NCC has the code for profits

Businesses are increasingly using critical IT systems and software that need protecting from fraud, viruses and cyclical renewal, and this is NCC's bread and butter.

The company supplies a niche safety net to customers' IT systems. For example, the average large company uses around 20-25 software applications that are vital to its business. What happens if the supplier goes belly-up, or stops providing support? NCC provides the answer by safe-keeping the codes in escrow, which can then be accessed by the licensee for vital amendments.

NCC is already by far the UK's biggest supplier of this service, with about 90 per cent of the market. The market would be bigger, but many companies simply don't realise the threat until something goes wrong. That's a situation NCC is working hard to address. The UK market has been estimated by market researcher Gartner to be worth up to £85m a year. But NCC reckons overall market penetration is barely 10 per cent of what it should be.

Big companies are leading the way and NCC is already providing services to over 90 per cent of FTSE 100 firms. Better still, as customers become aware of the issue it becomes apparent just how many source codes need protecting.

An annual licence will cost a customer under £1,000, and NCC has a customer base of over 10,000 clients. Since licences automatically renew, recurring revenues across the business are high. So far this year, escrow income is up 10 per cent, with renewals 7 per cent better or, put another way, roughly 80 per cent of last year's £18m escrow revenue has been banked in 10 months, excluding new business. Customer churn has remained around 10-12 per cent for the past five years.

NCC also provides IT information and security consultancy, but the most interesting bit is its testing services side, where its techies try to hack computer systems and steal data from clients, just to see if they can, and how easy it is. It also performs rugged checks on company websites. A big retailer, for example, could lose hundreds of online sales if its site slows down after a sudden burst of traffic. This part of the company has grown quickly. Five years ago testing sales totalled £4.4m. Last year's figure was over £19m, up nearly 50 per cent year on year. This year, testing sales are up 16 per cent so far and last week's £15m acquisition of testing specialist SDLC further strengthens this part of the business.

One draw-back is staff poaching, a problem that has hung around the company for years. That said, the SDLC acquisition brings on board a team of skilled testing professionals at a stroke.

NCC's shares have been relatively stable during the downturn, reflecting the solid performance of the business even in the most testing of times - the company has grown sales, EPS and cash per share through the recession. First-half cash earnings equated to 127 per cent of operating profits. This year's estimated 10.5p dividend (see table) would imply a respectable 2.7 per cent yield.

The shares currently trade on a 2010 PE ratio of 13, falling below 11 times forecast earnings for 2010-11 from broker Altium Securities - that's a 25 per cent discount to the software sector's rating. An earnings multiple of 15 times looks comfortably justified, given NCC's unblemished record of earnings growth since floating in 2004. That would imply a share price over 500p over, say, the next six to 12 months, about a third up from here.