Company Overview: Spirit Technology Solutions Ltd (ASX: ST1) is engaged in the provision of IT & Telecommunications services to its customers in Australia. It offers its services, including cloud services, managed IT services and cybersecurity services to small and medium-size businesses. It maintained a good concentration of customer mix with no individual customers accounting for more than 5% of its revenue for the fiscal year FY20.

ST1 Details

Recurring Revenue and Acquisition Synergy to Further Drive Growth: Spirit Technology Solutions Ltd (ASX: ST1) is a leading provider of Information Technology & Telecommunications (IT&T) services to the Australian market. The market capitalisation of the company as on 07 May 2021, stood at ~$247.87 million. The company has recently announced the completion of the acquisition of leading Telco provider Nexgen, which further enhances ST1’s suite of bundled IT and telco services.

The company will host a virtual investor session on 18 May 2021, to give an update on the recent acquisition of Nexgen and a trading update for 2021.

ST1 delivered record revenues in H1FY21 with growth of ~253% in total revenues to ~$44 million when compared to the previous corresponding period. The recurring revenue grew by ~99% to $21.1 million, and the revenue from Solutions & Projects grew by 1,089% to $22.1 million on a y-o-y basis. It posted an NPAT of $0.5 million in H1FY21, an increase of ~169% on the previous corresponding period. The operating cash flow during the period was at a positive $4.3 million. It ended the period with a healthy balance sheet and cash position of $12.9 million as of 31 December 2020.

H1FY21 Financial Performance (Source: Company Reports)

Decent Increase in Recurring Revenue: The company reported decent growth in recurring revenue by ~99% to $21.1 million in H1FY21, on the back of impressive performance in its key business segments. Managed services recurring revenue was up by ~598% to $7.7 million on the pcp, and voice services recurring revenue grew by ~40% to $2.4 million. The data services recurring revenue stood at $7.9 million during the same period under consideration. The growth in recurring revenue was also aided by the company’s ability to secure larger value revenue contracts of longer duration due to its ability to cross-sell its premium managed services and cybersecurity offerings.

Growth in Recurring Revenue (Source: Company Reports)

Completion of Acquisition of Nexgen Group: ST1 has announced the completion of the acquisition Nexgen Group on 8 April 2021. The transaction augurs well for the company, and it expects to have access to over five thousand new clients and around one hundred new sales people, as a result of the acquisition. As a result of the business synergy, the transaction is expected to generate an additional $36 million in revenue for the company, with 80% of this being recurring revenue. The average contract term of Nexgen’s clients is around 4.5 years, with no specific concentration to any customer. Nexgen has been tracking to a forecast FY21 EBITDA in the range of $7.2 million and $7.6 million. ST1 has raised a placement of $23.8 million for this purpose from institutional and sophisticated investors and has announced an additional upliftment of $10 million in its debt facility from CBA to $25 million.

Intention to Divest Infrastructure Assets: The company has been planning to divest its consumer infrastructure assets, which provides high-speed internet to thousands of residential customers. The divestment is in line with ST1’s shift to focus on large enterprises from SME’s. It plans to use the proceeds from the divestment to continue to acquire high growth assets across cybersecurity, cloud and IT services.

Top 10 Shareholders: The top 10 shareholders together form around 51.65% 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 11.22% and 8.52%, respectively, as also highlighted in the chart below:

Data Source: Refinitiv, Thomson Reuters, Analysis by Kalkine Group

Key Metrics: During H1FY21, the company reported an improved EBITDA margin at 8.4% compared to 6% in the previous corresponding period. Net margin also improved to 1.2% during the same period. There was an improvement in the ROE of the company too to 0.9% in H1FY21, compared to negative 2.9% in H1FY20. The current ratio stood at 0.90x, better than the industry median of 0.70x. There was also an improvement in the leverage of the company, with the debt-to-equity ratio at 0.11x in H1FY21 from a level of 0.16x in H1FY20.

Growth Profile and Profitability Metrics (Source: Refinitiv, Thomson Reuters, Analysis by Kalkine Group)

Key Risks: The company is exposed to interest rate risk as a result of the borrowings and the cash equivalents held on its balance sheet. It is also exposed to credit risks arising from the risk that a counterparty might default on its obligation of payment to the firm. It also operates in a space where there is intense competition for market share, where peers try to gain on market share by adding favourable price points in order to win clients.

Outlook: The acquisition of Nexgen augurs well for the company, as the business synergy of the two companies is expected to drive organic growth of ST1. The transaction provides ST1 with the opportunity to cross-sell its line of product suite, including Internet, Cloud, Voice, Mobiles and Cyber Security to the large customer base of Nexgen. ST1’s operating model has been transformed into an integrated IT & Telco business, and its products now represent offerings that are important for businesses to operate efficiently in remote scenarios in 2021 and further.

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

Data Source: Refinitiv, Thomson Reuters, 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 combined business of Spirit and Nexgen will have over 10,500 B2B customers nationally, post-integration. As per ASX, the stock of ST1 is trading above its average 52-weeks’ levels of $0.137-$0.450. The stock of ST1 gave a positive return of ~11.76% in the past nine months and a positive return of ~2.70% in the past one month. 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 some premium to its peer median EV/Sales (NTM trading multiple), considering the robust growth in recurring revenues, comfortable balance sheet position and the expected synergy benefits from Nexgen acquisition. For the purpose, we have taken peers such as 5G Networks Limited (ASX: 5GN), Macquarie Telecom Group Limited (ASX: MAQ), Aussie Broadband Limited (ASX: ABB). Considering the expected upside in valuation, impressive financial performance, decent rise in recurring revenue, expected synergy from the acquisition of Nexgen and the key risks associated with the business, we recommend a ‘Speculative Buy’ rating on the stock at the current market price of $0.380, as on May 07, 2021.

 

ST1 Daily Technical Chart (Source: Refinitiv, Thomson Reuters)

Note: Investment decision 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 Valuation has been achieved and subject to the factors discussed above.

---

Disclaimer - This report has been issued by Kalkine Pty Limited (ABN 34 154 808 312) (Australian financial services licence number 425376) (“Kalkine”) and prepared by Kalkine and its related bodies corporate authorised to provide general financial product advice. Kalkine.com.au and associated pages are published by Kalkine.

Any advice provided in this report is general advice only and does not take into account your objectives, financial situation or needs. You should therefore consider whether the advice is appropriate to your objectives, financial situation and needs before acting upon it.

There may be a Product Disclosure Statement, Information Statement or other offer document for the securities or other financial products referred to in Kalkine reports. You should obtain a copy of the relevant Product Disclosure Statement, Information Statement or offer document and consider the statement or document before making any decision about whether to acquire the security or product.

You should also seek advice from a financial adviser, stockbroker or other professional (including taxation and legal advice) as necessary before acting on any advice in this report or on the Kalkine website. Not all investments are appropriate for all people.

The information in this report and on the Kalkine website has been prepared from a wide variety of sources, which Kalkine, to the best of its knowledge and belief, considers accurate. Kalkine has made every effort to ensure the reliability of information contained in its reports, newsletters and websites. All information represents our views at the date of publication and may change without notice.

Kalkine does not guarantee the performance of, or returns on, any investment. To the extent permitted by law, Kalkine excludes all liability for any loss or damage arising from the use of this report, the Kalkine website and any information published on the Kalkine website (including any indirect or consequential loss, any data loss or data corruption). If the law prohibits this exclusion, Kalkine hereby limits its liability, to the extent permitted by law, to the resupply of services.

Please also read our Terms & Conditions and Financial Services Guide for further information.

On the date of publishing this report (referred to on the Kalkine website), employees and/or associates of Kalkine do not hold interests in any of the securities or other financial products covered on the Kalkine website.