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. 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

Acquisition Synergies & Decent Liquidity Position Remains Key Catalysts: rhipe Limited (ASX: RHP) is engaged in the sale and support of subscription software licenses to ~3,000 IT service provider throughout the Asia Pacific region. The company recently provided an update for 1QFY21, wherein it reported revenues of $14.7K, which increased ~16% year over year. Gross profit for the period came in at $13.8K, which also went up 16% on Y-o-Y basis. Operating expenditure excluding Japan JV for the period increased 7% year over year and came in at $9.6K. Operating profit including Japan JV stood at $3.9K, depicting a rise of 39% on prior corresponding period. Despite pandemic related challenges, the company continued to deliver robust revenue growth driven by the strong growth in Microsoft public cloud products including Office365 and Azure. Further, RHP witnessed strong growth in its solutions and services business. As at 30 September 2020, Microsoft Office365 seats were more than 680,000 including greater than 6,000 seats in Japan.

1QFY21 Key Highlights (Source: Company Reports)

The company’s results have shown a continued strong growth trajectory. Robust subscription-based revenue, during the period, helped the company to come out stronger during the COVID-19 global pandemic. During 2HFY20, RHP undertook a capital raise of $32.5 million, in order to take advantage of future acquisition opportunities. Consequently, the company ended FY20, with cash balance of $60.9 million, compared to a cash position of $25.5 million at the end of the previous year. Further, as at 30 September 2020, cash balance stood at $53.8 million, following the payment of $3.2 million fully franked dividend and NZ$4.25 million payment for recently completed Parallo Pty acquisition.

On 30 September 2020, the company acquired 100% of the share capital of Parallo Pty.  The buyout of this Azure specialist IT service provider will aid RHP to expand and strengthen its services portfolio and offer its partners with further capabilities to support their growth opportunities. The company also continues to invest in the Parallo business and support its development into the Australian market utilising existing employee and partner footprint. In FY20, the company entered into a joint venture with Japan Business Systems Inc. (“JBS”). Further in 2019, the company acquired 100% of Network2Share Pty Ltd. The acquisition is in line with the company’s strategy to combine Network2Share’s security software with Microsoft Office365 and other software licenses. We believe these buyouts are likely to help the company ride on its growth trajectory. 

In FY20, the company has witnessed an upward trend in sales, and EBITDA trending upwards since FY17, with the growth rate increasing year over year. The trend can be attributed to the continued growth delivered by the public cloud business and Microsoft Cloud Solutions Provider (“CSP”), along with an investment in operations to support the expansion of Microsoft Azure. RHP continued to witness robust growth from Microsoft’s key public cloud products, Microsoft Office 365, and Microsoft Azure. O365 annual recurring sales during the period reported a growth rate of 56% year over year and came in at $92 million. As at 30 June 2020, Microsoft O365 seats went up to more than 630,000, increasing by 40% since 30th June 2019. Annual recurring sales for Azure went up by 87% to $39.2 million. Annual Run Rate (ARR) sales from Microsoft CSP, including Office365 and Microsoft Azure, came in at $131 million at the end of FY20, up from $80 million at end of FY19 and $42 million at the end of FY18.

FY20 Results Driven by Strong Demand for Public Cloud software & Infrastructure: In FY20, the company’s operating profit came in at $15 million, which excluded the investments in rhipe Japan. Subsequently, the operating profit of RHP’s core licensing business grew 36% year over year.  Also, RHP invested in the development of both private cloud and public cloud businesses. During the same period, gross sales went up by 29% as compared to a prior corresponding period and came in at $325.2 million. The company also reported revenue growth of 15%, backed by increased contribution from Microsoft Azure and in public cloud. The Group’s reported EBITDA came in at $11.6 million, an increase of 16% year over year. Net profit after tax decreased by 19% on Y-o-Y basis and came in at $5 million. The company's operating profit grew 17% year over year in FY20 led by a 36% increase in licensing operating profit.

FY20 Key Highlights (Source: Company Reports)

Healthy Balance Sheet and Decent Liquidity: For FY20, the company reported EBITDA margin and net margin of 22.4% and 8.6%, respectively. EBITDA 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 0.04x, lower than the industry median of 0.25x. The company exited FY20, with a cash balance of $60.9 million. Total debt (lease borrowings) amounted to ~$3.9 million at the end of the period.

During FY20, the company generated an operating cash flow amounting to $13.7 million, indicating an increase of 13% on prior corresponding period cash flow of $12.1 million. During the period, the company invested ~ $2.1 million in its key subscription management platform, PRISM. As a result of the strong cash position at 30 June 2020, RHP stated the payment of a fully franked dividend of 2.0 cents per share to its shareholders. Most recently, the company announced an off-market share buy-back facility to buy-back all the shares held by shareholders who hold less than $500 marketable parcel in the company. RHP is also offering the Buy-Back Facility to holders of Less Than Marketable Parcels to sell their shares without any additional costs. Further, repurchasing outstanding shares is likely to aid RHP’s business, reduce its overall cost of capital, consolidate ownership, boost vital financial metrics, or free up profits to pay management bonuses.

Key Metrics (Source: Refinitiv, Thomson Reuters)

Top 10 Shareholders: The top 10 shareholders have been highlighted in the table, which together form around 34.33% of the total shareholding. Tutus McDonagh Pty. Ltd. held the maximum number of shares with a percentage holding of 14.84%, followed by First Sentier Investors holding 4.78% of the shares.

Top Ten Shareholders (Source: Refinitiv, Thomson Reuters)

Key Risks: Stiff competition from existing peers and their entrance in the new market pose a threat to the company's financial well-being. During the COVID-led pandemic, where work from home trend continues to spur, some end-user clients and IT resellers witnessed business decline, where staff were not being able to do work from home. Further, weakness in travel, marketing and challenging economic conditions may dampen the growth prospect of the business in FY21. Other risk factors include higher reliance on Microsoft, failure to keep pace with ever changing technologies, failure to retain existing customers and attract new customers along with geopolitical risks.

What to Expect: In FY20, the company commenced its joint venture operations in Japan where RHP holds 80% of the JV company, invested in Solutions business and revealed the beta program for SmartEncrypt with the full market launched planned for Q3FY21. For FY21, the company expects to witness growth in its top-line owing to various opportunities, challenges, and uncertainties. Further, the company’s ongoing investment in licensing sales and solutions capabilities are key positives, going forward. The company also targets to generate operating profit in FY21, given its careful management of cost cutting initiatives during the pandemic outbreak.

Key Valuation Metrics (Source: Refinitiv, Thomson Reuters)

Valuation Methodology: P/CF Multiple Based Relative Valuation (Illustrative)

P/CF Multiple Based Relative Valuation (Source: Refinitiv, Thomson Reuters)

Note: All forecasted figures and peers have been taken from Thomson Reuters, NTM: Next Twelve Months

Stock Recommendation: As per ASX, the stock of RHP gave a return of 13.74% in the last three months and is trading slightly above the average of its 52-week low and high of $1.155 and $2.760, respectively. During FY20, gross margin of the company stood at 93.8%, higher than the industry median of 62.5%. 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. On the technical analysis front, the stock has a support level of ~A$1.782 and a resistance level of ~A$2.201. 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), to name few. As a result, we have arrived at a target price offering an upside of lower double-digit (in percentage terms). Considering the returns, current trading levels, and strong balance sheet, we recommend a ‘Buy’ rating on the stock at the current market price of $2.010, down by 2.899% on 13 November 2020.

RHP Daily Technical Chart (Source: Refinitiv, Thomson Reuters)

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