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Procuring growth

Procuring growth
August 11, 2015
Procuring growth

The company's products and platforms are used by more than 500 organisations globally, including commercial, public and not-for-profit sectors, and it is now the largest independent eProcurement solution provider to the UK public sector. PROACTIS develops its own proprietary software using an in-house team of developers and sells through both direct and indirect channels via a number of Accredited Channel Partners.

It's a company that has been on my radar for quite some time after my interest was sparked when it signed a collaboration agreement with one of the constituents of my 2015 Bargain share portfolio, finance lender Inspired Capital (INSC:20p). Specifically, PROACTIS is developing an accelerated payment facility (APF) for UK small and medium-sized enterprises (SMEs) which will enable Inspired to accelerate the settlement of suppliers' pre-qualified invoices. PROACTIS estimates that its own 500-plus blue-chip clients are spending between £60-80bn each year across one million SME suppliers, so offering a significant market opportunity to tap into.

Indeed, research conducted by the Federation of Small Businesses highlights that one in five UK SMEs are being impacted by a 'serious deterioration of payment practices' and buying organisations are increasingly exerting power on their supply chain with SMEs experiencing the adverse effects of extended terms of trade. This trend presents an opportunity for the provision of supply chain finance for SMEs, while allowing buyers to maintain their working capital position. The boards of both PROACTIS and Inspired believe that by offering a solution to cash-pressurised companies the APF will have a high level of take-up within UK SMEs.

This is good example of how the company is monetising its proprietary electronic trading platform, Activate, by offering value added services to its customers' suppliers. Activate increases transparency within the payment cycle for vendors by clearly showing where their purchase invoice is in the invoice processing cycle.

 

Acquisitions create cross selling opportunities

In order to accelerate the development of Activate, PROACTIS acquired Intelligent Capture, one of the UK's leading providers of document scanning and optical character recognition services, a year ago. Priced on 8 times operating profit, and with recurring revenue accounting for 85 per cent of annual revenue of £1.5m, the £1.55m bolt-on acquisition has proved a shrewd strategic buy. That's because PROACTIS saw potential to cross-sell its existing services to Intelligent Capture's 40 clients.

It's been successful, too. For instance, Denbighshire County Council, an organisation that has been using PROACTIS own 'purchase-to-pay' solutions that automate and streamline the entire day-to-day buying process, from request through authorisation, ordering, invoice processing, and payment via accounts payable, has just implemented a managed service using Intelligent Capture.

The council has implemented a hybrid approach to invoice processing, with paper invoices being scanned and the resultant electronic images being uploaded to the PROACTIS managed service. Once uploaded, the relevant invoice information can be extracted and checked for accuracy, and any information not automatically located can then be resolved by a service clerk. The same managed service process is used for imported PDF invoices that are received by email and a dedicated query desk process is provided that will allow the council to resolve invoices with queries around data that is missing or invalid, including the ability to easily engage the supplier into the process.

The hybrid service adopted has two significant benefits: the first is that it drives the efficiency and cost reduction agenda; the second is that it opens the door to aspects such as the supplier network and accelerated payments once benefits of the first step have been realised.

PROACTIS is also cross-selling its own complementary product suite to clients of another acquisition, Intesource, an established provider of e-auction services using its own proprietary service delivery and software platform. PROACTIS paid a sensible price too (around five times operating profit on cash-free, debt free basis). The business has more than 25 clients delivering over £3m of recurring annual income and operating profit in excess of £400,000.

The third strategic acquisition the company made in the past 18 months, that of EGS, strengthens its position as the largest independent eProcurement solution provider to the UK public sector, a segment of the market covering 200 organisations controlling over £15bn of public spending across 150,000 suppliers. More than 90 per cent of EGS's clients follow a subscription business model based on three or four year contract terms. At the time of acquisition, EGS was generating annual recurring revenue of more than £1.6m and operating profit of £400,000 from around 70 clients that use its hosted software to control more than £2.5bn of spend through 40,000 active suppliers.

Importantly, all these bolt-on acquisitions have delivered which is why PROACTIS will report a surge in profits and revenues when it releases its full-year results on Tuesday, 13 October 2015. Last week's pre-close trading update confirmed that revenues increased by 69 per cent to £17.2m in the 12 months to end July 2015 to lift cash profits by 130 per cent to £4.6m. After deducting a non-cash charge of £1.7m for amortisation and depreciation, this means that PROACTIS's adjusted pre-tax profit is set to rise from £1.1m to £2.9m. On this basis, expect underlying EPS to more than double from 2.6p to 6.1p and support a 9 per cent rise in the payout per share to 1.2p.

Strong organic growth story

Of course, it's important that there is organic growth coming through, too, rather than just the profit uplift from some well-timed strategic acquisitions. On this score there are no concerns at all. In the first half to end January 2015, PROACTIS increased its like-for-like revenues by 18 per cent and reported 20 contracts with new customers which had an initial contract value of £2.6m. The company also enjoyed continued strong support from its existing client base with no fewer than 43-client product upgrades in the six-month period. The pre-close trading update reveals that it signed a further 19 deals with new customers in the second half and I would expect the closing order book, which increased by 20 per cent on a like-for-like basis to £15.5m in the six months to end January 2015, to have risen sharply since then.

This order backlog is important because PROACTIS is focused on increasing the lifetime value of a customer relationship and improving the visibility of future revenue. As a consequence subscription (or managed service, which have similar characteristics) deals have become an increasing large proportion of the new business across all channels to market. For instance, of the £2.6m of orders placed with new clients in the first half to end January 2015, about £500,000 was booked as revenue in the period.

This means that as new contracts are won the amount of deferred contract revenue is increasing significantly as can be seen by the £6.6m of deferred income on the company's balance sheet at the end of January 2015, up 21 per cent since July 2014. In turn, this improves the quality of PROACTIS's income stream and the earnings multiple investors are willing to value its shares on. The increasing size of the client base, and scope for cross selling, is playing its part, too, which explains why the number of subscription based deals has exceeded the number of licences in every six-month period since the second half of fiscal 2013. Moreover, investors are far more likely to attribute greater value to recurring revenues than one-off licence fees especially as renewal rates across all PROACTIS's business segments remain robust high. This high contract retention rate also highlights the value to potential customers of the product and service offering in terms of the savings and efficiencies they generate.

Another step change in profits

It's worth flagging up, too, that there is potential upside to analyst earnings estimates for the current financial year to end July 2016. Head of research Andrew Darley at broking house finnCap expects PROACTIS to deliver a 11 per cent increase in revenues to £18.9m, a third rise in cash profits to £6m and pre-tax profits of £3.3m in the 12-month period. On this basis, expect EPS of 6.6p and another hike in the dividend to 1.3p a share.

So after accounting for forecast net funds of £2.2m, worth 5.5p a share, at the end of July 2015, this means that the shares are being priced on 13 times cash adjusted earnings estimates and offer a prospective dividend yield of 1.4 per cent. But these forecasts don't include any contribution from the Inspired collaboration agreement, a conservative assumption in my view. There is scope for uplifts from further bolt-on deals, too.

That's because the board outlined at the time of the interim results in March that "it remains committed to further M&A activity and is in an excellent position to provide a platform for further complementary bolt-on acquisitions". I would agree because having run through my cashflow model I reckon that after factoring in anticipated capital expenditure of £2m this fiscal year, then analysts' cash profit forecasts of £5m should result in free cashflow of somewhere between £2m and £2.3m and lead to a doubling of net funds to £4m, or 10p a share, by the end of July 2016. So given the record of PROACTIS's board of making earnings accretive acquisitions, then if only half that cash pile is deployed on sensibly priced bolt-on deals, I reckon there could be scope for 10 per cent earnings upgrades from acquisitions alone.

Importantly, the interests of the insiders are clearly aligned with outside shareholders because chief executive Rod Jones owns 4.96 per cent of the shares, finance director Tim Sykes owns 0.5 per cent and operator officer Sean McDonough has 0.8 per cent. Founder and non-executive director Rodney Potts owns 22.5 per cent of the shares and non-executive chairman Alan Aubrey, who is also the chief executive of FTSE 250 technology fund IP Group (IP:212p), has a 2.6 per cent stake. This adds some comfort that the directors will continue to use the company's cash pile wisely.

 

Chart break-out imminent

Admittedly, I have been monitoring PROACTIS for quite some time with a view to initiating coverage, but have been holding off until a chart break-out through the 97p share-price high, which halted prior rallies in November and May this year, is imminent. I feel that time has come. Technical analysts will note that a confirmed close at 98p or above will clearly signal a triple top break-out on the point-&-figure chart and, in my opinion, pave the way for a return to the 2007 bull market high of 117p.

Furthermore, with a bumper set of full-year results set to be released in a few months time, I can see the shares re-rating in the interim period as investors' cotton onto the organic and acquisitive growth story PROACTIS offers. Trading on a bid-offer spread of 91p to 93p, valuing the company at £36.6m, I rate the Aim-traded shares a strong buy with potentially 25 per cent share price upside on offer to my fair value target price of 117p. At that level they would be rated on a more reasonable rating of 16 times fiscal 2016 cash adjusted earnings estimates. Buy.

MORE FROM SIMON THOMPSON...

I have published articles on the following companies in the past two weeks:

CareTech: Buy at 245p, target 300p; Burford Capital: Buy at 170p, target 190p; K3 Business Technology: Run profits at 275p; Trakm8: Buy at 178p, target 200p ('Hitting the right numbers', 30 July 2015)

Non-Standard Finance: Buy at 107.5p; Software Radio Technology: Buy at 27.5p, target 40p; Character Group: Run profits at 500p; Communisis: Hold at 50p ('Value judgements', 3 August 2015)

Fairpoint: Buy at 138p, target 190p; Creston: Run profits at 155p; Sanderson: Buy at 71p, target 80p to 85p; Renew Holdings: Buy at 340p, target 375p ('Break-outs looming', 4 August 2015)

Globo: Buy at 42.75p, target 69p; Cambria Automobiles: Run profits ('Short sellers in for shock treatment', 5 August 2015)

Cohort: Run profits at 357p, target 375p; Cineworld: Run profits at 530p; Paragon: Buy at 412p ('Acquisitive growth drives re-ratings', 6 August 2015)

Town Centre Securities: Buy at 310p, target 350p ('Equity market watch', 11 August 2015)

Equity market strategy ('Equity market watch', 11 August 2015)

■ Simon Thompson's book Stock Picking for Profit can be purchased online at www.ypdbooks.com, or by telephoning YPDBooks on 01904 431 213 and is being sold through no other source. It is priced at £14.99, plus £2.95 postage and packaging. Simon has published an article outlining the content: 'Secrets to successful stockpicking'