Alternative Networks' undervalued growth potential

Key to Alternative Networks' transformation were two acquisitions it made at the start of 2014 at a cost of £52m. These acquisitions - virtual desktop specialist Intercept IT and 'cloud' hosting provider ControlCircle - both delivered double-digit revenue growth last year, which fuelled a two-thirds increase in full-year sales at the company's advanced solutions division. The division accounted for almost half of last year's sales and organic growth came in at a healthy 3 per cent.

The Intercept IT and ControlCircle acquisitions augmented Alternative Networks' flagship Synapse offering, a procurement, operating and billing portal. This has provided significant new client opportunities and cross-selling potential. Indeed, the expanded offering helped Alternative Networks to attract larger customers including a global insurer and a 'Magic Circle' law firm in the last financial year. And it signed at least 25 cross-selling contracts, worth over £0.6m in first-year gross profit. These included an agreement for Lark Insurance - an existing fixed-line, mobile and wide-area network customer - to tack on services from both of the new subsidiaries. The benefit of offering a wider range of services was also evident in a 5 per cent rise in clients' average monthly spend to £5,660 despite pricing pressures.

The company's mobile business is also performing well, with sales up 4 per cent last year. The division widened its gross margin by 5 percentage points to over 43 per cent, and grew its subscriber base by 12 per cent to about 91,400.

Alternative Networks' debt burden rose following last year's acquisitions, but quickly dropped, underlining the attractions of the company's strong cash generation. From a post-acquisition peak of about £41m, net debt was down to £29m at the end of September. And solid cash generation is helping to underpin management's target of delivering 15 per cent dividend growth a year. The fact that about three-quarters of revenues are recurring in nature should also provide reassurance, as should the near 50 per cent increase in the business pipeline in the final six months of the last financial year to 223 orders.

A thorn in Alternative Networks' side, though, is its declining fixed-line division. Revenues there slumped 9 per cent last year. However, this division now accounts for only a fifth of sales and should not overshadow the progress elsewhere. Nevertheless, investors appear to be valuing shares in Alternative Networks based on the negatives, rather than the business's increasingly glaring growth potential. At 13 times forecast 2016 EPS, the shares trade at a discount to slower-growth peers. Meanwhile, the commitment to strong dividend growth is expected to lift the yield to a useful 3.6 per cent come 2016.