Company Overview: rhipe Limited (rhipe), formerly FRR Corporation Limited, is engaged in the wholesale of subscription software licenses to various technology service provider resellers. In addition, the Company provides value added consulting and support to assist service provider resellers transition their own clients to cloud and subscription centric business environments. It provides cloud licensing and solutions for its software vendors across the Asia Pacific region. Its divisions are focused on cloud licensing (private, public and hybrid), cloud solutions (consulting services), and cloud operations (billing, provisioning, support, marketing). It offers Microsoft Indirect Cloud Solutions Program (CSP) program for Australia. Its program allows the Company to wholesale Microsoft's public cloud offerings, such as Office365, Azure and Enterprise Mobility Suite (EMS) to rhipe's reseller channel on a monthly subscription pay-as-you-use basis.
 

RHP Details

Microsoft Product Sales Remain a Key Catalyst to Growth: Rhipe Limited (ASX: RHP) is engaged in the sale and support of subscription software licenses to ~3,000 IT service provider resellers across the Asia Pacific region. The company possesses intellectual property in the form of PRISM (Platform for Recurring Subscription Management), to support consumption of its cloud license programs. During the financial year ended 30^th June 2019, the company has continued to invest in the platform to maintain a strong competitive position to attract new vendors. The company has invested in the development of both private cloud and public cloud businesses. Since the launch of its public cloud business in FY16, the company has been a key provider to one of the renowned players in the software industry, Microsoft. Results from the services delivered to Microsoft were a key contributor to growth in FY19. The private cloud business also managed to deliver a decent performance in FY19, particularly in Asia. The company delivered higher sales growth in FY19 as compared to FY18, as a result of growth across areas where material investments were made. Group revenue for the year went up by 35%, on account of growth in sales of the Licensing business. Licensing revenue comes in the form of margins earned from the customers for the services provided by Rhipe, along with sales incentives from the software vendor. Growth in sales and revenue was also supported by the investments made in the front office headcount, with the number of employees increasing from 203 as at 30^th June 2018 to 313 as at 30^th June 2019. The above investment also led to an increase of 25% in operating expenses.

Key positives during FY19 found their way through to 1HFY20. During the half year ended 31^st December 2019, the company has delivered continued license sales growth and another half reporting a positive contribution by Microsoft’s key products. The company also witnessed a larger uplift in non-Microsoft sales during the period than previous years. The company notified that the estimated costs related to the Japan joint venture have come down due to delays in hiring the desired resources, which, in turn, led to a revision in the operating profit guidance for FY20.

Going forward, the company will focus on controlling its operating expenses to keep a proper balance between investing in new growth opportunities and delivering the desired level of operating profit. Significant sales growth from Microsoft’s key cloud products is a key indicator of a prolonged strong competitive position in the market. Moreover, the company is further planning to strengthen its foothold through the continued development of PRISM. The company will now continue to invest in new growth opportunities, with the earlier investments being validated by a strong business performance to date.

In 1HFY20, the company reported total sales amounting to $152.7 million, representing growth of 33% or $38.3 million, on the prior corresponding period sales of $114.7 million. As depicted in the figure below, the company has seen the sales trending upwards since 1HFY17, with the growth rate increasing in each half. The below trend has been strongly backed by continued growth delivered by the public cloud business and Microsoft CSP. During 1HFY20, the above elements contributed to 2/3^rd of sales growth.


Growth in Sales (Source: Company Reports)

1HFY20 Performance Highlights: During the first half ended 31^st December 2019, the company witnessed strong demand for public cloud software and infrastructure, that boosted the sales by 33% as compared to prior corresponding period growth of 30%. On account of increased contribution from Microsoft Azure and sales across the Asian operations, the company delivered revenue growth of 24%. Group’s reported EBITDA came in at $7.0 million, up 53% on the prior corresponding half. Net profit after tax came in at $3.3 million, representing a YoY increase of 7%. Earnings per share for the half amounted to 2.33 cents, representing an increase of 5% on prior corresponding period EPS of 2.22 cents. The Board declared an interim fully franked dividend of 1.2 cents per share, to be paid on 25^th May 2020.


Financial Results (Source: Company Reports)

The company continued to see growth from Microsoft’s key public cloud products, Microsoft Office 365 and Microsoft Azure. O365 sales during 1HFY20 reported a growth rate of 61% on the prior corresponding period, with sales amounting to $34 million. O365 annual recurring sales went up by 50% to $71 million. As at 31^st December 2019, Microsoft O365 seats went up to 547,000, increasing by 97,000 since 30^th June 2019. Microsoft Azure sales witnessed a growth of 141% on the prior corresponding period. Annual recurring sales for Azure went up by 111% to $31.5 million.


Microsoft Azure ARR Sales (Source: Company Reports)
 
Investment for Growth: During the period, the company continued to invest in growth opportunities across products and markets, that led to an increase of 24% in operating expenses. The company has invested in its operations across South East Asia, Korea, Australia and New Zealand, to support the increasing demand for cloud software. In addition, investments were also made to support further expansion of Microsoft’s Public Cloud business. With steady growth in the License business, the company expanded the headcount for the business, primarily in the front office operations, to retain the performance benefits. The company also invested in its Solutions business to enhance the support provided to vendors and partners. Collective investments in the Licensing and Solutions activities acted as a key catalyst for sales and revenue growth.
 
Cash Position: As at 31^st December 2019, the company reported a cash balance of $24.0 million, up from a cash balance of $23.2 million as at 31^st December 2018. During the half, the company generated an operating cash flow amounting to $5.8 million, representing an increase of 52% on prior corresponding period cash flow of $3.8 million. The period was characterised by an investment of $1.6 million in PRISM and dividend payments of $2.8 million.
 
Progress on Strategic Initiatives: The company has completed the setup and capitalisation with respect to the Japan JV, with a staff count of 5. The company is progressing on its marketing and sales strategy for the unit and targets to establish a business pipeline for future growth. Dynamic Business IT Solutions, that was acquired in March 2019 has seen increased investment to enhance the capabilities and provides a strong pipeline to deliver the future earnout target.
 
As a result of a decrease in the estimated investment for the Japan JV, the company has revised the operating profit guidance for FY20. Earlier, investment in the JV was anticipated at $3.0 million, which has now come down to ~$1.5 million. As a result, the company now expects FY20 operating profit including the impact of Japan JV, to be $14 million as compared to $13 million earlier.
 
Shareholding Update: In a recent announcement dated 19^th February 2020, the company updated that the Commonwealth Bank of Australia now holds a voting power of 0.31% in Rhipe Limited.

Top 10 Shareholders: The top 10 shareholders have been highlighted in the table which together form around 45.77% of the total shareholding. Tutus McDonagh Pty. Ltd. held the maximum number of shares with a percentage holding of 17.07%, followed by First Sentier Investors holding 5.91% of the shares.
 

Top Ten Shareholders (Source: Thomson Reuters)

Key Metrics: For the half year ended 31^st December 2019, the company reported gross margin, EBITDA margin and net margin of 94.0%, 19.9% and 12.2%, respectively. The margins stood higher than the respective industry medians. This indicates better profitability position in comparison to the broader industry. The period was characterised by a decent liquidity position, with a current ratio of 1.33x.


Key Metrics (Source: Thomson Reuters)

Guidance: Operating profit for the financial year ending 30^st June 2020, has been estimated at $16 million, excluding the impact of Japan JV. Including the costs associated with the Japan JV and other additional investments, operating profit has been estimated at $14 million. In FY20, the company anticipates costs of ~$1.5 million. DBITS, acquired in March 2019, will also see increased investment and is expected to contribute $1 million to EBITDA for the first 12 months. SmartEncrypt, acquired in August 2019, will see an investment of up to $1 million in FY20.


Key Valuation Metrics (Source: Thomson Reuters)
 
Valuation Methodologies:

Method 1: EV/Sales Based Valuation 

EV/Sales Based Valuation (Source: Thomson Reuters)
 
Method 2: EV/EBITDA Based Valuation

EV/EBITDA 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 returns of 30.84% over a period of 1 year. Over the course of FY19, the company has carried out investments to add to its key capabilities, through the acquisition of DBITS and SmartEncrypt. The most recent development initiative has been the JV in Japan, that comes with significant growth opportunities. As depicted in the financial performance, the company has delivered well on its strategic initiatives so far and has attained a strong competitive position in the market. Going forward, the company will focus on new opportunities, including expansion into new geographies, growth momentum across new and existing vendors, investments in the License and Solutions businesses, etc. We have valued the stock using EV/Sales and EV/EBITDA based relative valuation methods and for the purpose, have taken the peer group - Data#3 Ltd (ASX: DTL), TechnologyOne Ltd (ASX: TNE), WiseTech Global Ltd (ASX: WTC), etc. As a result, we have arrived at a target price offering an upside of lower double-digit (in percentage terms). Hence, we give a “Buy” recommendation on the stock at the current market price of $2.040, down 2.857% on 21^st February 2020. 
 

RHP Daily Technical Chart (Source: Thomson Reuters)

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