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The Mike Murphy shares

The six shares that our Mike Murphy stock screen is identifying now
November 23, 2007

We ran Michael Murphy's tech stock screen (see ) on the UK market, and these are the results it gave us.

IC TIP: Buy

Several of the six companies that comprise this portfolio share common characteristics.

The first and most important is that they're all solidly profitable, cash-generative and successful. All the companies on the list operate in specialised niches, many of them in software. Alterian, for instance, dominates the space for software in the marketing services market, while Sage is globally powerful in accounting and business operations software. The key point here is that there's absolutely no question that these companies can turn technology into hard cash - these are not start-ups desperately searching for a way to monetise their technology. They’ve arrived..

But many of the companies are also in a period of rapid transition - accelerated by recent large acquisitions. Immunodiagnostic Systems Holdings is typical in that it has just completed two huge takeovers, which will effectively transform the whole business - the two transactions cost it £30m, doubling the company's market cap. E2V has also made a major acquisition in the past year (Atmel Grenoble) that needs bedding down and part of Sage's whole business growth strategy seems to be the piecemeal acquisition of specialist software outfits that it can fit into its ever-growing product range.

The last key common characteristic is that many of these companies face competition in their chosen spaces from potentially much bigger global outfits that could, but crucially haven't, muscle in on their space - that's particularly true for Sage and Alterian. That means the City is spooked by the potential for tough competition that actually hasn't really arrived yet.

The two most interesting and arguably least risky investment propositions are the relative giants in this list - Sage and e2v. Accounting and business software giant Sage is the victim perhaps of its own success - while other technology companies have comprehensively recovered from the whole dot.con fiasco, Sage's shares are still close to levels seen at the beginning of this decade. This seems a little unreasonable as both its sales and its profits have doubled over those intervening five years and recent results point to a continuing upward trend. In October, Sage issued a relatively strong trading update noting that it expects full-year results to be in line with market expectations, with full-year revenues expected to be £1.158bn up from £0.892bn last time, with earnings before interest, tax, depreciation and amortisation of £283m, compared with £239m last year. It also announced the departure of its US chief executive and chief financial officer as part of its strategic review of the American business - these departures were by and large welcomed by analysts who reckon the group management is serious about getting the US business back on track.

Here's the table of screen results and some key metrics, and below that you'll find descriptions and background on the companies. The links go to further company data and articles.

Mike Murphy bargain techs

NameCapital (£m)Op margin %Price to R&DSales growth %RoE %Close
Immunodiaostic Systems Holdings PLC54.921.143.32232.92.29
Sage Group (The) PLC3172.224.933.123.215.32.4325
Bond International Software PLC66.923.242.626.2212.04
Ascribe PLC46.522.322.45525.70.4

High-growth, low share price

NameCapital (£m)Op margin %Price to R&DSales growth %RoE %Close
e2v Technologies PLC159.810.41454.913.82.6

Biggest Tech fallers

NameCapital (£m)Op margin %Price to R&DSales growth %RoE %Close
Alterian PLC58.511.832.232.1121.33
Average of all six1931.335.620.1

Sage

Back in September, Investors Chronicle tipped Sage as a buy at 256p, pointing to its ever-wider range of products in fast-growing markets such as project management software and the prospect of margin growth in the recently acquired medical software business. Crucially, we noted at the time that, although Sage faces tough competition from bigger rivals such as Microsoft, it's currently valued well below its global peers. Most analysts seem to share this view, with Merrill Lynch recently upgrading the group to 'buy' from 'neutral' with a price target of 270p - it sees Sage group as a core tech holding in the coming months as its valuation has reached low levels not seen since the middle of the last recession. Merrill Lynch also made the crucial point that earnings estimates for the group have been raised every single year for as long it can remember. This was helped, in part, by a strong business model that sees 65 per cent of revenues coming from long-term contracts with millions of customers (5m customer base), insulating the company against short-term shocks in the financial markets.

E2V

E2V is also one of the biggest, and most esteemed, names in British technology. It started life more than 50 years ago as the Phoenix Dynamo Company, then changed into the English Electric Valve Company which transformed itself again into that giant that we used to now as GEC and then Marconi Technology. Luckily e2v was salvaged from the wreckage of this great industrial fiasco and has spent the past five years as an independent company building up a strong reputation in two key areas - sensors and semi-conductors - as well as electronic tubes (the company made the first 3” electronic tube used in the filming of the Queen’s coronation in 1953). It has been a pretty amazing transformation by any standards - sales have gone up from £100m to £173m this year and profits have shot ahead from just £4m back in 2005 to their current £13.72m. But e2v's biggest challenge is probably the next two years as it beds in a huge acquisition - the £74m takeover of Atmel Grenoble, a highly profitable electronic sensor group whose highly specialised components are used in products as varied as camera’s and smart RF sensors.

But recent trading seems to have got a big tougher. A trading statement from October noted that, overall, the group's performance in the first half was "in line with expectations with sales growth strongest in the aerospace and defence sector for sub-systems within the electronic tube product group, while the sensors and semiconductor product group benefited from a full six months trading from the Grenoble facility". Looking forward, e2v reckons sales and profits will continue to be impacted by the sustained weakness of the US dollar as well weak demand in the dental digital x-ray market. Still the Grenoble deal looks excellent value - a £74m price tag for a company that produced Ebitda of just over £13m seems a pretty good price, especially as the Grenoble unit is powering a strong transformation in sales in divisions such as aerospace sensors. Looking forward to next year, profits are expected to rise by another 30 per cent (helped in part by moving some production to a lower-cost factory in Mexico), and cash flow at the operating level is likely to rise substantially above £20m a year, hopefully making a dent in net borrowings, which currently stand at £78m versus a market cap of £159m.

Immunodiagnostic System Holdings

Potentially the fastest-growing star in this shortlist - and the most risky - is Aim-listed Immunodiagnostic System Holdings (IDH) which is clearly one of the most exciting companies in the specialist healthcare technology and equipment market. IDH makes diagnostic testing kits and both sales and profits have doubled over the past three years as the group has placed itself firmly on the global map - and it boasts a solid reputation for consistently beating analysts' expectations on earnings. Only last spring it released year-end results that predicted operating profits 10 per cent higher than City hopes, and turnover 20 per cent ahead of the previous year, with prospects for the new financial year looking buoyant. Until recently its biggest issues seemed to have been around scale - it's needed to find ways to sell its clever technology outside its traditional home markets in the UK, and cut out middlemen and sell the products directly. Still, it has had some recent luck, especially with the withdrawal of a key competitor (Nichols Institute Diagnostics) which pulled out mid 2006. NID was a significant competitor, with an automated instrument offering a number of competing tests, and enjoyed a significant market share.

But IDH’s current biggest challenge, as we alluded to earlier, is that it now has to consolidate two huge acquisitions. Biocode Hycel S.A. is one of those acquisitions - it's a Belgian-French group that develops IVD instruments and reagents for specialist areas like immunoassay, and haematology. This was taken over for £12m financed by a huge new placing of shares and is clearly going to be a management challenge for IDH as it lost £1.85m on sales of £8.07m. The biggest challenge will probably be the even bigger acquisition of IDS Nordic for £17m (£10m in cash via loans plus another £7m placing) – with this second deal Immunodiagnostic has effectively doubled in scale overnight.

Bond International Software

Bond International Software is a perennial favourite for most growth style investors. It's another one of those niche global software developers that we British do so well - its particular specialism is in software and support for the global staffing industry, while its leading product is something called 'Adapt', which according to Bond is the "benchmark recruitment software that is used by more than 90 per cent of the world's leading recruitment agencies". What impresses investors is that this is a company that's grown sales from £7m back in 2003 (with profits of £450,000) to £17m four years later (profits increased to over £3.3m). Look a little deeper, and you'll see that Bond has also excelled at the boring business of increasing cash flow - last year operating cash inflows before capex was £5.5m, which is not bad for a company valued at £55m. Some commentators have noted that recent and projected growth rates are set to slow down as Bond starts to run out of potential for growth, but the management seems alive to this threat - and, like many companies in this list, they've embarked on some potentially transformational purchases. Earlier this year, for instance, it swooped on a company called Gowi, which propelled it into a related but new sub-market for software for what's euphemistically called 'human capital management'. The acquisition (for £8.7m) already seems to be paying off - in just under six months since acquisition, the human resources (HR) and payroll division generated revenues of £2,743,000 and an operating profit of £409,000. Bond has also moved sideways into outsourced HR and payroll services for the state school sector following the acquisition of Strictly Education Limited in February 2007 for £2.86m. According to Bond, this business generated revenues of £989,000 and an operating profit of £188,000, and "is well on target to beat its budget for the year". All of these acquisitions seem designed to quietly extend the range of Bond's product range into markets not too far from its core and they seem to be working. Bond still seems to be growing aggressively in its core markets, with new contract wins with the likes of airline bmi, which has recently bought a product called Bond Talent, an online recruitment and talent-management system.

Alterian

Alterian is another under-appreciated play on fast-growing niche software services. Its particular specialism is marketing software, specifically tying together the huge range of different software tools used by marketing folk into one simple-to-use technical architecture. And, like Bond, its key challenge is to convert that technology into strong recurring revenue streams that should hopefully boost margins and provide generous cash inflows. The trick then for Alterian in its chosen specialism is to build a global presence without committing too much money to building a global salesforce. That means striking deals with partners like Cornerstone in North America (a database management provider) who can help it build profile and sell more bits of software. And North America is clearly where the biggest growth prospects lie - a recent trading statement noted that revenues across the pond increased by approximately 60 per cent at constant exchange rates, compared with UK-based revenue which increased by approximately 8 per cent. Like Bond, Alterian has been growing fast - back in 2004, sales were £5.67m; this year they hit £14m and profits have also increased from £890,000 last year to £2m this year, with most analysts expecting £5.4m (and EPS of 13.3p a share) next year. If they do hit those forecasts, Alterian will be trading on just 10 times future earnings, which looks criminally low for such a quality outfit.

Ascribe

The riskiest share in our list is probably medical software specialist Ascribe. Like both Bond and Alterian, it has an interesting niche providing web-based systems for the likes of the NHS. It has also been steadily growing - sales have grown from £6m in 2005 to £15m this year, and profits have also increased from £1.13m to £1.7m. But Ascribe's greatest strength - its market niche - is also its greatest weakness. Three initials should suffice to explain its predicament: NHS. It is one of the companies charged with the unfortunate task of delivering on the government's massive IT renewal programme - potentially a goldmine, but in reality fraught with delays and controversy. Like nearly every other company in this sector, Ascribe has been hit by problems and, back in July, warned that group turnover and profits for the year ended 30 June were expected to be slightly below market expectations. Ascribe explained that this was a "consequence of delays in customer orders and contract implementations, as well as its investment in personnel…uncertainty over the National Programme for IT moving to local procurement has distorted investment decisions and led to a number of delays in customer orders". To be fair to Ascribe, most of these contracts are just delayed and are now being delivered on, and many customers have extended their contracts this year, providing increased confidence about long-term maintenance income, which still exceeds 60 per cent of forecast turnover in the current financial year. Ascribe's other big gamble is on expansion abroad, which could be a huge growth area.