Nine British disruptors

So persuasive is the thinking that 'disruptors' have glorious futures that some value managers (doubtless sick of underperforming their growth-focused rivals) have persuaded themselves that the eye-popping ratings commanded by these types of stocks actually represent a bargain. Anything can be justified by a 'discounted cash flow' model if assumptions about future growth and profitability are bullish enough. Whether one takes the view that it’s all a load of guff or that any investment aside from disruptors represent value traps, a lot of money has been made by people buying the hottest of these stocks.

Given past performance, I thought it may be of interest to attempt to put together a screen aimed at identifying this type of situation. However, while I do think this is an interesting exercise for this column, it is not meant to be a call to arms to go headlong into these stocks, which in many cases have wince-some valuations.

It is not easy to clearly define the characteristics that will allow a company to disrupt an established industry and grow rapidly. The technology may not work, the idea may not catch on, or (as recent experience has started to demonstrate) the sheer scale of successful companies may create a government backlash. And while we hear plenty about the huge profits made by investors in this space, the stand-out successes (the Amazons of this world) tend to be built on mountains of failure (the Pets.coms, Webvans and Boo.coms of of dot-com crash infamy). Given the hyperbole that currently exists about disruptive technologies, it would be foolish to dismiss out of hand the idea that the market has got carried away with its hopes and dreams for disruptors and the speed at which disruption may occur.

Nevertheless, something interesting is certainly going on, and for those that like to use fundamentals to scour the market, the real action seems to be taking place in the 'top line' (revenues) of hot companies’ profit-and-loss statements. Arguably there is a view that when it comes to disruptors, profits are for losers. After all, if a company has a historic market opportunity, surely it should plough every dime (sadly for UK-focused investors it is normally dimes not pennies) it can muster into growth. Given that minimal profit often proves little impediment to share price gains, my attempt to screen for disruptors focuses on sales. Specifically, it adapts my Great Expectations earnings momentum screen to focus on sales.

The screen works by looking for strong share price momentum, strong forecast revenue growth and, most importantly, strong upgrades to revenue per share expectations. I’ve allowed stocks to qualify for the screen if they fail one of the four price momentum tests, and where this is the case it is marked up in the table below. The full criteria are:

■ Revenue per share (RevPS) forecasts for each of the next two financial years upgraded by at least 10 per cent over the preceding 12 months.

■ Revenue growth of 10 per cent or more forecast for each of the next two financial years.

■ Share price momentum at least double that of the market over the past year and better than the market over the past six months, three months and one month.

Six stocks passed all the screen’s tests and they are ordered by three-month price momentum in the table below. A further three stocks failing one momentum test are listed below the fully qualifying shares. One thing to take note of in the table is how vast some of these companies’ market caps are compared with forecast next-12-month revenue (Fwd NTM Rev). This represents an extreme level of valuation risk, which suggests that, if sentiment turns, investors could really lose their shirts! I’ve provided brief write-ups of the disruptive credentials of all the UK stocks highlighted that passed all the screens tests.

UK disruptors

Source: S&P CapitalIQ

FairFX

FairFX (FFX) is one of a number of companies looking to disrupt the £60bn foreign exchange market for individuals and businesses. The group offers highly competitive rates through a peer-to-peer currency matching platform. The service aims to be very user friendly and attracts high satisfaction ratings.

The rate of growth suggests FairFX is genuinely disrupting the market, and the group is adding to its clout through acquisition. Deals have been used to bring more elements of the supply chain under its control in order to increase the efficiency of its operations. It has also bought companies to move it into new areas, and significantly, it moved into banking through two acquisition in 2017. The company also became profitable last year and brokers forecast that the breakneck growth will soon be seen on the bottom line (earnings) as well as the top line (sales).

A qualm investors may have with this business, which generates low fees on high transaction values (£15.5m on £1.1bn in 2017), is whether its FX platform and brand provide it with a real barrier to entry. There are other 'disruptors' chasing the same opportunity and changes to regulation are making it easier for new entrants to come into the market.

Blue Prism

The fourth industrial revolution starts here! Blue Prism (PRSM) gets robot workers (software programmes) to relieve humans of tiresome, repetitive back-office jobs. Fortunately for Luddite hacks, from the gobbledygook on the company's 'about us' page, copywriting is low on the list for its Robotic Process Automation software, which aims to “rapidly build and deploy automations through leveraging the presentation layer of existing enterprise applications… configured and managed within an IT governed framework and operating model which has been iteratively developed through numerous large scale and complex deployments.”

However, language that is confusing to the layman seems to play well with the executive class. Work has been flooding in. Sales rose 145 per cent in the company’s first half, with 559 software contract deals secured, which included 298 bits of upselling. This compared with 209 deals in the same six months a year earlier. The customer base expanded to 700 during the first half from 271 a year earlier. Meanwhile, the perceived quality of sales is boosted by the fact that 93 per cent of first-half revenue was recurring. The company also boasts many big-name corporates on its client roster, including Coca-Cola, Commerzbank and IBM, and collaborates with some of the biggest names in technology, including Google and Microsoft. The potentially 'revolutionary' nature of the product and the appetite of corporates has put a rocket under the shares, which have risen 28-fold since the company’s 2016 float.

As well as having a penchant for selling software, Blue Prism's top brass are keen sellers of the company’s sky-rocketing shares. Since interim results in June, both the chairman and the chief executive have sold about 8 per cent of their holdings, respectively, netting £9.0m and £7.6m. Meanwhile the chief customer officer made £5.7m offloading about two-fifths of his stake and three people “discharging managerial responsibilities” pocketed £4.5m between them through the sale of a combined 250,000 shares. The price of the share sales ranged from 1,803p to 1,990p.

JD Sports Fashion

Can JD Sports (JD.) really be classed as a disruptor? Given JD is chiefly a bricks-and-mortar sportswear retailer, it certainly seems a bit of a stretch. But some characteristics of the industry mean it is not entirely risible to argue JD has some disruptor credentials. For one thing, its model of combining sports footwear and clothes in a single store is very novel in continental Europe, which has been a key focus of the group’s recent growth. Small beer as far as disruption goes, though.

What is perhaps more salient for anyone trying to paint JD as a 'disruptor' is that big sportswear brands, such as Nike and Adidas, have started to demand retailers offer shoppers a first-rate experience in exchange for exclusive deals. The trend has been for brands to focus their largesse on an ever-narrower group of retailers. JD’s scale – especially following its move into the US with a large, revenue-boosting acquisition – and its panache for omnichannel “retail theatre”, means it is regarded by industry analysts as having a strong presence among the select few.

The Gym Group

Technology has been harnessed by Gym Group (GYM) to try to create a new model in a well-established industry. As such, it has a credible claim to having a disruptive business model. True, its operation is still anchored in a very physical world based on leased property filled with treadmills, weights and the like. However, the group is using technology to help provide 24-hour access to gyms while keeping staffing levels low, and membership costs down. The group has also invested in collecting and analysing data to help it understand how customers use gyms and to find out what equipment and services they want. This is helping it to improve its use of capital, the effectiveness of marketing and customer satisfaction.

Importantly, the strategy seems to be working. Gym Group boasts a stunning compound annual sales growth rate over the past five years of 26.5 per cent and, despite its low membership fees, last year it achieved a very impressive underlying return on capital employed of 32 per cent (above the 30 per cent target). To expand, the company needs to source suitable sites. Last year 38 were added through new openings and an acquisition, which took the total to 128 and a further 30 openings are expected in 2018 with a target of 200 by 2020.

While Gym Group does have 'disruptive' credentials, it is not the only company targeting the low-cost, high-tech gym space. What’s more, while growth certainly looks impressive, the leisure sector in general is notorious for providing investors with funky new concept chains that expand fast but disappoint very quickly too.

Learning Technologies

While the 'digitalisation' of education and training can be regarded as a disruptive trend, it is a market that is already fairly well established. The market in 2017 was estimated to be worth between $90bn and $110bn. But while e-learning may be out of the initial gold-rush phase, there are significant growth opportunities. Growth per tear is estimated to be not less than 10 per cent.

However, it's not only industry growth that Learning Technologies (LTG) seeks to exploit. The e-learning sector is made up of lots of small disparate companies. Learning Technologies – along with several private equity players – sees the sector as ripe for consolidation. By building scale along with geographical and product diversity, Learning Technologies believes it can steal a march on competition and create the breadth of service wanted by multinationals while forging deeper, higher-value client relationships.

It’s a nice idea and one that the company has already demonstrated has mileage. Indeed, the company met an initial growth target to take sales from £7.5m to £50m, set out at the time of its 2013 float, a year early. Meanwhile, a “transformational” acquisition completed in May means it will smash its latest target of £100m sales by 2020.

Its $150m (£107m) purchase of US-focused talent management group Peoplefluent brings it £83m of revenues. What’s more, the deal is expected to increase recurring revenues – the type of sales that are prized by investors for their predictability – from 39 per cent to 68 per cent of the total. Despite about £35m of the purchase being funded by debt, strong cash generation means half-year net debt of £15.7m was well below expectations. The company will lay out its strategy and expectations for the integration of Peoplefluent when it reports half-year results on 25 September.

Such large deals always carry noteworthy integration risks, but there’s also the potential for major rewards. Some encouragement can be taken from the fact that directors put £1.9m into the 98p share placing that contributed £85m towards the acquisition. Meanwhile, a non-executive has spent £400,000 on shares at 107p since the deal completed.

First Derivatives

Behind many disruptor’s business models is a desire to harness the power of 'big data'. And behind many big data solutions is First Derivatives’ (FDP) Kx technology. The company regards itself as a world leader based on its ability to capture and analyse vast amounts of data from both real-time and historical sources. And this is a great market to be a leader in if the company’s estimates of the market’s size are correct. These estimates, made in conjunction with research firm Gartner, put a market value on annual licence sales of $63bn this year, rising to $83bn in 2020.

The company has long been investing in its product, traditionally targeting the highly regulated finance industry and the reams of data it generates in day-to-day activities. Indeed, the company has produced 21 years of consecutive double-digit revenue growth. While fintech still accounts for over three-quarters of revenues, First Derivatives is branching out into new sectors. However, because the same Kx technology is the foundation of all its products, it is able to streamline research and development and support. It is also actively trying to identify and work with companies that wish to use big data to disrupt markets and says it has a pipeline of exciting opportunities.