Gamma Communications in a strong cash position

Gamma Communications (GAMA) sells a cloud software solution to businesses to bring together their telecommunications services. Rather than having a hardware switchboard, they can have a cloud product that can integrate Microsoft Teams with a Three phone service.  

The benefits of this in an increasingly digital and flexible working world are clear. Last year, despite the economic headwinds in the UK, Gamma grew revenue by 10 per cent. The UK makes up over 85 per cent of revenue. The European business lagged with only 1 per cent growth.

Promisingly, the gross margin remained at 51 per cent, which is indicative of a good software business. The low cost of delivery means that as the company scales up its operating profit, we could see a disproportionate increase in cash. Last year, operating cash flow rose 10 per cent from £89.9mn to £99.1mn – faster than group revenue growth.

Earnings per share did fall by 8 per cent due to a £12.5mn non-cash charge in relation to the Spanish business. “Challenging local market conditions” and rising interest rates meant the value of the business there dropped. Rising interest rates impact software businesses, and non-cash charges could trend across the industry in 2023, particularly for acquisitive companies. 

Broker Peel Hunt is impressed by Gamma’s “solid recurring revenue”. Last year, recurring revenue made up 89 per cent of total sales, exactly in line with the year before. Peel Hunt expects adjusted earnings per share to slip 3 per cent due to macro conditions. However, with strong cash conversion, this still has Gamma trading on a 2023 free cash flow yield of 6 per cent. The share price has come down in the past few months and the cash flow looks enticing. Buy.

Last IC View: Hold, 1,140p, 6 Sep 2022