[ QSound Report ]
All right, here's the beef. I will split this report into two sections: one focusing on the fundamentals, and the other on the technical characteristics of the stock.
Fundamentals
This section will focus on past and recent conversations with management, including CEO David Gallagher, Executive Vice President Fran Munoz, and LRP Analyst Kevin Skislock.
Let's talk about strategy.
QSound's strategy is broken down into multiple fronts: Internet, Cetera, Thunderbird, and Consumer Electronics. For the most part, I will focus on the Internet aspect:
The company's Internet strategy is broken down into e-commerce and Internet media. From these two branches, we have the soon-to-be-released Affiliate Direct, and the more well-known iQ line of 3D enhancement software.
With their recent acquisition of 'virtualspin.com,' the e-commerce side of the business has suddenly gained greater prominence, and it seems that as of this moment, there is understandably quite a bit of confusion as to how it all works in the grand scheme of things. For all we know currently, it is supposed to be complementary to QSound's business.
But how?
Remember these questions from Post#705:
"2. To what extent does the Affiliate Direct program cover the whole e-commerce process? Does it just take care of the buy, sell, and payment process? Does that then leave the store display setup for Virtual Spin?...
3. How about the current payment process? Isn't Cybercash somehow already taking care of that function?..."
I didn't know the answer to this, and neither yet did one of our top contributors, John Kessinger, so we were really stuck. <gg>
The answer (thank you Mr. Munoz):
Affiliate Direct doesn't get involved in the transaction handling itself. It is a marketing tool to drive traffic to the website in question.
My extrapolation:
Just like how QSound has signed up affiliates to increase sales and traffic for iQ (see all those banners?), it is my assumption that this Affiliate Direct e-commerce package will allow other merchant-clients to set up multiple affiliate-gateways all over the net to drive traffic and sales toward their websites.
The really cool thing about such a package is that QSound effectively is able to set up a toll-road at many posts on the internet: just like how credit card companies are paid a tiny royalty for every transaction that passes through its card, QSound is able to collect on royalties for every sale that goes through its affiliates. I believe the number stated was around 3%.
In this case then, the more merchants that sign up, the merrier. I imagine that with each merchant, they will want to expand their affiliate base as well, making QSound's toll-web even larger. These multiple revenue streams hopefully will provide a recurring income stream that should effectively help stabilize QSound's business.
Referring to some older notes from a previous conversation, there was a last count of about 500 active sites to which QSound had posted its iQ banners. Including the Geocities deal, that number goes to 10,000. It is my understanding that they are looking to expand this number by one more zero.
Now, as in the 80/20 rule, you would expect the top 20% to generate 80% of your revenues, but in this case, it looks like the number follows more closely a 90/10 proportion: the top 500 bring in more revenue than the others combined. As expected, the top traffic and revenue drivers are from audio and radio-related sites.
So that explains the potential for the Affiliate Direct package. How that relates to the Virtual Spin acquisition is this:
Virtual Spin provides all the capabilities of a store front, cart, checkout, authorization, and order. Apparently, while Virtual Spin has the ability to help set up a banner on other web sites, it does not have the ability to track the source, frequency, etc. generated from those banners, as my understanding goes, so please correct me if I am incorrect.
Affiliate Direct can take care of that shortcoming, and it is a service that they can present to the existing client base of 1,000 merchants at Virtual Spin. It would make sense to imagine that these other merchants will be motivated to use Affiliate Direct also to set up as wide a base of affiliates as they can to drive up web traffic and sales, another winning situation for QSound because of their toll structure.
From this standpoint, QSound completes its e-commerce package by providing the whole solution, from beginning to finish, a place to set up a virtual store (via VSpin), solutions for the entire sales process, and tools to enhance traffic expansion.
The ability for the merchants to aggressively expand their sales through an affiliate base(instead of just setting up a shop)appears to be the key difference between QSound's solution and the current offerings in the net(though there are competitors with similar business models, it seems). The more driven the merchant is to expand the affiliate base, the greater the benefit to QSound, which is able to sit back and reap the benefits of a continued royalty stream, which brings us back to the consistency in the company's business model (i.e. put up the initial capital, and let the royalties come in).
With 99% gross margins, Mr. Gallagher's comments are essentially affirmed: "Revenues equal gross margins."
By the way, it is my understanding that Mr. Fran Munoz, who was brought into the ranks in April, would not have come on board if he didn't think QSound's prospects in the e-commerce field were good. Comments from Kevin Skislock indicate the Mr. Munoz made it clear that he has not joined QSound to run VSpin with just 1,000 customers. Apparently, he has aggressive plans for Virtual Spin.
One other comment from Skislock, which I too have observed and agree with:
Qsound's business success in the past has ultimately depended on the success of others. For all of us holding onto the stock due to the Cetera prospects, we know quite well the consequences of inept execution by the relevant third parties. This new deal apparently gets QSound into a state where their performance can be directly controlled.
In my opinion, the biggest business that QSound has had the most control over is the RealNetworks/iQ relationship, and that in turn has been the most rewarding revenue driver of the most recent quarter, directly contributing to bring the company to at least flat-to-positive territory in terms of earnings.
If QSound can continue to execute their plans for Virtual Spin in the same manner that they have with iQ, then the outlook for this side of the business is arguably favorable.
Moving quickly on the list is the Cetera: Mr. Gallagher's conversations with relevant contacts point to the release date as being July 15. Based on my other conversations with others who have contacts at Starkey and the House Ear Institute (partners of the Cetera), the software is a GO, and that they are focused 100% on getting the hearing aid out on July 15. Two confirmations. That's a good sign. QSound will receive an initial royalty lump sum of (I believe) $300,000 upon initiation of the Cetera royalty stream, then it's $50 per hearing aid.
Next, given the release date of July 15, which is later than the initial expected release date of "Month X"(we've had many, as we all know), earnings projections of $0.30 for the rest of the fiscal year are arguably aggressive and beyond the realistic end of the expected earnings spectrum. More realistically, given the shorter alloted time for the rest of the year, management has expressed more comfort with earnings being in the $0.20 to $0.25 range.
As I myself have mentioned in the past, I did not expect significant revenue contributions to be present until the Cetera was released. For anyone who could put two-and-two together, it's obvious that the previously stated expectations of $0.30 were not feasible, as they were based on a more timely release of the Cetera, which we well know is now coming out in July. It's good to get a more approximate-but-realistic number by the end of this year.
Still, given these numbers, my rough calculations warrant a current fair value of the stock at $3.10. Hey, that's currently where the price stands. That's based on some "aggressively conservative" assumptions, such as a 40% risk premium and an earnings expectation of $0.20 by the end of the year, and applying a P/E multiple of 20 for the present value of those expected earnings.
Basically, you are getting a fair price for the current prospects of the company, but once the Cetera deal is locked in and selling, I would make a move to reduce that risk premium to say, 25%. Once that's established, on the upper end of the price target, with an EPS expectation of $0.25, I'd put a cap of about a $4.25 price target. The cheaper these shares get at this time, given the increasing likelihood of the above circumstances coming into existence, the better value you will get for your shares.
Technical Picture
QSound's upward trend remains intact. The price currently sits at an existing support level of $3.00, and the longer it sits here, the closer the 89-day moving average comes from beneath to provide further support. On a short term basis, the technical strength has diminished. The near term downtrend remains intact, and momentum has eased, but to its credit, the Accumulation stream and the stock's performance relative to the S&P500 has been able to persist and remain on the bullish side of the spectrum. As long as this stock is outperforming the market, that's a good thing, but I don't know how much longer. As I commented to someone earlier today, July 15 needs to get here sooner. <g>
An interesting thing to note also is how volatility has considerably declined. Bollinger Bands have narrowed considerably, making the prospect of a Bollinger Squeeze an interesting possibility. An upside breakout to this Squeeze would result in the simultaneous breakout from a 3-month wedge that QSound has been trapped in, which possibly could provide fuel to an upside move to $4.00, a reasonable point of resistance for the issue. Downside appears to be limited to about $2.70, where the current uptrend-line stands.
That's it.
Rainier
PS. Please feel free to add in any comments or corrections to the above information. |
