Asset finance software specialist Alfa Financial (LON:ALFA) today issued a profit warning as it warned that a decrease in revenues would be accompanied by an increase in costs. The shares have immediately declined but recovered some ground in afternoon trade:
This is not something I am very familiar with, but looking at its previous news releases, this has been a very poor ride for long-term investors. Hitting the markets only two years ago at an initial price of 325p, it rose further and in 2018 was over 500p a share. Since then a profit warning in June 2018 hit the share price hard, and it’s been drifting ever since.
A large part of this was simply disappointment, that the planned growth anticipated has failed to materialise and indeed, revenues are shrinking. With the shares valued at a punchy valuation, there was some distance for them to fall. Some of the few people that did do well are the founders who cashed out a decent amount.
It is evident that Alfa are a fairly major player in their field, with revenues derived from just 31 customers. This type of concentration can have both upsides and downsides, as may become apparent.
What did the Alfa Financial profit warning say?
This comes as a trading update RNS. We have some figures for the interims:
Revenues for the half year are expected to be approximately £31m (2018: H1 £32.9m) with operating profit of approximately £5m (2018: H1 £8.6m), reflecting delays in the implementation of particular projects and a reduction in customer spend on optional upgrades and non-critical work driven by the broader macro uncertainty.
These should be fairly accurate as the results are published in a week and a bit.
Looking forward, the Board anticipates baseline revenue for the full year to be in the region of £63-£65m, based on existing customer agreements and assuming that the challenging market conditions that prevailed in the first half of the year continue.
This is a big fall, of around 10% at the worst case scenario. Worse still, this is a long way below the £87.8m seen two years ago.
We also have the problem of rising input costs:
Competition for talent is high across our markets and consequently we expect to award remuneration increases for our delivery teams in excess of general inflation rates. Additionally, we expect to incur some one-off legal costs in the second half of 2019.
As a result, the Board now expects Alfa’s full year profit for 2019 to be significantly below its previous expectations.
No guides for this are available on Research Tree, but with profits of just £5m at the halfway, it seems it’ll be long way under that of the previous year.
The outlook for the company looks markedly different that what it did in 2017. Back then, turnover had almost doubled in a short period of time, and the company was highly profitable at a great margin of 41%. This was far greater than Craneware, which also issued a profit warning recently.
There were high quality profits as well, which were converted into cash. It is not the case that the company is using all its money on necessary capital expenditures. Aside from 2015, the expenditures involved in this category have been relatively light.
So to a certain extent, the IPO simply has functioned as a way for owners to get a payout: some £60m was paid out in dividends in 2017. It doesn’t seem to be the case that money was required for expansion: the company were cash-rich with no debt. To be fair, the directors still speak for almost 200m of the 300m shares available in the company.
Whatever the beef with the IPO, we come to assess the company on its merits and the current share price as it stands. Cash is still good and increased to over £53m. There is no debt on the balance sheet. Furthermore it is comforting to see that goodwill and intangible items are a lot smaller than the cash pile, which dominates the balance sheet. With only modest liabilities the tangible asset position is positive.
The Alfa business specialises mainly in Europe, although it has some operations in US and the Rest of the World. The asset finance sector is clearly a complex area where opportunities are increasing due to the use of technology and in particular, cloud storage. Like many software firms there is more than one revenue stream: either a licensing fee for the software or annual subscription and charges for additional implementations and support.
The biggest risk is customer concentration, from the annual report this has gone up a tad:
The top 4 customers therefore account for 54% of revenues (46% in 2017). Which makes any move surrounding these quite sensitive to the figures.
Is the Alfa Financial profit warning a buying opportunity?
I do not pretend to have any knowledge of Alfa’s software. Needless to say these are complex, large contracts. The worry is why further business has not been won. The number of customers decreased from 32 in 2017 to 27 in 2018. This is a significant decrease and goes some way to explain why revenues have fallen. Is this the product, or more general market conditions? It is difficult to tell.
To be positive, there will be clearly more opportunities around the world. The business generates cash, and their pile is increasing with no finance costs to pay. Whether there are acquisitions out there which are of suitable size remains to be seen. And of course, other providers of similar solutions will be looking to up their games. The nature of these contracts looks to be that they are big and bulky, and customers stay a long time.
As always the assessment has always got to do with the valuation. The rapid growth that was anticipated at IPO has now largely disappeared, and this was underpinning the share price. The company was valued at something like £1.2bn with profits of just £33.8m in 2017. This was obviously a huge multiple. Given the many disappointments in this sector, it goes without saying that it would take a real special case for a new company to come in and dominate. On this evidence it looks that Alfa, while competent, are not that.
However, the rapid decrease in price has now led to Alfa’s market capitalisation being more realistic. It’s now something like £250m at current prices. This is still a punchy valuation considering the last set of profits, and in some ways you are still paying for future profits today.
Another potential is that Alfa simply get taken over by a competitor. Adjusted for cash, this may be tempting to some, particularly with exchange rates benefiting foreign owners.
Despite the IPO being rather useless for investors I feel the company has been fairly competently run. Further, the owners still retain a majority stake. In the short-term they are certain to be survivors, but I don’t have enough conviction to invest for the long-term. 3/5.