Taldor is an Israeli based company providing its customers with a handful of IT, software, hardware, infrastructure and communication solutions. The government and financial sectors are responsible for more than 60% of the company’s revenue.

This customer mix, combined with the nature of Taldor’s mission-critical solutions, induces high stability in revenue. Demand for products and services is recurring and the relationship with the customers is long lasting.

Management seems to be promising. A newly appointed CEO with extensive experience of more than 15 years at the helm of Yael group – one of Israel’s leading system integration companies.

Although the sector grows at a GDP+ rate, Taldor is priced at a single digit P/E ratio of 9 (based on our outlook for this year). Moreover, 2016 is expected to be accompanied by sustained growth, due to delays in government tenders originally intended for 2015.

On top of the expected growth, the Israeli IT sector is recovering from lowered profitability of the IT companies (Taldor. Malam, Ness) that specialized in fixed cost contracts, mainly governmental, between the years 2011-2013. As ness was acquired by Hilan (IT competitor) the others accepted more rational pricing.

The storyline is simple in this case: long-term stable revenue and upcoming profitable growth. Yet still, the single digit cash flow multiple is not reflective of the given circumstances and possible bonuses.

Bonuses can be found in:

  • Potential acquisitions ahead. The local IT sector is perhaps the most M&A-rich sector in Israel, fueled by significant advantage to scale, relatively low margins and the limited size of the market. Smaller private companies often sell for low single digits multiples, allowing for both risk-aversive and value-creating acquisitions to be done. For instance, just this December Taldor purchased XGlobe, a hosting service provider, for a mere 5.5 multiple. Operational leverage is expected to boost profitability even more. Eventually, each merger taking place accelerates the consolidation cycle of the entire market, since it enhances the ability of the bigger participants to reduce prices and lowers existing margins even more.
  • Taldor is not immune to this phenomenon itself. Larger competitors might view the company as quite a bargain, as they can eliminate almost half of OpEx and “see” the company at 6x Operating income. From our understanding, it is only a matter of time.

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This post is excerpted from the Reading Capital May 2016 Letter to Investors.

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