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Buy, Sell or Hold CriticalControl Solutions with Technology Analyst Steve Li of Industrial Alliance Securities

Update: The post was included in the Festival of Stocks: October 25, 2010

Discovering a micro/small cap stock that delivers both profitability and growth while being cheap is a rarity. Today’s interview highlights one such stock in the technology sector in Canada.

If any of you have ever heard of the company Computer Modelling Group (CMG:TSX), you’ll notice, as you read through the interview, how comparable the stock we highlight today is to Computer Modelling Group. Now, if you’ve never heard of Computer Modelling Group, take a minute and check out it’s price chart and simply consider what your investment would be worth today should you have invested in the company when it’s market capitalization was under $30 million. Enough said.

Due Your Own Due Diligence.

Steve Li is a Technology Analyst at Industrial Alliance Securities

Biography: Steve Li joined Industrial Alliance Securities in 2006 as an Equity Research Analyst. He covers the technology sector with a focus on small caps. Previously, he has held trading positions at various leading firms. Steve graduated from HEC Montreal with a Bachelor of Business Administration in finance in 2000 and from McGill University with a graduate diploma in treasury management in 2003.

Q: Mr. Li, why don’t you start off by telling us a little bit about what CriticalControl Solutions (CCZ:TSX) does? Perhaps you can describe the logistics of the business model, the outlook, margins etc.

A: CriticalControl Solutions integrates technology to labour intensive processes, such as imaging and data entry, to empower its clients to better control critical business information. More specifically, the company provides production data management, enterprise content management, information capture and business process outsourcing services in 4 market segments, including oil and gas, government, healthcare and financial services. Gross margin within the energy segment is about 60%, while in the non-energy sector is about 40%.

What we find the most interesting is that its main market segments, energy and government business from Western Canada, are currently at the trough of the cycle. Given its business model is transaction-based, a bounce could occur very rapidly. Moreover, the outlook is promising given the increasing need for automation and the use of technology in its target markets.

Q: What about valuation? How does CriticalControl Solutions’ valuation compare with its peers? Can you also delve a little bit in the company’s balance sheet? Do you have a target price?

A: Based on an EV/EBITDA multiple of 8.0x, we derive a 12-month target price of $1.25. Currently, we have a Speculative Buy recommendation. The company’s cash position stood at $0.6M at the end of last quarter, while total debt was at $10.3M. The company has positive working capital of $9.8M, so the debt level is not concerning. Peers are valued at 8.5x this year’s EV/EBITDA and 7.3x next year’s EV/EBITDA, while CCZ trades at 4.9x and 3.6x, respectively. We believe the current share price is undervalued and represents an attractive buying opportunity for investors.

CriticalControl Solutions Valuations Chart

CriticalControl Solutions Valuations Chart

Q: Can you describe CriticalControl Solutions’ competitive environment? How is the company positioned versus its competitors?

A: In the energy vertical, Zedi (ZED:TSX-V) and CriticalControl dominate the space. Zedi is a larger with about $27.9M in sales for the first 6 months of 2010, while CriticalControl generated $15.9M. The approach for both companies in somewhat different; Zedi locks its customers within their solutions, whereas CriticalControl offers its customer the flexibility to choose different solutions from different vendors. In the non-energy verticals, the market is very fragmented. In Western Canada, CriticalControl is the market leader in offering an end-to-end solution for business process outsourcing including ECM, imaging and data entry services. Competition offering the complete or partial solution includes consulting firms such as Deloitte & Touche, WesternIM, Arc Business Solutions, West Canadian, Xerox Global Services, Iron Mountain, to name a few.

Q: What catalysts do you see that could move CriticalControl Solution’s stock price?

A: Catalysts are numerous. First, we believe that earnings results may solidify investor confidence in management’s ability to maintain profitability during a difficult operating environment where low natural gas prices and reduced government spending in Alberta have slowed organic growth. Secondly, management has been actively acquiring companies over the past year. We believe the acquisitions will start to pay off in the upcoming quarters with increased size and number of project opportunities. Thirdly, management will continue to seek accretive and complementary acquisitions to bolster growth. The recent acquisitions have been executed at attractive valuations and have been accretive. Fourthly, increased automation and regulation in the energy sector should be a boon for CCZ’s solutions. Finally, the company is well positioned in the Marcellus region and therefore will benefit from natural gas production increase in the region.

Q: Where do you see the next phase of business/revenue growth for the company coming from?

A: It will come both organically and via acquisitions. Organically, we are upbeat about the potential from the US shale gas opportunity, and also we are excited about the size and the amount of contracts CriticalControl is bidding on.

Q: What is your opinion of the company’s management, Mr. Li? How have they performed leading up to this point? Have they delivered on their promises?

A: CriticalControl has great management bench depth. They have been aggressive in building the business and consistent in their actions. Alykhan Mamdani (Founder, President & CEO) and his team have executed on acquisitions while keeping a close eye on cost structure. They take thoughtful and quick decisions when required.

Q: Lastly, what are some potential risks associated with this stock that could hamper your investment thesis?

A: We are currently at the trough of the cycle for a number of their solutions. This restrained environment may last longer than our expectations. Also, as CriticalControl seeks larger contracts, they may face more fierce competition. Lastly, CriticalControl faces a $7.5M lawsuit for unspecified damages against Vangent. Management believes that the lawsuit is a tactic designed to interfere with a pending retender of a contract (currently performed by Vangent). We believe the claim by Vangent against CSI is unfounded since the company has not suffered any monetary or reputational loss.

Thank You, Mr. Li!

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