Cliff Note #84 - TSS Solutions | $TSSI

The Data Center Company No One Is Talking About

TSS Solutions (TSSI)

Themes: AI - Capacity Expansion - New CEO - Finally Able To Scale

Important Note:

Beware, there are serious caveats. That is why the company sells at such a low P/S of 0.26x. However, given the data center and AI theme, we think it would be criminal not to add TSSI to an equally weighted index, where underperformance won’t kill the performance.

Data: 

• Founded: 2004

• Exchange: OTC

• Price: $0.50

• Shares Outstanding: 21.6M

• Market Cap: $10.8M

• TTM Revenue: $40.9M 

• LT Debt: Zero

• Current Portion of LT Debt: Zero

• Cash: $28M (Balance not representative of operations and is due to company factoring receivables to finance a piece of the business. Further explanation in Cliff note. Cash balance is likely minimal).

• P/E  trailing 12 months: NA

• P/E 2024 est: NA

• P/S trailing 12 months: 0.26x (we choose to use P/S over EV/S due to the large swings in cash balances from factoring receivables).

• P/S on 2024 revenue est: NA

What they do:

Provides data center infrastructure, support & maintenance services. To be clear, the company does not actually construct on-site data centers. Most of what it does are integration services at its facility in Round Rock, Texas, and then deliver “racks” to its customers. A rack is typically made from steel that houses servers, cables, and other equipment.  (More on all this in the Cliff Note). 

Industries/Customers served:

Any industry that has data center requirement needs. Anywhere from the end customer that operates its own on-site data center to 👉 providers of equipment that need to use TSSI services so that the provider’s end customers can build/expand their data centers to 👉 companies that build data centers to rent to rack “space” to end customers (such as co-location and hyperscale facilities). 

In the company’s words:

TSS specializes in simplifying the complex. The TSS mission is to streamline the integration and deployment of high-performance computing infrastructure and software, ensuring that end users quickly receive and efficiently utilize the necessary technology. Known for flexibility, the company builds, integrates, and deploys custom, high-volume solutions that empower data centers and catalyze the digital transformation of generative AI and other leading edge technologies essential for modern computing, data, and business needs. 

Added Industry/business model color

TSSI typically engages with OEM “partners” that provide data center equipment that farm out their clients’ data center needs to TSSI.

A data center is a physical facility that organizations use to house their critical applications and data (servers, data storage drives, network equipment & cabling, and power management). Making it all work requires integration services.

Common Types of Data Centers:

Traditional Centers (Enterprise Centers): Customers build and house their own data center(s).

Retail Colocation Facilities: Rents or leases space to multiple organizations to house their data centers. A company basically rents a “hotel room” with most of the necessary equipment, cabling, power needs, integration needs, and maintenance that may already be present.

A Wholesale Colocation facilities: Also allows a customer to rent space, but the customer will have to basically provide its own equipment and perform the integration work.

Hyperscale Centers: Basically a very large version of the wholesale colocation model, servicing the very elite large customers ($GOOG $NFLX etc). These centers would not allow smaller companies or potentially even enterprise customers to rent space.

Cloud or Hybrids data centers: Customers do not have exclusive use or access to servers, meaning that a rack could be servicing multiple customers. 

Modular data centers are built at a facility and delivered to the customer’s location, typically outside. This option is easier for a company to plan/expand than with an enclosed data center. Traditional data centers that are enclosed require more pre-planning in terms of deciding how big of a building to build to accommodate imprecise expansion needs over time. Modular centers are lighter, customizable, smaller, quicker to deploy, require less equipment, can be more energy efficient, and can be located closer to the processing “edge.”

Historical Business Segments:

System integration - TSSI builds what is commonly referred to as a rack at its facility in Round Rock, Texas and delivers that rack to the customer (Traditional, colocation or modular). We currently do not think that targeting the hyperscalers is part of the company's current strategy.

Services - TSSI enters into maintenance contracts with its customers to ensure data centers are running smoothly and to replace/repair equipment that breaks. The company carries out this offering by monitoring centers remotely and by performing yearly inspections. Contracts typically last up to four years:

Reseller business - This is a relatively new segment (4 years) for the company, whereby the OEM customer asks TSSI to procure equipment or perform services for the customer that the OEM cannot accommodate. In these situations, the OEM pays TSSI to perform the services and purchase equipment. TSSI ability to perform some of these extra integration services allows its OEM partners to capture more revenue from its end customers

New Venture Just Announced Last Week - Data Center Moves, “an innovative relocation service offering. The service is designed to help businesses manage their critical infrastructure while ensuring seamless transitions and minimizing disruptions before, during and after the relocation process.” 

Some History: 

During the company’s “legacy” years, its primary focus was to build expensive brick-and-mortar traditional data centers and direct involvement with most of the aspects of project implementation, including project management and installing the centers with servers and related technology.  TSSI was essentially a construction company with high capital needs and increasingly low-margin opportunities. A series of acquisitions focused on growing this low-margin model did not deliver optimal returns.  

In 2011, a new CEO and turnaround specialist, Anthony Angelini, entered the picture and sold some assets to focus on the integration piece of the business, which was essentially being ignored by the past management team. He also helped save the company from bankruptcy by arranging financing and brightening the company to operate around the breakeven level. By 2021, the company was debt-free.

COVID put the brakes on the company’s progress. In the third quarter of 2022, the Board surprised investors by appointing a new CEO, Darryll Dewan, to help accomplish some things that the previous CEO just couldn’t bring to the finish line, including scaling the business and diversifying the customer base, which was anywhere from 70% to 90% dependant on one OEM customer (we believe that is DELL).

It appears that the new CEO is now ready to implement a growth plan after using 2023 as a transformational year. Will the company be able to break out of its historical revenue range of around ~30 million and do it profitably?

Reasons to add to Index: 

1. New CEO has used 2023 as a restructuring point. This mainly consisted of a few items.

   1. Revamping the manufacturing facility to scale and handle larger workloads.

   2. Reducing the time it takes for the company to complete a rack integration.

   3. Putting together a direct sales strategy, as opposed to just relying on its OEM partners to connect TSSI to end customers.

   4. Make sure TSSI is viewed as an expert in the industry by writing white papers on data centers related to AI.

   5. Clearing out all inventory that was stacking up because of past management’s inability to scale and deploy racks in a timely manner.

   6. Making personnel changes at the managerial level.

   7. Prices for some of the services are increasing (prices have not been raised in years).

2. While prior management did not do a great job of pushing the modular data center business, which has higher margins, the new CEO seems hyper-focused on growing that piece of the business. He’s partly doing this by educating OEM customer sales reps, who engage with companies that need to build or expand their data centers, that modular is a faster and more efficient option to expand data centers. 

3. It appears that DELL is aggressively starting to push modular data solutions. This is great for TSSI since DELL is likely their biggest customer, which is a bit of info that most investors are probably not aware of.

4. TSSI was awarded Dell Technologies' First Choice Partner Award for 2023.

5. The CEO's background involves working at DELL, so that should help solidify TSSI’s relationship with them.

6. While the data center market is expected to grow at about 10% over the next few years, the The modular data center market is expected  to reach US$ 135 billion by 2034, exhibiting a CAGR of 18.3%.

7. Ok, here we unfortunately go… AI is transforming the data center industry, as companies are scrambling to expand their data center needs. We feel that TSSI’s  modular solution is an excellent option to capitalize on this trend if it can quickly deploy racks. Keep in mind that NVDA and DELL are working closely together to develop data center solutions.  

8. So far, TSSI has been largely ignored as a potential beneficiary of bullish AI data center trends. But we expect investors to start making the connection soon. TSSI Is sending subtle hints to the market that it understands how AI is impacting the demand for types of data centers and related services that cater to AI and the unique challenges that AI poses for data centers. For example, on March 12, 2024, the company issued a comprehensive paper on this subject and press released it. Furthermore, the TSSI description in the last two press releases is clearly different from prior releases and clearly highlights that it is targeting the AI opportunity. 

9. TSSI hits one of our favorite multi-bagger markers: Gaining more revenue for new customers. From the Q3 conference call: We will soon announce a new set of service capabilities, extensions of what we do today that our existing customers can utilize, and that it also opened up new markets for our current customer base. 

10. On this subject, we are really curious to learn more about the new service TSSI just press released about helping companies that are relocating their data centers. This seems to be a service that will be offered outside the DELL relationship and could help the company diversify its revenue. We see a big opportunity for the TSSI to offer services to companies using colocation facilities for their data center needs that could use TSSI for equipment, integration, and maintenance services.

11. The third-quarter conference call included some information arbitrage. The company mentioned that revenue growth could be as high as 60% for 2023 the full year, which implies that 2023 revenue will come in at $49 million compared to  $30.6 million in 2022 and that fourth quarter 2023 revenue will be $19.9 million vs.$10.9 million in 2022. 

Valuation: 

This is where it gets a little unclear. TSSI Has been struggling to post consistent growth for the last few years, dancing right around about breakeven or right above and below. Until we can start to see some consistent bottom line growth, and less volatility in revenue, it’s going be hard to start thinking of exact price targets.
However, the upside could be crazy significant.

Even if the company proves it can maintain a small level of profitability, we think it's quite possible shares will trade on a price-to-sales multiple due to the hot nature of the industry. The current P/S on trailing revenue is 0.26x and 0.72 if we eliminate the volatile reseller business.

If things get humming, and the AI crowd gets a hold of this stock, we see the stock being able to trade at a price to sales of 1.0x to 4.0x, depending on the level of profitability and diversification of revenue that might be achieved. To be conservative, we are only going to value the stock on the price of sales, assuming it is off of the revenue without reseller revenue, until we understand that opportunity more. We view that revenue as more of a side hustle since it seems more related to data center applications and can be quite volatile. The growth in the integration and services revenue is what, in our opinion, could possibly lead to the expansion of valuation multiples. On this premise, we see a potential valuation range of $0.72 to $2.87, but only if the company can maintain profitability.

Otherwise, we believe shares will float around the same range they have been in for the last few months. Obviously, we would rather value the company on a growing EPS assumption, but we will have to wait and see on that.

Caveats:

Beware, there are serious ones that exist. That is why the company sells at such a low P/S of 0.26x. However, given the data center and AI theme, we think it would be criminal not add TSSI to an equally weighted index, where underperformance won’t kill the performance.

1. The heavy customer concentration with DELL is definitely an issue and could materially constrain valuation. However, TSSI is servicing DELL’s customers, so in reality, one could assume the revenue is diversified and stable.

2. We believe TSSI’s facility heavily caters to whatever DELL wants (and their scaling needs). This could make it harder for the company to deal with DELL competitors or other types of OEMs in the data center space.

3. TSSI Still has to prove it can materially expand profits.

4. TSSI has not fulfilled customer diversification promises.

5. Our biggest concern is the large volatility in quarterly revenue, margins, and EPS over the years. Although we like the new CEO, it remains to be seen if he can fix these issues, especially with DELL representing the majority of revenue. Regardless, we still like the bet where the upside could be huge.

Research Tasks 

1. What are the company’s options to grow beyond DELL?

2. Has the company gained trust in DELL so that DELL will send them more business?

3. What are other areas of the data center business that the company could enter?

4. Why not just sell the company to DELL or another integration company? The DELL relationship seems like a very interesting bargaining chip to market.

5. Why doesn't TSSI engage with IT resellers or channel partners to help you sell services? 

6. What can the company do to materially increase the recurring service and maintenance revenue?

7. Learn more about the direct selling strategy that the new CEO has put in place.

8. Conduct a site visit.

9. Any plans to build out another facility to service non-DELL customers?

PR/CC/Filings/Presentations Commentary

Third Quarter Conference call:

We will soon announce a new set of service capabilities, extensions of what we do today that our existing customers can utilize and that it also opened up new markets for our current customer base. We expect to close this year with strong growth in revenue, net profit and EBITDA compared to 2022. Our Q4 revenue opportunities could result in revenue growth as high as 60% for 2023 the full year.

We have modernized our integration facility here in Round Rock, Texas. We can now service 4 times to 5 times the level of rack integration business at less cost than before with fewer and more skilled TSS personnel. We're working closely with our OEM partners to share our insight into the complicated requirements of these solutions, including form factors, cooling and deployment, which results in our ability to rapidly embrace emergency technologies such as AI and direct liquid cooling.

As IT and data center infrastructure rapidly evolve based on the development such as AI and machine learning, our OEM partners' offerings and strategies to deliver new offerings must adjust and ramp quickly.

TSSI White Paper on Data Centers:

“As the need for compute power and infrastructure continues to grow exponentially, particularly driven by AI and ML, the data center market and related technologies are having a significant impact on how people store, use, and protect data across virtually every industry,” said Darryll Dewan, CEO of TSS. “While these trends and the industry have the potential to change rapidly, understanding what is happening now will better prepare people for the future and pave the way for advancements that will drive and support the infrastructure needs of society.”

Links

Third Quarter Conference call: https://seekingalpha.com/article/4652886-tss-inc-tssi-q3-2023-earnings-call-transcript

TSSI White Paper on Data Centers: https://www.globenewswire.com/Tracker?data=wCHu1DrWX6X4h2O6LODm62NOfO_CsVsZW-n9xhGBZRrKUzdAhmvuG4TXJkpsGcetR1RjcjATs4Ccmsl4uSfy1abXarevji1_5CzwCGH78LN6eEF2zkMO3XC_L9RafKuYTFD96x0yn9fo-IfjymseIr7ZkSyxOf5m49_KO4SgR5k=

Dell video example of modular centers: https://www.dell.com/en-us/dt/solutions/modular-data-centers.htm#video-overlay=6345403535112