Redknee Solutions Inc (RKN): Greenhaven Road Likes This Telecom Software Supplier

Greenhaven Road Capital is bullish on Redknee Solutions Inc (TSE:RKN), a Canada-based provider of communication software products, solutions, and services. Greenhaven Road, a concentrated hedge fund, recently released its Q3 investor letter discussing its investment thesis on Redknee Solutions, Etsy Inc., TripAdvisor, Fiat Chrysler Automobiles, and Limbach Holdings. In this article, we will take a look at Greenhaven Road’s thesis on Redknee Solutions.

Here is everything Greenhaven Road’s Scott Miller said about the telecom software provider:

This past quarter RedKnee conducted a rights offering, allowing existing shareholders to buy additional shares at a discounted price. The company will use the proceeds to fund their restructuring, which includes significant layoffs and product investments. Redknee is domiciled and listed in Canada so participating as a U.S. investor was rather difficult and required a pile of paperwork to be submitted. I know of some funds who threw their hands up in frustration and did not attempt to participate, and others who attempted the compliance gauntlet but were ultimately slayed. Those who could not or chose not to participate in the rights offering could have sold their rights on the open market. However, certain brokerages, such as Charles Schwab, prohibited U.S. clients from trading their rights at will, and instead automatically sold the rights at very low prices as the transaction approached. It is nice to be a buyer from an indiscriminate seller like Schwab. In the days before the rights offering deadline, there were arbitrage opportunities to buy rights and sell common stock, pocketing an easy 5 cents per share, which is meaningful on a percentage basis for a sub-$1 stock. I ultimately thought that 0.63 CAD was a very attractive price at which to purchase additional shares and exercised all of our rights, purchased a substantial number of additional rights for pennies, and exercised our oversubscription privilege. Instead of trying to be arbitrageurs, we took the opportunity of the rights offering to triple our ownership of RedKnee at very attractive prices.

The rights offering was fully backstopped by ESW Capital, a growth private equity firm focused on business software companies. ESW has invested over $100M into RedKnee and placed the CEO, who knows the playbook very well and has taken substantially all of her compensation in company stock. ESW’s track record of success in the software industry was discussed at length in Greenhaven’s Q1 letter. Suffice it to say, I think the “A Team” has arrived. They have begun to outline a restructuring process that will rationalize what had become a bloated organization following two major acquisitions.

Redknee’s billing software is used primarily by wireless phone companies. Under previous management, copious amounts of money were spent on R&D to expand beyond the telecom market. The ESW plan is to focus the company entirely on telecom and have customer needs drive the product investments. Turnarounds take time, even when the “A Team” is executing them. The recent rights offering was done at a substantial discount to any multiple of run rate recurring revenue at which competitor stocks are currently trading. I would expect Redknee’s short-term earnings to be between dismal and horrible as tens of millions of dollars of restructuring costs hit the income statement. However, over time, ESW has a very good chance of building the company into a profitable business that could be a successful acquirer in the telecom software vertical.

We paid a more than fair price to back a very strong and well incented team trying to execute their 41st software turnaround and focus on the wants and needs of their customers. I like our chances.

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Ontario-based Redknee Solutions Inc (TSE:RKN) delivers end-to-end convergent monetization and customer care solutions, including real-time rating, charging and policy for data offerings, messaging and voice services. It has over 250 clients in more than 90 countries.

For its fiscal third-quarter ended June 30, Redknee posted a loss of $26.7 million, or $0.25 loss per share, compared to a loss of $12.3 million, or $0.11 loss per share, in the same prior year quarter. Revenue for the quarter was $32.6 million, down from $40.5 million in the same quarter last year.

Meanwhile, shares of Redknee Solutions Inc (TSE:RKN) are down more than 32% so far this year. Over the last 12 months, the company’s stock has lost more than 48% of its value. However, RKN has jumped over 23% during the last three-month period.