SCISYS — Update 11 April 2016

SCISYS — Update 11 April 2016

SCISYS

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SCISYS

Margin recovery

Final results

Software & comp services

14 April 2016

Price

66p

Market cap

£19m

Net debt (£m) at end FY15

1.0

Shares in issue

29.0m

Free float

63%

Code

SSY

Primary exchange

AIM

Secondary exchange

N/A

Share price performance

%

1m

3m

12m

Abs

(4.3)

(5)

(21.8)

Rel (local)

(5.5)

(8.7)

(13.8)

52-week high/low

89p

58p

Business description

SCISYS provides a range of professional services in support of the planning, development and use of computer systems in the space, media/broadcast and defence sectors, as well as to other public and private sector enterprises.

Next events

AGM

June 2015

Trading update

July 2016

Interim results

September 2016

Analysts

Richard Jeans

+44 (0)20 3077 5700

Dan Ridsdale

+44 (0)20 3077 5729

SCISYS is a research client of Edison Investment Research Limited

FY15 results reveal that the difficult H1 is firmly behind it, as SCISYS bounced back with a strong H2. In H1, SCISYS was hit by difficulties in a major fixed-price development project, but this was fully resolved in October. The group has a healthy order book of £37.2m, c 23% ahead of a year earlier, of which £25.8m is scheduled for delivery in FY16. Hence 69% of FY16 revenues are already in the bag and the group has a healthy pipeline of new business. SCISYS has a medium-term goal to return the business to 8%+ operating margins, which leaves the shares looking attractive trading on c 9x our FY17e earnings (based on a 6.6% margin).

Year end

Revenue
(£m)

PBT*
(£m)

EPS*
(p)

DPS
(p)

P/E
(x)

Yield
(%)

12/14

40.4

3.2

8.2

1.61

7.9

2.4

12/15

36.1

0.6

1.3

1.78

49.5

2.7

12/16e

38.0

2.3

6.2

1.90

10.6

2.9

12/17e

39.9

2.7

7.0

2.10

9.3

3.2

Note: *PBT and EPS are normalised, excluding amortisation of acquired intangibles, exceptional items and share-based payments.

Final results: Poor H1 partly offset by strong H2

FY15 revenue slipped by 11% to £36.1m (we forecast £36.0m) while adjusted operating profit fell by 76% to £0.8m (we had £0.4m). Having reported a £1.2m loss in H1, the group recorded its strongest H2 ever, although this was partly explained by the conservative H1 provisioning that unwound in H2, after the problem project was resolved. SCISYS was also hit by the strength of sterling against the euro, but this has swung in the other direction in 2016. FY15 adjusted EPS tumbled by 84% to 1.3p (vs our forecast 0.9p loss) and the group ended the year with £1.0m of net debt, which was in line with the January trading update. While the interim dividend was suspended to conserve cash, the company has reinstated dividends with a final payment of 1.78p, which is 11% ahead of the previous year’s total payout.

Improved control procedures in place

The problem project revealed in H1 was the group’s first significant problem project since FY07, as SCISYS has been managing its projects more effectively, having put more rigorous procedures in place. It occurred because the project fell below the minimum size criteria for board-level risk monitoring and SCISYS has since implemented new procedures to include project complexity in the criteria for monitoring projects. On a positive front, the resolution revealed the strong relationships the group has with its customers and bankers and highlights the advantages of maintaining a balance sheet supported by sizeable property assets.

Forecasts and valuation: Below 69p book value

We have maintained our FY16 and FY17 revenue and profit forecasts. The stock trades on 0.50x our FY17e revenues and 5.3x EBITDA – attractive given seven consecutive years (FY08-14) of margin improvements and a strong cash flow discipline. The group retains a strong balance sheet that includes the freehold on the group’s HQ, which was sold in 2007 for £9m and repurchased in 2011 for £5m.

Investment summary: Margin recovery

Company description: Leader in European IT services

SCISYS is a specialist systems house operating across a broad spectrum of market sectors including media & broadcast, space, government and defence & commercial sectors. The group has blue-chip clients, industry expertise and growing revenue visibility. The challenge is translating this opportunity into profitable growth.

Exhibit 1: SCISYS's share price (p) history over last 10 years

Source: Bloomberg, regulatory news

Financials: Historically strong cash flow management

The group’s main revenue models are a mixture of fixed-price contracts, time and materials (consultancy and professional services), along with services and support contracts. There is also some software licensing of SCISYS’s IP, as well as hardware procurement and integration and pass-through, third-party software licences. In recent years the focus has been on driving efficiencies through the business. In June 2015, SCISYS was hit by a profits warning relating to cost overruns on a fixed-priced project (since resolved) and by the strength of sterling against the euro. Annual cash flow is influenced by timing of payments around the year end. In FY15 operating cash flow before taxes was £1.6m and, despite the problem project, SCISYS still managed to generate positive free cash flow of £0.2m. We forecast operating cash flow of £3.1m in FY16, rising to £3.5m in FY17, and for the group to return to a net cash position of £0.3m at end-FY16.

Sensitivities: Pressure on government to reduce spending

While further UK public sector cuts are anticipated, we note that most of the group’s public sector customers are in high-priority areas. In Media & Broadcast, some procurement activity has been deferred in the last two years and public sector customers have been breaking up projects into smaller ones to spread out costs. Nevertheless, SCISYS now has a balanced portfolio, is expanding in the private sector and c 50% of group revenues are outside the UK. Further, SCISYS has a low-risk customer base and no bad debtors.

Valuation: Seeking to return margins to 8% within five years

The stock trades on 10.6x our earnings forecasts in FY16, falling to 9.4x in FY17 and to 9.1x in FY18. Based on our forecasts and a conservative weighted average cost of capital (WACC) of 11%, and a long-term margin target of 8%, our DCF model values the shares at 91p, or 38% above the current share price. In our view, this valuation is supported by the group’s strong record of cash generation, margin recovery potential, a healthy balance sheet, an increasingly diverse customer base and the potential for further value-enhancing acquisitions.

Company description: Leader in high-end ICT services

SCISYS is a leading developer of ICT solutions, e-business and advanced technology solutions. It operates in a broad range of market sectors including space, government & defence, environment and media & broadcast. In the UK the group operates through SCISYS UK (with offices in Bristol, Chippenham, Reading and Leicester and c 270 employees at end-2015). In Germany (with offices in Bochum and Darmstadt and c 180 employees) it operates through its wholly owned subsidiary SCISYS Deutschland GmbH (previously VCS), which was acquired in September 2007.

Customers: Major public and private enterprises

SCISYS has a long track record with a large number of blue-chip private companies and major public sector enterprises. This reflects the very high level of IT expertise and domain knowledge that SCISYS has in its target verticals. Importantly, SCISYS is advising and supporting these organisations with the implementation of their longer-term, strategic, core business process systems. Therefore, while lengthy sales cycles and programme delays are commonplace, these system investments are not discretionary. Customers include the MoD, Transport for London, Airbus Defence & Space, the European Space Agency, the BBC, Deutsche Welle, the Environment Agency, the Coal Authority and the RNLI. The recent acquisition of Xibis added a number of major UK retailers as customers, including Halfords and Interflora.

Exhibit 2: SCISYS revenue breakdown by sector and key customers

Source: SCISYS

Strategy: while the untypical problem project of FY15 has been a setback, the key elements of the group's strategy remain unchanged, with the focus on revenue growth and margin improvement. Additionally, the problem project has put an increased emphasis on the management and control of risk. Acquisitions remain on the agenda, although the depressed share price and limited financial resources are likely to limit the size of any deals in the near term.

We note that SCISYS has established strong operational and cost disciplines, which is reflected in the margin progression over the period of FY07-FY14, along with strong cash generation. The problem project of FY15 is likely a one-off. Management seeks to capitalise on this resilience to grow revenues both organically and through selective acquisitions. The plan is to expand the business into adjacent sectors and new regions, with a focus on Northern Europe, exploiting existing capabilities wherever possible, or via acquisitions as with Xibis.

The acquisition strategy is being led by Dr Klaus Meng, who has a 9.7% shareholding in SCISYS, and Steve Brignall, technical director. One area of interest is cyber security, which could have synergies with the defence segment (within ESD). Also, management is keen to add critical mass to the Media & Broadcast division and expand the offering beyond radio play out systems. The company can grow organically through transferring its public sector domain knowledge and IP (eg environmental regulations to private sector utilities, media to commercial radio and electronic architecture to the commercial sector). Management also seeks to drive operating margins higher, with an initial objective to return to FY14 levels of 8%+ within the next five years.

Final results: Poor H1 partly offset by strong H2

SCISYS remained profitable and generated positive free cash flow in FY15, in spite of the operational challenges and the weaker euro (the average rate fell 10% against sterling compared with FY14). Professional fees slipped by 8% over the year and group revenue fell by 11% to £36.1m (we had forecast £36.0m), though revenue would have been £2.5m higher at constant exchange rates. At contribution level, the three main divisions were all significantly weaker, with Enterprise Solutions & Defence (ESD) worst hit, nearly halving to £1.7m, which reflected the problem contract in the division. Central costs eased by 3% to £6.3m and adjusted operating profit fell 76% to £0.8m (we forecast £0.4m). Having reported a £1.2m loss in H1, the group recorded its strongest H2 ever, although this was partly explained by the conservative H1 provisioning that unwound in H2, after the problem project was resolved. SCISYS was also hit in H1 by the strength of sterling against the euro, which reduced H1 profits by £0.7m, but this has swung in the other direction in 2016. FY15 adjusted EPS tumbled by 84% to 1.3p (vs our forecast 0.9p loss) and the group ended the year with £1.0m of net debt, after making a final deferred payment of £0.8m for Xibis along with a small investment in ToMM Apps. While the interim dividend was suspended to conserve cash, the company has reinstated dividends with a final payment of 1.78p, which is 11% ahead of the previous year’s total payout. This reflects management’s optimism in the outlook, which is supported by the strength of the order book - boosted by a high level of activity in Q4, including two particularly large contracts.

The two significant contracts signed In Q4 were a £4m four-year contract to develop, support and host a business/regulatory application for the UK Ministry of Defence and a further contract from Thales Alenia Space France for the system extension and software enhancement in the Galileo Ground Mission Segment (GMS). The latter contract is carried out under a programme of the European Union, funded by the EU, and is worth c €5.2m over two years.

Exhibit 3: Professional fees

Professional fees (£000’s)

2008

2009

2010

2011

2012

2013

2014

2015

Space

10,685

11,312

11,566

15,319

12,481

15,732

14,531

12,898

ESD

13,041

14,704

14,560

13,163

13,088

12,168

10,753

9,920

M&B

6,671

6,584

7,147

8,443

7,651

7,568

7,149

6,179

Xibis

21

805

Total professional fees

30,397

32,600

33,273

36,925

33,220

35,468

32,454

29,802

As % total revenue

79.9%

78.1%

76.3%

87.3%

84.2%

83.3%

80.4%

82.5%

Other revenue

7,333

8,777

10,127

5,181

6,165

6,916

7,676

6,088

Other external revenue

326

343

191

170

68

214

229

216

Total revenue

38,056

41,720

43,591

42,276

39,453

42,598

40,359

36,106

Source: SCISYS

Space: revenues slipped 11% to £16.4m, while the contribution fell 18% to £3.3m (though it was steady at £4.0m on a constant currency basis), and the margin dipped 140bp to 20.0%. The division is most exposed to the movement of euro against sterling since almost all its revenues are euro denominated while the UK Space unit has costs in sterling. The division’s performance is underpinned by long-term programmes with customers including the European Space Agency (ESA) and the European satellite navigation system Galileo. Specific roles include at Galileo, where SCISYS’ Space division takes responsibility for a large proportion of the ground segment software, and at ESA where SCISYS experts are in charge of developing the rover visual localisation flight software for its rover mission to Mars. As in the past decades, operations support activities for ESA's Space Operations Centre in Darmstadt, Germany, have added a robust revenue stream. Working closely with its long-term partner Thales Alenia Space France, SCISYS recently secured another multi-year project worth more than €5m under a programme of the European Union to maintain and enhance the GMS, which is the heart of the Galileo satellite navigation system. SCISYS says that it is pursuing a variety of initiatives to complement its traditional revenue streams. The proprietary PLENITER product suite will serve the commercial space market better, and SCISYS's expertise in earth observation and robotics and autonomy will be taken to adjacent sectors. The unit benefits from healthy growth drivers underpinned by government funding, and has operations in Germany and the UK. The ESA’s budget rose from €3bn in 2008 to €5.3bn in 2016 for a CAGR of 7.3%, in spite of a challenging economic backdrop and tight public sector environments. Its 2016 budget has increased by an impressive 18% (see Exhibit 4) and the combined German and UK contribution rises by 7% to €1.2bn. This is good news for SCISYS, since ESA apportions work to its suppliers based on location, matching their country’s contribution to its overall budget.

Exhibit 4: European Space Agency’s budget continues to grow strongly

€m

2013

2014

2015

2016

Germany

772.7

765.7

797.4

872.6

UK

300

270

322.3

324.8

Germany + UK

1072.7

1035.7

1119.7

1197.4

(3.4%)

8.1%

6.9%

Other

3209.4

3066.4

3313.3

4052.6

Total budget

4282.1

4102.1

4433

5250

(4.2%)

8.1%

18.4%

Source: European Space Agency

Enterprise Solutions & Defence (ESD): in FY13, the group’s three UK-based, non-space divisions (Environment, Government & Defence and Application Support) merged to form this enlarged division. In FY15, revenues fell 10% to £12.2m, while the contribution tumbled 46% to £1.7m, providing a contribution margin of 14.3%. The significant issues around the single failed project overshadowed the strong underlying performance of the division. Resources were committed to working on the problem project and could not therefore be utilised on other profit-making opportunities. During H2 many of the long-term sales efforts of ESD – particularly in the defence, security and maritime sectors – came to fruition. A major contract was won under the Imagery Exploitation Programme (IEP), providing improved situational awareness and analysis for enhanced intelligence-gathering capabilities across the nation's armed forces. The team won a multi-year research programme with the Defence Science and Technology Laboratory (DSTL) to investigate an optimised future operations room in support of the Maritime Air Defence Command. Another multi-million pound project was secured with the UK Ministry of Defence (MoD) to deliver software and services to support defence supply chain operations and movements for the design and delivery of the Customs Compliance Management Information System (CCMIS) application and the provision of ongoing hosting and support services. A large framework contract has been agreed in the security sector that started to bear fruit late in 2015.

Media and broadcast: revenues dipped 21% (although just 9% in constant currencies) to £6.4m while the contribution fell by 19% to £2.0m, resulting in an 80bp higher margin. At constant currencies, the revenue decline was £0.9m in H1, but just £0.7m for the full year, suggesting that the division has turned the corner. To establish growth potential, sales activities progressed with the existing client base and potential customers in Germany, the UK and internationally. The award of the second exclusive, large-scale framework by the BBC was a major step in securing future revenues from its UK-based activities. The scope of SCISYS's dira! product was extended further, particularly around mobile computing capabilities and multimedia-based functionality. The Radio Digital Archive (RDA) project won under the BBC framework agreement partly relies on these new technologies and provides online search and retrieval functionality for archived content to journalists so that it can be reused quickly and easily in future programmes.

Xibis: revenues were £0.9m in its first full period, although this was below our forecast of £1.2m. The founder directors left the business shortly after acquisition, ahead of their scheduled departure dates, and a £0.8m deferred payment was paid based on the audited 2014 results (the subsequent earnout for 2015/16 was surrendered). New management was appointed from the team and in H2 the new team stabilised the business and returned the financial performance to planned levels, securing landmark contracts with new customers, and worked successfully with the group’s ESD division to win joint projects.

Exhibit 5: Contribution by division

Contribution (£,000's)

2008

2009

2010

2011

2012

2013

2014

2015

Space

2,932

1,877

1,348

3,635

3,007

3,974

3,980

3,283

Enterprise Solutions & Defence

1,823

3,912

4,255

2,529

3,522

3,972

3,203

1,745

Xibis

 

 

 

 

 

 

(13)

27

Media & Broadcast

1,635

1,809

2,734

3,259

2,980

2,395

2,481

2,011

Gross contribution

6,390

7,598

8,337

9,423

9,509

10,341

9,651

7,066

Central overheads (adjusted)*

(5,722)

(6,162)

(6,670)

(7,259)

(7,224)

(8,346)

(6,467)

(6,256)

Share-based payments

161

67

128

113

49

35

42

11

Exceptional items

28

173

341

88

328

1,191

135

0

Adjusted operating profit (loss)**

857

1,676

2,136

2,365

2,662

3,221

3,361

821

Source: SCISYS. Note: *Central overheads have been adjusted for exceptional items and share-based payments. **FY15 includes associates.

Cash flow: operating cash flow before taxes dipped by £3.2m to a £1.6m. We note that cash flow is subject to timing of cash receipts in the December/January period. After interest (£0.2m), tax (£0.6m) and capex (£0.6m), the free cash outflow was £0.2m. After acquisitions mainly relating to the final purchase price for Xibis (£0.9m) and dividend payments (£0.3m), the group swung from £0.3m net cash to a net debt position of £1.0m.

Outlook: the group's year-end order book rose 23% to £37.2m from £30.3m a year earlier, and there is a healthy pipeline of new business. SCISYS says that the positive outlook is supported by “encouraging major wins during the second half of 2015 and we expect significant opportunities to materialise during the first half 2016 across all our divisions; some of which have already materialised”.

Investment case: Returning the business to 8%+ margins

SCISYS is a specialist systems house with a focus on several verticals, including Space and Media & Broadcast. The group’s third division, ESD, covers a mix of public sector (including environment) defence, commercial and charity (essentially the group’s non-space UK business activities). The group has blue-chip clients, industry expertise and growing revenue visibility. The challenge is translating this opportunity into profitable growth. The group’s customers are large, competitors can be sizeable and the software requirements are often complex and expensive. Therefore, winning business is a challenge (on average, sales cycles are six to 18 months), but equally once the customers have signed up, there are often significant opportunities to win additional projects. We estimate that across the group over 80% of revenues come from existing customers which, together with the long-term contract profile of many of the deals, highlights the ‘visibility’ in the business.

Exhibit 6: SCISYS revenues (£m) and operating profit margin (%)

Source: Company accounts, Edison Investment Research forecasts

We continue to forecast moderate near-term revenue growth, although this could prove conservative if management can successfully exploit its strengths in its key areas such as Space and Defence, while also expanding the business outside the public sector. As we highlight in Exhibit 6, a recovery and ultimately a resumption of the 2008-14 margin expansion should be a major driver of earnings and valuation in the medium term. We believe there are a number of factors that will contribute to our current assumption of operating margin recovery to 7.2% by FY17, and potentially towards double digits in the longer term.

Pricing and project management: management has increasingly been focused on ‘value pricing’ (charging for core software, pricing based on customer ROI, etc) and far greater project management skills within the organisation.

‘Reusability’ of platform software: while core third-party software platforms are consistent across many projects (ie use of Oracle, Microsoft etc), nearly all customer solutions are bespoke to their requirements. However, in many cases in specialised industry verticals (eg media, military, trading exchanges), SCISYS has developed key software IP. Management has focused project teams not only on efficient ‘reuse’ of this IP, but also increasingly on charging customers for the value of using it (ie 100% gross margin licences).

Workforce profile and rationalisation: in a consulting business like SCISYS, human resources will always be the major cost, typically expensive and difficult to manage in a flexible way (ie management teams in the sector often do not like to cut consultants in a quiet period as they can be very difficult to hire back when business picks up). However, there are a number of opportunities for SCISYS to restructure its workforce in the medium term, not only in terms of cultural focus on profitability, but also through the more efficient use of experienced consultants (eg high-level consulting and mentoring), while developing the junior cohort under them.

Improved group structure and succession planning: in FY07 the group suffered from a lack of communication between project managers and management, and employees were often promoted without having the appropriate skills. Layers of management have been removed and the group has been investing in an improved career development strategy, as well as providing more appropriate succession planning. The senior management structure has been reorganised to operate through an executive board.

Smarter bidding: because of the nature of the target markets, bids are lengthy and therefore costly. We conservatively estimate that ‘lost’ bids probably affect the P&L by c £0.2m a year. This is partly unavoidable. However, management is now far more selective about the bids for which it tenders (ie typically high-value, high chance of winning).

Competition: in some areas of the business, such as media, the competitors are small and specialist (eg Dalet, GlobeCast, Jutel, David). However, many large enterprise and public sector projects require a wide range of hardware and software integration. Therefore, in many cases the major consultants are on the shortlist (Deloitte, Capgemini etc), as are the major electronics suppliers (IBM, Fujitsu etc). While these players have massive balance sheet strength and pricing power compared with SCISYS, they often lack the very specialist know-how and IP in specific industry verticals. Therefore, as customers recognise the need to outsource to an ‘IT expert’, we believe SCISYS can continue to take market share.

Financials: Consultancy, development and support

Business model: IT consultancy, software development and support

The business model has predominantly been fixed-price and managed budget projects with a reasonable proportion of cost plus work. Importantly, the group is increasingly able to price on a ‘value proposition’ basis (charging for its IP and software), as well as improving the focus on contract project management. Every project is different and the group therefore has the expertise (and the cost and project management required) to customise its approach for each customer assignment. SCISYS’s offering can be very simply split into three stages:

Consultancy: this includes fairly traditional business case development, programme and project management, business process analysis, IT architecture review and strategy, procurement management, solution architecture, business change etc. The consultancy process focuses on maximising business benefits matched with value for money. This therefore means that when scoping a project specification, SCISYS will often recommend ‘off-the-shelf’ and ‘open source’ software alongside its own bespoke designs.

Implementation: the challenge then is to seamlessly integrate the software into a platform solution for the customer. Many of the group’s complex projects take many months in the design stage and often even longer to implement on customer sites (as customers often ‘roll-out’ a new software platform in stages across multiple sites). Clearly, there is a significant overlap in personnel and in-house expertise on the consultancy and implementation teams. When pricing the implementation of projects, the group is moving towards a more total value-based approach. In some cases this involves charging customers (by the ‘user’) for software licences.

Support: SCISYS has grown its ongoing support function quickly over the last few years. As well as SCISYS projects, the team increasingly supports third-party software sitting on customers’ premises (in many cases these are older software solutions where there is little support from the developer, but SCISYS has the in-house experience to help). There are a number of pricing models for the support function but, in line with typical IT services companies, we estimate this activity has the highest underlying gross margin.

Forecasts: EPS edges up on lower than expected share count

Despite a healthy order book, there remain uncertainties. Hence, we have broadly maintained our forecasts, although we have tweaked the divisions, and EPS edges up on lower share count. The euro has risen 10% against sterling since the end of FY15, which helps to underpin our forecasts, although considerable uncertainties remain relating to the EU referendum on 23 June. Nevertheless, with a strong order book and pipeline, we believe the group is on course to resume margin progression.

Exhibit 7: Forecast changes

Revenue (£m)

Adjusted operating profit (£m)

EPS (p)

Old

New

Change (%)

Old

New

Change (%)

Old

New

Change (%)

2015

36.0

36.1

0

0.4

0.8

122

(0.9)

1.3

N/A

2016e

38.0

38.0

0

2.5

2.5

0

6.1

6.2

2

2017e

39.9

39.9

0

2.9

2.9

0

6.9

7.0

2

2018e

41.0

0

3.0

0

7.2

0

Source: Edison Investment Research

Our key forecast assumptions are as follows:

Revenues: we assume group revenues rise 5.3% to £38.0m in FY16, then rise by 4.9% to £39.9 in FY17. We assume ESD stabilises in FY15, as the recent problematic projects have now been resolved, and its higher-risk exposures to the UK public sector are now greatly reduced (eg the Environment Agency). We have assumed £1.2m of revenues from Xibis in FY16, representing 3% of total revenues. We note that revenues can be influenced significantly by low-margin hardware sales (as well as subcontracting in the Space division), which can be difficult to predict. However, management is de-emphasising these low-margin revenues.

Operating costs/margins: roughly 60% of costs are staff costs, including c £4m of annual research and development, which is largely customer-financed, although there is some direct R&D in Media & Broadcast relating to dira!, as well as a small amount in the mobile apps business. We assume operating costs rise by 0.6% to £35.5m in FY16 and by 4.2% to £37.0m in FY17. Consequently, our operating margin forecasts are at 6.6% and 7.2% in FY16 and FY17.

Investment: we forecast a capex/sales ratio of 2.0%, to support management’s plans to grow the business. We assume annual working capital outflows of 0.5% of sales.

Tax: we have maintained our assumptions to 21% in FY16 and 22% thereafter. We understand SCISYS claims R&D tax credits of c £0.4-0.5m a year, which offsets UK taxable profits, while it pays c 30% on German profits. Further, it has c £4-5m of brought-forward UK tax losses.

Exhibit 8: Forecasts

 

2013

2014

2015

2016e

2017e

2018e

Revenues (£'000s)

 

 

 

 

 

 

Space

19,787

18,559

16,432

16,477

16,953

17,425

Enterprise Solutions & Defence

14,453

13,483

12,202

13,026

13,996

14,386

Xibis

 

29

901

1,200

1,400

1,439

Media & Broadcast

8,144

8,059

6,355

6,951

7,151

7,350

Central

214

229

216

350

360

370

Group revenue

42,598

40,359

36,106

38,004

39,860

40,970

Growth (%)

8.0

(5.3)

(10.5)

5.3

4.9

2.8

Administrative expenses

(39,377)

(36,998)

(35,288)

(35,502)

(36,989)

(37,980)

Adjusted operating profit

3,221

3,361

818

2,502

2,871

2,990

Operating margin (%)

7.6

8.3

2.3

6.6

7.2

7.3

Growth (%)

21.0

4.3

(75.7)

205.8

14.8

4.1

Net interest

(217)

(177)

(196)

(210)

(190)

(170)

Associates

0

0

3

0

0

0

Profit before tax norm

3,004

3,184

625

2,292

2,681

2,820

Adjusted EPS (p)

9.3

8.2

1.3

6.2

7.0

7.2

P/E - Adjusted EPS

7.1

8.0

49.9

10.6

9.4

9.1

Source: SCISYS, Edison Investment Research.

Sensitivities: Public sector, fixed-price projects

The UK government’s commitment to reduce public sector spending has put pressure on some of the group’s customers. Following the government’s spending review in 2010, Defra, which includes the Environment Agency (one of SCISYS’s main customers), had its budget cut by 30%. While the outlook remains uncertain, the public sector spending cuts have been included in our forecasts and SCISYS is seeking to broaden the offering to the private sector. In our view, SCISYS has a balanced portfolio, with many of the group’s public sector contracts in key priority areas (eg the Warrior upgrade programme and Media Broadcast – BBC). Roughly half of group revenues are from core Europe (mainly Germany), which mitigates the exposure to the UK public sector, and the group continues to hedge its near-term exposure to the euro. There is a risk of cost overruns on fixed-price projects, as we saw in 2015, but SCISYS has put in place rigorous risk monitoring and control procedures and, following the FY15 problem project, SCISYS has tightened the criteria for which bids need the board’s sign-off. In all, we view SCISYS as a relatively robust business with a low-risk customer base, and we note the group has no bad debtors.

Valuation: A play on growth and margin expansion

SCISYS has developed a strong niche as an expert player in highly specialised IT markets. As these markets continue to gain in complexity, SCISYS should, in our view, benefit from an improving negotiating position. Several factors should help the group to continue to expand margins, including the reuse of bespoke software platforms, better project management and a continuing de-emphasis on third-party software and hardware resales. Further, albeit for the impact of the problem project of FY15, the management has built an excellent track record in driving margins higher and has an objective to return margins to 8% within five years. The peer group’s mid-cycle margins have traditionally been in the 8-10%+ range, while its larger IT services competitors typically trade on around 14x year two earnings with operating margins at around 12%. We highlight the following points on the group’s valuation:

Traditional valuation measures: in traditional P/E valuation terms, the stock trades on 10.6x our forecasts in FY16, falling to 9.4x in FY17 and to 9.1x in FY18.

Peer comparison: comparison with fellow IT services businesses is difficult, given the different business mixes, partly relating to low-margin reselling of hardware. However, the stock trades at a significant discount to the average of its UK peers in Exhibit 9 (noting considerable dispersion), as well as its North American and Europe-based large caps.

Exhibit 9: Peer comparison

Share

Market cap

EV/sales

EV/EBITDA

P/E

price

local currency

Year 1

Year 2

Year 1

Year 2

Year 1

Year 2

SCISYS

66

19.5

0.52

0.50

6.0

5.3

10.6

9.4

1) IT services companies quoted on LSE and AIM (£m)

Computacenter

840

1031

0.29

0.28

7.4

7.0

15.7

14.7

FDM

575

618

3.61

3.26

17.0

15.4

24.4

22.0

IS Solutions

147.5

54

2.95

2.67

14.6

12.4

19.4

16.6

K3 Technology

335

107

1.36

1.33

8.9

8.3

14.0

12.8

Redcentric

185

270

2.64

2.40

11.3

10.2

18.7

16.4

Medians

2.64

2.40

11.3

10.2

18.7

16.4

2) Large cap IT services companies (local currency m)

Accenture

114.49

74168

2.20

2.07

13.1

12.2

21.4

19.7

Atos

71.53

7409

0.60

0.59

5.2

4.9

10.6

9.7

Capgemini

81.14

13971

1.24

1.19

9.3

8.7

15.7

14.1

CGI group

63.08

19549

1.97

1.91

10.4

10.0

18.0

16.7

CSC

33.27

4593

0.76

0.75

4.7

4.2

13.3

12.0

Medians

1.24

1.19

9.3

8.7

15.7

14.1

Source: SCISYS, Bloomberg. Note: Prices as at 5 April 2016.

Cash generation: the group generated free cash flow of £13.1m over the last 10 years. Based on our forecasts, the FCF yields for FY16-18 are c 9%, c 11% and c 11% respectively. We note the strong balance sheet (£4.4m cash and £5.3m debts, unutilised working capital facilities of £3.6m, while the Chippenham freehold and other smaller properties provide extra flexibility).

Discounted cash flow valuation: based on our conservative forecasts (which include 3.0% compound annual revenue growth over the next 10 years, a 8% long-term margin target and 2% terminal growth rate) and a weighted average cost of capital (WACC) of 11%, our DCF model values the shares at 91p, or 38% above the current share price. Discounting back from our forecasts, the market is attributing a break-even WACC of 13.9% to the stock. The 11% WACC assumption is conservative in the current ultra-low interest rate environment, and we note a 1% cut to 10% would lift the valuation to 121p.

Exhibit 10: Cash flow

£000’s

FY09

FY10

FY11

FY12

FY13

FY14

FY15

FY16e

FY17e

FY18e

Adjusted operating profit

1,676

2,136

2,365

2,662

3,221

3,361

818

2,502

2,871

2,990

Depreciation

662

626

769

919

958

795

730

790

823

843

EBITDA

2,338

2,762

3,134

3,581

4,179

4,156

1,548

3,292

3,695

3,833

Working capital

446

1,563

(302)

1,902

(4,367)

753

22

(190)

(199)

(205)

Exceptional items/misc

(170)

(341)

(88)

(373)

(1,191)

(135)

0

0

0

0

Operating cash flow

2,614

3,984

2,744

5,110

(1,379)

4,774

1,570

3,102

3,496

3,629

Net interest

(69)

(91)

(158)

(214)

(217)

(177)

(196)

(210)

(190)

(170)

Tax paid

(355)

(356)

(951)

(157)

(1,325)

100

(583)

(341)

(413)

(536)

Purchase of tang assets

(681)

(663)

(987)

(1,116)

(666)

(618)

(619)

(760)

(797)

(819)

Free cash flow

1,509

2,874

648

3,623

(3,587)

4,079

172

1,791

2,096

2,103

Source: SCISYS, Edison Investment Research. Note: FY11 is before the purchase of the Chippenham HQ

Exhibit 11: Financial summary

£'000s

2013

2014

2015

2016e

2017e

2018e

Year end 31 December

IFRS

IFRS

IFRS

IFRS

IFRS

IFRS

PROFIT & LOSS

Revenue

 

 

42,598

40,359

36,106

38,004

39,860

40,970

Cost of Sales

0

0

0

0

0

0

Gross Profit

42,598

40,359

36,106

38,004

39,860

40,970

EBITDA

 

 

4,179

4,156

1,548

3,292

3,695

3,833

Adjusted operating profit

 

 

3,221

3,361

818

2,502

2,871

2,990

Amort'n of acq'd intangibles

(283)

0

0

0

0

0

Exceptionals

(1,191)

(135)

0

0

0

0

Share based payments

(35)

(42)

(11)

(50)

(50)

(50)

Operating Profit

1,712

3,184

807

2,452

2,821

2,940

Net Interest

(217)

(177)

(196)

(210)

(190)

(170)

Associates

0

0

3

0

0

0

Profit Before Tax (norm)

 

 

3,004

3,184

625

2,292

2,681

2,820

Profit Before Tax (FRS 3)

 

 

1,495

3,007

614

2,242

2,631

2,770

Tax

(153)

(766)

(241)

(471)

(579)

(609)

Profit After Tax (norm)

2,701

2,394

381

1,821

2,102

2,210

Profit After Tax (FRS 3)

1,342

2,241

373

1,771

2,052

2,160

Average Number of Shares Outstanding (m)

29.0

29.0

29.0

29.3

29.9

30.5

EPS - normalised (p)

 

 

9.3

8.2

1.3

6.2

7.0

7.2

EPS - FRS 3 (p)

 

 

4.6

7.7

1.3

6.0

6.9

7.1

Dividend per share (p)

1.46

1.61

1.78

1.90

2.10

2.30

Gross Margin (%)

100.0

100.0

100.0

100.0

100.0

100.0

EBITDA Margin (%)

9.8

10.3

4.3

8.7

9.3

9.4

Operating Margin (%)

7.6

8.3

2.3

6.6

7.2

7.3

BALANCE SHEET

Fixed Assets

 

 

16,164

17,155

16,553

16,523

16,497

16,473

Intangible Assets

7,006

8,233

7,831

7,831

7,831

7,831

Tangible Assets

9,137

8,899

8,635

8,605

8,579

8,555

Deferred tax asset & associates

21

23

87

87

87

87

Current Assets

 

 

19,270

18,886

17,839

19,320

21,052

22,462

Stocks

344

325

211

222

233

239

Debtors

13,829

12,334

12,299

12,957

13,600

13,990

Cash

3,969

5,798

4,352

5,165

6,242

7,256

Current Liabilities

 

 

(12,261)

(10,561)

(12,003)

(12,291)

(12,555)

(12,532)

Creditors

(9,508)

(9,686)

(8,699)

(9,237)

(9,751)

(9,978)

Short term borrowings

(2,753)

(875)

(3,304)

(3,054)

(2,804)

(2,554)

Long Term Liabilities

 

 

(4,090)

(5,023)

(2,333)

(2,122)

(1,911)

(1,700)

Long term borrowings

(3,888)

(4,595)

(2,007)

(1,796)

(1,585)

(1,374)

Other long term liabilities

(202)

(428)

(326)

(326)

(326)

(326)

Net Assets

 

 

19,083

20,457

20,056

21,430

23,083

24,703

CASH FLOW

Operating Cash Flow

 

 

(1,379)

4,774

1,570

3,102

3,496

3,629

Net Interest

(217)

(177)

(196)

(210)

(190)

(170)

Tax

(1,325)

100

(583)

(341)

(413)

(536)

Capex

(666)

(618)

(619)

(760)

(797)

(819)

Acquisitions/disposals

0

(358)

(889)

0

0

0

Financing

(16)

(61)

(14)

0

0

0

Dividends

(381)

(435)

(340)

(517)

(557)

(628)

Net Cash Flow

(3,984)

3,225

(1,071)

1,274

1,539

1,475

Opening net debt/(cash)

 

 

(1,241)

2,672

(328)

959

(315)

(1,853)

HP finance leases initiated

0

0

0

0

0

0

Other

71

(225)

(216)

0

0

(0)

Closing net debt/(cash)

 

 

2,672

(328)

959

(315)

(1,853)

(3,328)

Source: SCISYS accounts, Edison Investment Research

Contact details

Revenue by geography

Methuen Park
Chippenham, Wiltshire,
SN14 0GB
UK
01249 466 466
www.scisys.co.uk

Contact details

Methuen Park
Chippenham, Wiltshire,
SN14 0GB
UK
01249 466 466
www.scisys.co.uk

Revenue by geography

Management team

Chief executive officer: Klaus Heidrich

Finance director: Chris Cheetham

Klaus joined the executive board in 2009, became COO in January 2012 and CEO in January 2014. He joined VCS (now SCISYS Deutschland) in 1989 as a sales engineer. From 1992 he was responsible for marketing & sales of VCS and developed VCS media activities. He left VCS for Management Data AG in Hamburg, but returned to VCS a year later to take responsibility for strategic business development. From 2005 until January 2012 he was a director of the Media Broadcasting Solutions business unit.

Chris qualified as a chartered accountant with Ernst & Young in 1990 and worked in the corporate finance department until 1996. He has extensive experience gained from working as financial director and company secretary in the software industry for the last nine years. He was appointed financial director on 1 January 2007.

Non-executive chairman: Mike Love

Non-executive deputy chairman: David Jones

Mike was CEO of SCISYS (formerly CODASciSys) from 1986 (when he led the management buy-in of the business) until 2003, when he became non-executive chairman. He stepped back in as executive chairman in late 2007 and returned to a non-executive role in January 2012. Mike entered the software industry in 1976 with Logica, moved to the European Space Agency in the late 1970s and joined SCISYS in 1981.

David joined the board as a non-executive director in 2002 and took an executive role in 2007 when he became operations director for the government division. He was promoted to COO in January 2010, CEO in January 2012 and deputy chairman in January 2014. His earlier career includes some 20 years at Admiral and Allied Worldwide, and he was a founding member of the DRA Software Engineering Centre Advisory Board.

Management team

Chief executive officer: Klaus Heidrich

Klaus joined the executive board in 2009, became COO in January 2012 and CEO in January 2014. He joined VCS (now SCISYS Deutschland) in 1989 as a sales engineer. From 1992 he was responsible for marketing & sales of VCS and developed VCS media activities. He left VCS for Management Data AG in Hamburg, but returned to VCS a year later to take responsibility for strategic business development. From 2005 until January 2012 he was a director of the Media Broadcasting Solutions business unit.

Finance director: Chris Cheetham

Chris qualified as a chartered accountant with Ernst & Young in 1990 and worked in the corporate finance department until 1996. He has extensive experience gained from working as financial director and company secretary in the software industry for the last nine years. He was appointed financial director on 1 January 2007.

Non-executive chairman: Mike Love

Mike was CEO of SCISYS (formerly CODASciSys) from 1986 (when he led the management buy-in of the business) until 2003, when he became non-executive chairman. He stepped back in as executive chairman in late 2007 and returned to a non-executive role in January 2012. Mike entered the software industry in 1976 with Logica, moved to the European Space Agency in the late 1970s and joined SCISYS in 1981.

Non-executive deputy chairman: David Jones

David joined the board as a non-executive director in 2002 and took an executive role in 2007 when he became operations director for the government division. He was promoted to COO in January 2010, CEO in January 2012 and deputy chairman in January 2014. His earlier career includes some 20 years at Admiral and Allied Worldwide, and he was a founding member of the DRA Software Engineering Centre Advisory Board.

Principal shareholders

(%)

Dr Mike Love

14.68

Dr Klaus-Gunter Meng

9.72

Downing

8.8

Herald Investment Management

8.26

Rowan Dartington & Co

6.06

Hargreaves Landsdown Asset Management

5.23

Alto Invest

5.20

Companies named in this report

Accenture (ACN), Atos (ATO), Cap Gemini (CAP), CGI Group (GIB.A), Computacenter (CCC), CSC (CSC) , IS Solutions (ISL), K3 Technology (KBT)

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Frankfurt +49 (0)69 78 8076 960

Schumannstrasse 34b

60325 Frankfurt

Germany

London +44 (0)20 3077 5700

280 High Holborn

London, WC1V 7EE

United Kingdom

New York +1 646 653 7026

245 Park Avenue, 39th Floor

10167, New York

US

Sydney +61 (0)2 9258 1161

Level 25, Aurora Place

88 Phillip St, Sydney

NSW 2000, Australia

Wellington +64 (0)48 948 555

Level 15, 171 Featherston St

Wellington 6011

New Zealand

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