Company Overview: The Citadel Group Limited (ASX: CGL) is involved in the expansion and distribution of technology and education solutions to state and federal government departments and the private sector. The company primarily specialises in controlling complex data through integrating technology know-how, systems, and people in order to provide information anytime and anywhere. Most of the company’s revenues are derived from software solutions and long-term managed services contracts. The company’s offerings are divided among three key segments – Knowledge, Health, and Technology. The company was incorporated in 2007, with more than 200 employees across Australia.
 

CGL Details
 

 
CGL Rides on Higher SaaS Revenues Along With Acquisition Synergies: The Citadel Group Limited (ASX: CGL) is a technology-based company, which is engaged in the provision of software and services, consulting, and professional services as well as product sales and installation services across Australia. CGL remains on track for continued progress towards its strategy to increase the size of SaaS business, gain multiple contract wins, and leverage a significant pipeline of opportunities. Growth in the SaaS business has been a key highlight for CGL business. During 1HFY20, the company has made significant efforts to enhance its software and platform capabilities. The return on investments made for developing the platform capabilities was evident in the success of the Citadel-IX offering, which increased the company’s customer engagement, positioning the Group with significant opportunities to scale. Moreover, the company also secured additional contracts in Defence and National Security. During the period, the company successfully integrated Noventus acquisition realising $10.9 million of revenue in 1HFY20 and strengthening its offerings in the Government, Defence and National Security verticals.
 
Recently, CGL stated that it has inked a strategic agreement to acquire Wellbeing Software Group Limited (Wellbeing) for consideration of £103 million. The Wellbeing acquisition will aid CGL to leverage numerous growth prospects and transform its business into a worldwide healthcare software company. Wellbeing has responded well to curb the impact of COVID-19 crisis, by ensuring business continuity and support all customers remotely. Wellbeing is also witnessing prospects across managed data centre services for its core product, along with artificial intelligence opportunities to detect COVID-19 risk in patients. The move is a part of CGL’s strategy to strengthen its foothold in the healthcare software sector in the UK. Post the completion of Wellbeing acquisition, Citadel expects to have a combined cash balance of ~$10 million along with an additional undrawn working capital facility of ~$10 million.
 
The company is focusing to shift its business mix in order to enhance the proportion of revenue and earnings from its Enterprise Software and Health Software segment. The move will aid the company to realise long term profit and recurring revenue streams. Notably in 1HFY20, total software revenues increased 18.9% year over year and came in at $18.9 billion, which comprised 31% of the total revenue. Total service revenues, on the other hand, increased a whopping 25% year over year in 1HFY20.
 
Over the period of 1HFY16-1HFY20, Software revenue from continuing operations has reported a CAGR of 29.1%, with continuous upward movement. The return on investments made for developing the platform capabilities was evident by the success of the Citadel-IX offering, which reported revenue growth of 15% from 1HFY19. Citadel-IX has more than 25,500 users in 1HFY20 and the company is aiming to have more than 200,000 users by end FY21. Looking at the current business scenario, the trend is expected to be continued as the company confides in the investments made on developing its capabilities during FY20.
 

Growth in Software Revenue (Source: Company Reports)
 
Going forward, the company expects FY20 revenue guidance to be in the range of $128-$132 million and EBITDA to be between $28-$30 million, with the successful integration of  Noventus acquisition, which is expected to achieve more than $20 million revenue in FY20, depicting an increase of more than 11%. Further, post Wellbeing buyout, CGL expects to diversify its recurring revenue base, with revenues increasing in the range of41% to 48% of FY20 pro forma normalised estimates. Moreover, the company’s commitment towards reshaping the business through the Citadel-IX strategy truly holds the potential to boost revenue growth and drive financial security for its investors. Dividends for FY20 is predicted to be in accordance with FY19. In 1HFY20, the company declared a dividend of 4.8 cps.
 
1HFY20 Financial Highlights: During the year ended 31 December 2019, the company reported total revenue amounting to $61.1 million, up 24.4% on prior corresponding year. The company’s shift in the business mix along with International expansion was key positives during the quarter. Total software revenue for the period went up by 18.9% year over year, as a result of investments made for the development of secure cloud-based software solutions. For instance, the company invested significantly in the security of the Citadel-IX platform. In addition, the company extended the 10-year contract with Queensland Health. Total Service revenues for the period stood at $41.5 million, up 25% year over year. 
 

1HFY20 Financial Performance (Source: Company Reports)
 
Operational Highlights: In 1HFY20, the company reported gross margins of 41.2%, down from 47.5% in the year-ago period. Gross Margin has been impacted by Noventus outperformance and lower first-quarter revenue. EBITDA for the period stood at $12.5 million, down 5.3% year over year. EBITDA for the period incorporated $800k of restructuring costs and one-off expenses, which more than offset the positive impact of AASB16 adjustments of $1.1 million.
 
Balance Sheet and Cash Flow Details: The company exited the period with a cash balance of $12.3 million and total assets amounting to $151.8 million. The company has a debt of $19.6 billion as of 31st December 2019. During the period, the company has cash from operations of $5.1 million, up from $3.6 million in 1HFY19.
 

Cash Details (Source: Company Reports)
 
Taking Initiatives to Deal With Covid-19 Impacts: With regards to effects on its business from Covid-19, the group has ensured that no significant projects or contracts have been delayed or cancelled in the period following the release of its H1FY20 results. In order to deal with the uncertainty around the covid-19 impacts, Citadel group has placed plans to reduce operating expenses, defer any non-essential capital projects, and manage liquidity and cash flow within bank covenants.
 
 Top 10 Shareholders: The top 10 shareholders have been highlighted in the table which together form around 73.38% of the total shareholding. Jakeman Holding Co Pty. Ltd. holds the maximum number of shares with a percentage holding of 13.67%, followed by Mcconnell (Mark) with a holding of 7.69%.
 

Top Ten Shareholders (Source: Thomson Reuters)
 
Key Metrics: In 1HFY20, the company reported an EBITDA margin of 20.6%, higher than June’19 EBITDA margin of 4%. In 1HFY20, the company reported an operating margin of 11.3%, higher than June’19 margin of 10.5%. ROE in 1HFY20 stood at 4.1%, higher than June’19 ROE of 3.3%. Debt levels for 1HFY20 also stood at decent levels, with a debt-to-equity multiple of 0.15x, lower than the industry median of 0.48x and the prior corresponding year multiple of 0.31x, lower the industry median of 0.49x. Current ratio of the company stood at 1.96x in 1HFY20. The company is optimistic about business growth, looking at the potential contribution to gross margin from SaaS offerings like Citadel-IX.
 

Key Metrics (Source: Thomson Reuters)
 
Outlook: In FY20, the company is aiming for growth across all its operating segments with a continued focus on the recurring revenue model. Through continued innovation on the SaaS platform, the company is unlocking its true potential for growth. Furthermore, significant contract wins have added to future revenue streams and increased the credibility of the business. Revenue for FY20 is expected to grow year over year. The successful integration of Wellbeing is expected to increase recurring revenues from 41% to 48% of FY20 pro forma normalised estimates. Following the acquisition of Wellbeing, gross profit from software is predicted to be more than 60% of Citadel’s total gross profit. Further, for FY20 gross profit contribution of software is expected to rise from 47% to 63%. The company remains on track to invest in core Health and Enterprise Software and focus on developing secure cloud-based software solutions, which is likely add to its recurring revenue models.
 
 

Key Valuation Metrics (Source: Thomson Reuters)
 
Valuation Methodology: EV/Sales Multiple Based Relative Valuation (Illustrative)

EV/Sales Based Valuation (Source: Thomson Reuters)
 
Note: All forecasted figures and peers have been taken from Thomson Reuters, NTM: Next Twelve Months
 
Stock Recommendation: The stock of the company generated positive returns of 154.32% over a period of one month. Currently, the stock is trading below the average of its 52-weeks trading range of $1.205 - $7.18. The stock is available at a P/E multiple of 24.52x, with an annual dividend yield of 3.5%. The company reported decent 1HFY20 results, with revenues increasing year over year. The company has executed various contracts that will support revenue growth in the coming years. The company is focusing to make higher investments for product enhancements and new technological capabilities. The contract extension with Queensland Health signifies the company’s commitment to its clients and will build a greater sense of confidence among other long-standing relationships of CGL. We have valued the stock using EV/Sales multiple based illustrative relative valuation method and arrived at a target price offering an upside of lower double-digit (in percentage terms). For the purpose, we have considered peers like Infomedia Ltd (ASX: IFM), Appen Ltd (ASX: APX), rhipe Ltd (ASX: RHP) to name a few. Considering the key business developments, expected contribution from acquisitions and contracts, product development initiatives, and anticipated growth in the SaaS business, we give a “Buy” recommendation on the stock at the current market price of $3.09 on 24 April 2020. 
 
 
CGL Daily Technical Chart (Source: Thomson Reuters)

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