At the end of last week, the company announced the acquisition of Norwegian-based Breiband, the only provider of radio and satellite broadband in the country and one that has a 13,000 customer base, and growing. The company has around one per cent of the addressable market, but the potential opportunity is huge as there are 356,309 Norwegian households with less than 2 megabits per second (Mbps) broadband coverage, and over £1.4m in the Nordic region, according to research consultancy Point Topic. A number of Nordic region governments are expected to initiate some form of subsidy scheme, similar to those in France/UK offering free kit and installation, to segments of the under served population in the near future.
SSW is paying £6.5m to acquire Breiband of which £1.07m will be in shares priced at 6p each, and £540,000 of the £5.44m cash consideration is subject to an 18-month retention period. Breiband has net assets of around £1.8m and last year made cash profits of £1.1m on revenue of £8.2m, so a cash profit multiple of six seems very fair to me. The company has average revenue per user (ARPU) of £634, significantly higher than SSW's of £412, but this also reflects a higher cost of acquisition of £510 compared with SSW's of £335.
The second acquisition announced last week was that of SkyMesh, a Brisbane-based national provider of satellite broadband to residential and business customers in Australia. The company has 28,000 customers, of which 17,500 are satellite broadband, 7,000 are fixed line and 3,500 are fixed wireless. Interestingly, SkyMesh is one of the largest satellite broadband providers for NBN, the Australian government enterprise, which invested in its own satellite called Sky Muster and became operational in April 2016. NBN's second satellite, Sky Muster™ II is scheduled to blast into space in early October.
SkyMesh has 29.5 per cent of the market share of NBN's satellite services and added 1,000 new satellite connections in June this year alone. These customers are much cheaper to recruit at an average cost of around £187, but deliver less ARPU of £278. Still, it's a very profitable business as SkyMesh generated cash profit of £600,000 on revenue of £7.8m last year. The £5.1m consideration for the acquisition is being satisfied through the issue of £510,000 new SSW shares, the payment of £4.1m in cash on completion, and a further £510,000 payment deferred for 90 days.
A cash profit multiple of 8.5 times earnings is higher than for the Breiband acquisition, but this also reflects the immediate opportunity as there is little fixed-line telecoms infrastructure outside of the main coastal regions due to the huge land mass and geographical isolation of the country's interior. As a result, there are few viable options other than satellite broadband. To address this issue, the Australian government has already invested in its own satellites, Sky MusterTM, via its government backed enterprise NBN, to provide cost effective broadband services for up to 400,000 identified households and businesses.
The effect of the two earnings enhancing acquisitions is to add 41,000 subscribers to SSW's customer base of 35,000, making the company the leading satellite broadband provider in Europe, and in the top five globally. It also means that SSW is well on the way to hitting its target of 100,000 customers by the end of 2017. Importantly, the transactions will be earnings accretive in the first year of ownership given that SSW is paying in total £11.6m for companies that reported aggregate cash profits of £1.7m last year.
In order to fund these two deals, SSW has raised £12.1m of new equity in a placing by issuing 201.66m shares at 6p each, representing 65 per cent of its existing share capital of 308.3m shares. This means that the existing share capital rises to around 546.3m shares after accounting for the consideration shares issued. The £10m total cash consideration is being funded from the net proceeds of £11.4m from the share placing with the £1.4m balance of the funds raised used for working capital.
Avonline calls an earnings accretive acquisition
The deal making doesn't end there either because earlier last month SSW acquired rival Avonline, a satellite broadband business primarily in the UK and one boasting a customer base of 9,500, of which 92 per cent are consumers.
Last year, the business generated revenues of £5m and guidance from SSW's management, led by chief executive Andrew Walwyn, is to expect Avonline to make cash profits of £2.5m in its first year under SSW's ownership. The initial cash consideration is £10m, of which £500,000 is deferred for the first year and only becomes payable when annualised gross monthly billings, as defined by annualised sales value invoiced less costs associated with service delivery, hits £2.5m. If gross monthly billings exceed £2.5m in the period then there is an incentive payment to the vendors amounting to five times the excess above this target. Both the company and the vendors expect this additional cash payment to be no more than £2m. Avonline's annualised gross monthly billings were £1.9m at the start of 2016, so would have to hit £2.9m for the additional £2m cash payment to be made, a good indication of the strong growth of the business.
This deal was completely debt funded as SSW tapped a new £12m debt facility from the Business Growth Fund, the UK's most active provider of growth capital to SMEs. BGF is an independent company backed by the UK's main banking groups. Around £2m of the new facility was used to redeem a 12-month term loan note issued by the BGF to SWW at the end of April, so making a net new investment by BGF of £10m. The debt provider has subscribed for £9.6m of new unsecured loan notes at a fixed coupon of 10 per cent and repayable in full in May 2024, or earlier subject to an early repayment charge of 12 months' interest; and £2.4m of convertible notes which also carry a 10 per cent coupon and are convertible into 26.66m shares at 9p each. SSW has issued BGF with warrants on 74m shares with a strike price of 7.5p a share and these are exercisable anytime from the end of July 2019 until they lapse in August 2021.
The unsecured debt facility may seem expensive, especially as there is a redemption premium of £5.5m, but it has to be put in context as the £1m annual interest charge to fund the £10m initial cash consideration for the Avonline acquisition is covered 2.5 times over by projected cash profits, so leaving surplus cash profits over the eight years of the credit facility to enhance earnings per share. Moreover, £2m of the £12m debt facility was used to complete two acquisitions in France which added 2,400 customers to the customer base, cementing SSW's position as the second largest satellite broadband provider in the country and extending the suite of products it has to offer. The French government's subvention scheme, which has a stated commitment to enable 150,000 broadband subscribers on satellite by the end of 2018, is underpinning robust organic growth in the country following the company's previous acquisitions of Sat2Way and Vertical Connect.
The bottom line
Michael Armitage at broking house Arden Partners had previously forecast revenues of £19.7m and cash profits of £2.9m in the 12 months to end November 2017 based on 39,632 subscribers. This estimate factored in the 9,500 Avonline customers, the 2,400 customers from the two small French acquisitions in May, and SSW's 25,000 existing customer base at the end of June. Mr Armitage then assumed 5 per cent organic sales growth thereafter to reach his forecast.
However, the acquisitions of Brieband and SkyMesh have given a massive boost to those profit projections as these two businesses are generating combined annual cash profits of £1.7m plus. Also, SSW has just reported that its existing operations are now operating profitably on a monthly basis and are expected to be profitable on a cash profit basis in the second half to end November 2016. This reflects increases in ARPU due to improved operations, economies of scale, and the fact that all acquisitions made to date have delivered organic growth post completion.
Moreover, as customer numbers rise then there will be incremental benefits to margins from cost savings, economies of scale and from streamlining management structures. As a result Mr Armitage has raised his cash profit estimate from £2.9m to £5.5m which translates into pre-tax profits of £3.4m and EPS of 0.63p. This means that the shares are priced on just under 10 times earnings for the financial year to November 2017. The company is forecast to report cash profits of £1.1m in the current year to end November 2016, pre-tax profits of £500,000 and EPS of 0.1p as the full benefit of the three major acquisitions made last month will be seen in the next financial year.
The point is that this projected five-fold surge in cash profits is simply not in the price. That's because assuming SSW can make cash profits of £5.5m next year, as now seems realistic to me, and hits Mr Armitage's net debt forecast of £10.3m at end November 2017, then based on the increased share count of 536m its equity is currently only being valued at £33m, or two times proforma net assets of £16m and on a modest cash profit multiple of 8 times enterprise value of £45m.
Furthermore, after factoring in the BGF redemption premium of £5.5m, exercise of the BGF warrants, £2.4m of convertibles and director options over 29.5m shares, then on a fully diluted basis the company still only has an enterprise value of £47.8m, or 8.7 times cash profit estimates for the 2017 financial year. This is based on a raised share count of 666m to give a market value of £41m and reduced net borrowings of £6.8m post the exercise of the warrants and conversion into equity of the convertible unsecured loan notes. The point here is that given the strike price of the warrants (7.5p each) and convertibles (9p per share) is significantly higher than the current share price then the issue of the 100m shares here has negligible impact on the enterprise value of the company so shareholder interests are not being greatly diluted. That's well worth noting.
So, having first recommended buying the shares at 5.5p ('Blue sky tech play', 21 Mar 2016), and reiterated that advice at 7.5p early in anticipation of some earnings accretive acquisitions being made ('On the acquisition trail', 5 Jul 2016), I maintain fair value at between 9p to 10p share, or on 15 times next years earnings. Mr Armitage has a targte price of 11p. Given potentially 50 per cent plus share price upside, I would use the pull back in SSW's share price post the discounted placing as a strong buying opportunity.
For good measure the shares are heavily oversold and close to support around the 6p level, thus increasing the chances of a rally. Once investors have fully digested the financial implications of the three transformational acquisitions, and a dearth of equity research means that this article may be the first opportunity for many to do so, then I feel a bounce back rally is not only fully warranted, but also a strong probability. Buy.
