Investing is extremely difficult if you are focusing on large-cap companies and their short-term performance. Even the smartest hedge fund managers can’t produce any meaningful alpha after taking into account their management and performance fees. On the other hand, investing is easy if you are focusing on small-cap companies and their long-term performance. In this article we will share an idea that is likely to beat the market by a large margin over the next couple of years.
Mitel Networks Corporation (NASDAQ:MITL) has been a popular stock among hedge fund managers, with Jim Simons of Renaissance Technologies, Paul Singer of Elliot Management and Joseph A. Jolson of Harvest Capital Strategies holding a more than 1% stake in the Canadian communications company. Constantinos Christofilis, Peter Muller, and Josh Goldberg are also among hedge fund managers with positions in the stock at the end of the fourth quarter of 2013. We pay attention to what hedge funds are doing because our research has shown that the most popular stocks among hedge funds tend to outperform the market by a large margin on average (read the details here).
Mitel Networks Corporation (NASDAQ:MITL) is a $900 million market cap company that provides communication and collaboration software and services primarily to small-to-medium sized businesses (SMBs). Historically, it has been a profitable company with strong growth, high free cash flow generation and a track record of beating consensus estimates.
Mitel Networks Corporation (NASDAQ:MITL) recently completed its $370M acquisition of Canadian rival Aastra Technologies (TSX:AAH), expanding its market position in Canada (where MITL was already the leader before the deal) and Europe while providing a better platform for growth in the U.S. It also increases Mitel Networks Corporation (NASDAQ:MITL)’s global end user base to over 60M, expands its client base to larger enterprises, and combines two sales forces with minimal overlap. Financially, the transaction provides scale benefits (with combined revenue exceeding $1.0 billion), $50 million in low-risk run-rate synergies by 2016 (the vast majority of which will be realized by 2015), reduced net leverage and a strong cash flow profile. Given the extensive experience both companies’ management teams have in integrating acquisitions and realizing cost savings (four transactions were successfully completed by each company over the past several years), the synergy guidance could be conservative, in our view. It is worth noting that the present value of the $50 million in synergies on an after-tax basis is approximately $400M, which is roughly in-line with the combined increase in market values of the two companies since the deal was first announced on November 11, 2013. This implies investors believe management’s goals are achievable, while any further synergies, either on the revenue or cost side, would provide further upside for the stock.
Mitel Networks Corporation (NASDAQ:MITL)’s valuation looks reasonable, trading at an EV/EBITDA multiple of 9.2X, in-line with its peer group of communications equipment companies. Synergies related to the deal should aid Mitel Networks Corporation (NASDAQ:MITL)’s earnings over the next two to three years, which are admittedly not within the investment horizon of many shareholders, but any progress in realizing them should aid investor sentiment and, eventually, the multiple assigned to its earnings stream. Given the large size of the deal, successfully realizing synergies from the combined company will be the key driver of future stock performance. With strong track records of both management teams in integrating past acquisitions, we believe execution risk related to the Aastra deal is fairly low and shareholders will be rewarded over the long-term.