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SYNACOR (NADSQ: SYNC)

05/12/2016

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Synacor, Inc Ticker: SYNC

Current Price: $3.43 52 Week High: $3.98
52 Week Low: $1.03 Shares Out: 30.0 million
Public Float: Market Cap: $103.0 million
PE Ration: n/a Price to Sales: 0.89

Overview:

On May 4th, Synacor announced a partnership with AT&T worth upwards of $100 million a year upon full deployment. Syncacor held the company's Q1 conference call on May 10th and provided some color behind the AT&T win, expected revenue and investment related to the contract.

Synacor helps customers deliver relevant content to their consumers across all devices. Synacor's content reaches 120 million monthly visitors, 120 service providers, 3500 enterprises, 500 million email boxes and more than 1000 web publishers. Synacor delivers modern, multiscreen experiences and advertising to consumers through a B2B2C business model.

After the AT&T announcement there was some uncertainty whether Synacor had enough existing capital to fund the investment necessary to support the new partnership. Management provided an update during the Q1 conference call surrounding potential funding needs.

At this point cash flows from operations are expected to be sufficient to pay for the estimated $10m investment set to occur over the next 12 months related to the AT&T partnership. Synacor ended Q1 with $15.7m of cash and generated $3.9m from operations in the first quarter. The $10m investment will be split 80/20 with $8m expected to hit in 2016 with $2m hitting in 2017.

The $10m investment cost to support the AT&T partnership is primarily operating expense and is driven by the need to hire new talent on top of the 400 employees on the payroll today. My experience tells me that a majority of the costs of hiring new talent will be related to backfilling existing employees that will be assigned to the AT&T account. AT&T is the elephant in the room and will make up better than 30% of Synacor's annual revenue beginning as early as 2017 and it makes sense to service this customer with the company's best and brightest talent base.

During the Q1 conference call Synacor laid out the 3/30/300 plan that calls for $30m adjusted EBITDA, $300m revenue over the next 3 years (by 2019). The three financial goals laid out by management are very attainable, which makes shares of SYNC an attractive investment despite shares being up over 100% since the AT&T partnership announcement just last week.

To put this 3/30/300 plan in perspective it is important to understand Synacor's business outlook prior to the AT&T contract award. Management guided FY2016 revenue between $125 million to $130 million without AT&T, which equates to a year-over-year growth rate of 16% from FY2015.

The AT&T contract will hit in earnest in FY2017, but the full value of the $100m annual contract will only show a partial year in 2017 as Synacor beefs up staffing and prepares to service the account.

However, if we focus on the 2019 revenue goal of $300m the company is already 75% of the way there with the current book of business running at an annual pace of $225m. Synacor will need to grow its existing book of business excluding AT&T by a 17% CAGR over the next 3 years to hit the $300m revenue by 2019.

During the Q1 conference call Synacor also announced that the company signed a 3-year renewal with a major carrier. The renewal is most likely with Synacor's second biggest customer Verizon. Verizon generated $25 million of revenue for Synacor in 2015 based on a review of the company's 10-K filing.

The other 10% accounts for Synacor in addition to Verizon include CenturyLink and Toshiba. All together these three major accounts drove $53.5 million of revenue in 2015 and represented 49% of the book of business. The addition of AT&T will result in Synacor's the top 4 customers generating over $150m in revenue by 2017, which is nothing to sneeze at.

The other important trend to understand is the revenue mix between recurring high margin repeatable revenue and fee-based revenue. In Q1 2016 recurring revenue grew 114% year-over-year ($13m versus $6.1m) and represented 43% of Q1 2016 revenue versus only 23% of Q1 2015.

Growth in recurring revenue is important because it is repeatable, high margin and generates more net income than fee based revenue. The higher the mix of recurring revenue the higher the valuation SYNC should receive by sell-side analysts based on a price to sales valuation.

Analyst's assigned Synacor a price target of $0.7m of market cap for every $1m in sales based on FY2016 estimates. The contract by AT&T is worth between $50m and $75m towards Synacor's FY2017 revenue total.

Assuming a modest growth rate of 10% for the existing book of business it is reasonable to assume that Synacor can produce between $185m and $210m of revenue in 2017. This also implies that the enterprise value is worth a minimum $130m and $147m or between $4.33 and $4.90 per share today.

Conclusion:

Synacor attracted a lot of attention from investors after the company landed a $100 million contract with AT&T, after a closer look SYNC has further upside despite rising over 100% since May 4th.

Synacor is funding the estimated $10m investment related to the AT&T contract over the next 12 months from existing cash from operations and will see modest revenue contributions of $4 to $6m from AT&T in FY2016.

In addition to signing AT&T to a $100m annual contract Synacor renewed a contract with a major carrier (Verizon) during the Q1 2016 that is worth $25m of annual revenue.

Synacor continues to shift the overall business towards recurring high margin revenue versus lower margin fee based revenue. Synacor grew recurring revenue by 114% year-over-year in Q1 2016 versus Q1 2015 and has no plans to stop there.

We believe sell-side analysts will take a closer look at the book of business and agree with our consensus that SYNC remains undervalued despite rising over 100% in the last week.