Company Overview: Spirit Technology Solutions Limited (ASX: ST1) is engaged in the business of IT & T services and includes telecommunication services, cloud services, managed IT services and cyber security services to SMB firms. Its range of product offerings and services includes high-speed internet, security, cloud, mobile, voice and managed services.

ST1 Details

Decent Revenue Performance Driven by Organic Growth & Demand for Products: ST1 is focused on building its brand as a modern telco for businesses. It has transformed itself to be an integrated IT & Telco business with product offerings that are vital for the efficient and effective functioning of its client’s businesses. The company has posted ten consecutive quarters of recurring revenue growth to March 2021. 

Growth in Recurring and S&P Revenue:

• Recurring and S&P revenue grew by over 150% to $35.7 million during the Jan to April 2021 period, when compared to the previous corresponding period.
• It has witnessed organic growth with 30% of deals in excess of $250,000 in Total Contract value and 17% of deals exceeding $500,000 (mid-market & bundles).
• TCV on recurring sales grew by ~145% to $11.9 million during the Jan to April 2021 period.
• The company reported Services Pending Delivery at $10.4 million and IT Services & Technology sales at $6.1 million during the period.

Increase in Recurring Revenue (Source: Analysis by Kalkine Group)

Nexgen Acquisition to Drive Synergies:

The company has completed the acquisition of Nexgen Group, as announced on 8 April 2021. It has successfully raised capital amounting to $23.8 million from institutional and sophisticated investors in order to fund the acquisition. The transaction is of immense strategic interest to ST1 as it brings over five thousand new clients to its fold.

• The acquisition adds over one hundred new sales people to Spirit and will help in driving organic growth.
• Nexgen is expected to generate ~$36 million in additional revenue, with 80% of it being recurring revenue.
• The average contract term for Nexgen customers is 4.5 years with no specific client concentration.
• Offers a diverse range of customised communication services and plans across multiple providers, networks and technologies.

Update on FY21 & H2FY21 Performance:

ST1 has delivered a decent performance during the period, despite the challenging conditions owing to widespread lockdowns and restrictions in Australia.

• Revenue grew by ~200% to $104.5 million in FY21, from the prior year.
• Underlying EBITDA has increased by ~208% to $11.5 million innFY21, compared to $3.7 million in FY20.
• It has posted revenues of $60.5 million in H2FY21, reflecting an increase of ~37% from ~$44 million in H1FY21.
• Recurring revenues continue to deliver stellar performance with an increase of ~33% to $27.2 million in H2FY21.
• TCV stood at a record $31.8 million during Q4FY21 on the back of decent organic growth and demand for the company’s products.
• It ended the year with $24.2 million of cash and available debt, and net debt of $1.5 million as of 30 June 2021.

Trend in Cash Balance (Source: Analysis by Kalkine Group)

Top 10 Shareholders: The top 10 shareholders together form around 46.81% of the total shareholding, while the top 4 constitute the maximum holding. Regal Funds Management Pty. Ltd. and Crazy Diamond Pty. Ltd. are holding a maximum stake in the company at 9.41% and 8.43%, respectively, as also highlighted in the chart below:

Top 10 Shareholders (Source: Analysis by Kalkine Group)

Key Metrics: The company reported an EBITDA margin of 8.4% in H1FY21, compared to 6% in H1FY20. It also posted an improved ROE at 0.9% in H1FY21, compared to a negative 2.9% in the previous corresponding period. The current ratio stood at 0.90x, higher than the industry median of 0.63x.

Growth Profile and Profitability Metrics (Source: Analysis by Kalkine Group)

Key Risks: The company is exposed to the following risk factors:

• Interest Rate Risk: It is prone to interest rate risk due to the presence of borrowings and cash equivalents on the balance sheet
• Credit Risk: The Group’s counterparties might default on the receivables or contractual obligations, thus exposing the company to credit risk.
• Liquidity Risk: ST1 is also prone to liquidity risks and has to maintain sufficient cash reserves and have provision for adequate borrowing facilities.
• Technological Risks: Its line of business makes it prone to technological obsolescence and has to invest in technology in order to remain relevant in the space.

Outlook: The company seems to be optimistic about its prospects after reporting decent performance in FY21. It has witnessed increased traction in the sale of its products across data, cyber, managed services, voice and Spirit’s bundled offering. After taking into consideration a conservative view on FY22 given the labour costs and IT hardware supply chain challenges, it expects revenue to be in the range of $150 - $155 million, reflecting an increase of 44%-48% from FY21. It anticipates underlying EBITDA to be in the range of $19.4-$20.2 million in FY22.

Valuation Methodology: EV/Sales Multiple Based Relative Valuation (Illustrative)

Source: Analysis by Kalkine Group

*% Premium/(Discount) is based on our assessment of the company’s NTM trading multiple after considering its key growth drivers, economic moat, stock's historical trading multiples versus peer average/median, and investment risks.

Stock Recommendation: The company’s director James Joughin has undergone a change of interest in the company and has acquired 71,431 ordinary shares for a total consideration of $20,000.68 on 2 June 2021. As per ASX, the stock of ST1 is trading below its average 52-weeks’ levels of $0.250-$0.450. The stock of ST1 gave a positive return of ~6.66% in the past one year and a negative return of ~11.11% in the past three months. We have valued the stock using an EV/Sales multiple-based illustrative relative valuation and have arrived at a target price of low double-digit upside (in % terms). We believe that the company can trade at a slight premium to its peer median EV/Sales (NTM trading multiple), considering the robust increase in revenues, optimistic outlook and expected synergy from Nexgen acquisition. For this purpose, we have taken peers such as 5G Networks Ltd (ASX: 5GN), MNF Group Ltd (ASX: MNF), Superloop Ltd (ASX: SLC), to name a few. Considering the expected upside in valuation and current trading levels, robust growth in top-line, continuous increase in recurring revenue, acquisition synergies with Nexgen and key risks associated with the business, we recommend a ‘Speculative Buy’ rating on the stock at the current market price of $0.315, (as on 23 July 2021, 11:52 AM (GMT+10), Sydney, Eastern Australia).

ST1 Daily Technical Chart, Data Source: REFINITIV

Note 1: The reference data in this report has been partly sourced from REFINITIV

Note 2: Investment decisions should be made depending on the investors’ appetite on upside potential, risks, holding duration, and any previous holdings. Investors can consider exiting from the stock if the Target Price mentioned as per the analysis has been achieved and subject to the factors discussed above alongside support levels provided.

Technical Indicators Defined: -

Support: A level where-in the stock prices tend to find support if they are falling, and downtrend may take a pause backed by demand or buying interest.

Resistance: A level where-in the stock prices tend to find resistance when they are rising, and uptrend may take a pause due to profit booking or selling interest.

Stop-loss: It is a level to protect further losses in case of unfavourable movement in the stock prices.

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