Interactive Investor

Stockwatch: a small-cap with capital growth and takeover potential

After a share price rally this week, the market is finally pricing in some good news, but analyst Edmond Jackson doesn’t think the current valuation is anything like enough.

9th February 2024 10:38

Edmond Jackson from interactive investor

Substantive contracts for Beeks Financial Cloud Group (LSE:BKS) have awoken this drifting share – re-rating it more than 50% to 150p from 95p on 29 January. The shares are currently worth 140p. This does, however, simply restore the stock to levels it traded at a year ago.

This Glasgow-based company provides cloud computing, connectivity and analytics for financial services firms. Given a circa £90 million value relative to high-quality earnings now coming through, I think it’s worth re-iterating capital growth potential. Market price has traded volatile-sideways for around five years while earnings have yet to genuinely to kick in.

Two key factors are behind this delay. First, a long gestation period for the “pipeline” actually to translate into contracts. Second, there’s up-front spending on infrastructure and the like to implement.

The historic table shows negligible profits, chiefly due to goodwill amortisation and some capitalising of costs, and while operating cash flow is good, it has been absorbed by capital expenditure.

Beeks Financial Cloud Group - financial summary
Year end 30 Jun

 201520162017201820192020202120222023
Turnover (£ million)1.32.74.05.67.49.411.918.822.7
Operating margin (%)34.58.4-17.016.116.210.1-3.82.1-1.5
Operating profit (£m)0.50.2-0.70.91.21.0-0.50.4-0.3
Net profit (£m)0.30.1-0.80.81.10.61.60.8-0.1
EPS - reported (p)0.60.3-1.62.32.11.13.11.4-0.1
EPS - normalised (p)0.60.5-0.13.02.31.64.81.50.0
Return on total capital (%)11845.8-75617.018.67.6-2.61.0-0.9
Operating cashflow/share (p)1.41.91.31.34.16.310.57.610.6
Capital expenditure/share (p)0.61.61.74.35.56.912.921.010.9
Free cashflow/share (p)0.80.3-0.4-3.01.4-0.6-2.4-13.4-0.3
Dividend/share (p)0.00.00.00.300.350.350.00.00.0
Cash (£m)0.070.030.022.92.31.43.410.27.8
Net debt (£m)0.050.20.3-2.1-1.00.8-1.9-4.3-2.0
Net assets (£m)0.30.4-0.44.85.66.713.830.832.8
Net assets per share (p)0.60.8-0.89.711.113.124.647.050.0

Source: historic Company REFS and company accounts.

Finally, an inflection point beckons, and has just got better. Material profits for the June 2024 and 2025 financial years were targeted before latest news about how 2025 is guided “significantly ahead of previous expectations.” The company broker’s revenue forecast rises 16% higher to £39.6 million and earnings per share (EPS) 20% better at 8.3p. June 2024 numbers remain unchanged: net profit at just over £5 million on £30 million of revenue.

It reflects, for example, a doubling of a “Proximity Cloud” contract to $3.6 million over four years, with Beeks anticipating “considerable further expansion with this customer” which as yet has 30% of its trading under cloud.

Moreover, this 2025 upgrade is before factoring in an exchange cloud contract just announced “with one of the largest exchange groups, globally” – the third major international exchange to sign up to Beeks’ offering. It involves “a multi-home, fully configured and pre-installed physical trading environment fully optimised for global exchanges to offer cloud solutions to their end users.” Management continues to see a growing pipeline of opportunities for such.

In prior communications to investors, Beeks has indicated a substantive exchange deal can derive revenue of about $50 million over four years, but the question is - what kind of margin may accrue? While the 2024 net profit margin looks in high teens percent, perspectives can vary according to what adjustments to earnings you judge are fair.

Valuation multiple only in the teens

A 140p share price implies a digestible price/earnings (PE) ratio of near 17x looking 17 months ahead, and possibly lower still, according to what emanates from this major exchange contract. If upfront investment is needed, however, the earnings benefit would be further out.

Beeks is one of those companies where you are going to see differentials between reported and adjusted profit, also cash flow versus earnings. Last October’s annual results highlighted underlying EBITDA up 33% to £9.1 million, assuming you are content to normalise away acquisition costs and share-based payments. Yes, it is a “see-through” to how the business is genuinely performing, but these are still costs to grow the business.

In fairness regarding EBITDA, that is how Beeks probably would be valued in a takeover situation – which I reckon will be the long-term outcome.

Heavy depreciation and amortisation charges apply also, hence a £331,000 annual operating loss and £650,000 pre-tax loss after interest costs. When investors are in optimistic mood they may look past this, but when pessimistic it can be a hurdle.

The June 2023 cash flow statement showed net cash from operations up from £4.4 million to £6.9 million. However, £4.3 million of this was spent on property/plant/equipment and there were £2.8 million capitalised development costs.

Additionally, £0.6 million debt was repaid also £1.3 million lease liabilities, hence altogether a £2.4 million annual decrease in cash. The latest update does however reveal the net cash position rose from £4.4 million last June to £5.5 million at end-December.

The situation remains premature for paying dividends. As yet there is nothing guided for 2025. Possibly that could change but I would not raise hopes for any worthwhile yield here. It seems quite tricky to predict cash flows, and whether Beeks is now over a major period of investment, or expenditure will always be required with new IT contracts, tailoring to specific customer needs.

Recall the long-term history of Fidessa Group

The business model is “infrastructure-as-a-service” or IAAS, enabling financial firms to deploy to various exchanges, and trading venues becoming increasingly cloud-based. For likely reasons of client confidentiality and competitiveness, Beeks is not upfront about specifics, which can make the story quite abstract to grasp.

Yet it re-iterates why I first drew attention to the stock as a long-term “buy” at 80p in early September 2018; a modest parallel with financial software group Fidessa. I had followed Fidessa for a couple of decades when also (originally) called royalblue, in software development for portfolio managers. In key respects, Beeks is a modern equivalent, helping traders navigate the cloud and how exchanges are now run.

Both businesses have established “moats” where it is hard for rivals to unpick commercial relationships once established, implying that once earning power gets established it should be high-quality, hence rated well.  

Fidessa started out as a small-cap seemingly always on a pricey PE of 30-40x despite annual earnings growth varying in a zero to 20% range. You either looked beyond this or avoided the stock, which was similarly volatile as here, yet was eventually taken over in 2018 for £1.5 billion. I do not imply such value manifesting for Beeks, I just point out some similarities.  

Last year’s de-rating significantly reflected investors de-risking from small-caps, and also growth ratings contracting under higher interest rates. Yes, it remains down on the 200p level tested variously in 2021-22, but those highs were made in the wake of monetary stimulus during Covid, hence a more speculative market.

I would not therefore see the jump to 140p as pricing in full potential; more that the stock drifted off investors’ radar and there has been a reminder as to what is taking shape. Finally, it looks like patience is being rewarded.

Mind the current technical situation of recent buying

There was heavy buying before this contract news, which does not look good. Nearly 2.5 million shares were traded over three days prior to the announcement, versus nearly 3.0 million over two months previously. Price rose from 96p to 108p before the news triggered a jump. So it is not surprising to see some settling back, which could mean the “technical situation” (balance between buyers and sellers) involves more stock may steadily come back on to the market.

It is a tricky call in the near term, as yesterday the stock did firm from about 137p to 140p, although a widening spread (it should be possible to trade inside the two-way price) can be responsible. As yet, Beeks does look pretty well supported, but it’s unclear quite whether money that went in before the news will exit or stay.

The price has risen over 70% in five years despite some frustrating volatility and patience required. This makes my view quite cautious, but I would target 200p – potentially better - on a two-year view according to news flow, hence continue to rate Beeks a long-term “buy”.

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

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