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This week’s buy: a top performer

Intellidex: earnings soar as Adapt IT’s
 canny acquisition spree continues.

Through canny acquisitions, Adapt IT has been one of the top performers in the information and communications technology services sector, consistently growing earnings at double digits for the past five years. Its share price has followed this stellar performance, growing more than twentyfold in that period.

Central to its success has been the bolt-on, earnings-enhancing acquisitions of niche software providers which has brought sector diversification, access to blue-chip clients and annuity-type income. It operates in 19 countries and with the expanded service offerings and customer base from the acquisitions, Adapt IT’s organic growth has also been pleasing.

It is showing no signs of slowing down, growing revenue 38% in the half-year to end-December with headline earnings climbing 35% to 18.58c/share (1H14: 13.74c). Despite pressures from higher finance costs, operating profit surged 85%, boosted by the acquisition of AspiviaUnison, a cloud telecommunications and management solutions provider acquired in September last year that comes with juicy margins more than double those of the existing operations.

Adapt IT’s revenue can be segmented according to the sectors in which it operates.

Traditionally, the education sector has been the cash cow of the group but it has since been overtaken by the manufacturing sector, where revenue grew 32% to R90 million (1H14: R68 million). Revenue from clients in the energy sector grew 86% thanks to the inclusion of Aquilon, an acquisition made in the second half of 2013.

The financial services division, which benefited from the inclusion of four months’ revenue from AspviaUnison, saw its top line increase 44% and the operating margin expand to 15% (1H14: 5%).

With the operating margins improving nicely in three of the group’s four segments, the overall operating margin grew to 14% from 11%.

While we are generally bullish on Adapt IT’s prospects, investors should closely monitor the possible dilutive balance sheet effects and cash-flow pressures arising from financing arrangements for past acquisitions. As part of the purchase considerations for most of its acquisitions, there is a contingent earn-out portion payable in cash and/or through the issue of shares if the acquisition meets certain targets.

For instance, the company paid only R72 million for AspviaUnison while a maximum of an additional R128 million is payable if AspviaUnison meets all its profit targets. Only the present value of an estimate of the future settlements are shown on the balance sheet. We have therefore modelled the possible effects of these obligations and adjusted for them in our valuations.

We like Adapt IT’s growth potential and we have confidence in the abilities of the management team to continue outperforming its peers. After a number of value- accretive acquisitions which expanded the company’s exposure to four sectors in more than 19 countries , we think Adapt IT is now better structured, more diversified and well positioned for sustained growth in the future.

As it continues with this strategy we expect benefits of economies of scale to start kicking in, which might see margins for existing operations expand.

Intellidex’s discounted cash-flow model presents a target price of R10.80/share with a forward price: earnings multiple of 20.3. The share is trading below its intrinsic value and we recommend it as a buy.

Bull factors

  • Strategic focus on expanding higher-margin business solutions and managed services divisions
  • Recovery in private sector ICT/IT spend supported by the adoption of cloud- based services
  • Acquisitive growth strategy and expansion into markets outside SA

Bear factors

  • Continued weakness in public sector expenditure on ICT services and hardware
  • Intensely competitive market

Background: Adapt IT is a holding company with interests in a variety of information technology services and special solutions. It services the mining and manufacturing, energy, financial services and education industries. It has operations in Southern Africa, East Africa, Asia, the US and Europe.

Disclosures: The analyst has no financial exposure to the instrument discussed. The opinion represents his true view. For Intellidex’s full disclaimer, methodologies and definitions please click here.

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