Kape Technologies (KAPE:123p), a provider of cyber security software and a constituent of my 2017 Bargain Shares portfolio at 47.9p when the company was known as Crossrider, has pulled off a major earnings enhancing acquisition that sent its share price surging. It also vindicates my decision to recommend exploiting the glaring valuation anomaly on offer when the shares were priced at a bargain basement 70p only a couple of months ago (‘Exploit Kape’s valuation anomaly’, 18 Sep 2019).
Kape is paying $127.6m (£99m) for Colorado-based Private Internet Access (PIA), a leading provider of virtual private network (VPN) solutions that encrypt and secure internet connections and protect individuals' privacy and digital data. Founded a decade ago, PIA now has over 1m paying subscribers globally, of which almost half are based in the US. It’s an area of cyber security that Kape’s management know incredibly well.
Since acquiring CyberGhost, a leading cyber security software-as-a-service (SaaS) provider of VPNs, in March 2017, Kape has more than trebled its user base. Digital privacy is a fast-growing market that is worth $24bn globally and is expected to grow by 50 per cent by 2022, according to industry experts. It’s not difficult to understand why as the increasing occurrence of data breaches and phishing attacks by cyber fraudsters are making consumers more concerned about their own data privacy and the need to guard against identity theft.
Strategically, the acquisition offers multiple benefits for Kape. It doubles the company’s customer base to 2m subscribers, provides the business with a strong presence in North America, enhances its brand awareness (PIA features in Tech Radar’s top 10 VPN list as a good value proposition offering expert features), offers the opportunity to leverage Kape’s proprietary technology platform to deliver continued strong organic growth, and adds additional privacy products to Kape’s existing product suite: Plus Ultra – a software that speeds up internet connections; LibreBrowser – a completely private browser; and Private.sh – a private and encrypted search engine based on proprietary cryptography technology.
Importantly, it’s a sound deal financially for Kape’s shareholders as PIA has shown consistent revenue growth and cash conversion rates above 100 per cent, increasing annual revenue from $13.3m in 2014 to $47.4m in 2018 when the company produced cash profit of $14.7m. Last year, PIA generated operating cash flow of $16.3m, a cash conversion rate of 110 per cent.
Kape will pay the vendors $95.5m consideration over the next two years and also repay PIA’s $32.1m existing debt. Kape had net cash of $36.4m at 30 June 2019 which can be used to pay off PIA’s debt, and plans to fund the initial $32.9m cash element of the deal through a $40m short-term debt facility (priced at 5 per cent above Libor) from its largest shareholder, Unikmind, a company owned by Tedi Sagi, the founder of the gambling software company Playtech (PTEC). Kape’s directors expect the combined business to generate proforma 2020 revenue of between $120m to $123m and underlying cash profit of between $35m to $38m. They also anticipate making $3.5m to $4.5m of cost savings in the first 12 months post completion.
|2017 Bargain shares portfolio performance|
|Company name||TIDM||Opening offer price on 3.02.17 (p)||Closing bid price on 22.11.19 (p)||Dividends||Total return (%)|
|Kape Technologies (formerly Crossrider)||KAPE||47.9||122||3.55||162.1|
|BATM Advanced Communications (see note seven)||BVC||19.25||42.1||0||134.8|
|Chariot Oil & Gas (see note one)||CHAR||8.29||3.96||0||48.7|
|Cenkos Securities (see note two)||CNKS||88.425||106||9.5||30.6|
|Manchester & London Investment Trust (see note three)||MNL||291.65||377||3.0||28.4|
|Bowleven (see note four)||BLVN||28.9||9||15||-0.1|
|Management Consulting Group (see note five)||MMC||6.183||6||0||-3.0|
|Tiso Blackstar Group (see note six)||TBG||55||19.7||0.54||-63.2|
|FTSE All-Share Total Return||6485||7539||16.3|
|FTSE AIM All-Share Total Return||977||1032||5.6|
|1. Simon Thompson advised selling two-thirds of the Chariot Oil & Gas holding at 17.5p on 3 April 2017 ('Bargain shares on a tear', 3 April 2017). Return reflects the profit booked on this sale. Simon subsequently advised using some of the proceeds from the share sale to participate in the one-for-8 open offer at 13p a share in March 2018 which is taken into account in the total return ('On the earnings beat', 5 Mar 2018). Simon turned buyer of the shares at 4p on 17 April 2019 ('Chariot's North African adventure', 17 April 2019).|
|2. Simon Thompson advised selling the Cenkos Securities holding at 106p on 3 April 2017 and the 106p price quoted in the above table is the exit price on the holding ('A profitable earnings beat', 3 Apr 2017).|
|3. Manchester and London Investment Trust paid total dividends of 3p a share on 2 May 2017. Simon Thompson then advised selling half of the holding at 366.25p on 26 June 2017 ('Top slicing and running profits', 26 June 2017), and selling the remaining half at 377p ('Bargain shares second chance', 17 August 2017). The 377p price quoted in the table is the final exit price.|
|4. Simon Thompson advised banking profits on half your holdings in Bowleven shares at 33.75p, and running the balance ahead of drilling news at the Etinde prospect in Cameroon in the second quarter of 2018 (‘Hitting pay dirt', 9 Apr 2018). The company subsequently paid out a special dividend of 15p a share on 8 February 2019. The total return reflects this share sale.|
|5. Simon Thompson advised to sell Management Consulting's shares at 6p in February 2018 (‘How the 2017 Bargain share portfolio fared’, 2 February 2018). The price quoted in the table is the 6p exit price.|
|6. Tiso Blackstar has transferred its UK listing to the Johanesburg Stock Exchange. Price quoted is sterling equivalent bid price at current exchange rates.|
|6. Simon Thompson advised banking profits on half your holdings in BATM shares at 49.9p, and running the balance for free ('Bargain Shares: Exploiting pricing anomalies and top-slicing', 3 December 2018). Simon then advised reinvesting the profits back into the shares at 43.5p ('BATM armed for a re-rating', 11 July 2019). Total return takes into account these trades.|
|Source: London Stock Exchange share prices.|
The other benefit of the acquisition is that it dilutes Unikmind’s stake to 55.9 per cent, so broadens the shareholder base. PIA’s co-founders Andrew Lee and Steve DeProspero, and a number of PIA’s employees, will own 23.1 per cent of the enlarged share capital. The founders are subject to a 12-month lock in period on their consideration shares which will account for 10.4 per cent of Kape’s enlarged share capital. Operationally, PIA’s chief executive Ted Kim will join Kape’s board and lead the North American operations, thus adding expertise to the existing management team. Mr Lee has agreed to provide consulting services to Kape for a three-year period.
The acquisition is scheduled to complete early in 2020, so will have no impact on 2019 forecasts which analyst Martin O’Sullivan at brokerage Shore Capital believes will deliver a 43 per cent rise in adjusted pre-tax profit to US$12.6m on revenue up 39 per cent to US$72.3m, driven by ongoing organic growth and the contribution from the 2018 acquisitions: Intego, a Mac and iOS cyber security and malware protection software-as-a-service (SaaS) business; and Berlin-based ZenMate, a digital privacy company focused on VPN solutions.
However, the contribution from PIA will have a material positive impact on 2020 forecasts. Mr O’Sullivan has raised his revenue estimate by 45 per cent from US$83.1m to US$121m, almost doubled his cash profit estimate to US$35.6m, up from US$14.3m forecast in 2019, and is pencilling in a 2020 pre-tax profit of US$31.4m, or almost 150 per cent higher than his 2019 forecast.
On this basis, Shore Capital upgraded its diluted earnings per share (EPS) estimates by 70 per cent to 15.6¢ (12.2p), implying 129 per cent year-on-year growth. In other words, even after rallying by more than 50 per cent on news of the PIA acquisition, Kape’s shares are still only rated on a forward price/earnings (PE) ratio of 10. Also, reflecting 2020 estimated free cash flow of US$19.6m, Shore Capital expects Kape to end the 2020 financial year with net borrowings of US$15.2m, highlighting the potential for the US$40m Unikmind shareholder loan to be paid down.
This means that at the current share price of 122p, and using a fully diluted share capital of 190m shares, Kape has an implied enterprise value of US$311m, or 9 times 2020 cash profit forecasts. That’s a low valuation for a business that is expected to generate free cash flow of US$19.6m in 2020, rising to US$26.6m in 2021. Indeed, analysts at brokerage N+1 Singer estimate the intrinsic value of the shares is between 176p and 228p, the mid-point of which seems a sensible fair value to me based on a 2020 target PE ratio of 16.5.
So, even though the shareholding in Kape has already delivered a 162 per cent total return to boost the total return on my 2017 Bargain Shares Portfolio to almost 40 per cent, handsomely outperforming both the FTSE All-Share index (16.3 per cent total return) and the FTSE Aim All-Share index (5.6 per cent total return), I still see potential for another 66 per cent share price upside. Buy.
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