INTRINSIC VALUE ASSESSMENT OF

POINTER TELOCATION LTD. (PNTR)

SEPTEMBER 26, 2018 This article was written with David J. Flood from The Investor’s Podcast

IntroductionPointerTelocationLtd.isanIsraeli-basedcommunicationequipmentcompanywhoseprincipalbusinessinvolvesprovidingcommandandcontroltechnologiesforMobileResourceManagement(MRM).Atthetimeofwriting,thefirm’smarketcapstandsataround$105Millionanditsrevenuesandfreecashflowsforthepreviousfinancialyearwerearound$78Millionand$6Millionrespectively.Thecompany’scommonstockhasfluctuatedbetweenahighof$19.65andalowof$10.25overthepast52weeksandcurrentlystandsat$12.90.IsPointerTelocationLtd.undervaluedatthecurrentprice?

The Intrinsic Value of Pointer Telocation Ltd.TodeterminetheintrinsicvalueofPointerTelocationLtd.,we’llbeginbylookingatthecompany’shistoryoffreecashflow.Acompany’sfreecashflowisthetrueearningswhichmanagementcaneitherreinvestforgrowthordistributebacktoshareholdersintheformofdividendsandsharebuybacks.BelowisachartofPointerTelocationLtd.’sfreecashflowforthepasttenyears.

Asonecanseethecompany’sfreecashflowhasbeenerraticoverthepastdecadewhichistheresultofcyclicalfluctuationsinthecompany’sbusiness.InordertodeterminePointerTelocationLtd.’sintrinsicvalue,anestimatemustbemadeofitspotentialfuturefreecashflows.Tobuildthisestimate,thereisanarrayofpotentialoutcomesforfuturefreecashflowsinthegraphbelow.

INTRINSIC VALUE ASSESSMENT OF

POINTER TELOCATION LTD. (PNTR)

Whenexaminingthearrayoflinesmovingintothefuture,eachonerepresentsacertainprobabilityofoccurrence.Theupper-boundlinerepresentsan8%growthratewhichassumesthatthefirm’sfuturefreecashflowgrowthincreasesbeyonditslong-termhistoricalaverageof4.57%.Thisassumptionisbasedonthefactthatthecompanyhasachievedsignificantdevelopmentoverthepast18monthstobecomeaproprietarytechnologycompanywithincreasedgrowthprospectsincludingacontractwinwithNissanIndiaandarecurring$2-3MillionU.S.contractforthefirm’sCelloTrackNanoproduct.Assuch,thisuppergrowthlinehasbeenassigneda35%probabilityofoccurrence.

Themiddlegrowthlinerepresentsa4.57%growthratewhichisbasedonthecompany’shistoricalfreecashflowgrowthratefortheperiod2005-2017.Thisfuturegrowthrateassumesthatthefirmcontinuestogrowinlinewithitshistoricalaverageandthatrecentdevelopmentsofincreasinggrowtharenotsustained,ithasbeenassigneda55%probabilityofoccurrence.

Thelowerboundlinerepresentsa-2%rateinfreecashflowgrowthandassumesthatthecompanysuffersacontractioninearningsduetocompetitiveandcyclicalpressures.Thisgrowthratehasbeenassigneda10%probabilityofoccurrence.

Assumingthesepotentialoutcomesandcorrespondingcashflowsareaccuratelyrepresented,PointerTelocationLtd.mightbepricedata7.2%annualreturnifthecompanycanbepurchasedattoday’sprice.We’llnowlookatsomeothervaluationmetricstoseeiftheycorrespondwiththisestimate.

PointerTelocationLtd.’scurrentearningsyield,whichistheinverseofitsEV/EBITratio,is10.44%whichisabovetheindustrymedianof2.73%.Thissuggeststhatthefirmisundervaluedrelativetotheindustry.SpecificpeergroupanalysissuggeststhatthefirmisundervaluedonanEV/EBITDAandMarketCappersubscriberbasis.

INTRINSIC VALUE ASSESSMENT OF

POINTER TELOCATION LTD. (PNTR)

Source:PNTR2018InvestorPresentation

AssumingarepricingcongruentwithcurrentmarketvaluationsforITRNandMIXTwouldyieldafairvalueofaround$15.50–$16.20representing20-35%upsidefromthecurrentprice.

Finally,we’lllookatPointerTelocationLtd.’sfreecashflowyield,ametricwhichassumeszerogrowthandsimplymeasuresthefirm’strailingfreecashagainstitscurrentmarketprice.Atthecurrentmarketprice,PointerTelocationLtd.hasafreecashflowyieldofaround6.9%.

Takingallthesepointsintoconsideration,itseemsreasonabletoassumethatPointerTelocationLtd.maycurrentlybetradingatadiscounttoitspeersandtheglobalcommunicationsequipmentmarket.Furthermore,thecompanymayreturnbetween7-8%atthecurrentpriceiftheestimatedfreecashflowsareachieved.Now,let’sdiscusshowandwhytheseestimatedfreecashflowscouldbeachieved.

The Competitive Advantage of Pointer Telocation Ltd.PointerTelocationLtd.hasvariouscompetitiveadvantagesoutlinedbelow.

• BarrierstoEntry.PointerTelocationLtd.’sproductscomplywithcoldchainmonitoringregulationsforuseinfood(EN12830)andpharmaceuticals(GDP)cargo.TheyarealsocertifiedascompliantwithFAAandIATArulesonairborneassettrackingandcoldchainlogisticsandrecentlyreceivedAIS140IndianITSstandardcertification.Theseregulatoryrequirementscreatebarrierstoentrywhichlimitsthenumberofcompetitorslikelytoemerge.Thechartbelowshowshowthecompany’sproductsandservicesareapprovedacrossmultipletargetmarkets.

INTRINSIC VALUE ASSESSMENT OF

POINTER TELOCATION LTD. (PNTR)

Source:EdisonResearchAnalysis,PNTR,March2018

• HighSwitchingCosts.PointerTelocationLtd.isconsistentlyderivingaround67%ofrevenuefromrecurringservicesrevenue.Thissuggeststhatthefirm’scustomerbaseis“lockedin”withhighswitchingcostsleadingtoongoingservicesrevenues.

Source:PNTR2018InvestorPresentation

INTRINSIC VALUE ASSESSMENT OF

POINTER TELOCATION LTD. (PNTR)

• NicheAttribute.PointerTelocationLtd.has18yearsofexperienceintheMRMmarket,inwhichtimeithasbuiltsignificantmarketpositionsinunderserveddevelopingmarketssuchasIsrael,Brazil,Argentina,Mexico,andSouthAfrica.Atpresent,thecompanyhas3millionunitsinstalledacross80countrieswithabroadclientbaseinplace.

Source:PNTR2018InvestorPresentation

Thecompanyisabletoofferatailoredservicetoitscustomerswhichincludesfleetmanagement,advanceddiagnostics,anddrivermonitoring.Theseproductsandservicesareapowerfulvaluepropositionsincetheysavecustomerstimeandmoneybyhighlightinginefficienciesandpotentialcostsavings.

Source:PNTR2018InvestorPresentation

Pointer Telocation Ltd.’s RisksNowthatPointerTelocationLtd.’scompetitiveadvantageshavebeenconsidered,let’slookatsomeoftheriskfactorsthatcouldimpairmyassumptionsofinvestmentreturn.

INTRINSIC VALUE ASSESSMENT OF

POINTER TELOCATION LTD. (PNTR)

• TheMobileResourceManagement(MRM)marketiscyclicalinnaturewithMRMproductsalestiedtonewvehiclesalesandreplacementcycles,bothofwhicharethemselvessubjecttocyclicalpressuressuchaseconomicactivityandinterestrates.TheemergenceofaneconomicdownturnwouldthuslikelyhaveanegativeimpactonPointerTelocationLtd.’srevenuesandearnings.

• WhilePointerTelocationLtd.reportsinU.S.Dollars,themajorityofitsrevenuesarederivedfromitsoperationsinIsrael,Brazil,Argentina,andMexico.ThisgivesrisetocurrencyrisksinwhichastrengtheningU.S.DollarandweakeningEMcurrenciesarelikelytonegativelyimpactthecompany’sfinancialperformanceintheneartomid-term.

• Atpresent,PointerTelocationLtd.hasanunprovisionedtaxclaimof$11.5MillioninBrazil.TheBrazilianTaxauthoritiesareclaimingthatthefirm’sBraziliansubsidiaryisatelecomcompanyandisthussubjecttoahigherrateoftax.PointerTelocationLtd.’smanagementrejectsthisassertionand,undertheinstructionoftheirlawyers,havenotmadeprovisionsforthisclaim.Thefirm’slegalcounselexpectsthefiguretoreducedsubstantiallythroughnegotiationbutwarnsthattheissuemaytakeyearstoresolve.

Opportunity CostsWheneveraninvestmentisconsidered,onemustcompareittoanyalternativestoweighuptheopportunitycost.Atthetimeofwriting,10-yeartreasuriesareyielding3%.Ifwetakeinflationintoaccount,therealreturnislikelytobecloserto1%.TheS&P500IndexiscurrentlytradingataShillerP/Eof33.6whichis98.8%higherthanthehistoricalmeanof16.9.Assumingreversiontothemeanoccurs,theimpliedfutureannualreturnislikelytobe-3.4%.PointerTelocationLtd.,therefore,appearstoofferamuchbetterreturnforinvestorsatpresent,butotherindividualstocksmaybefoundwhichofferasimilarreturnrelativetotheriskprofile.

Macro Factors Investorsmustconsidermacroeconomicfactorsthatmayimpacteconomicandmarketperformanceasthiscouldinfluenceinvestmentreturns.Atpresent,theS&PispricedataShillerP/Eof33.6.Thisis98.8%higherthanthehistoricalaverageof16.9suggestingthatmarketsareatelevatedlevels.U.S.unemploymentfiguresareata30-yearlowsuggestingthatthecurrentbusinesscycleisnearingitspeak.U.S.privatedebt/GDPcurrentlystandsat202.80%andisatitshighestpointsince2009whenthelastfinancialcrisispromptedprivatesectordeleveraging.

Summary PointerTelocationLtd.appearstobesellingatadiscounttoitspeersforanumberofreasonsincludinginvestorsentimentregardingthecompany’sgrowthprospectsandthecurrencyrisksassociatedwiththefirm’sbusiness.Giventhatthecompanyisasmallcapfirmwithbusinessoperationsfocusedaroundemergingmarkets,investorsshouldnotbetoohastytodisregardtheseconcerns.TherealsoexiststheissueofanunresolvedtaxclaimfromtheBrazilianauthoritieswhichcannotbeneglectedbyinvestorsconsideringthispotentialinvestment.

Thereare,however,anumberofpositivedevelopmentsandtailwindswhichhavethepotentialtofacilitatesignificantfuturegrowthforthecompany.Telematics’demandinemergingmarketshassofarlaggedthatoftheirdevelopedcounterparts,butthisislikelytochangeinthefutureasregulatorycatch-upoccurs.TheMobileResourceManagement(MRM)iscurrentlyvaluedat$55Billionandissettogrowby32%CAGRthrough2020and24%CAGRthrough2022.ResearchfirmBergInsighthasnotedthatMRMpenetrationofnon-privately-ownedcommercialfleetsintheU.S.wasonly23%in2016butisprojectedtoincreaseto41.7%by2021.ThesamemetricsforLatinAmericais10%to17%.ThistranslatestoamarketCAGRof15%intheUSand13%inLatinAmerica.

INTRINSIC VALUE ASSESSMENT OF

POINTER TELOCATION LTD. (PNTR)

Source:PNTR2018InvestorPresentation

PointerTelocationLtd.hasgrownitssubscriberbaseatanannualizedrateof18%since2015,andthistrendlookssettocontinueasthecompanyleveragesnewproductsinitsInternetofVehicles(IOV),logistics,andAdvancedTelematicssegmentstoincreaseitsuserbaseandselladditionalservicestoexistingusers.

Source:PNTR2018InvestorPresentation

Withregardstofinancialstability,thefirmiscurrentlyinamoderatelyrobustpositionwithadebt/totalcapitalratioof11.9%andacurrentandquickratioof1.61and1.31respectively.Cashandequivalentscurrentlystandat$7.2Millionmeaningthepossibilityforaccretiveacquisitionswithoutrecoursetodebtfinancingareopenalongwiththepotentialforfuturedividenddistributions.

INTRINSIC VALUE ASSESSMENT OF

POINTER TELOCATION LTD. (PNTR)

Source:PNTR2018InvestorPresentation

Insummary,PointerTelocationLtd.appearstobeafinanciallystablecompanywithnumerouspotentialgrowthprospects.Thefirmcurrentlypossessesanarroweconomicmoatstemmingfromhighswitchingcostswhicharelikelytobemaintainedinthenear-to-mid-term.However,thismaybegintoerodeifTelematicsbecomesintegratedearlyintheproductionchainthroughfactoryinstallations.Investorsshouldassumethatfluctuationsinrevenuesandearningswillcontinueandthatvolatilityinsharepriceislikelytooccurgiventhecyclicalityofthecompany’sbusinessoperationsanditsexposuretocurrencyrisksandemergingmarkets.Basedontheconservativeassumptionsusedintheanalysisofthecompany,PointerTelocationLtd.mayreturnaround7-8%atthecurrentmarketprice.Disclaimer:Theauthordoesnotholdfractionalownershipinanycompaniesmentionedatthetimeofwriting.

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