first glance, this is a deep value opportunity. Back of the envelope, the software business alone is worth more than SPOK’s current enterprise value.
Secondly, while it’s been a perennial value trap, those buying today could see strong returns in the coming year. As seen from the recent quarter, sales have bounced back towards pre-pandemic levels. And, while growth isn’t massive, the next year could show dramatic improvement for this segment. This could entice investors to re-enter this name.
Thirdly, as seen from B. Riley Financial’s (NASDAQ:RILY) rejected takeover bid, it’s clear others are aware this company offers more value than meets the eye. I’m not saying a second bid from B. Riley, or another bid financial/strategic buyer, is likely. But you can’t rule out it happening in the next few years.
Sure, like with many “cheap stocks,” there’s the risk this name becomes “cheaper,” as it continues to underwhelm investors with its transition strategy.
However, at today’s prices, the potential upside may far outweigh additional losses. Even as COVID-19 cases surge, the “worst case scenario” may already be priced into shares.
SPOK Stock, Where It Was, and Where It’s Going
For further background, check out Vince Martin’s Jan 2019 Seeking Alpha article on the company. But here’s a quick overview of the situation with Spok Holdings:
As Martin discussed, the company years back saw the writing on the wall for its paging business and decided to shift towards a similar business line that had a future (healthcare communications software).
But, despite initial success, this unit, which was supposed to be an area of growth, began to underwhelm. As seen from this 2019 investor presentation, software sales held steady around $70m/yr. between 2015 and 2019.
And now, with COVID-19 in the mix, Spok’s software unit saw its sales temporarily decline. Yet, recent quarterly results show that things are starting to come back.
Per the latest financials, software bookings have soared 39% quarter over quarter and 5% versus the prior year’s quarter. Deals pushed back due to the outbreak are now closing.
Another silver lining: “paging unit erosion,” Spok’s phrase for the level of decline in its legacy business, continues to slow down.
With the wireless unit declining more slowly than before, coupled with the software unit resuming growth, things are looking up as we approach 2021.
Looking to 2021, the key here with Spok is the success of the Go rollout. The company may have a big opportunity in its hands with this SaaS-based, cloud-native solution.
Also, the presumed “return to normal” for elective procedure volumes. Per Spok’s Nov 10 investor presentation, these volumes are currently at 65% of pre-COVID levels. However, they are anticipated to pick up some more, and level off at the 85% level, by the end of the year.
Sharp Discount to Its Back-of-the-Envelope Value
SPOK stock has been “cheap” for years. What’s to stop it from getting even cheaper? As seen from the five-year chart below, trying to pick the bottom with this has been like catching a falling knife:
Why is this time different? With a massive gap between its current share price and underlying value, markets may be pricing pandemic headwinds too much into shares.
Back of the envelope, here’s my estimate of Spok’s underlying value.
Since the company uses much of the cash it generates from the wireless business to fund the software unit, I’m going to use EV/Sales to value each component.
For the wireless business (TTM sales ~$84.9m), I’ll use the overall stock’s current EV/Sales ratio (0.83x). That gives us ~$70.5m.
For the software business (TTM sales ~$65.3m), I’ll use similar M&A deals for healthcare communications software companies.
The most relevant comp is the 2019 purchase of rival Voalte ($40m annual sales) by Hill-Rom (NYSE:HRC). Hill-Rom paid $180m, or 4.5x sales, for the company.
Vocera (NYSE:VCRA), SPOK’s most relevant public peer, paid even more for another rival (Extension Healthcare). At the time, Extension generated just under $7m in annual sales. Based on the transaction value ($55m), that’s a deal multiple around 8x sales. However, given that Extension was still in its early stages, it’s not apples-to-apples for our purposes.
So, what’s a good multiple to use? An EV/Sales ratio of 3x seems to be a solid conservative estimate. That gives us ~$196m.
Outside its operating businesses, the company has $79m in cash and zero outstanding debt.
All together ($70.5m for wireless, $196m for software, plus $79.2m of cash), that gives us $345.7m, or around $18 per share.
Why Shares Could Bounce Back Once We Get Over The Pandemic
While it’s clear shares today trade at a sharp discount to underlying value, that alone won’t put more points into SPOK stock.
So, what will? Like other stocks hard-hit by the outbreak, this is a primarily a “return to normal” wager.
We’ve already seen software sales gets back to normal, as seen in the Q3 results. But, as uncertainty continues to clear up in 2021, bookings could continue to rise.
I don’t expect blockbuster revenue growth compared to 2021. But it seems very likely we will get back to the ~$70m-$75m revenue levels seen in the late 2010s.
Yet, the “return to normal” catalyst isn’t the only factor at play. Albeit secondary, the company’s potential as a takeover target is another reason this stock looks appealing.
After Rejected Offer, Still A Takeover Target?
Back in March, B. Riley Financial offered to buy Spok for $12 per share.
Citing its experience acquiring similar communications companies in prior years (magicJack, United Online), it makes some sense why this investment bank/holding company made its bid.
But, while Spok rejected the offer, the bid gives more credence to the argument that this stock is cheaper than it looks on the surface.
Per its PR Release, B. Riley discussed how this company’s overhead is too large relative to the scale of its operating businesses.
In other words, plenty of fat that could be cut by a strategic acquirer. Sure, with the dwindling wireless business attached to it, I can see why Vocera or Hill-Rom may not interested in acquiring the company in its current state.
Granted, its takeover target potential alone isn’t a reason to buy SPOK stock. Yet, it’s easy to see a deal happening in the next few years.
Risks On The Horizon
As mentioned above, the bull case for SPOK stock is a bit binary. Most of it hinges on the U.S. healthcare sector fully recovering from COVID-19.
While recent vaccine developments indicate 2021 will be the year we get out of the woods, it’s far from guaranteed.
And with the surge in cases as of late, and U.S. states reimplementing stringent lockdown orders, the near-term could mean another tough quarter for Spok.
So, why buy now if another tough quarter could send shares even lower? Even if we see a repeat of last spring’s lockdowns, this risk is likely reflected in shares today.
As seen from its Q2 2020 results, the software unit took a 15.7% revenue hit when lockdowns were at their worst.
But, while bad news, the situation wasn’t too devastating to the company. Most of its revenue (software and wireless) is recurring in nature. And, when it comes to new Go bookings, deals were mostly delayed rather than canceled outright.
In short, if the pandemic gets worse before it gets better, expect SPOK stock to remain at or slightly below current prices. But, as we get deeper into 2021, things should continue to clear up.
Get Paid While You Wait For Today’s Storms to Pass
Even through today’s headwinds, the company has maintained its $0.125 per share quarterly dividend. At today’s prices, that means a yield of ~5.1%.
And, while much of the payout is currently coming out of capital, not profits, this should reverse in the coming quarters.
The software business remains a work in progress. But, with the launch of its SaaS-based Go platform, things could continue to improve going forward.
Also, the wireless business’s decline continues to slow down. As the company manages its decline, generating as much cash flow from it as possible, Spok has the capital it needs to grow its software business.
The end result? At today’s prices, downside is minimal compared to the long-term potential gains if the software unit continues to grow.
Bottom line: Buy SPOK stock before the recovery is priced in, and get paid while you wait.
Disclosure: I am/we are long SPOK. 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.