The company reported a cash loss of £495,000 in the first half to end-May 2016 in yesterday's results announcement, but analysts expect it to report cash profits of £1.6m in the second half to end-November 2016. On this basis, expect full-year pre-tax profits of £500,000 and EPS of 0.1p.
The key to the dramatic transformation is the addition of 50,000 new customers through three game-changing acquisitions made in July: Norwegian-based Breiband, the only provider of radio and satellite broadband in the country and one that has a 13,000-strong customer base; SkyMesh, a Brisbane-based national provider of satellite broadband to 28,000 residential and business customers in Australia; and UK rival Avonline, a satellite broadband business with a customer base of 9,500, of which 92 per cent are consumers.
These three acquisitions generate over £21m of annual revenue and £4.2m of cash profits and are the reason why analyst Michael Armitage at house broker Arden Partners expects cash profits to rise five-fold in the financial year to November 2017 to produce pre-tax profits of £3.4m and EPS of 0.63p. This means that the shares are priced on 11 times earnings for the financial year to November 2017. I covered the financial impact of all three deals in quite some detail four weeks ago ('Into orbit', 2 August 2016) when I rated the shares a buy at 6.15p, having first recommended buying at 5.5p earlier this year ('Blue sky tech play', 21 March 2016).
Importantly, the business continues to grow organically and is adding 200-plus customers each month, so adding further weight to expectations of a strong ramp-up in profits in the next financial year. All acquisitions made to date have delivered organic growth post completion. Moreover, as customer numbers rise, there will be incremental benefits to operating margins from cost savings, economies of scale and streamlining management structures.
It's also worth flagging up that the UK government's Broadband Delivery UK initiative, a scheme aimed at offering subsidised broadband to homes and businesses in England, Scotland and Northern Ireland which have internet connections of less than 2Mb, has been streamlined following its launch in January. SSW is one of the satellite broadband retail service providers and is now "starting to really see some traction" here.
Quantifying a fair valuation
To put the valuation into some perspective, based on the current share count of 536m, the company is being valued at £37.5m, or on a cash profit multiple of 8.6 times its' enterprise value after accounting for pro forma net debt of around £10m. That's a low multiple. However, one reason why some investors may be slightly cautious is because of the pricing of recent fundraisings.
Not only did the company dramatically increase its share count by issuing 201.66m shares at 6p each in July to raise £11.4m of net proceeds to fund the £10m initial cash consideration of the Breiband and SkyMesh acquisitions, it also funded the £9.5m cash acquisition of Avonline by increasing its debt facility from £2m to £12m with 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, and which was used to fund two acquisitions in France at the time, 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 May 2024, or earlier subject to an early repayment charge of 12 months' interest; and £2.4m of convertible notes which carry a 10 per cent coupon and are convertible into 26.66m shares at 9p each. The loan notes have a redemption premium of £5.5m and SSW has issued BGF with warrants on 74m shares with a strike price of 7.5p a share. These warrants are exercisable anytime from the end of July 2019 until they lapse in August 2021. This financing arrangement has a bearing on the true enterprise value of the company and is therefore worth quantifying.
After taking into account the £5.5m cost of the BGF redemption premium, the £5.55m cash inflow from the exercise of the 74m BGF warrants, conversion of BGF's £2.4m convertible loan stock into 26.66m new shares and director options over 29.5m shares, then on a fully diluted basis the issued share capital increases from 536m shares to 666m shares. However, there is a positive impact on net borrowings because the exercise of share options and conversion into equity of the convertible unsecured loan notes reduces forecast net debt from £10.3m to below £7m at end-November 2017. This means that at the current share price of 7p, and using the fully diluted share count of 666m, the equity valuation is around £46.6m. This implies an attractive enterprise value of £53m, or 9.6 times cash profit estimates for the 2017 financial year.
The point is that because the strike price of the warrants (7.5p each) and convertibles (9p per share) is higher than the current share price (7p), the issue of the 100.66m shares to BGF, which would end up with 15 per cent of the enlarged share capital, has negligible impact on the enterprise value of the company. That's important because it means that shareholder interests are not being significantly diluted.
Benefits of debt financing and equity raise
I realise that the debt funding arrangement is complicated, and may look expensive, but it gives SSW a five-year line of credit to grow the business. The equity raise has benefits too as it has strengthened the balance sheet and enabled the company to pull off two major earnings-enhancing acquisitions.
Clearly, for the board to hit its target of having 100,000 customers by November 2017, we can expect further bolt-on deals, but I would anticipate these to be funded at a much lower cost of capital given that risk profile of the company has improved since it moved into profit and strengthened its balance sheet. I would also expect any acquisitions to be earnings-accretive and prompt further earnings upgrades. In fact, it's a company I expect investors to warm to as the financial upside from acquisitions, and ongoing organic growth, become clearer to a wider audience.
It's noteworthy too that the share price has successfully tested the 6p support level three times this summer and look to have formed a firm base from which a move to my fair value target between 9p and 10p share can be achieved. Mr Armitage has an even higher target price of 12p. Offering around 40 per cent upside to the upper end of my target price range, I rate the shares a buy on a bid-offer spread of 6.7p to 7p.
