GTK: GENTRACK GROUP LIMITED
I first started looking at Gentrack Group (Gentrack) after having some success investing in a company called Hansen Technologies (Hansen). Hansen is a company which designs billing software for Energy and Utilities companies, pay TV operators and Telco providers. In the last few years it has gone from strength to strength with contract wins and acquisitions delivering profit growth and a large PE rerating.
Whilst researching Hansen it became apparent that the industry dynamics for this type of software are attractive with:
• A high degree of recurring revenue (Gentrack estimate that 50-60% of their revenue is “highly likely” to reoccur);
• Low additional costs of bringing on customers, leading to high margins.
• Very low capital costs leading to high returns on capital.
Gentrack is a New Zealand based competitor to Hanson in the utilities space. However their shares have struggled. Since listing the GTK share price has fallen 9% whilst HSN over that time period has risen 180%.
The discrepancies don’t end there. Gentrack trades at a forward P/E of 16x versus Hansen at 26.5x. Why is this? Well the reasons are two fold, firstly Hansen does have a substantially higher rate of earnings growth over the last two years (with a 31% jump in eps for the December half on the back of acquisitions). Secondly, Gentrack made the cardinal sin of downgrading barely 6 weeks after listing. For a newly listed company this can severely impact credibility with the institutional market.
Normally, the early downgrade would be a rather large red flag but in the case of Gentrack it is a bit different. Gentrack is not a roll-up of multiple businesses, there are no proforma earnings in the prospectus to work through and it certainly isn’t a poor quality retail business packaged up to look good by Private Equity.
Gentrack is a business that has been around since 1989 and has been consistently profitable over at least the last six years:
The company’s revenue stalled in 2014 as a few contracts were delayed and the NZD rallied. Growth has resumed off the new base in FY15 and looks set to continue in FY16.
The company has two key products:
Gentrack Velocity which is a software solution for billing within Utilities companies
Airport 20/20 which is an operational software system for airports handling all areas from aeronautical billing, flight information display, resource management as well as passenger and baggage processing systems
The utilities business is the larger of the two and has broadly been flat in recent years. It was the cause of the downgrade in FY14. On the other side, the Airports division has seen revenue grow by 56% in the last two years (whilst doubling EBITDA last year). The company has a dominant position in Australasia and is growing rapidly offshore with 9 of the top 100 busiest airports globally in their customer base. Amongst this are airports such as Hong Kong International, London City and JFK in New York.
The company estimates the global market for Airport operational software to be US$370m, they currently have revenue of NZ$6.5m. This implies that there is plenty of blue sky.
So despite the rough introduction to listed life, the growth is there. The company has guided to revenue growth of 10%+ in FY16 but flat EBITDA on increased staff and systems spend. The company is actively recruiting new staff in Auckland, Melbourne and London in order to keep up with the current growth pipeline. Australia and the UK are the focus in terms of growth.
So the future looks bright despite the struggles in the share price. What does mean for the valuation? A simple DCF is below:
The following has been assumed:
• Guidance for this year holds (although we think the company has learnt from prior mistakes and there is potential upside there)
• Revenue growth of 10% the year after and 5% through to 2020
• A normalisation in the EBITDA margin
• Terminal growth of 4%
• A discount rate of 10%
There are a few things worth noting:
• FCF conversion is excellent, typically well above 100% due to low capex and high non-cash amortisation
• The company expenses all R&D through the P&L
• The forecast EBITDA growth rate over the next four years is 8.9%, which is below the 10.6% over the last six years
So we have a September 30 valuation of $167.4m or $2.30 per share (9.6% above the current share price). Add in a dividend yield of 4.7% and the numbers start to stack up. The beauty of these companies is that one or two contract wins can skew the numbers to the upside and add significant value. Ultimately this is a company that can grow its value over time. The company also has cash of $12.4m and has stated it would be happy to take on debt up to 1x EBITDA for appropriate acquisitions. This effectively gives it $26m of fire power.
The key risk in any investment is future earnings. When 50-60% of your revenue is “highly likely” to reoccur, then by definition 40-50% of your revenue is “highly unlikely” to reoccur. This means this is a project based component every year which can be volatile, hence some years (like FY14) the company will fail to meet guidance and the share price will suffer accordingly.
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