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Tangoe: Dancing on an Old Grave, Digging a New Hole?

by Melissa Davis and Sonya Colberg - 8/28/2012 2:12:04 PM

Talk about tricky moves. As a young public company with a tainted leadership team and an expensive shopping habit, Tangoe (Nasdaq: TNGO) could have easily tripped over tough questions alone by now. So far, however, Tangoe has spent more than a full year successfully dancing around a maze of potential landmines.

While the previous company led by its CEO and CFO literally exploded – with the pair directly blamed for that notorious collapse – and its growth depends more heavily on acquisitions than management likes to admit, records indicate, Tangoe has yet to stumble even once since it burst onto the stage. A $20 highflier, in fact, Tangoe trades at a rich premium when compared to both the general sector overall and the specific multiples that it has paid for the companies it keeps buying to fuel its amazing growth.

Hatched a dozen years ago just as the first public company long steered by its top executives approached death, Tangoe specializes in the niche arena known as telecommunications expense management (TEM). In a nutshell, Tangoe basically promises notable reductions in a major ongoing business expense by using a technology-driven system designed to shrink the bloated bills that companies often receive for everything from Internet to landline and cell phone services.

Currently in the midst of a muscular growth spurt, Tangoe has spent the past two years gobbling up smaller players that resemble itself in order to further bulk up its own share of that tasty market. That feast has cost a fortune, however, with growth-hungry investors footing much of the tab along the way.

Tapping the capital markets twice in the span of just 10 months, records show, Tangoe has raised a combined $100 million (after fees) and effectively spent most of that to fuel the very growth that makes its stock look so appetizing in the first place. In a shopping frenzy that began around the festive season and never really stopped, records show, Tangoe has managed to run up a bill totaling more than $75 million on acquisitions so far (not counting the $4 million owed on previous deals) and still remains on the hunt for even more.

Because of that expensive (and often risky) growth strategy, Tangoe looks an awful lot like the so-called “rollup” companies that have by now given investors plenty of reason for alarm. 

As the last acquisition-driven company examined by TheStreetSweeper has already proven, those highfliers can sometimes crash in spectacular fashion. Just look at Swisher Hygiene (Nasdaq: SWSH) for some timely evidence. The stock chart for that rollup company tells a horror story (briefly summarized later) all by itself.

Tangoe looks more like a fairy tale at this point itself. Applauded from the start, when it debuted as a bleeding company with a decade of losses, Tangoe rapidly doubled in price months before reaching its first anniversary on the Nasdaq exchange. The stock went on to peak above $23 a share and continues to hover near the high end of that range, records show, even after a dilutive secondary offering and the recent expiration of a lockup period that could still flood the market with a river of shares.

In other words, at current levels, Tangoe arguably reflects few (if any) of the serious risks that could threaten its generous stock price. By rewarding Tangoe with such a lofty valuation, the remainder of this report would suggest, the market has overlooked all or most of the following:

TheStreetSweeper has researched Tangoe extensively this summer, reviewing many of these disturbing topics in detail, and packaged its findings in a comprehensive two-part investigative report. As the first installment in that Tangoe series, this story examines both the dark history of its leaders and the recent drivers of its celebrated growth; the remaining article, set to follow soon, will further expand on issues highlighted in this story and cover new ground as well.

TheStreetSweeper contacted Tangoe through its public relations firm, seeking input for this report, but received no response from the company.

Broken Record?

By topping expectations every time that it posts quarterly results – and then touting “strong organic growth” in its core business as a key driver of that success – Tangoe has clearly managed to dazzle Wall Street with its performance so far. Analysts universally embrace Tangoe because of that rapid expansion, but they also seem to overlook the hidden contributions that have come into play.

For the past two quarters in a row, records indicate, Tangoe actually needed some extra help to impress a market spoiled by a string of pleasant surprises. The first time, company records suggest, Tangoe relied on both a well-timed acquisition and a noncore business to breeze past consensus estimates.

While management had originally predicted that a recent acquisition would add only $500,000 to its first-quarter sales, records show, Tangoe actually wound up booking $800,000 in revenue from that acquisition instead. When specifically asked about potential differences between the projected and actual contributions provided by the new companies that it had just purchased, however, Tangoe stuck by its original numbers – portraying its old guidance as “in line” – despite the outsized boost that it had received as a result of that especially helpful deal

Tangoe offered no clue at all (other than a brief mention later buried in its official corporate filings) that it had booked 60% more revenue from that mid-quarter acquisition than analysts had likely baked into their own forecasts. With Tangoe exceeding top-line estimates by little more than $1 million that quarter, though, the company obviously relied on that extra $300,000 for a material portion of its relatively modest upside.

More importantly, its filings suggest, Tangoe also needed a handy surge in noncore operations to boost its profits above forecasts and avoid a potential outright miss. Long after Tangoe shifted away from its original focus on consulting services and software licensing, its filings show, the company has suddenly enjoyed a convenient uptick in those forgotten businesses. In both of its most recent quarters, Tangoe has posted steep gains in its noncore operations – an overlooked segment now growing even faster than the celebrated TEM business itself – with that comeback proving critical on the first of those occasions.

Tangoe recorded a 40% jump in sales generated by that overlooked division in the first quarter, a stark difference from the meager single-digit gains that it had realized over the course of the previous three years. For some reason, its filings suggest, Tangoe spontaneously fielded an extra $800,000 worth of orders for its older services – with half of that generated by lucrative software licensing fees – long after the company had given up on actively pursuing that business itself. Without that helpful burst in demand, records indicate, Tangoe would have strained to simply meet (let alone beat) profit forecasts for the first quarter and ruined its perfect record for outperformance by now.

Because software license fees often carry gigantic margins (of 80% and beyond), most of those sales drop straight to the bottom line. By recording a $400,000 increase in those valuable fees during the first quarter (with a similar boost in other noncore services further adding to that help), records indicate, Tangoe wound up with a convenient surplus that it really seemed to need.

Due largely (if not entirely) to the huge uptick in its noncore businesses that quarter, records suggest, Tangoe managed to once again beat profit targets by a penny a share – requiring a mere $375,000 cushion – and keep its reassuring pattern neatly intact.    

The day after the company delivered that particular upside “surprise,” with management bragging about organic growth in its core TEM business as usual, Tangoe actually hit its highest price on record. If Tangoe sparked a thrilling celebration with those financial results, however, the company also jarred some rather disturbing memories in the process.

Vanishing Act

Back when Tangoe CEO Albert Subbloie and CFO Gary Martino filled those same positions at doomed Information Management Associates (IMA), court records show, that company reported a hefty surge in its own software licensing fees that set its stock on fire as well. Within months of announcing the welcome “turnaround” that ignited its shares, however, IMA revealed that it had grossly embellished its true financial performance and now faced a material restatement as a result.

Outraged shareholders later responded by filing a class-action lawsuit against IMA and its top executives, naming Subbloie and Martino as the only individual defendants and therefore holding them personally responsible for the fiasco.

“Defendants engaged in a common course of conduct that operated as a fraud on the integrity of the market for IMA common stock by intentionally or recklessly issuing quarterly financial statements which materially overstated the company’s actual revenues and assets and materially understated its expenses and net loss,” that lawsuit proclaimed. Indeed, “25% of the revenue originally reported did not exist …

“These manipulations created the appearance that IMA’s financial condition was improving drastically from a year earlier,” the lawsuit added, “when in fact IMA’S financial condition was rapidly deteriorating” instead.

Dangerously low on cash, the complaint stated, IMA fabricated half of its quarterly revenue from licensing fees – booking millions that it could not reasonably expect to collect – and wound up securing the funds that the company desperately needed in order to survive. As the CFO responsible for compiling those numbers, records show, Martino wasted no time basking in the glory of the applause that erupted on that report. The very day that IMA loudly trumpeted its newfound “success,” the company also casually noted that Martino had decided to step down as its longtime finance chief and oversee a new subsidiary instead. While Martino retained his secondary role as chairman of the board, he quickly distanced himself from the executive suite – and the finance office in particular – ahead of the disaster that would soon begin to unfold.

Before his replacement could even close the books on another quarter, records show, IMA returned to the market with jarring news of a massive restatement that instantly hammered its stock and ultimately left the entire company in ruins. As IMA spiraled toward bankruptcy, records show, its longtime leaders – permanent fixtures at the company they had cofounded for about a decade by then -- effectively vanished from the scene.

After first quietly joining the board of the company that would soon become Tangoe itself, records indicate, Subbloie and Martino steadily clipped all formal ties linking them to their original failure. When they carried out their first big move by resigning from their leadership positions at IMA (as CEO and chairman respectively), a local news report shows, the Nasdaq promptly responded by halting the battered stock. When they followed up with their second (and final) step by vacating their regular boardroom seats a few months later, the press release announcing that development included no stock symbol at all.

While the disgraced leaders volunteered to serve as “consultants” for another 90 days at that point, IMA soon ran out of time and spared them the leftover hassle. Two weeks later, records indicate, the company – its stock already halted, its resources now drained – filed for Chapter 11 bankruptcy protection and then faded into oblivion.  

By the time that Tangoe itself went public more than a decade later, IMA lingered on as little more than a distant memory. Tangoe included only a brief mention of the IMA bankruptcy in its original registration statement, and then skipped even that in the more timely proxy statement that has since followed. With the former leaders of IMA now left to share its story (on those rare occasions when it resurfaces at all), the company sounds less like a victim of fraud -- a view that strapped investors clearly took -- and more like a routine casualty of the dot-com crash instead.

Following an interview with Subbloie earlier this year, for example, a local business newspaper simply mentioned that IMA had filed for bankruptcy after “the Internet bubble burst” in a glowing article that basically painted its former leader – and his new company – as a proven success.

Costly Production

Yet Tangoe looks a bit vulnerable itself. Even though its top executives stand accused of cooking the books in the past, records indicate, Tangoe has taken no extra precautions to prevent a disaster like that from striking again.

For starters, its filings continue to suggest, Tangoe has yet to even implement standard internal controls over its financial reporting process. Furthermore, records show, Tangoe has placed a tarnished auditing firm – with a record of outright “audit failures” – in charge of catching any misstatements that the company, without its own safeguards, might have included in its books.

When IMA selected its own auditors, court records show, the company actually chose two different top-name firms that (at the time) ranked among the most respected in the country. Of course, those same records indicate, IMA also terminated both of those auditors after they took exception with its accounting practices upon a thorough review of its books.

Tangoe did hire one of those big-name firms for a consulting project, its filings show, with PricewaterhouseCoopers reviewing its compensation policies and recommending bigger payouts for its top executives. But Tangoe stopped short of splurging on that respected firm as its actual auditor for some reason, records show, even though its business model heightens the complexity of its financial reports.

Despite the moderate image that its leaders like to present, Tangoe bears an obvious resemblance to traditional rollup companies with inherently risky business strategies. Leaning heavily on acquisitions to supplement its organic growth, records show, Tangoe regularly buys up smaller companies and then books their revenues as its very own.  While perfectly legal and even formerly popular, that strategy has also proven notoriously susceptible to accounting tricks and other hidden dangers that can result in some rather tragic consequences for investors.

Take Swisher as a convenient example. A popular growth stock with massive gains itself not so long ago, Swisher went public in late 2010 with grand plans to consolidate firms that provide cleaning services into a single empire under the seasoned guidance of the same executives who built the Blockbuster and Waste Management (NYSE: WM) chains. Thanks to the breathless pace of its top-line growth and the high-profile status of its leaders, Swisher soon took off as a powerful momentum stock – its market value ballooning past $1.5 billion at its peak  -- but deflated for good once TheStreetSweeper sounded an alarm about the company.

Regardless of its expertise at cleaning bathrooms and such, the company itself turned out to be a real mess. A repackaged failure with its original stock trashed by its namesake founder on his way to prison for fraud, Swisher looked even worse than some rollup companies that might have fuzzy numbers and red ink all over their books. With its dark secrets exposed, Swisher took an ugly hit and – now in the process of scrubbing its financial statements – could soon lose the stock listing that it secured less than two years ago. A double-digit stock at the height of its craze, Swisher has already plunged to just $1.66 a share in the meantime.

These days, the same rollup company that made such a big splash with its sharp gains is instead making embarrassing news for its stupidity by landing in a popular weekly column known as “The 5 Dumbest Things on Wall Street.”

“Come on, guys,” TheStreet.com prodded on Friday. “Why is it so hard to hand in your homework? Dog ate your 10Qs?”

For its part, records indicate, Tangoe routinely tries to downplay acquisitions (a topic often mentioned as a mere afterthought) and carefully distance itself from the dangerous rollup strategy that has wrecked so many former highfliers over the years. Every time that Tangoe issues its financial results, for example, the company simply starts by reporting an explosion in total revenue – with acquisitions keeping that number above 50% until the most recent quarter – and then goes on to trumpet solid “organic growth” in recurring revenue from its core operations as well.

To date, records show, Tangoe has consistently pegged that organic growth rate at “20% or better” and cited a figure closer to 30% as recently as a year ago. For some reason, however, Tangoe now seems reluctant to share the exact number that should have resulted when management took the extra steps required to calculate that growth rate in the first place.

During its past two quarterly conference calls, for example, Tangoe merely offered a vague “estimate” that placed its organic growth rate “in the low to mid-20% range” and (as usual) above the targets set by the company itself. While this estimate may look both solid and consistent, the possibilities implied by that range all fall below the figure supplied a year ago and therefore represent a slowdown in organic growth. Without the precise formula (and underlying numbers) that Tangoe uses to calculate its organic growth rate, however, investors cannot monitor – or independently verify – this reassuring metric on their own.

Tangoe does supply obligatory “pro forma” numbers in its regulatory filings, though, which represent the estimated contributions provided by acquisitions to its total revenue. Based on those figures (often used to extract organic growth rates at other acquisitive companies), Tangoe has achieved far more modest internal gains than those that management keeps broadcasting to the public.

Without any helpful surge from acquisitions, those estimates indicate, Tangoe would have seen its core revenue grow by just 13% -- a full ten percentage points below the midpoint of the range presented by management – throughout the first half of the current year. Furthermore, earlier pro forma numbers suggest, Tangoe would have mustered only single-digit revenue gains on its own the year when the company arrived on the market in the midst of a tantalizing growth spurt.

Thanks to yet another buyout deal (its biggest one so far), Tangoe can now bank on some help with its future growth rate as well. When Tangoe reported its latest quarterly results, the company relied on a major last-minute acquisition – which literally closed that same day – to offer a noteworthy boost in its full-year guidance.

Without rushing into that deal, records indicate, Tangoe would have been stuck with a forecast that Wall Street (accustomed to better) might view with alarm. Excluding the projected cushion provided by that deal, Tangoe would have issued guidance that actually fell a bit shy of its previous top-line estimates for the second-half of the year and (when adjusted to reflect a change in the share count) simply matched its prior bottom-line forecasts at best.

While Tangoe may have raised its guidance by a healthy margin as a result of that deal, however, outright bulls raised some rather pressing questions in response. Now that Tangoe has purchased so many of its smaller rivals, one analyst wondered, was the company finally ready to “take a breather on some of the M&A (merger and acquisition) activity for a while?” If not, the analyst asked, would Tangoe be returning to the capital markets with its hands out once again?

After buying up a string of smaller players with the help of its IPO proceeds, Tangoe had raised another $37.8 million (after fees) this spring and just pledged the equivalent of all that – and then some – for its biggest acquisition in history. Once Tangoe covered the $30 million down payment on that $41 million deal, its filings show, the company would have $48.4 million left in the bank and need most of that for looming bills.

Tangoe must cough up $34.4 million to cover leftover acquisition payments and operating leases over the course of the next 12 months, its filings show, with the bulk of that eaten up by the hefty sums that it still owes on companies already stuffed into its bulging portfolio. Beyond that, Tangoe has also listed “amounts due under various debt and credit facilities of $17.6 million” in its most recent quarterly report. With all but $14 million of its existing funds already committed for acquisition and lease payments, its filings indicate, Tangoe lacks even the cash necessary to offset those existing liabilities.

In other words, its filings clearly suggest, Tangoe effectively ended the first half of this year in a “net debt” or “negative net cash” position.

At the same time, of course, Tangoe must cover routine expenses – with the company spending $2.4 million so far this year on rent payments alone – and obviously save some cash to finance its actual operations. Since Tangoe needs so much money to cover its bills and generates only so much cash on its own (while barely clearing $500,000 in actual profits in the first half of this year), records indicate, the company looks strapped even without the added burden of yet another expensive shopping trip.

Regardless of its financial situation (and the gentle suggestion of a friendly analyst), however, Tangoe has so far refused to back away from its capital-intensive growth strategy. When directly pressed on that sensitive matter upon closing its new record-breaking deal, in fact, Tango bluntly stated that it would “continue to look at acquisitions” and strongly implied that it had plenty of cash to spare.

Curtain Call?

At this point, however, Tangoe could find itself hunting for attractive targets in vain. After all, logic would suggest, Tangoe cannot keep on acquiring other players in the same space (and booking their revenue as its own) if it has run out of companies to buy.

“With the closing of this acquisition,” Barclays quickly noticed, “Tangoe has really completed the majority of the possible consolidation in the TEM market, as they are significantly larger than the next closest competitor” and significantly smaller than a pair of heavyweights that round out the group.

Besides Tangoe itself, Barclays indicated, only two industry giants – IBM (NYSE: IBM) and Vodafone (Nasdaq: VOD) – remain as major stand-alone players in that field. With the market valuing IBM and Vodafone at $225 billion and $145 billion, respectively, those companies obviously fall outside of Tangoe’s modest price range.

If anything, records suggest, Tangoe better hope that IBM simply keeps on sending a lot of business its way.

Tangoe landed IBM as a major client back in the fall of 2009, when the two companies forged a “strategic relationship” that offered benefits to both parties involved. After that, Tangoe counted on IBM for more than 10% of the revenue that it reported for two years in a row. Tangoe in turn rewarded its big partner for the business that it provided, filings show, issuing IBM warrants for a huge pile of its stock in exchange for meeting established revenue targets.

Before IBM swallowed a Tangoe rival of its own during the first quarter of this year, records show, it scored plenty of those warrants and exercised them at prices that offered some rather handsome paper gains. By the end of the very next quarter, however, that situation had apparently changed. Since its big partner failed to meet “specified new contractual revenue commitments” under a revised agreement set forth last year, Tangoe revealed in its recent quarterly filings, IBM earned no additional warrants and that agreement effectively expired.

When questioned about IBM three months earlier (more than nine months into that amended 12-month agreement), however, Tangoe had reassured investors about the status of that important relationship. Subbloie had specifically characterized the situation as “status quo” during the first-quarter conference call, adding that company leaders “don’t see any change in the relationship” with IBM and “still feel good about the channel partnership” that the company had established.

To some Tangoe skeptics, however, that arrangement looked shaky at best -- and hopeless at worst – even then.

“The question had been, ‘When your strategic partner acquires a big competitor, does it hurt your sales?’” recalled a hedge fund manager with a short position in the stock. “The answer seems to be, ‘Yes.’

“This seemed like a ‘pay-to-play’ deal in the first place,” the bear added, “given that IBM seems to have gotten paid in Tangoe warrants/shares a significant dollar amount relative to the sales they generated for Tangoe. Now IBM has no remaining incentive to do business with Tangoe. Plus, they own a Tangoe competitor.

“It’s bad all around for Tangoe.”

After leaning comfortably on IBM as a major source of its past revenue – and depending heavily on acquisitions as a crucial driver of its recent growth – Tangoe could obviously take a fall without the ongoing support long provided by either (let alone both) of those important crutches. By dumping so much of their own stock lately, Tangoe insiders sure seem unwilling to even wait and see if the company will continue to stand tall. Since February alone – the very month when IBM happened to close its acquisition of a Tangoe rival – insiders have literally sold the equivalent of 17% of all the company stock that freely trades on the open market today.

Granted, Tangoe already looks rather pricey regardless of any potential shock that might hammer the stock on down the road. The company currently trades at almost six times its prior-year sales (a total that includes plenty of IBM revenue) in a sector that trades at an average of less than two times sales instead. If the market stripped Tangoe of its rich growth premium and valued the company in the same manner as its peers, current industry multiples reveal, that $20 highflier would suddenly become a single-digit stock – fetching barely $6 a share – and blend right in with the rest of the crowd. 

 

* Important Disclosure: Through its members, TheStreetSweeper established a financial position in TNGO prior to the publication of this report and will profit on future declines in the share price. At the current time, TheStreetSweeper has sold a total of 123,773 shares of TNGO short at an average price of $20.65 a share. Going forward, TheStreetSweeper may choose to adjust the size of its TNGO investment -- by increasing, decreasing or covering its short position in the stock -- and will fully disclose the details of any future transactions as those trades occur. 

* Update: Since the release of its investigative report on Tangoe, TheStreetSweeper has closed out its short position in the stock by executing the following transactions: covering 43,171 shares on Aug. 28 at an average price of $17.26 a share; covering 44,100 shares on Aug. 29 at an average price of $17.03; covering 11,000 shares on Aug. 30 at an average price of $16.62 a share; covering 3,000 shares on Aug. 30 at an average price of $16.20 a share; covering 1,900 shares on Sept. 4 at an average price of $16.73 a share; covering 2,102 shares on Sept. 5 at $16.84 a share; and covering the final 18,500 shares on Sept. 6 at $15.51 a share. As a result, TheStreetSweeper has no financial position in TNGO at the present time.Going forward, however, TheStreetSweeper may choose to establish a new short position in the stock. If so, it will fully disclose the details of any future transactions in the stock as those trades occur. 

As a matter of policy, TheStreetSweeper prohibits members of its editorial team from taking financial positions in any of the companies that they cover. To contact Melissa Davis, the editor of this website and the author of this story, please send an email to editor@thestreetsweeper.org.

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