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7digital Group — Ready to rock ’n’ roll

7digital Group — Ready to rock ’n’ roll

7digtal has now reported its FY17 results, which show a strong uplift in revenues, reflecting the 24-7 acquisition, and a greatly reduced EBITDA loss. The publication of the results was delayed in order to conduct a thorough review by new auditors, resulting in a significant strengthening in reporting procedures and systems, and a restatement of historical figures. The rapidly shifting streaming market gives the group significant B2B opportunities, with music a key element of customer engagement for retailers, connected devices and mobile network operators.

Fiona Orford-Williams

Written by

Fiona Orford-Williams

Director, TMT

7digital Group

Ready to rock ’n' roll

FY17 results

Software & comp services

16 August 2018

Price

4.5p

Market cap

£18m

Net cash (£m) at 31 December 2017

7.0

Shares in issue

399.6m

Free float

84%

Code

7DIG

Primary exchange

AIM

Secondary exchange

N/A

Share price performance

%

1m

3m

12m

Abs

0.0

(7.1)

(33.8)

Rel (local)

2.2

(4.5)

(35.0)

52-week high/low

7.0p

3.9p

Business description

7digital Group provides an end-to-end, white-label digital music platform and access to global music rights that enable its clients, which include businesses in the radio, electronics, social media and telecoms industries around the world, to offer music streaming and download services to their own customers. Its global customer base includes musical.ly, Onkyo, Panasonic, MediaMarktSaturn, Cdiscount, Electric Jukebox, eMusic and i.am +.

Next event

H118 results

September 2018

Analysts

Fiona Orford-Williams

+44 (0)20 3077 5739

Neil Shah

+44 (0)20 3077 5715

7digital Group is a research client of Edison Investment Research Limited

7digtal has now reported its FY17 results, which show a strong uplift in revenues, reflecting the 24-7 acquisition, and a greatly reduced EBITDA loss. The publication of the results was delayed in order to conduct a thorough review by new auditors, resulting in a significant strengthening in reporting procedures and systems, and a restatement of historical figures. The rapidly shifting streaming market gives the group significant B2B opportunities, with music a key element of customer engagement for retailers, connected devices and mobile network operators.

Year end

Revenue (£m)

EBITDA (£m)

PBT*
(£m)

EPS*
(p)

DPS
(p)

EV/ EBITDA
(x)

PE
(%)

12/16^^

11.2

(4.3)

(5.6)

(4.9)

0.0

N/A

N/A

12/17^^

16.8

(1.6)

(3.8)

(2.3)

0.0

N/A

N/A

12/18e

21.8

2.4

0.0

0.0

0.0

4.2

N/A

12/19e

26.5

6.5

3.4

0.8

0.0

1.5

5.7

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

FY17 – results reflect MMS acquisition

FY17 revenues, up 50%, reflect the May 2017 acquisition of its largest competitor, 24-7, from MMS. Revenues from MediaMarktSaturn (MMS, now 7digital’s largest customer) underlie the 74% increase in high margin licence revenue. This resulting gross margin improvement has enabled the group to narrow its EBITDA loss significantly, ahead of our previous forecast. Over FY17, 7digital carried out a major project to integrate the three tech platforms (its own, Snowite and 24-7’s Juke), with FY17 capex of £4.7m. This will improve its ability to offer clients ‘Platform-as-a-Service’. Year-end net cash, bolstered by the December 2017 capital raise, was £7.0m. The previous CFO, Matt Honey, has resigned and David Holmwood (previously financial controller at Universal Music) has been serving as CFO on an interim basis. He and other candidates for the permanent role are currently being considered.

Outlook – ingredients for success

FY17 was a transformative year: the 24-7 acquisition added scale, enabling the group to move towards EBITDA profitability, and the December 2017 capital raise provided ample funds to see the group to cash flow (and operating profit) break-even, targeted for H218e. The group has continued to add reference clients across a range of industry verticals, cementing its position as the leading B2B end-to-end music platform provider. With its ‘ducks in a row’, we expect FY18e and FY19e to show good progress. H118 sales are indicated at £9.3m, up 57% and management points to a strong pipeline and increasing momentum across the business.

Valuation: Positioned for growth

On a FY19e P/E of 5.7x based on our revised forecasts, 7digital trades at a considerable discount to software peers (UK sector, excluding outliers, on 24x). With the platform, reference clients and balance sheet structure now more secure, and with a significant amount of operational leverage in the business, we expect the group to move to a growth rating.

FY17 results reflect acquisition and integration of MMS

Strong investment case intact

■

FY17 was a transformative year for the group, which in acquiring its largest European competitor (24-7, bought from MMS), gained both scale and reach across Europe. While the cost of integrating the platforms exceeded our expectations, we understand that the bulk of this work is now complete and the platform is more robustly positioned to support the scaling of the client base.

■

The group has been reporting a steady trickle of new reference clients across a range of sectors, which, while fairly small in terms of revenue contribution, support the investment case that there remains an untapped market for streamed music services for the casual listener – beyond the current three dominant global platforms (Spotify, Amazon and Apple Music) that will be served by a range of business models.

■

We forecast FY19e to be the first year of operating profitability for the group and, despite capital expenditure remaining elevated, we expect net cash flow break-even in H218.

■

While the December 2017 capital raise was significantly dilutive in terms of EPS, the group has a greater degree of balance sheet flexibility.

■

The bulk of revenues are now from high-margin licence sales and we see scope for EBITDA margins to increase rapidly from the 11% forecast in FY18 to 25% in FY19.

Thorough audit and restatements

7digital appointed a new auditor, BDO, in January 2018. In the course of its appraisals, BDO discovered some weaknesses in the internal reporting. This triggered an exhaustive review of system and accounting practices within the group. The review also led to a number of corrections in prior year accounts, mostly relating to the accounting relating to acquisitions.

■

For FY15, cost of sales accruals at the year-end relating to content revenues has been reduced by £773k.

■

For FY16, a number of adjustments have been made to the balance sheet treatment of the Snowite acquisition. £546k, previously apportioned to goodwill, has now been reclassified as a bespoke application intangible asset, increasing amortisation by £137k for the year. A shareholder put option has also been brought on balance sheet (+£114k of liability) and £109k of revenue under accrued has been added back. In addition, £551k of FX gains were incorrectly recognised as revenue and a further £241k of revenue was mis-stated. Other adjustments relate to third-party work being moved from WIP to other debtors, patents being reclassified as intangible assets from current assets, liabilities within Snowite that had been presented as loans being reclassified as trade and other payables, and errors in the calculation of share-based payments.

■

The auditors have qualified the accounts on a material uncertainty over the going concern basis on a technical issue regarding a short-term funding to cover restructuring payments. Two of the group’s largest shareholders have committed to cover this eventuality. Only letters of intent had been issued at the time of the audit sign-off, hence the note of caution. Management’s view is that if the timing of the firm commitment had been sooner, the auditors would not have made this qualification.

While the detailed audit process has undoubtedly been painful (and painstaking) for those involved, investor confidence in the published figures should be greatly enhanced. A permanent appointment to the post of CFO will further enhance the group’s financial credibility.

EBITDA loss much reduced

In its final audited results, revenues have been reported of £16.8m, slightly lower than those pre-announced in February (£17.3m), as revenue previously booked to FY17 has been shifted out to FY18 under the IFRS15 definitions. The EBITDA loss of £1.6m compares to a previously announced figure of £1.0m.

We had previously updated our FY17 figures for both the December 2017 £8.5m equity issue and these preliminary figures. However, given that the final results differ from these preliminary numbers, in terms of looking at the operational performance of the group, we believe it more relevant to compare to our previous forecast (published in September).

7digital’s results were a little better than our forecast for an EBITDA loss of £1.7m and a substantial improvement on FY16’s £4.3m loss (restated). This outperformance came despite the small shortfall in revenues indicated above.

Operational progress largely reflects the MMS deal

The 50% increase in revenues in FY17 was largely due to the acquisition of 24-7 from MMS effective May 2017. As part of this transaction, 7digital not only acquired 24-7’s roster of clients (the largest of which are Juke and Danish telco TDC), but also agreed additional project work for MMS. Together, this underlies £18m of contracted revenues over the next three years. MMS generated £7.0m of revenue in FY17, but £2.0m of this relates to one-off revenues. Although these were paid in advance, under IFRS 15 they will be recognised in H118.

High-margin licensing revenues increased by 74% to £11.6m, with the monthly recurring element of this licensing revenue increasing by 71% to £8.4m. Total exit monthly recurring revenues (MRR) increased by 23% as at the year-end, largely driven by this transaction and a steady underlying increase in MRR from the other clients where it has a good spread of reference clients across key industry verticals. For instance, during the year (and subsequently) it has announced deals with, for instance, SoundHound (voice-enabled connected devices), Global Eagle Entertainment (in-flight entertainment) and DTS (automotive audio), as well as expanding its relationship with social media app musical.ly.

The Creative division (12% of sales) delivered another year of good revenue growth at 6%. During FY17, it retained key broadcast clients such as the BBC’s Pick of the Pops, The Folk Show and The Golden Hour, and also added new clients including Amazon (news bulletin productions) and BBC iPlayer (video documentary), as well as benefiting from a wider network of clients across the group. Within the Content division (19% of group revenues), direct-to-consumer downloads continue to weaken, but this was more than offset by higher-margin, one-off projects for music labels and the continuing shift to high-res formats. Revenues were up by 21%, a result much better than we had anticipated.

With 69% of FY17 revenues derived from licence sales (FY16: 60%), gross margins increased to 72% from 69%, underpinning a 55% increase in gross profits. This margin increase and delivery of a cost-saving programme meant that with the absorption of the cost base of 24-7 from May 2017, operational expenses increased by only £3.7m for the year, enabling the group to deliver a small EBITDA profit in H217.

Exhibit 1: Summary results

Revenues

FY16

FY17

change

FY17
(Nov 2017 Edison forecast)

Variance to forecast
(£000s)

FY18e (new)

FY19e (new)

License sales

6,679

11,616

74%

14,721

(3,105)

16,838

21,635

Content

2,625

3,167

21%

1,845

1,322

2,692

2,423

Creative

1,912

2,018

6%

2,294

(276)

2,220

2,442

Other

0

0

250

(250)

0

0

Total revenues

11,216

16,801

50%

19,110

(2,309)

21,750

26,500

Revenue growth

7.9%

49.8%

29.5%

21.8%

Gross profit:

Licensing

6,167

9,436

53%

13,249

(3,813)

15,491

20,121

Content

798

1,939

143%

203

1,736

135

242

Creative

805

660

-18%

1,147

(487)

799

928

Total gross profit

7,770

12,035

55%

14,849

(2,814)

16,425

21,291

Gross margin

69.3%

71.6%

77.7%

75.5%

80.3%

Operating expenses

(12,080)

(13,643)

13%

(16,596)

2,953

(14,025)

(14,760)

EBITDA

(4,310)

(1,608)

-63%

(1,747)

139

2,400

6,530

EBITDA margin

N/A

N/A

11.0%

24.6%

Normalised EBITA

(5,603)

(3,761)

-33%

(2,875)

(886)

(25)

3,345

Normalised PBT

(5,616)

(3,816)

-32%

(2,875)

(941)

0

3,358

Reported PBT

(5,475)

(5,026)

-8%

(4,267)

(759)

(1,100)

3,358

Source: 7digital – historics, Edison - forecasts

Outlook – on track for profits and positive cash flow in H218

FY17 was largely about the acquisition and integration of 24-7, and the on-boarding of reference clients across strategic verticals. In FY18, management will focus on the relaunch of the Juke services on the 7digital platform across 15 territories (as these services come online, we would expect to see a commensurate pick up in MRR, as well as converting larger clients in its target verticals . Negotiations with companies in the retail and telecoms sector in North America looking promising for H218.

Management has reiterated its guidance that, given a strong pipeline and the increased momentum it is seeing, it is on track to reach operational profitability in H218, and to become net cash-flow positive in the same accounting period.

Forecast changes; lower FY18 EBITDA, higher FY19

We update forecasts for the FY17 reported results, changes in accounting, higher level of capital expenditure and associated amortisation in future periods.

At the operating level, this results in a decrease in our forecast EBITDA in FY18e from £3.0m to £2.4m (11% EBITDA margin), although a higher amortisation charge means that we reduce our normalised EBITA forecast from £2.1m to breakeven. With the bulk of the integration work now done, we forecast the level of capital expenditure to decrease from the £4.7m reported in FY17 (28% revenues) to £3.5m in FY18 and £2.5m in FY19. For FY19e, we are now expecting EBITDA of £6.5m, reflecting the improving gross margin from the change in mix and the limited rise in operating expenses as the cost of merging the platforms falls away and the synergistic benefits start to come through. We currently model a 25% EBITDA margin for FY19e. Overall, these changes mean that, provided working capital continues to be managed tightly, the group should be cash-generative from H218. We forecast a year-end net cash position of £3.3m.

Exhibit 2: Summary forecast changes

£000s

FY18e
Old

FY18e
New

Change

FY19e
Old

FY19e
New

Change

Revenues

24,856

21,750

-12.5%

27,587

26,500

-3.9%

EBITDA

2,965

2,400

-19.0%

4,646

6,530

40.6%

Normalised operating profit

2,145

(25)

N/A

3,762

3,345

-11.1%

Reported operating profit

493

(1,125)

N/A

3,762

3,345

-11.1%

Normalised PBT

2,130

0

N/A

3,762

3,358

-10.8%

Reported PBT

478

(1,100)

N/A

3,762

3,358

-10.8%

Normalised net income

2,130

0

N/A

3,386

3,022

-10.8%

Source: Edison

Valuation and investment case

The revised expectations mean that FY19 should be the first forecast year of profitability since the strategy shift in 2015. The shares are trading at a PE multiple of 5.7x for that year, with reverse DCF implying that negligible revenue or margin growth is being factored in.

We believe the investment case for 7digital remains compelling and that it should be on a growth rating; 10% annual revenue growth FY10–25 with EBITDA margins reaching 25% (11% WACC, 2% perpetuity), for instance, would point to a DCF valuation of 12.6p/share – implying a PE of 16x FY19 earnings – more in line with UK software peers.

Exhibit 3: Financial summary

£'k

2015

2016

2017

2018e

2019e

31-December

IFRS

IFRS

IFRS

IFRS

IFRS

INCOME STATEMENT

Revenue

 

10,392

11,216

16,801

21,750

26,500

Cost of Sales

(3,308)

(3,446)

(4,766)

(5,325)

(5,209)

Gross Profit

7,084

7,770

12,035

16,425

21,291

EBITDA

 

(2,102)

(4,310)

(1,608)

2,400

6,530

Normalised operating profit

 

(2,862)

(5,603)

(3,761)

(25)

3,345

Amortisation of acquired intangibles

0

0

0

0

0

Exceptionals / FX

(128)

313

(1,124)

(1,100)

0

Share-based payments

(137)

(172)

(86)

0

0

Reported operating profit

(3,127)

(5,462)

(4,971)

(1,125)

3,345

Net Interest

11

(13)

(55)

25

12

Joint ventures & associates (post tax)

0

0

0

0

0

Exceptionals

(4,767)

0

0

(0)

0

Profit Before Tax (norm)

 

(7,618)

(5,616)

(3,816)

0

3,358

Profit Before Tax (reported)

 

(7,883)

(5,475)

(5,026)

(1,100)

3,358

Reported tax

(3)

(12)

380

0

(336)

Profit After Tax (norm)

(7,621)

(5,628)

(3,816)

0

3,022

Profit After Tax (reported)

(7,886)

(5,487)

(4,646)

(1,100)

3,022

Minority interests

0

0

0

0

0

Discontinued operations

0

0

0

0

0

Net income (normalised)

(7,621)

(5,628)

(3,816)

0

3,022

Net income (reported)

(7,886)

(5,487)

(4,646)

(1,100)

3,022

Basic average number of shares outstanding (m)

108

114

170

399

399

EPS - basic normalised (p)

 

(7.1)

(4.9)

(2.3)

0.0

0.8

EPS - diluted normalised (p)

 

(7.1)

(4.9)

(2.3)

0.0

0.8

EPS - basic reported (p)

 

(7.3)

(4.8)

(2.7)

(0.3)

0.8

Revenue growth (%)

1.8

7.9

49.8

29.5

21.8

Gross Margin (%)

68.2

69.3

71.6

75.5

80.3

EBITDA Margin (%)

N/A

N/A

N/A

11.0

24.6

Normalised Operating Margin

N/A

N/A

N/A

-0.1

12.6

BALANCE SHEET

Fixed Assets

 

1,127

2,676

6,481

7,112

7,427

Intangible Assets

423

2,201

6,157

6,913

7,363

Tangible Assets

704

475

324

199

64

Investments & other

0

0

0

0

0

Current Assets

 

6,212

4,664

13,980

10,491

11,896

Stocks

0

0

0

0

0

Debtors

4,556

3,826

7,002

7,151

8,712

Cash & cash equivalents

1,656

838

6,978

3,341

3,184

Other

0

0

0

0

0

Current Liabilities

 

(3,201)

(6,223)

(11,951)

(10,637)

(9,335)

Creditors

(3,031)

(6,080)

(11,917)

(10,603)

(9,301)

Tax and social security

0

0

0

0

0

Short term borrowings

0

0

0

0

0

Other

(170)

(143)

(34)

(34)

(34)

Long Term Liabilities

 

0

(2,057)

(2,078)

(2,078)

(878)

Long term borrowings

0

0

0

0

0

Other long term liabilities

0

(2,057)

(2,078)

(2,078)

(878)

Net Assets

 

4,138

(940)

6,432

4,889

9,110

Minority interests

0

0

0

0

0

Shareholders' equity

 

4,138

(940)

6,432

4,889

9,110

CASH FLOW

Op Cash Flow before WC and tax

(2,102)

(4,310)

(1,608)

2,400

6,530

Working capital

(2,439)

3,400

2,188

(1,463)

(2,863)

Exceptional & other

(150)

(465)

(676)

(1,100)

0

Tax

(3)

(12)

294

0

(336)

Net operating cash flow

 

(4,694)

(1,387)

198

(163)

3,331

Capex

(848)

(447)

(4,881)

(3,500)

(3,500)

Acquisitions/disposals

1,828

109

297

0

0

Net interest

11

(7)

55

25

12

Equity financing

0

0

10,694

0

0

Dividends

0

(1)

0

0

0

Other

0

(4)

135

0

0

Net Cash Flow

(3,703)

(1,737)

6,498

(3,637)

(157)

Opening net debt/(cash)

 

(5,312)

(1,656)

(838)

(6,978)

(3,341)

FX

48

919

(358)

0

0

Other non-cash movements

0

0

0

0

0

Closing net debt/(cash)

 

(1,656)

(838)

(6,978)

(3,341)

(3,184)

Source: 7digital accounts, Edison Investment Research. Note: FY15 and FY16 restated.

Edison is an investment research and advisory company, with offices in North America, Europe, the Middle East and AsiaPac. The heart of Edison is our world-renowned equity research platform and deep multi-sector expertise. At Edison Investment Research, our research is widely read by international investors, advisers and stakeholders. Edison Advisors leverages our core research platform to provide differentiated services including investor relations and strategic consulting. Edison is authorised and regulated by the Financial Conduct Authority. Edison Investment Research (NZ) Limited (Edison NZ) is the New Zealand subsidiary of Edison. Edison NZ is registered on the New Zealand Financial Service Providers Register (FSP number 247505) and is registered to provide wholesale and/or generic financial adviser services only. Edison Investment Research Inc (Edison US) is the US subsidiary of Edison and is regulated by the Securities and Exchange Commission. Edison Investment Research Pty Limited (Edison Aus) [46085869] is the Australian subsidiary of Edison. Edison Germany is a branch entity of Edison Investment Research Limited [4794244]. www.edisongroup.com

DISCLAIMER
Copyright 2018 Edison Investment Research Limited. All rights reserved. This report has been commissioned by 7digital Group and prepared and issued by Edison for publication globally. All information used in the publication of this report has been compiled from publicly available sources that are believed to be reliable, however we do not guarantee the accuracy or completeness of this report. Opinions contained in this report represent those of the research department of Edison at the time of publication. The securities described in the Investment Research may not be eligible for sale in all jurisdictions or to certain categories of investors. This research is issued in Australia by Edison Investment Research Pty Limited (Corporate Authorised Representative (1252501) of Myonlineadvisers Pty Ltd (AFSL: 427484)) and any access to it, is intended only for "wholesale clients" within the meaning of the Corporations Act 2001 of Australia. 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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

295 Madison Avenue, 18th Floor

10017, New York

US

Sydney +61 (0)2 8249 8342

Level 12, Office 1205

95 Pitt Street, Sydney

NSW 2000, Australia

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

295 Madison Avenue, 18th Floor

10017, New York

US

Sydney +61 (0)2 8249 8342

Level 12, Office 1205

95 Pitt Street, Sydney

NSW 2000, Australia

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Forward-looking information or statements in this report contain information that is based on assumptions, forecasts of future results, estimates of amounts not yet determinable, and therefore involve known and unknown risks, uncertainties and other factors which may cause the actual results, performance or achievements of their subject matter to be materially different from current expectations. For the purpose of the FAA, the content of this report is of a general nature, is intended as a source of general information only and is not intended to constitute a recommendation or opinion in relation to acquiring or disposing (including refraining from acquiring or disposing) of securities. The distribution of this document is not a “personalised service” and, to the extent that it contains any financial advice, is intended only as a “class service” provided by Edison within the meaning of the FAA (ie without taking into account the particular financial situation or goals of any person). As such, it should not be relied upon in making an investment decision. To the maximum extent permitted by law, Edison, its affiliates and contractors, and their respective directors, officers and employees will not be liable for any loss or damage arising as a result of reliance being placed on any of the information contained in this report and do not guarantee the returns on investments in the products discussed in this publication. FTSE International Limited (“FTSE”) © FTSE 2018. “FTSE®” is a trade mark of the London Stock Exchange Group companies and is used by FTSE International Limited under license. All rights in the FTSE indices and/or FTSE ratings vest in FTSE and/or its licensors. Neither FTSE nor its licensors accept any liability for any errors or omissions in the FTSE indices and/or FTSE ratings or underlying data. No further distribution of FTSE Data is permitted without FTSE’s express written consent.

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

295 Madison Avenue, 18th Floor

10017, New York

US

Sydney +61 (0)2 8249 8342

Level 12, Office 1205

95 Pitt Street, Sydney

NSW 2000, Australia

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

295 Madison Avenue, 18th Floor

10017, New York

US

Sydney +61 (0)2 8249 8342

Level 12, Office 1205

95 Pitt Street, Sydney

NSW 2000, Australia

Sarine Technologies — Cost reductions driving profitability

Sarine’s prudent cost management in Q218 translated into a 12.4% y-o-y increase in EBIT to US$4.7m, despite the lack of top-line growth. The company continues to focus on increasing the recurring revenue streams from retail-oriented services led by Sarine Profile and the 4Cs grading reports, with its second technology lab that recently opened in Mumbai. Despite the progress in already initiated projects with downstream customers being slower than expected, management remains confident that these services will become an important contributor to group sales.

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