Amdocs A Good Value As Is, But With Growth Upside

By Stephen D. Simpson, CFA | June 18, 2013 AAA

Value-priced software and technology service companies often struggle to attract and maintain investor attention. To its credit, Amdocs (NYSE:DOX) is doing what it can to reward patient investors, as management has been allocating significant percentages of free cash flow (FCF) to buybacks and dividends. It has been a while since the company has logged double-digit revenue growth, but if the company can successfully repeat its business model in emerging, there could once again be a growth kicker to what already looks like a solid value.

SEE: Equity Valuation In Good Times And Bad

Servicing The Service Providers
Amdocs is the second-largest player in business support systems (BSS) and operational support systems (OSS) for the telecom services market. What that means in English is that Amdocs provides software and services that help companies like AT&T (NYSE:T) and Sprint (NYSE:S) manage their billing, customer service/support, marketing, and ordering.

These systems are both highly complex and mission-critical, often taking years to implement. That means that it's expensive and onerous for a telco to change vendors, and it likewise rewards companies with extensive scale and scope โ€“ which is why many of Amdocs' top competitors are quite large (Accenture (NYSE:ACN) and IBM (NYSE:IBM), for instance).

Amdocs' core addressable market is estimated to be worth $40 billion or so, but the company doesn't address as much of that as it could, or at least not yet. About 70% of the company's revenue comes from North America, where AT&T, Sprint, and Bell Canada are major customers. Europe is the second-biggest operating region for the company, but emerging markets provide less than 15% of the company's revenue. Likewise, there are areas of the BSS and OSS markets where Amdocs has a relatively limited presence (network management, workforce management, etc.) and could conceivably enter and capture a bigger percentage of customer spending.

SEE: Is Cloud Computing An Investable Trend?

Can Amdocs Replicate A Proven Model In New Territories And Markets?
While Amdocs has done a very good job of serving the North American telco market (and, to a lesser extent, Western Europe), there's more work to do overseas. Asia has multiple large telecom markets, but the company's presence here is still relatively slight. Latin America, though, may be progressing a little better โ€“ Amdocs has relationships with both America Movil (NYSE:AMX) and Telefonica (NYSE:TEF), who together control about 80% market share across the region.

I also wonder if the company can do a better job outside of traditional telco, namely in the cable provider/broadband space. Customer service needs there aren't dramatically different, and the company did enter this market about ten years ago by way of an acquisition. Still, it hasn't emerged as a big driver for the company so far.

Competition May Be Heating Up
It's still not entirely certain what Oracle (Nasdaq:ORCL) intends to do in the telecom space, but it's clear the company is serious about addressing this vertical more directly. As a lot of what Oracle does involves automating and improving basic business functions, I don't think it's a stretch to say that Oracle may emerge as a threat in some or all of Amdocs' markets.

Amdocs should be in a good place. As I said before, switching costs are pretty significant and the company has long-term relationships with many of its customers. Still, it's a relatively fragmented market (Amdocs largest segment market share is about 15% to 20%), and that could embolden a company like Oracle. Were that to happen, though, it would not be unthinkable that a company like IBM could look to acquire Amdocs.

SEE: Biggest Merger and Acquisition Disasters

The Bottom Line
In theory, Amdocs should have multiple growth opportunities โ€“ emerging markets, more data-related services, and the cable/broadband market. That said, it has been about five years since the company posted double-digit growth, so I think forecasting a major growth improvement is a bit of a stretch. As it is, I look for the company to grow its revenue at a 3%-4% rate, with free cash flow growing a little faster (5%-6%).

With those growth rates, I believe Amdocs is worth about $44 to $45 per share today. That's a pretty good premium to the current stock price, but I will again remind readers that low-growth software stocks often trade at discounts to fair value for a long time. Still, with at least the potential to improve growth and an undemanding present valuation, I think this could be an interesting stock for patient, long-term oriented investors.

At the time of writing, Stephen D. Simpson owned shares of America Movil.

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