Shares in software solutions group K3 Technologies (LON:KBT) plunged 30% today as it revealed that delayed contracts and a customer entering into administration will cause profits to be below expectations. The share price fall seems to have steadied at -30%:
This has been a bit of a ride, as the price has jumped around a lot over the past couple of years. Today’s fall however takes it back to levels seen a couple of years ago, and obviously a long way from its peak.
K3 are not a new IPO either, having originally listed in 2001. It has under its belt a long list of acquisitions concentrating on the software market with the aim of creating synergies, cross-selling opportunities and recurring revenues. Indeed, its website lists a long list of household names as clients.
What’s gone wrong at K3 Business Technology?
The bad news is delivered in a trading update coming this morning. It should be noted that the previous update indicated a H2 weighting, and this has not materialised.
The second half of the financial year started confidently, with an encouraging pipeline of both major new deals and high-margin ‘follow‐on’ software licence orders. However a major new contract in the final process of agreement has now been put on hold by the counterparty and a large customer has entered into administration. In addition, certain customers are choosing to purchase additional software licence tranches at a slower pace than anticipated.
A broker update released today suggests that this customer is Bonmarche, which would fit in with this commentary.
Helpfully, the impact is quantified:
As a result of these factors, management now expects that results for the year will be significantly below current market expectations. While there are important trading weeks remaining during the current financial year, in light of these softer trading conditions, management has taken a cautious view of the outcome for the financial year, and currently estimates that the Group’s adjusted operating profit for the year will be approximately £1.5m. The Company’s net debt position at the year end is anticipated to be £2.2m. A final (and total) dividend for the year, in line with existing guidance, is expected to be proposed with the publication of final results.
Unhelpfully though, it is not mentioned that this appears to be a massive miss. The broker update today (available on Research Tree) suggests that this £1.5m is down from £5.3m, and also these figures are before adjustments. After this, the company is expected to show a statutory loss for the year.
K3 Business Technologies: A Turnaround In Progress?
The high-level summary of results have a striking feature (figures from Stockopedia):
We have a nice level of growth and profits, then in 2017 the company slumped to a massive loss. Reading further into this, the revenue spike was not what is seems as the end-date of accounts was changed meaning that this period was for 17 months.
However, the loss still stands and this was caused by the company having a large reorganisation. There is a heavy emphasis on adjusted costs, but the statutory impact of this was a huge loss: almost £5m went on exceptional costs (mainly redundancy), and almost the same in writing off previously capitalised development costs. Issuing shares has allowed these items to be financed at no real damage to the debt pile: since 2015 the share count has grown by over 10 million, considering there are just 42.9m in issue that is significant.
Turnover has thus decreased: H1 turnover this year was £38.2m and with today’s profit warning it seems there is no more room for delays or any other unexpected events in order to even match last year’s revenue result.
Weak balance sheet woes at odds with valuation
Even considering the previous profit guidance for this year, the valuation of this company is rich at a P/E of 20+ (before today’s warning). As is common with many companies in this sector a large part of growth is baked into this price. However, K3 has plenty of form for delivering profit warnings, and given that the same excuses are seen (companies delaying projects, H2 weighting) it seems that if you want to buy into this share you will have to tolerate these sharp drawdowns. The retail landscape here is not great, and in my opinion Bonmarche will be one of a few higher-profile casualties as several other businesses are pretty marginal at present.
Perhaps of more importance to investors is the balance sheet, and perhaps the fact that net debt is quite modest. It is worth noting that the majority of this is up for renewal this year -as of the last interims secured bank loans were £10.8m. This seems quite expensive, as the quoted rates from the last annual report are 2.1%-6% over LIBOR. In these accounts the interest charge was £667,000 for the year, and in the first half of 2019 that cost was £441,000.
Backing for these liabilities seem scant. Current assets are less than current liabilities, although this situation will reverse itself when the refinancing is done. But what doesn’t change is that the net tangible asset values here are weak. Of its £107m in assets, almost £70m of that is made up of goodwill and intangibles, giving a slightly negative NTAV. Considering that some of these types of assets could be written off to zero pretty quickly in the event of business changing, this could be a worry.
Is there a bull case for K3 Business Technologies?
Clearly something is going right as they enjoy a premium valuation. And their list of clients are impressive. They also boast a very high renewal rate of 98%, so this also indicates some kind of strength in their service. One can imagine that there may be some value creation possible in that the interaction between different software packages is weak. There are also plenty of ways a software company can raise revenues, from hosting, to support, to recurring subscriptions.
The K3 strategic pivot seeks to guarantee more revenues as they have focused more on their own proprietary software (which carries higher margins) and also focusing away from the UK. As of the last year, 44% of revenues came from international operations. Whilst today’s events could be seen as a setback, the turnaround is still very much underway and potentially the company could be larger in future.
The company was expensive before the profit warning, and I would still regard it as slightly pricey after it and I would still want another 30% fall to be interested. That said, I can some of the reasons why it may be attractive: there are many users of the software, which appears to fulfil some definitive needs. There is also a dividend being paid, which although small reflects confidence that things will be on track.
Against this I struggle to think that this will be the bottom of the share price. Specialising in retail is not a place to be at the moment and there will be plenty more casualties and therefore lost revenues. And these are likely to be major: despite having 3,700 customers, a lost contract and an administration has hammered profits.
The last aspect is also the balance sheet, which appears weak. A refinancing is scheduled for October this year, but it remains to be seen on what kind of terms this will be on, and it could be more adverse than before. It could be that yet another issuing of shares could be on. While this company is far from being a duud, at the current price I still think risk is greater than reward. 2/5.Like this? Share on social media: