Stockwatch: A niche tech stock at an inflection point

by Edmond Jackson from interactive investor |

It’s for enterprising not conservative investors, but hedge funds are bullish and directors are buying.

Irrespective of the General Election and Brexit outcome I’m intrigued by £77 million AIM stock D4t4 (LSE:D4T4) which has drifted down from around 270p last April to 190p currently.

The fall appears chiefly due to revenue timing issues where any hint of “second half-year weighted” nowadays gets interpreted as profit warning number one. Yet, forward visibility on contracts seems good and the software is a market leader in data collection, analysis and storage, enjoying an impressive list of international clients.

D4t4 looks an emerging quality business – just with lumpy revenues – whose rating ought to rise in the longer run otherwise the company may get taken over.

2016 acquisition creates platform for growth

D4t4 is the old “IS Systems” business which has a chart history going back to before the 2000 tech-bubble when it soared from around 50p to 280p, slumping to just 6p, then making a steady climb back up. The company changed name in July 2016 to reflect a refocusing towards data, which you can see from the table has re-rated earnings.  

Source: TradingView Past performance is not a guide to future performance

Its showcase product is Celebrus, a customer data platform originally part of Celebrus Technologies, that was acquired nearly five years ago for £7.5 million and with whom IS had worked for 15 years. The idea was to integrate data feeds that collect data from people’s interactions with websites, mobile applications and social media – poured into big data engines for in-depth analysis, in real-time since the launch of Celebrus version 9 last April.

It delivers competitive advantages by way of speed and ability to capture data from many sources, versus a “batched” approach that can take many hours – hence is higher quality data that’s able to generate more value. Such product is in use by leading global companies like Citibank, HSBC and Qantas. Clients are serviced in 22 countries and management claims very low turnover once licences are signed.

Hedge fund raised its stake from 5.94% to 6.09% at end-November

Further to a news announcement on major shareholdings, I was interested to read from the monthly newsletter of the European smaller companies hedge fund involved, that its managers had visited D4t4’s headquarters. They were impressed by a demonstration and reckon Celebrus beats all competition in a software industry niche that will support growth for many years to come.

“We are convinced D4t4 will enjoy growth opportunities, both from acquiring new customers and its existing customer base by selling upgrades and other products,” they said.

The prospect is helped by customers typically implementing D4t4’s solutions on a specific geography or business line, then rolling them out to other areas and activities. Market intelligence provider IDC estimates that nearly 30% of data generated will be consumed in real time by 2025 versus less than 5% today, offering significant growth opportunities for Celebrus.

D4t4 isn’t a one-product company however: in the last financial year it generated 36% of £25 million sales from its own products including Celebrus, 29% from third-party products, 22% from support and maintenance with the rest from delivery services. So, it’s fairly well-balanced, albeit with some marketing risk given it’s partnered with larger analytics group SAS for 60% of such revenue (Dell Technologies also). This would appear to make D4t4 potentially a long-term buy for SAS, though might restrict rivals from wanting to.

D4t4 - financial summary            
Year ending 31 Mar 2014 2015 2016 2017 2018 2019
Turnover (£ million) 9.8 12.8 18.6 17.7 18.4 25.2
Operating margin (%) 9.8 5.3 17.7 24.3 18.2 25.1
Operating profit (£m) 1.0 0.7 3.3 4.3 3.4 6.3
Net profit (£m) 0.8 0.5 2.9 3.9 2.9 5.8
IFRS3 earnings/share (p) 3.1 1.9 7.6 10.0 7.3 14.5
Normalised earnings/share (p) 3.1 1.9 7.6 10.0 7.3 14.5
Price/earnings multiple (x)           13.0
Operating cashflow/share (p) 2.9 -0.8 16.5 6.1 1.8 22.6
Capex/share (p) 0.5 0.6 0.9 0.4 2.1 1.1
Free cashflow/share (p) 2.4 -1.4 15.6 5.7 -0.3 21.5
Dividend per share (p) 1.6 0.6 2.0 2.3 2.5 3.0
Yield (%)           1.6
Covered by earnings (x) 1.9 3.4 3.8 4.5 2.9 4.8
Net assets per share (p) 21.3 33.6 40.0 46.2 52.9 63.3
             
Source: historic Company REFS and company accounts            

Near-term revenue issues within a glowing narrative

After Celebrus 9 was announced early last April, the stock blipped around 275p, and an 18 April update for the financial year just ended tweaked profit expectations slightly higher.  Regarding Celebrus, the company said:

“we expect to see both a further increase in licence sales and recurring revenue growth in the 2019-20 year.”  

Come the 25 June prelims however, the narrative altered to growth in term license sales for Celebrus, albeit hurting near-term perpetual sales. The 22 August AGM statement then flagged up “some second half bias to the year overall, though this is not expected to be as pronounced as that experienced in the year to 31 March 2018.” However, the extent of new business opportunities meant the board was confident of progress going forward.

A 21 October update cited £8.8 million first-half revenue, well down on £14 million last year (swelled by a £1.7 million accounting upward adjustment). So, come the actual 25 November interims, the hit to the stock was only 5% to 205p, though it has festered a bit since, reaching 188p on 4 December. A sceptic might say the recent experience casts some doubt about claims as to revenue visibility, and not for the first time.

Smaller companies are prone to operational gearing: interim operating profit slumped from £3.9 million to £847,000 on revenue down 37% to £8.8 million, hence adjusted earnings per share (EPS) down from 7.37p to 1.76p. Net cashflow from operations fell even more, from £9.5 million to just £167,000, hence £925,000 dividends were effectively paid out of cash reserves which fell from £12.2 million to £11.2 million – net assets were £25.8 million, of which goodwill/intangibles represent 37%. That’s still a strong balance sheet.

More a case of lumpiness than competitive issues

Volatility within D4t4’s financial years isn’t unusual, and the software does appear to have a strong market position. In recent financial years the operating margin has re-rated to a high-teens to mid-20% range. The hedge fund investor reckons this will be sustained on circa 8% revenue growth in the 2021 financial year, for free cash flow of around £6 million, although D4t4 could beat this if investments in the US (that have recently constrained margins) start bearing fruit. Over 80% of revenue is US dollar-derived, so there is some exchange rate risk, but D4t4 looks a small if useful hedge against Brexit. 

It is still a smaller company and technology is a fast-moving sector, so this kind of stock is one for enterprising not conservative investors. Yet given UK uncertainties of further disruption to business if there’s a hung parliament or Labour majority, and of Brexit if the Conservatives win, domestic cyclicals may be higher risk. 

Two non-executive directors buy £110,000 worth of shares

You could say it’s taken him time to make an initial purchase since being appointed in July 2018, yet still notable that Peter Whiting bought 22,000 shares at 192.5p on 26 November.

He was followed on 27 November by chairman Peter Simmonds adding 35,000 shares, also at 192.5p, to own 346,500 overall. It accords with my sense that D4t4 shares are at an inflection point given the likelihood of better second-half revenue progress.

If forecasts are met for £5.8 million net profit in the current year to March 2020, rising to around £6 million in 2021, then at 190p the stock is on a forward price/earnings (PE) ratio of around 11 times, yielding 1.8% if the dividend rises from 3p last year to 3.3p. Broadly it’s a modest rating if growth credentials kick in. Buy.

Edmond Jackson is a freelance contributor and not a direct employee of interactive investor.

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