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Gamma dials up growth

The group is growing too fast for forecasts to keep up
October 3, 2019

The way in which we work has evolved significantly in recent years, underpinned by technological advancements and improved connectivity. These days, there’s an expectation of anytime, anywhere availability – between colleagues, and between businesses and their customers. But such availability depends on strong, reliable communications.

IC TIP: Buy at 1085p
Tip style
Speculative
Risk rating
High
Timescale
Long Term
Bull points

Strong growth
Broker upgrades
Overseas expansion
Rising gross margins

Bear points

Dean One disappointment
Founder share sales

Enter Gamma Communications (GAMA), a supplier of various communications products and services to businesses of all sizes, across both the public and private sectors. Gamma has its own voice, data and mobile network, giving it greater control over what it does. Its offering includes, but isn’t limited to, unified communications as a service (UCaaS), inbound call control services, business-grade broadband and a ‘Gamma Mobile’ service.

The core UK business is running smoothly. Indeed, smoothly enough for the shares to have been included in the IC’s most recent ‘Alpha Aim Quality Screen’, and expectation-beating trading means analysts have consistently lifted their forecasts over recent years (see chart). If the latest half-year numbers are anything to go by, the upgrade trend has further to run.

 

In 2018, all of Gamma's revenues came from the UK, with three-quarters from indirect sales through a network of channel partners, and the rest from direct sales. For the first six months of the current year, indirect sales rose by 7.6 per cent to £111m. Here, the group countered intensifying competition with its cross-selling capabilities, and its UCaaS product ‘Collaborate’. Collaborate, which launched in March, enables instant messaging and document sharing among other features. It already had over 4,000 users at the period-end. The gross margin on indirect sales climbed from 52 per cent to 56 per cent, which reflected growth in higher-margin areas relating to cloud telephony, including ‘SIP Trunking’ and ‘Cloud PBX’.

Meanwhile, the direct business saw even greater revenue growth of 16 per cent to £40m. But the gross margin there slipped from 46 per cent to 45 per cent, because of lower margins on some big bits of new business.

Overall Gamma’s revenues rose by 15 per cent to £158m, and its gross margin climbed from 45 per cent to 49 per cent. An efficient operating structure, which kept a lid on growth expenses, allowed the cash-profit margin to increase from 16 per cent to 19 per cent.

However, Gamma’s fledgling European activities were a source of disappointment. Targeting overseas growth is a plank in the ‘Gamma 2023’ strategy alongside ambitions to evolve its cloud telephony position into the UCaaS market, improve the strength of its fixed and mobile telecom offering, and build its digital capabilities. Acquisitions are central to the goal of expanding into Europe, but the company has not covered itself in glory with its first foray a year ago, which was the purchase of Netherlands-based telecoms group DX (known as Dean One) for £11.5m. Poor trading, particularly a greater-than-anticipated decline in ISDN sales, has already caused Gamma to write off £8m in goodwill and intangible assets associated with the deal and to discount making an £8.1m performance-linked contingent payment. Still, the deal has given the group a foothold in Europe and better-than-expected performance is reported from Gamma's February acquisition of Dutch business Nimsys, which cost £3.7m plus a potential £3.2m performance-linked payment.

Overall, Gamma’s Dutch business contributed £7.3m to revenues in the first half. The net cash position and a six-month increase in operating cash by almost a half to £27.4m means there should be plenty of scope for further deals.

GAMMA COMMUNICATIONS (GAMA)  
ORD PRICE:1,085pMARKET VALUE:£1bn 
TOUCH:1,085-1,090p12-MONTH HIGH:1,250pLOW:639p
FORWARD DIVIDEND YIELD:1.1%FORWARD PE RATIO:24 
NET ASSET VALUE:144p*NET CASH:£44.8m 
Year to 31 DecTurnover (£m)Pre-tax profit (£m)**Earnings per share (p)**Dividend per share (p)
201621424.521.97.5
201723828.424.68.4
201828534.930.39.3
2019**32747.940.310.5
2020**36255.346.211.9
% change+11+15+15+13
Normal market size:750    
Beta:0.87    
*Includes intangible assets of £35m, or 36.7p a share
**Numis forecasts, adjusted PTP and EPS figures