Comtech Telecommunications, a provider of satellite communications products to governments and business, appears undervalued and has underperformed peers over the past five years. The COVID-19 pandemic has led to delayed orders and a fall in revenue, prompting the company to seek a way out of its acquisition of Gilat Satellite Networks.
Yet Comtech’s biggest issue is by far its corporate governance and lack of succession planning for long-time CEO and Chairman Fred Kornberg. Shareholder dissent against directors has been very high in recent years, as the average director tenure is twice as high than the Russell 3000.
An activist could ask the company to stop its acquisition binge, announce a clear succession plan, or put itself up for sale, as many competitors are either part of a larger company or private.
The nomination deadline for the December annual meeting is currently open and closes on October 3.
The good and the bad
Comtech is a $382-million market capitalization company manufacturing and selling products for the satellite telecommunications industry. It has two business divisions, one serving commercial clients and the other serving government agencies, including the U.S. Army. The commercial business primarily makes and sells earth-station modems, solid-state amplifiers, and traveling wave tube amplifiers, as well as technologies for routing 911 calls. The government business offers tactical satellite-based communications, field support, and end-to-end integration.
The commercial business’ customers include broadcasters such as AT&T’s DirecTV and EchoStar, defense companies like L3Harris Technologies, General Dynamics, and Raytheon, as well as telecom companies such as Verizon, BT Group, China Mobile, and CenturyLink. The government solutions business’ customers include the U.S. Navy, the U.S. Army, Boeing, and Lockheed Martin.
In fiscal 2019, around 40% of sales, or $269 million, were to the U.S. government.
The satellite telecommunications sector, of which Comtech is part of, has been buoyant, expected to post compounded annual growth rates of between 7% and 9% over the next five to 10 years, according to research from Research and Markets and GrandView Research. GrandView forecasts that the size of the market will double from around $63 billion to $123 billion in seven years, as demand for small satellites for earth observation services is increasing in industries ranging from agriculture to energy and defense.
Yet Comtech’s competitive landscape is challenging. Many of its competitors, such as ViaSat and L3Harris, are also its customers, and they might decide to produce certain parts in-house. Many of the company’s competitors are also either part of a bigger company or private.
Communication equipment companies have been quite attractive for activist in recent years, with 9% of them targeted in 2019 and 8% in 2018. Activists active in the sector include Viex Capital, Cove Street Management, and Starboard Value.
Strong results, weak stock
Comtech has more than doubled its sales from $283 million in 2015 to $678 million in 2019, according to Activist Insight Vulnerability, largely thanks to a few acquisitions, including TeleCommunication Systems in 2016 for an enterprise value of $423 million. Its Ebitda margin expanded from 8.6% in 2015 to 10.1% in 2019.
In the third fiscal quarter ended April 30, Comtech reported a drop in sales of 20% year-over-year, due to order delays stemming from the COVID-19 pandemic. As a result of the pandemic, Comtech is now trying to walk away from a big $532 million acquisition of Israeli-based Gilat Satellite Networks, which provides in-flight connectivity solutions. Comtech argues Gilat experienced a material adverse effect on its business given that the COVID-19 hit the airline industry hard, and issues with the regulatory authorities in Russia.
Despite the strong results, Comtech stock has underperformed its peers on a total shareholder return basis. Its five-year TSR is negative 29% versus positive 10% for the median peer. One-year TSR is negative 44%, versus negative 7% for peers.
In part because of the Gilat hangover, poor corporate governance, and the COVID-19 pandemic, Comtech appears extremely undervalued. The company currently trades at an enterprise value to Ebitda of around 9.5, below its five-year average of 13. Comtech valued Gilat at around 14 times enterprise value to expected Ebitda for 2019. According to Activist Insight Vulnerability, Comtech is valued at a price-to-sales of 0.60, versus 2.48 for the peer median.
The biggest single issue with Comtech is its outdated corporate governance. Comtech CEO Fred Kornberg, who is 83, also serves as chairman and the company does not have a succession plan in place. Kornberg was reappointed to the top role in 2016, just one year after he handed the reins to Stanton Sloane. Before that, he had been serving as CEO since 1976.
The board of directors, which is likely controlled by Kornberg, also needs to be refreshed. The youngest board member is 70, and the average tenure is 15.5 years, more than double the average for Russell 3000 directors. The lead director is Edwin Kantor, an 87-year-old who has served for 19 years. It is rare nowadays to see such a stale and clubby board.
In other corporate governance affronts, Comtech does not have a majority voting standard in uncontested elections, does not provide the right to call special meetings, and has a classified board, according to Activist Insight Governance.
Shareholders have expressed their discontent in recent years. Lead director Kantor received 34% of votes against his re-election in 2019, while Kornberg himself got 5% of ‘against’ votes. In prior years, two directors got more than 10% of votes against their re-election. This is a weakness that an activist can exploit.
An activist shareholder is likely to seek to refresh the board and press the company to hire a headhunting firm to find a new CEO to replace Fred Kornberg or at least publicly announce a succession plan. The pool of internal candidates looks good. Chief Operating Officer Michael Porcelain is 50 and has been in the role since 2002. Chief Financial Officer Michael Bondi is 46 and has served since 2004.
On strategy, an activist could criticize the company’s M&A binge and demand it be halted, as the market does not appear to be enthusiastic about diversification. With the stock price now hovering near 2017 lows and the company undervalued, this could be an opportune time for an activist to strike.
As many of Comtech’s peers are either private or part of bigger companies, an activist could ask management to put the company up for sale. This could be especially the case if Comtech has a hard time finding a successor for Kornberg.