Brave new worlds
The UK government’s drive to modernise its data handling as a means to promote efficiency and save money is producing substantial workloads for IT businesses. The UK Government Digital Transformation Strategy is procuring billions of pounds worth of new projects, spending £3.1bn in fiscal 20/21 and, according to public.io, rising to £20bn per year by 2025.
Globally, spending in this area is expected to grow at a compound rate of 15-16 per cent through to 2030 such is the backlog of legacy system replacements. Total spend is expected to exceed $1 trillion by 2025 (according to research by Markets and Markets), double the spend in 2020. This is a long-term programme aiming to transform fundamentally the way the public sector operates, how it evolves strategies, improves delivery of services to customers and reduces costs. As chart 1 shows, the government estimates that wholly digital service provision costs a tiny fraction of in-person, mail or phone-based services. A significant amount of the work to deliver this transformation is consciously being placed primarily with UK-based, small-to-medium sized enterprises (SMEs).
This is a deliberate departure from the somewhat tortured history of government IT projects where large, often global consulting firms delivered a series of late, over-budget and often ill-suited IT systems with very little standardisation. Many systems then delivered were unable to communicate with other branches of government and frequently struggled to make available good information even within the commissioning department.
Undertaking the wholesale digital conversion of UK public sector services would historically have been unfathomably expensive and the relentless stream of budget cuts since the start of austerity in 2009 has put traditional IT solutions ever further beyond reach. But in the last five years there has been a number of revolutions in IT that have slashed the cost of even very wide scale projects such as this. The main driver has been the ability to use highly capable, very wide ranging libraries of highly flexible, scalable open source software, software-as-a-service (SaaS) products and cloud infrastructure.
These on-demand services are provided by the likes of Amazon Web Services (AWS), Google Cloud or Microsoft Azure. Previous projects in this area used either bespoke, unique software built from scratch or a solution based around locally installed, closed and expensive Enterprise Resource Planning (ERP) systems such as SAP or Oracle. Although one should always be wary of the words “this time it’s different” (sometimes dubbed the four most dangerous words in investment – because things have an unnerving habit of always being very much the same), in this instance it could be true.
The use of open-source SaaS allows organisations of any size to access tools on a pay-as-you-use basis that were previously only available to large organisations with substantial IT budgets and extensive IT departments in-house. Highly complex solutions such as artificial intelligence (AI), ‘software robots’, machine learning, virtual reality and blockchain can also be used to build fast, robust and capable systems that run 24/365 rather than office hours only and perform core tasks more quickly and at much lower cost. IT services are able to become almost a pure revenue cost without the need for high and depreciating capital investment.
Chart 1: Relative cost of public sector service provision
Source: Digital Government by the then Cabinet Office Minister Francis Maude, 2013 | Arbitrary units of cost
Chart 2: Staff hours in Civil Service millions/annum - before & after digital transformation
Source: Public.io, Oxford Brookers, Deloitte
A path well trodden
Investors have already been able to make (very) good money from this government exercise through specialist IT companies Kainos (KNOS) and The Panoply, recently renamed TPXimpact (TPX), and there is now a third option, Made Tech (MTEC). This was one of the most recent companies to IPO in London, being admitted to the Aim market only at the end of September. The business is wholly focused on digital transformation within public sector organisations, in the UK for now but with an eye longer-term on global markets.
So, investors are likely to be familiar with this space but how much room is there for a third player and will it emulate the success of its two peers? The markets in which Made operates clearly have solid momentum and positive drivers as evidenced by Kainos’ and TPXimpact’s success but any potential investor looking deeper into Made will find things a little opaque. Prior to its IPO, Made did not publish detailed financials, with only scant details of a three year trading history included within its ‘Admission to listing’ document. Looking at historic filings at Companies House to find a longer trading history we found that Made has posted only minimum filings which showed balance sheets but not profitability. While newly quoted companies are permitted to show very limited financial data, this does make it harder for new investors to feel confident.
The same, but different
So, will Made Tech be the next Kainos or TPXimpact showing rapid growth post IPO and delivering impressive returns for investors? Kainos has been something of a stock market darling rising from its 2015 IPO price of 139p to stand today at an all-time high of over 2000p. Meanwhile, TPXimpact has been a little less impressive but has still risen from 74p at IPO to 270p (via a recent peak of 310p). Both have posted high revenue and earnings growth in the last three years with both largely ironing out all of the bumps from Covid: the government’s moves to digitise its services may have slowed in the various lockdowns but the momentum has been sufficiently strong to enable participants to sustain strong trading. Kainos, for example, has recently posted three earnings upgrades.
While Made has the same core drivers as these peers, there are some important differences.
First, there is the lack of financial information save for the brief summary of the last three years’ trading in the Admission Document. This shows a strong but uneven revenue progression (see table 1), near trebling from 2019 to 2021 but without any detailed breakdown. Margins too have been inconsistent with reported gross returns at 28, 43 and 38 per cent across this period. Ebitda margins had been over 10 per cent but fell to only 5 per cent in 2021 even when adjusted for the then unrecovered £1.22m increase in sales team salaries. Trading prospects and outlook were stated but not with a particularly clear picture. Q1 of the FY2022 financial year (June to August 2021) is reported to be ‘over 100 per cent higher’ than in Q1 of FY2021, but in the absence of other quarterly trends and any idea how impacted that prior period was by Covid, it is not safe to extrapolate that growth. A ‘backlog’ or pipeline of £51m of bookable revenue was also reported but without timescale, analysis of new/renew/extension or any historic comparison levels, investors cannot readily assess how positive this is. Made has recently secured £10m of new contracts with the DVLA, which looks positive but again detail is light on the duration and nature of the work.
Second, Kainos and TPXimpact have other revenue streams whereas Made appears to have just the one: conversion work from UK public bodies. Kainos has a resale business for Workday (an on‑demand financial and human capital management SaaS provider) and recently formed a partnership for ‘software robots’ and other AI with global leader in the field, UiPath. TPXimpact derives close to one third of revenue from commercial rather than public sector clients, and is split fairly evenly between consulting and software.
While institutional investors will doubtless have had greater visibility of Made’s history and prospects in the IPO process, the lack of specific data on the business does leave private investors somewhat in the dark. The market opportunity is both apparent and substantial and there is strong evidence from the peer group that investors can do well holding stocks aligned with that market space. That, of course, does not guarantee that Made will follow the same path and track record is pivotal in these markets. Nor is there any assurance that the UK government will grow spending as is hoped. It is always a risk to map across the experience and delivery success of one company onto another despite operational and end-market similarities. Made is growing and is securing work but this a very competitive space although with the policy by the UK to keep (for now at least) much of this work in the hands of UK-based SMEs, competition may be more limited.
It is hard to estimate how fast Made will grow and how profitable it will be within that. If revenues can rise from the last reported £13.3m to, say, £20m in FY2022 and then to nearer £30m, the Enterprise Value (EV) to sales ratio would be around 6x: Kainos remains closer to 10x but TPXimpact is at only 3x. On a profitability basis, ultimate margins are unclear at Made but if they were to remain at 5 per cent, Ebitda would reach £1.5-£1.6m leaving the EV/Ebitda ratio at a demanding 120x: Kainos trades on c.40x and TPXimpact, 21x. If margins rebuild to get between the historic 5 per cent and Kainois’ 21 per cent, this valuation metric would drop, but remain high at c.50x.
There are a lot of ‘ifs’ and ‘buts’ here and investing on that basis is rarely sound especially when there is a paucity of financial information. The best strategy here for smaller investors is really to wait and see what Made is actually able to deliver quarter-by-quarter. This need not harm potential longer-term returns if Made is able to deliver sustained, strong growth.
Unlike many of the other 2021 IPOs, Made Tech’s share price has not moved far from its placement price of 122p. Initially spiking by around 15 per cent, the shares have now settled at around 7 per cent above: this does suggest some investor reticence with Made, for now at least. Private investors need to follow that lead until more and detailed financial and performance information have been published. If this is going to be the next Kainos, there would be no harm in waiting: Kainos has risen around 7-fold since its IPO but has done so fairly steadily over six years after a flattish performance in its early days as a PLC. If Made does follow the same path there is probably still time enough for investors to secure a favourable entry price. Meanwhile, a better option might be to go with the devil you know and play this sub-sector through Kainos or TPXimpact.
Table 1 : Made Tech’s trading history
Year to May
Operating profit *
Profit before tax *
Source: Made Tech *Adjusted/normalised for £1.223m exceptional staffing costs in FY2021