Company Overview: rhipe Limited (ASX: RHP) is involved in the wholesale of subscription software licenses to a variety of technology service provider resellers. The company offers cloud licensing and solutions for its software vendors across the Asia Pacific region. Its divisions are focused on cloud licensing, cloud solutions, and cloud operations. It offers Microsoft Indirect Cloud Solutions Program (CSP) program for Australia. The company holds intellectual property in the form of PRISM (Platform for Recurring Subscription Management), to boost the consumption of its cloud license programs.
 

RHP Details

 
 
Higher Investments and Relationship With Microsoft Aids RHP: rhipe Limited (ASX: RHP) is involved in the sale and support of subscription software licenses to approximately 3,000 IT service provider resellers throughout the Asia Pacific region. In 2019, the company delivered robust results, which demonstrated that RHP has been able to capitalise further on its 2018 profitability. Notably, during the period, the company strengthened its foothold across key geography, product, and licensing program along with robust subscription-based revenue, which helped the company to enter FY20 with bright colors. The company remained on track to invest in key growth strategies that provided rhipe with the opportunity to build market share and capitalise on the changing IT industry.
 
Markedly, the company has invested in the platform to maintain a strong competitive position to attract new vendors. Also, RHP invested in the development of both private cloud and public cloud businesses. The company had launched its cloud business in FY16, since then RHP 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. Group revenue for the year soared up 35%, on the back of higher 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. In 2019, the company also acquired Microsoft Dynamics consulting business “Dynamics Business IT Solutions Pty Ltd (“DBITS”), to integrate the same in its business solutions in order to expand the value-added services to its reseller clients. The company is performing well with DBITS acquisition and expects further opportunities for growth in the days ahead.
 
Coming to the 1HFY20. For the period ended 31st December 2019, the company provided continued license sales growth and witnessed a positive contribution by Microsoft’s key products. The company also witnessed a larger uplift in non-Microsoft sales during the period than the previous years. During the period, the company began its joint venture operations in Japan where rhipe owns 80% of the JV company, invested in Solutions business and acquired an Australian based security software company.
 
In the time span between 1HFY17-1HFY20, gross sales have reported a CAGR of 45.13%, with continuous upward movement. In 1HFY20, the company reported total revenues amounting to $26.6 million, representing growth of 24%, on the prior corresponding period revenues of $21.5 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. 
 
 
 
 
The company’s robust operating profit growth in 1HFY20 was led by a number of significant investment in the Indirect Microsoft Cloud Solutions Provider (“CSP”) program for Office365, sustained expansion in operations across Asia, New Zealand and Australia, along with an investment in operations to support the expansion of Microsoft Azure. These investments are expected to aid growth in sales, revenue, and gross profit for the Group in the days ahead. Moreover, RHP’s investments in these future growth areas ensure its competitive advantage over peers in the rapidly expanding cloud industry. Going forward, the company continues to retain a strong balance sheet with significant cash reserves. It is also maintaining appropriate liquidity in an increasingly volatile and uncertain time.
 
Sneak Peek at 1HFY20 Key Performance: During the period, the company witnessed strong demand for public cloud software and infrastructure that boosted the sales by 33% as compared to a prior corresponding period increase of 30%. The company also reported revenue growth of 24%, backed by increased contribution from Microsoft Azure and sales across the Asian operations. The Group’s reported EBITDA came in at $7.0 million, an increase of 53% year over year. Net profit after tax increased 7% year over year and came in at $3.3 million.
 

Key Highlights (Source: Company Reports)
 
Microsoft Product Sales Remain a Key Catalyst to Growth: RHP continued to witness robust growth from Microsoft’s key public cloud products, Microsoft Office 365, and Microsoft Azure. O365 sales during the period reported a growth rate of 61% year over year and came in at $34 million. O365 annual recurring sales went up from $59 million in 1HFY19 to $71 million in 1HFY20. As at 31st December 2019, Microsoft O365 seats went up to 547,000, increasing by 97,000 since 30th June 2019. Microsoft Azure sales saw a rise of 141% year over year. Annual recurring sales for Azure went up by 111% to $31.5 million.
 

Microsoft Azure ARR Sales (Source: Company Reports)
 
Balance Sheet & Cash Flow Details: The company exited the period, with a cash balance of $24.0 million, as compared to $23.2 million as at 31st December 2018. Total debt (lease borrowings) amounted to ~$4.6 million at the end of the period. During the half, the company generated an operating cash flow amounting to $5.8 million, indicating an increase of 52% on prior corresponding period cash flow of $3.8 million. During the first-half, the company paid dividends of $2.8 million and invested ~ $1.6m in its key subscription management platform, PRISM.
 
Recent Update:

1. Shareholding Update: In a recent announcement, the company updated that the Mitsubishi UFJ Financial Group, Inc, a substantial holder of the company, has decreased its voting power from 9.41% to 8.34%.

2. In another update, the Board of rhipe Limited stated that it has successfully completed a $33.6 million unconditional placement of ordinary shares to institutional and sophisticated investors. The capital raising will strengthen the company’s balance sheet and will position it well to pursue future acquisitions and expand its existing cloud software subscription business.

 
Top 10 Shareholders: The top 10 shareholders have been highlighted in the table which together form around 45.25% of the total shareholding. Tutus McDonagh Pty. Ltd. held the maximum number of shares with a percentage holding of 14.84%, followed by Mitsubishi UFJ Financial Group Inc holding 8.34% of the shares.
 

Top Ten Shareholders (Source: Refinitiv, Thomson Reuters)
 
Key Metrics: For the half-year ended 31st December 2019, the company reported gross margin, EBITDA margin and net margin of 94.0%, 19.9% and 12.2%, respectively. Gross and net margins stood higher than the respective industry medians. This indicates a better profitability position in comparison to the broader industry. Debt to equity ratio for the period stood at 0.08x, lower than the industry median of 0.50x.
 

Key Metrics (Source: Refinitiv, Thomson Reuters)
 
Risk Analysis: Due to the rising level of uncertainty occurring from COVID-19, rhipe Ltd believes that the company is suitable to revoke its previously announced FY20 operating profit guidance. Further, competitive pressure from existing competitors and their entrances in the new market pose a threat to its financial well-being. Moreover, higher reliance on Microsoft, technological innovation change, failure to retain existing customers and attract new customers along with geopolitical risks add to the woes.
 
What to Expect: Going forward, RHP 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. Substantial 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 intending to bolster its position through the continued development of PRISM. The company will continue to invest in new growth opportunities, with the earlier investments being validated by a strong business performance to date.
 

Key Valuation Metrics (Source: Refinitiv, Thomson Reuters)
 
Valuation Methodology: P/CF Multiple Based Relative Valuation (Illustrative)
  
P/CF Based Valuation (Source: Refinitiv, 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 35.37% in the last three months. The stock of RHP closed at $1.99 with a market capitalization of ~$320.65 million. The stock made a 52-week low and high of $1.155 and $3.12 and is currently trading close to the average of its 52-week trading range. 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. We have valued the stock using the price to cash flow multiple based illustrative relative valuation method and for the purpose, have taken the peer group - Data#3 Ltd (ASX: DTL), TechnologyOne Ltd (ASX: TNE), and NEXTDC Ltd (ASX: NXT). As a result, we have arrived at a target price offering an upside of lower double-digit (in percentage terms). Hence, considering the above aspects, we give a “Buy” recommendation on the stock at the current market price of $1.99 on 19 June 2020.
 
 
RHP Daily Technical Chart (Source: Refinitiv, Thomson Reuters)

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