Through a prism, darkly

Alternative Investment Market (Aim)-traded software company Blue Prism (PRSM) is in a hurry. It joined the market last March, placing 27m shares with institutional investors at 78p. Its shares are now trading at 766p. What can we make of its vertiginous rise?

The company is at the vanguard of a big corporate trend: the automation of routine tasks. Some argue that this will help solve the productivity puzzle discussed in our cover feature last week ('Lean mean profit machines', 18 May 2017): In the common parlance, 'robots' are coming for our jobs.

For Blue Prism, the term robot can be misleading: it sells 'robotic process automation' software that allows companies to automate back-office work. An example of such a 'robot' is one that can validate an insurance claim, add policy details and information from third-party systems, and pass it on to a claims handler, replacing the current management process.

The majority of Blue Prism's revenue (86 per cent in FY2016) comes from software licences, which include maintenance and support services, with the remainder from training and consultancy projects. It sells the licences to companies both directly and via 'partner' channels. In January, it announced that its partnership with Accenture (US: ACN) had delivered 40 clients, and that the professional services group would 'certify' more than 600 of its employees on Blue Prism technology.

The distribution is at hyper speed. The company made 189 licence deals in the year to October 2016, up from 40 in the prior financial year. Of those, 81 were upsells, as customers made greater use of the automation software or extended its reach. Another 151 software deals were made in the five months to March 2017.

Wariness of such growth stories is prudent: cyber security company NCC (NCC) is a good example of a company providing 'solutions' in a high-profile growth industry (cyber security), which came back to earth with a bump last year after certain contracts were cancelled and deferred.

Blue Prism splits its future contracted revenue (customers not yet invoiced) from billings. Of the billings, revenue is recognised on the income statement over the life of the contract, typically three years. The deferred income sits on the balance sheet as a liability. This is a more prudent model than some have employed, but failing contracts remains a downside risk.

One thing you'll notice is that Blue Prism has no intangible assets. Research and development costs are fully expensed as none has yet "met the criteria for capitalisation". Those criteria include the ability to measure the expenditure, to quantify the 'future economic benefits' of the product, and to effectively sell the product.

Accounting rules require that an asset should be recognised, whether internally generated or acquired, if it meets the definition. Many listed software companies will break down their intangible assets so that investors can compare the value of acquired intangible assets against internal development. This is arguably more transparent, but there can be a downside to capitalising such assets if companies overstretch and set themselves up for future writedowns. So some prefer to expense the development costs.

How confident can an investor be in the value of a company like Blue Prism, especially if those capitalisation hurdles aren't met for a product it is currently selling? It's possible bosses are being conservative about the future economic benefits. "We are working in an emerging market and it is not clear which technology will win," the company told me, defending its prudent accounting approach.

Fair enough. The company has patents on its original proprietary software. It has submitted applications for some of the applied software 'architecture' that it has developed since. But competitors could yet unstick its customer relationships; particularly if that relationship is between an end-client and their consultant. Blue Prism's enterprise value is equivalent to a demanding 23 times expected FY2017 sales (recognised revenue), falling to 19 times in FY2018. Further revenue upgrades will be needed to keep the price at current levels. Clearly, there is a disruption premium in the shares. This company is first through the door, and has its back wedged firmly against it.

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