Company Overview: The Citadel Group Limited (ASX: CGL) is engaged in the development and distribution of technology and education solutions across Health, and Other Enterprises, National Security, and Defence. The company mainly focuses on controlling complex data through integrating technology know-how, systems, and people in order to provide information anytime and anywhere. A major portion of the company’s revenues are derived from software solutions and long-term managed services contracts. The company’s offerings are divided into three key segments – Knowledge, Health, and Technology. The company was incorporated in 2007, with over 350 employees across Australia.
 

CGL Details
 

CGL Rides on Higher SaaS Revenues Along With Acquisition Synergies: The Citadel Group Limited (ASX: CGL) is an enterprise software and services company that specialises in handling information in complex surroundings via people, integrating know-how, and systems to offer data and information anywhere and anytime. Formed in 2007, the company has more than 150 committed customer relationships and has worked with its top 10 clients for an average of more than 15 years. The company remains committed to continue with higher investments to create long-term value for its shareholders. The company remains on track to execute its Citadel 2.0 strategy, which will aid the company to progress towards its strategy to increase the size of SaaS business, gain multiple contract wins, and leverage a substantial pipeline of opportunities. Growth in the SaaS business has been a key highlight for CGL business. 
 

Long-Standing Customer Relationship (Source: Company Report)
 
Notably, in FY19, the company witnessed a growth of 23% year over year from software/SaaS and related software services, under its Citadel 2.0 strategy. The company also made a higher investment in developing the platform capabilities of the Citadel-IX offering, which increased the company’s customer engagement, positioning the Group with significant opportunities to scale. Moreover, the company also secured additional contracts in Defence and National Security. Also, the company’s Citadel-IX offering has experienced a whopping 157% revenue growth in FY19 and will position Citadel for a consistent recurring revenue stream from a significantly larger and diverse client base. In FY19, the company successfully exceeded all of its service level contracts and retained the highest level of delivery quality and information security to its clients. This has led to an enhancement to its already remarkable status.
 
Coming to 1HFY20, the company has made significant efforts to enhance its software and platform capabilities. During the period, the company successfully integrated Noventus acquisition realising $10.9 million of revenue and bolstering its offerings in the Government, Defence and National Security verticals.
 
In the time span between 1HFY16-1HFY20, Software revenue from continuing operations has reported a CAGR of 29.1%, with continuous upward movement. The return on investments made for developing the platform capabilities was evident by the success of the Citadel-IX offering, which reported revenue growth of 15% from 1HFY19. Citadel-IX has over 25,500 users in 1HFY20 and the company is seeking to have more than 200,000 users by end FY21. Looking at the current business scenario, the trend is expected to be continued as the company confides in the investments made on developing its capabilities during FY20.
 

Trend in Software Revenue (Source: Company Reports)
 
Going forward, CGL expects FY20 revenues to be in the band of $128-$132 million and EBITDA to be between $28-$30 million. The successful integration of Noventus acquisition is expected to achieve over $20 million revenue in FY20, representing an increase of more than 11%. Further, post Wellbeing buyout, CGL expects to diversify its recurring revenue base, with revenues increasing in the range of 41% to 48% of FY20 pro forma normalised estimates.
 
Robust Interim Results: In 1HFY20 for the period ended 31 December 2019, CGL’s total revenue increased 24.4% year over year and came in at $61.1 million. The company’s shift in the business mix along with International expansion positively impacted quarter’s performance. Notably in 1HFY20, total software revenues increased 18.9% year over year and came in at $18.9 billion, which comprised 31% of the total revenue. The increase was on the back of higher investments made for the development of secure cloud-based software solutions. Total service revenues, on the other hand, increased a whopping 25% year over year in 1HFY20. In addition, the company extended the 10-year contract with Queensland Health.  Gross margins during the period stood at 41.2%, down from 47.5% in the year-ago period. EBITDA for the period stood at $12.5 million, a decline of 5.3% on pcp. EBITDA for the period incorporated $800k of restructuring costs and one-off expenses, which more than offset the positive impact of AASB16 adjustments of $1.1 million.
 
At the end of the period, the company’s cash balance stood at $12.3 million and total assets amounted to $151.8 million. The company has a debt of $19.6 billion as of 31st December 2019. During the period, cash from operations came in at $5.1 million. In 1HFY20, the company declared a dividend of 4.8 cps.
 

1HFY20 Key Highlights (Source: Company Report)
 
Key Developments: On 6 April 2020, the company completed the acquisition of Wellbeing Software Group Limited (Wellbeing) for consideration of £103 million. The Wellbeing acquisition will assist CGL to leverage several growth possibilities and alter its business into a global healthcare software company. Wellbeing has come up stronger and responded well to reduce COVID-19 led crisis, by ensuring business continuity and support all customers distantly. The move is a part of CGL’s strategy to bolster its foothold in the healthcare software sector in the United Kingdom. The company had predicted that post the buyout of Wellbeing, CGL will have a combined cash balance of ~$10 million as well as an additional undrawn working capital facility of ~$10 million.
 
Recent Updates:

1. On 28 May 2020, the company announced that Anne Templeman Jones has stepped down as Chair of the Nomination and Remuneration Committee, a member of the Audit Risk Compliance Committee and as Director of the Company, effective immediately.
 
2. In another update, the company stated that Microequities Asset Management Pty Ltd, a substantial holder of the company, has increased its voting power from 5.17% to 6.37%.

 
Top 10 Shareholders: The top 10 shareholders have been highlighted in the table which together form around 74.59% of the total shareholding. Perennial Value Management Ltd. holds the maximum number of shares with a percentage holding of 10.46%, followed by Jakeman Holding Co Pty. Ltd. with a holding of 13.67%.
 

Top Ten Shareholders (Source: Thomson Reuters)
 
Key Metrics: In 1HFY20, the company reported an EBITDA margin of 20.6%, higher than June’19 EBITDA margin of 4%. In 1HFY20, the company reported an operating margin of 11.3%, higher than June’19 margin of 10.5%. ROE in 1HFY20 stood at 4.1%, higher than June’19 ROE of 3.3%. Debt levels for 1HFY20 also stood at decent levels, with a debt-to-equity multiple of 0.31x, lower than the industry median of 0.50x. Current ratio of the company stood at 1.96x in 1HFY20. The company is confident about business growth, looking at the potential impact on gross margin from SaaS offerings like Citadel-IX.
 

Key Metrics (Source: Thomson Reuters)
 
Key Risk: On the flip side, loss of any key contracts and key personnel, failure to commercialise R&D expenditure along with disruption through technological advances or product failures remain a potential headwind for the company.
 
Outlook: The company’s dedication towards reforming the business through the Citadel-IX strategy truly holds the promise to boost revenue growth and drive financial security for its investors. Dividends for FY20 is predicted to be in accordance with FY19. The company is focusing to shift its business mix to improve the proportion of revenue and earnings from its Enterprise Software and Health Software segment. The move will aid the company to realise long-term profit and recurring revenue streams.
 
In FY20, significant contract wins have added to future revenue streams and increased the credibility of the business. Revenue for FY20 and EBITDA is expected to increase year over year. The successful integration of Wellbeing is expected to increase recurring revenues from 41% to 48% of FY20 pro forma normalised estimates. The company remains on track to invest in core Health and Enterprise Software and focus on developing secure cloud-based software solutions, which is likely to add to its recurring revenue models.
 

Key Valuation Metrics (Source: Refinitiv, Thomson Reuters)
 
Valuation Methodology: EV/Sales Multiple Based Relative Valuation (Illustrative)

EV/Sales 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 corrected 12.27% over a period of one month. Currently, the stock is trading below the average of its 52-weeks trading range of $1.205 - $5.92. The stock is available at a P/E multiple of 22.7x, with an annual dividend yield of 3.78%. The company is focusing to make higher investments for product enhancements and new technological capabilities. CGL has implemented various contracts that will support revenue growth in the coming years. We have valued the stock using an EV/Sales multiple based illustrative relative valuation method and arrived at a target price offering an upside of lower double-digit (in percentage terms). For the purpose, we have considered peers like Infomedia Ltd (ASX: IFM), Vista Group International Ltd (ASX: VGL), and rhipe Ltd (ASX: RHP). Considering the key business developments, expected contribution from acquisitions and contracts, and anticipated growth in the SaaS business, we give a “Buy” recommendation on the stock at the current market price of $2.84, down 0.699% on 29 May 2020.
 
 
 
 
CGL Daily Technical Chart (Source: Refinitiv, Thomson Reuters)

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