Track Group

An above average business with a catalyst?

Was not sure if I was going to write this up. The stock is pretty illiquid, and is effectively a nano cap as insiders effectively own 65% of shares outstanding. Average daily trading volume only about $10k. So be careful! And it is already written up by Inflexio Research here.

But we now have a bit more information and it doesn’t hurt to give this stock a bit more attention! I feel quite optimistic about it. Trades <10x earnings while co is growing and only at about 1.5x recurring revenue and a lot of operating leverage.

The company provides tracking software and services to monitor convicts. Generally contracts are signed on a multi year basis. This is about 98-99% of revenue, the other 1-2% is the sale of tracking devices. It seems like revenue could be quite sticky and recession resistant. Their Track Group analytics software is also in the current Surveillance Training curriculum at the US DHS Federal Law Enforcement Training Center (FLETC) (source). So clearly they are a leader in their field.

Gross margins are high, and operating leverage is great as operating expenses seem to be largely fixed and have actually come down in the past years:

About 75% of revenue came from the US, and ~25% from Chile in 2021. And largest customer accounts for 16% of revenue. Chilean Peso has depreciated about 30% vs the US $ over the past 2 decades. Half of that actually happened in 2021.

Market cap is $27m, and the company had $36m of net debt as of latest 10-k. But what is interesting is that they only pay 4%, whereas before the refinancing in March 2021 they paid 8%. This seems to be on the low side with a debt/Ebitda of nearly 5x around time of refinancing.

One possible reason for this is that they signed a new contract from the Chilean prison system in middle of 2020. It was supposed to go to a competitor, but they did not sign in time, so it ended up going to Track group. They have been building 2 monitoring centres this year, and the contract will start right about now (from latest 10-k):

The Company previously disclosed on May 7, 2020 that the Chilean Prison System (“GENCHI”), which has been our customer since 2014, had notified the Company of its decision to award a new contract to a competitor of the Company. Subsequently, since the competitor did not proceed to sign the contract in due time, GENCHI rescinded the prior award to the competitor and re-awarded the Company with a new contract for forty-one months. The Company signed the new contract on July 30, 2020 and the Contraloria General de la Republica de Chile approved the new contract on October 1, 2020. As a result, the Company completed construction of a new monitoring center in Santiago, Chile and expects a back-up monitoring center in Southern Chile required by the new contract to be completed in December 2021. GENCHI will commence implementation of the new contract shortly after the completion of the back-up center.

Capital costs for the new monitoring centres + monitoring equipment will be around $2 million. So this could be a sizable contract.

Results were a bit dissapointing this year as gross margins declined by 2% points. But:

The decrease in the gross profit margin of 2% was largely due to amortization of newly developed software and amortization of monitoring center costs associated with a new contract of an international customer.

And:

As of July 1, 2021, the Company completed its new technology platform to improve the efficiency of its software, firmware, user interface, and automation. As a result of these improvements, $1,349,550 was capitalized as developed technology during the year ended September 30, 2021, and $1,514,482 was capitalized during the year ended September 30, 2020. A portion of this expense would have been recognized as research and development expense, absent the significant enhancements to the technology.

So it is possible that going forward R&D and overall expenses will be significantly lower once the new contract is in place. Amortization of software development + R&D expenses were about $4m this past financial year. This would mean normalized EBIT on flat revenue (before effects from further growth) could be about $5.5-6m. And FCF about $3.5-4m.

Operating leverage and the new Chile contract

Let’s say that the new Chile contract will give Track $6m of additional recurring revenue, which will provid about $3.5-4m of gross profit. Most of that would flow straight down, and EBIT would be about $9m. And net profit about $6 million (the company has NOLS of about $200 million in the US). This would mean a 20-25% FCF yield, for a company with sticky recurring software and service revenue on multi year contracts. If this was trading on the NASDAQ or something, with a larger float, it would probably fetch 20x earnings?

Property and monitoring equipment totalled only about $3.2 million in the latest 10-k, vs $2m incurred by the company for this new contract. While annual capex seems to hover around $2m as well. Since this contract is going into place roughly right now, we will know more after the release of Q2 report (in May) of 2022 fiscal year (which ends 30th September). Q1 will probably be dissapointing as well as there could be further costs incurred for training new personel and getting these monitoring centres and up and running.

Then of course there is the possibility of growth in the US. Revenue in US grew from $23m to $29m in 2020-21. There is a trend towards locking less people up and putting more into house arrest with an ankle monitor as it yields better results and is cheaper. Revenue growth has averaged about 11% in the past 6 years. If that continues, company could easily be earning half its current market cap in a couple of years.

The main risk

What bothers me most here is that 65% of company is controlled by insiders (source TIKR):

So if my rosy predictions play out, will minority shareholders benefit as well? Company provides minimal information. There are no conference calls, little to no information on new contracts and it trades on OTC exchange. Management seems to be pretty unwilling to talk to investors and answer questions.

So maybe earnings go up, but then some takeunder happens at maybe a 30% premium? Or it happens before they post their Q2 earnings. US security law seems very poor at protecting minority shareholders in cases like this. The At Home takeunder in 2021 kind of shook me up with how easy it was to rob minority holders. You are basically at mercy of large shareholders. Ironically you are much better protected in Hong Kong against take unders.

That is part of the reason why I wrote this up as well. The more exposure this gets, the less likely it is insiders can do something fishy here. And if you are an insider reading this and these premature allegations bother you, provide more information to investors! Like for example how large the new Chile contract is roughly going to be.

Best case scenario is that operating leverage really kicks earnings into high gear, debt is paid down and this gets uplisted to NASDAQ. I doubt it would trade below 10x FCF if that happens.

So I am long at average price of $2.55 per share. I may sell at any time, so do your own work, and don’t blindly follow anyone into a stock. And please let me know if you discover something I missed. And be extra careful since this is a pretty illiquid stock.