IT managed software specialist Smartspace Software (LON:SMRT) today issued a profit warning stating that revenues and sales would be below expectations following a delay in contract signings. The share price has fallen 30% already today:
The 6-month chart perhaps illustrates a wider picture, as the price has been consistently falling before today. The interim results provided few clues that this was to happen, so we may speculate that somehow market participants have gotten wind of this in the lead-up.
For those unfamiliar, this company was previously known as RedstoneConnect and changed its name in 2018. They offer a relatively specialised Saas (software as a service offering), aimed at managing large buildings in terms of desk booking, room management, car parking and the related analytics. This might seem a relatively trivial affair, after all, why could this not be managed in-house? But the numbers speak otherwise: Smartspace have gained thousands of customers in many countries, and more efficient utilisation has a proven benefit in reduced costs.
What’s gone wrong at Smartspace Software?
The news comes in a trading update today.
In its interim statement, published in October 2019, the Company noted its expectation that the year would be second-half weighted whilst also highlighting the unpredictability of the Group’s enterprise business due to the size of opportunities, the long sales and deployment cycles, and the nature of revenues generated, with a tendency towards a software licence model as opposed to SaaS
I don’t believe the interim outlook was coached in these terms, which used the words ‘less predictable’. Additionally the company believed (as a rationale for acquisition) that SaaS revenue was more beneficial for shareholders. Perhaps the licence model is a reflection that the market is customer-driven?
The source of the profit warning may be a ‘good’ one: no raw materials instead of reduced demand:
While the Company has made good progress and is in advanced stage contract negotiations, the division has been informed that one of its key hardware suppliers will not be able to fulfil its contractual obligation in respect of timely delivery of product. Although the supplier is seeking to fulfil the order as soon as possible, the Company has been informed that delivery will not take place in FY20
Hardware seems a puzzling reason, as I would have thought sourcing computer systems would be pretty easy. Perhaps this is related to software. Anyway, the impact is quantified:
As a result of this delay, the Company has been unable to conclude negotiations, and consequentially recognise revenue, on a number of material enterprise prospects due to impact in the current financial year. As a result, the Group therefore now expects to report revenues at a similar level to FY19, with an equivalent impact of this revenue shortfall on EBITDA
A broker note (available on Research Tree) is already available. This cuts revenues from £11.4m to £6.3m and EBITDA from -£1.2m to -£6.2m. It’s a massive miss, although they do see the recovery in the next year.
Smartspace Software: A much changed company
Comparison of historic figures is less relevant here. The company name change was more than mere semantics, as the change runs much deeper. In 2018, it sold off its Systems Integration and Managed Services divisions for £21.6m, leaving it with just Software and Hardware Integration divisions. The sale of the divisions accounted for most of its turnover and as such revenues dropped from £41.5m in 2017 to just £6.14m in 2018.
In some ways this was required. The business never really had any great record of profitability beforehand, and was consistently negative for cash generated from operations. Combined with an ad-hoc program of small acquisitions, the way of financing all this was by issuing stock, and lots of it, as the number in shares in issue expanded from 5m in 2014 to over 21m today. This was a smart move, as with the share price much higher in the past than it was today allowed the company to keep running without too much reliance on external debt.
The recent sale of its divisions was a huge one: the £21.6m price tag being greater than its market capitalisation at the time. Yet the sale proceeds did not stick around for long: funding losses, a new acquisition, and repayments of pre-existing borrowings ate up most of it.
With the current businesses seemingly loss-making for the next couple of years, a question must be whether this can be sustained. At 31 January, cash balances were £8.05m, at 31 July 2019 this was down to £3.8m, representing a relatively quick rate of cash burn. It can be seen that there is not much space for error here: the broker estimate for cash at the end of this year is £2.6m and with the recovery underway the business will begin to generate cash again, as it rises back up to £3.5m at the end of the 2021. They also note one of the bull cases for the business: that its technology could easily be adapted to cover more functions in a building such as catering.
The lack of debts contribute to a good balance sheet, for now anyway. Current assets are much larger than current liabilities and net assets are positive, even with a large intangible balance. This may be harder to maintain if the businesses are losing cash: a cursory glance at revenues tell us why: the costs of sales and capitalised development spend is much greater than the revenues they generate. On that note, there is regular capitalisation of ’employee and contractor costs’, so the profit figures may be massaged to a degree.
Are Smartspace Software shares good value?
This appears to me to be a bit of a binary situation: if the anticipated lost business is not recovered, then Smartspace may have a hard time surviving more years of the current performance. The market cap has dropped so far that another issue of shares may be hard to push through, and external finance may be expensive. Given the huge change in the business, this has been a turnaround case for some time.
I am not particularly sold on the business case here. Despite boasting 3,140 customers (in the annual report) the revenue figures of £6.3m suggest that those customers are not worth very much – on average around £2,000 a year each. No doubt this would be heavily skewed by some larger corporations. But given that it seems that a solution must be bespoke for each company, the payback time would not be immediate and over a longer period of time.
No doubt the software seems slick and user friendly but this appears to be a difficult segment to defend, unless there are significant benefits in uniformity. The healthcare provider Craneware (which issued its own profit warning) being an example of this. You would think that multi-site large corporations may end up doing a better job in-house.
The cash position doesn’t appear great here either, and with business uncertainty continuing, there may not be time left. 1/5.