Redcentric's risky acquisitions offer potential

Redcentric (RCN) is in a period of flux. The IT managed services and data centre company made three acquisitions in the last six months, on top of the two it made in the previous year. The acquisition of 4D Data Centres and three data centres from the collapsed Sungard increases Redcentric’s data capacity in a growing industry.

The lossmaking Sungard assets were acquired for below market value, and accounting standards mean that equated to an immediate profit gain for Redcentric. Nonetheless, Redcentric's balance sheet now has £102mn of intangible assets, up from £69mn, and there is potential for non-cash impairment charges if other assets subsequently need to be written down.

Total revenue increased 38.8 per cent to £61.5mn, and the addition of 4D Data means the proportion of recurring revenue rose by 2.1 percentage points to 91.7 per cent. Recurring revenue was a key performance indicator for tech investors during the technology boom.

However, while the accounting gain boosted headline figures, the Sungard data centres contributed to a 7.8 percentage point drop in adjusted cash profit (Ebitda) margins to 19 per cent. This drop in profitability combined with increased working capital led to operating cash outflow of £2.6mn, compared with inflows of £9.3mn last year.  

Management is planning to remove £7mn of annualised costs from the Sungard and 4D acquisitions which will boost profitability next year. Brokers think profitability will rise in the next couple years – with FactSet consensus EPS of 4p for full-year 2023 expected to rise to 8p in 2024. This would give an affordable looking forward 2024 PE ratio of 11, but we are little more cautious, and would first like to see evidence of an uplift on the back of the M&A spree. Hold.  

Last IC View: Hold, 123p, 21 July 2021