Broadening the managed services offering
The bolt-on acquisition of Willow Starcom strengthens K3’s (LONDON:KBT) hosting and managed services business, providing additional hosting capacity and expertise. The company expects the deal to be earnings accretive in its first full year of ownership. We have revised our forecasts to reflect the deal, with FY16 revenue and EPS increased by 3.0% and 2.5% respectively.
Acquisition of Willow Starcom
K3 has acquired Willow Starcom, a wholly owned subsidiary of Access Intelligence. Willow Starcom provides remotely managed, on-premise and cloud-hosted IT support services as well as related hardware, software support and consultancy. It operates in two data centres in Manchester and is a Microsoft (NASDAQ:MSFT) Hosting Partner. For the year ended 30 November 2014, the business generated revenue of £2.66m, EBITDA of £0.37m (14% margin) and PBT of £0.1m. K3 has paid £1.75m for the business on a debt-free/cash-free basis, funded from existing banking resources, equating to a trailing EV/Sales multiple of 0.7x (versus K3 at 1.2x) and a trailing EV/EBITDA multiple of 7.2x (versus K3 at 8.5x).
Changes to forecasts
We have made no change to our FY15 forecasts other than to reflect the £1.75m cost of the acquisition. We have factored in revenue of £2.6m in FY16 (in the Manufacturing & Distribution division) with an EBITA of £0.33m. We have increased our net interest expense forecast to reflect the higher level of debt. This results in an increase in revenue of 3.0%, EBITA of 3.1% and normalised EPS of 2.5%. We have not factored in any cost synergies; these could add upside to our forecasts.
Valuation: Trading at a discount to peers
The stock is trading on a P/E multiple of 11.7x FY15e EPS and 9.0x FY16e EPS. Sub-£200m market cap UK software stocks are trading on 17.5x current year and 14.7x next year EPS and UK IT service companies are trading on 16.8x current year and 14.1x next year EPS. K3 continues to invest in developing and supporting its own-IP solutions, including its “ax│is” solution. Combined with a focus on growing the SYSPRO and Sage businesses and selling hosting services to a larger proportion of customers, K3 has the potential to grow the business on a multi-year basis. We would expect triggers for a stock re-rating to include evidence that K3 continues to win more “ax│is” contracts, expansion of the international channel, and the managed services business winning customers. We believe that the stock could trade up to at least 15x FY15e EPS (289p per share).
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