Expecting an inflection in the second half

WANdisco 25 September 2018 Update
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WANdisco

Expecting an inflection in the second half

Interim results

Software & comp services

25 September 2018

Price

660p

Market cap

£275m

£/US$1.32

Net cash ($m) at end June 2018

13

Shares in issue

41.7m

Free float

92%

Code

WAND

Primary exchange

AIM

Secondary exchange

N/A

Share price performance

%

1m

3m

12m

Abs

(31.3)

(45.5)

(13.7)

Rel (local)

(30.7)

(45.0)

(16.7)

52-week high/low

1250.00p

532.50p

Business description

WANdisco is a distributed computing company. It has developed a suite of solutions based around proprietary replication technology, which solve critical data management challenges prevalent across cloud computing, big data and the ALM software markets.

Next events

Trading update

January 2019

Analysts

Dan Ridsdale

+44 (0)20 3077 5729

Alasdair Young

+44 (0)20 3077 5700

WANdisco is a research client of Edison Investment Research Limited

We expect WANdisco’s strong H1 commercial progress to translate into an inflection in growth in H2. Cloud partners Microsoft and Alibaba are likely to be key drivers of this, where revenues are recurring with good potential to scale-up. We leave our estimates unchanged and believe that achieving the required inflection in H2 could be a watershed for the perception of this business’s growth fundamentals.

Year end

Revenue ($m)

EBITDA*
($m)

PBT*
($m)

EPS
(c)

Net cash

($)

EV/Sales

(x)

12/16

11.4

(7.5)

(16.4)

(46.9)

7.2

31.3

12/17

19.6

(0.6)

(7.8)

(18.6)

23.1

17.3

12/18e

24.7

(0.5)

(8.0)

(18.1)

20.5

13.9

12/19e

31.8

1.3

(6.5)

(14.6)

21.0

10.8

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

Strategic progress set to bear fruit in H2

Strategic progress so far in FY18 includes agreements with Microsoft and Alibaba and an expanded collaboration with IBM to include BigSQL relational database technology, with royalty rates expanded from 30% to 50%. The Microsoft partnership yielded has four deals year to date YTD starting late in H1 and the pace should gather from here. Average deal size was in the low $100s of thousands but scale up potential of each is said to be good – for example the $200k Automotive contract win announced today covers less than 3% of the client data and the customer has identified over 20 projects where it can use Fusion. The expanded deal with IBM should support more frequent and larger deal flow with Q4 their peak quarter for closing business. The Alibaba technical integration was completed in early H2 and should add incremental bookings/revenues this year.

Inflection in recurring subscription revenues in H2

The H1 drop in bookings to $9m (vs $10.2m in H117) was as flagged at the trading update and not unexpected expected, given that H117 included a $4.1m IBM deal that did not repeat. Net cash stood at $13m, down from $23.1m at end FY17, but the forecast strong bookings in H2 should support positive cash generation in H2. Our forecasts demand bookings of $21.5m in H2, up 75% y-o-y, but with the company reporting a very strong pipeline we are leaving our estimates essentially unchanged. We also highlight that as cloud deals through Microsoft and Alibaba are based on an annual subscription model (versus perpetual licensing through IBM), a high proportion of revenues through these channels will reoccur and show uplift over time, supporting future growth.

Valuation: H2 inflection an upside catalyst

WANdisco’s shares have lost 45% of their value since the start of September, but we believe that achieving the required inflection in H2 could be a watershed for the perception of this business’s growth fundamentals. Our reverse DCF suggests the company needs to sustain growth of c 30%+ and achieve EBITDA margins of 25%+ to deliver upside. WANdisco’s cloud partners are growing revenues at substantially higher levels than this from much higher bases, while successful delivery of the company’s IP based, indirect model should support these higher margins.

Investment summary

Enabling live data

WANdisco is a distributed computing company. The company’s key product, Fusion, enables large amounts of data to be replicated while it is still being used, retaining data consistency in the process. We believe the company’s ability to do this is unique. It is enabled by a proprietary replication technology DConE built around Paxos, an algorithm for solving consensus in a network of unreliable processors which is protected by 11 patents and 28 patents pending.

Fusion can be applied to wide range of markets and use cases. The company’s core focus is on enterprise customer premise, cloud and hybrid data implementations, where Fusion can be used to facilitate the migration of large amounts of live data to and from the cloud, or between different cloud deployments and to improve the resilience, efficiency and flexibility of data networks. The company has assembled an impressive roster of tier one cloud and enterprise software partners. These agreements include IBM, Microsoft, Alibaba and Dell/Virtustream, as well as less formal agreements with Oracle and Amazon AWS.

The ALM business applies the same core technology to the Apache Subversion software versioning and revision software to enable developers across the world to work on the same code at the same time. WANdisco’s recent filing of a patent to protect the use of its core DConE technology in blockchain applications lays the cornerstone for the business’s expansion into another major field.

Strong strategic progress set to yield an inflection

WANdisco has taken three significant strategic steps in H1, which we expect to start to bear fruit in H2. In Alibaba Cloud and Microsoft, it has signed OEM and strategic co-sell agreements with two of the largest and fastest growing cloud service providers globally. The company’s recently expanded OEM collaboration with IBM to include relational database technology MySQL could significantly expand its addressable market, while the negotiation of royalties of sales through IBM to 50% from 30% should clearly be beneficial.

Cloud: Structural growth trends showing no signs of slowing

The market opportunity in cloud is significant. The migration of enterprise data to the cloud is the largest structural shift taking place in the enterprise technology market today. Calendar Q2 results from Amazon and Microsoft confirm the leading players are pulling off the rare achievement of sustaining or accelerating the growth of their cloud businesses even while these businesses get substantially larger.

Exhibit 1: Growth rates and market share of leading cloud-platform-as-a-service providers

Source: Synergy Research Group, company accounts, Edison Investment Research. Note: circle sizes are proportional to estimates market share.

Fusion’s most obvious cloud application is in enabling enterprises to move large volumes of data from on-premise environments to the cloud. It has been integrated into Amazon’s snowball product for this purpose. However, the vast majority of enterprises cannot simply move all their data to the cloud, nor can they rely on one single cloud provider for all their needs. Most are adopting hybrid environments through a mix of on-premises, private cloud and third-party, public cloud services with orchestration between the different platforms. Fusion plays strongly into the hybrid and multi-cloud market by facilitating the movement of workloads between private and public clouds as computing needs and costs change, giving businesses greater flexibility and more data deployment options.

Exhibit 2: Hybrid cloud revenue growth

Exhibit 3: Enterprise CTO cloud investment plans 2018

Source: Statista * forecast years

Source: Statista

Exhibit 2: Hybrid cloud revenue growth

Source: Statista * forecast years

Exhibit 3: Enterprise CTO cloud investment plans 2018

Source: Statista

Microsoft getting into gear

Microsoft’s hybrid cloud capability and focus has been a key factor in its success, due to its ability to cross-sell into its existing customer base. In a recent interview, Judson Althoff, Microsoft's executive vice president of worldwide commercial business, stated that ‘about 85% of our enterprise customers are already using one or more of our cloud services’.

This market presence, growth and focus on hybrid cloud potentially makes Microsoft a very powerful partner for WANdisco. In March this year, the companies announced their co-sell agreement (which is essentially the same as an OEM other than that Fusion will be branded WANdisco rather than Microsoft). Through this agreement, Fusion will be taken to market by Microsoft as a packaged offering and Microsoft’s channels are incentivised to sell the product. 

Starting late in the period, the partnership yielded three deals in H1: with a major bank to enable hybrid cloud; with a semiconductor company; and with a major retailer that has used Fusion to support a migration from Amazon AWS to Microsoft. A fourth deal, with an Automotive manufacturer was announced with the results. The breadth of vertical markets and use cases demonstrates the broad applicability of Fusion.

Driving shift to recurring revenues

We expect the frequency of deal flow through Microsoft to accelerate in H2. It is important to highlight that unlike IBM, sales via Microsoft and other cloud partners generate recurring subscription revenues, enhancing revenue visibility and requiring little integration, which benefits scalability.

Deployments also have the potential to scale significantly.

Initial deal sizes through Microsoft are in the low hundreds of thousands of dollars, although management believes all of these deployments have the potential to scale significantly as Fusion is used more extensively throughout the organisations. Management indicates that it sees opportunities to grow the annualised recurring revenue within large global businesses to as much as $5-10m within three to five years as the deployment of Fusion expands to cover more of the company’s data footprint.

For example, the automotive manufacturer contract win announced with the results has an initial contract has an ARR of $200k to deploy Fusion for the live replication of data between on-premise Hadoop clusters and Microsoft Azure. This initial contract covers only 3% of the client’s data, and the customer has identified 20+ projects which would require Fusion technology. As such, WANdisco management expect this contract to turn into a recurring, annualised multi-million dollar contract.

IBM: Expanded scope and better terms

The extension of WANdisco’s OEM agreement to integrate with IBM BiGSQL extends this partnership to cover another of IBM’s key big data products. BigSQL is a hybrid SQL relational database technology designed to run on the Hadoop big data platform to enable querying and analysis of large amounts of data from different sources.

Partly to cover the joint engineering work required to achieve this, WANdisco has renegotiated its royalty rate from this agreement. It will now receive a 50% royalty on IBM’s Fusion sales, up from 30% previously, and a guaranteed annual royalty commitment highlighting the strategic importance of this partnership to IBM and the strength of WANdisco’s IP.

WANdisco’s deals through IBM have been large (two $4m+ deals so far) and the timing unpredictable, with no large deals in H1 this year. The guaranteed royalty commitment will at least give visibility on a certain level of sales through this channel and it is possible the broader integration will support more frequent deal flow. Timing is likely to remain unpredictable although we highlight that calendar Q4 is typically IBM’s strongest for closing deals.

Other partnerships

The technical integration with Alibaba, with which WANdisco signed an OEM agreement in March, was completed in early H2, with the first deals expected to come through before the end of the year. The partnership with Oracle remains active with a healthy pipeline while we have no update on the collaborations with Amazon AWS or Dell/Virtustream, so we believe it is unlikely they will contribute significantly during FY19.

Blockchain

WANdisco formalised its entry into the blockchain arena with the announcement of a patent filing in August. The aim is to leverage its core replication technology to significantly improve the scalability and performance of private (permissioned) blockchain networks. To retain integrity, permissioned block chain implementations require each block to reach consensus with all the other blocks in the chain. This requires significant computing resources and significantly slows down performance, which is an obstacle to deployment in large-scale, high-throughput applications.

Through applying DConE’s replication technology, the overheads required to achieve consensus are significantly reduced. The alleviation of these capacity/performance constraints has the potential to enable the uptake of blockchain applications for uses ranging from financial services to supply chain management.

Partnerships with major blockchain developers the key next step

Although it is still early stages and it is difficult to quantify the opportunity, we understand the blockchain technology is substantially built. The company is now engaging with the key blockchain technology developers and the first commercial engagements are expected over the next 12 months. We highlight that many of WANdisco’s major partners (eg IBM, Microsoft, Oracle) are among the most active and serious protagonists within in the blockchain arena.

ALM

Revenues at the non-core ALM business continued to drift, with bookings of $2.8m (vs $3.2m in FY17) and revenues of $3.3m (H117 $4.6m). This operation is essentially run as a cash cow. It uses an annual subscription revenue model and is mainly a renewal business, with good renewal rates. Consequently, we continue to forecast a continued drift over our forecast period.

Forecasts

WANdisco has been making strong strategic progress over a number of years. In H2 we believe this will start converting into a sustained inflection in operationally geared growth.

The Microsoft partnership yielded four deals late in H1, with average deal sizes of c $100-200,000. Whilst we expect the contract sizes to remain broadly similar in H2, we anticipate that the number of deals will increase. We also expect the value of each individual contract should show uplift over time, with the possibility of each becoming multi-million dollar recurring revenue contracts. In theory, the expanded deal with IBM should support more frequent and larger deal flow. Judging by last year’s figures, we would expect IBM deal flow to be heavily Q4 weighted again which should help underpin the forecast sequential booking growth of 139%. The Alibaba technical integration was completed in early H2 and should add incremental bookings. We also expect that Oracle may soon start to provide deal flow.

Our estimates are essentially unchanged. Our FY18 bookings forecast of $30.5m implies a very significant uplift in H2 ($21.5m bookings in H2 vs $9m in H1). Achieving this will require the company to close some large scale deals, but we understand that there is sufficient depth of pipeline to deliver upside to this figure, though we also note the possibility of downside risk due to contract slippage.

Given the shift to recurring subscriptions, our FY19 estimates of 30% bookings growth will start to look conservative once we have better visibility the H2 inflection is taking place.

The implementation of IFRS 15 will reduce the lag between bookings and revenue as the licensing element (80%) of annual subscriptions is now recognised on signing the contract (previously it was drawn down over the term). We will adjust our estimates to reflect this once we have more visibility on the mix of bookings revenue in H2.

Costs are tracking to plan, with total cash costs (COGS, OPEX and capitalised R&D) of $15m, up by $1m on H2 last year and on track for our c $30m estimate.

Net cash at end June 2018 was $13m, down from $23.1m at end FY17, but the forecast strong bookings performance in H2 should support positive cash generation. However, the year-end balance depends on the timing of closing deals and collecting cash.

Exhibit 4: P&L model ($000’s)

Year-end December

2015

2016

2017

2018e

2019e

H117

H217

H118

H218e

Bookings

Big data

2,500

6,500

15,700

24,300

33,900

7,000

8,700

6,200

18,100

ALM

6,500

9,000

6,800

6,200

5,800

3,200

3,600

2,800

3,400

Total bookings

9,000

15,500

22,500

30,500

39,700

10,200

12,300

9,000

21,500

Growth

-48%

72%

32%

32%

0%

Total revenues

10,994

11,379

19,637

24,680

31,760

9,660

9,937

5,728

18,952

Overall growth

-2%

4%

73%

26%

29%

0%

0%

0%

0%

Cost of sales

(749)

(1,349)

(1,972)

(2,654)

(3,454)

(934)

(1,038)

(370)

(2,284)

As % of bookings

-8%

-9%

-9%

-9%

-9%

-9%

-10%

-6%

-12%

Gross profit

10,245

10,031

17,665

22,027

28,306

8,726

8,939

5,358

16,669

Gross margin

93.2%

88.1%

90.0%

89.2%

89.1%

90.3%

90.0%

93.5%

88.0%

Cash OPEX

(26,233)

(17,494)

(18,245)

(22,500)

(27,000)

(8,473)

(9,772)

(12,201)

(10,299)

EBITDA adjusted

(15,988)

(7,464)

(580)

(473)

1,306

253

(833)

(6,843)

6,370

Capitalised R&D

(8,369)

(5,860)

(6,303)

(6,744)

(7,216)

(3,019)

(3,284)

(2,442)

(4,302)

EBITDAC (EBITDA after capitalised development)

(24,357)

(13,324)

(6,883)

(7,217)

(5,910)

(2,766)

(4,117)

(9,285)

2,068

Source: Company data, Edison Investment Research

Valuation: Sustaining growth should deliver upside

WANdisco’s rating stands at 14x FY18e EV/sales, dropping to 11x for FY19e. This is a premium to peers (a diverse range from c 2x to 11x), although the recent share price fall has narrowed the premium substantially. WANdisco’s investment case has always been predicated on the potential for it to scale into a significantly larger, highly profitable business. We believe that progress in H2 should provide a watershed moment for these credentials.

Our DCF suggests the current share price requires sustained bookings growth of c 30% (ie a similar rate to FY18 and FY19) through 2025 with EBITDAC margins growing to over 25%. In practice, we believe that if WANdisco continues to strengthen its platform of tier one channel partners, it should be well placed to grow faster than this. Most of the company’s partners are growing their cloud revenues at significantly faster rates. With a broad addressable market, a strong IP position and an indirect sales model, healthy 30%+ margins should be readily achievable if execution remains good, although we expect the emphasis to remain on growth over margins in the near to medium term. The company’s potential strategic attractiveness should also not be ignored.

Exhibit 5: DCF sensitivity to medium-term growth and margins

Bookings growth FY18

30%

40%

50%

60%

70%

Bookings CAGR FY18-2025e

11%

21%

31%

41%

51%

Revenues 2020 ($m)

36,656

43,210

50,522

58,637

67,601

Implied share price (p) (excluding dilution)

Matured EBITDAC margin

20%

194

352

612

1,056

1,765

25%

233

420

731

1,245

2,086

30%

272

486

842

1,441

2,394

35%

309

553

960

1,627

2,710

Source: Edison Investment Research. Note: EBITDAC is EBITDA considering capitalised R&D costs as expenses. WACC is 10%.and we assume a progressive eight-year fade in growth rate from 2018.

Exhibit 6: Financial summary

$000s

2016

2017

2018e

2019e

Year end 31 December

IFRS

IFRS

IFRS

IFRS

PROFIT & LOSS

Revenue

 

 

11,379

19,637

24,680

31,760

Cost of Sales

(1,349)

(1,972)

(2,654)

(3,454)

Gross Profit

10,031

17,665

22,027

28,306

EBITDA

 

 

(7,464)

(580)

(473)

1,306

Operating Profit (before amort. and except.)

 

 

(16,104)

(7,494)

(7,687)

(6,208)

Acquired Intangible Amortisation

0

0

0

1

Exceptionals

(32)

0

0

0

Share based payments

(1,787)

(2,201)

(3,200)

(3,200)

Operating Profit

(17,923)

(9,695)

(10,887)

(9,407)

Net Interest

(268)

(315)

(315)

(315)

Profit Before Tax (norm)

 

 

(16,372)

(7,809)

(8,002)

(6,522)

Profit Before Tax (FRS 3)

 

 

(10,047)

(14,004)

(11,202)

(9,721)

Tax

772

489

408

354

Profit After Tax (norm)

(15,600)

(7,320)

(7,595)

(6,167)

Profit After Tax (FRS 3)

(9,275)

(13,515)

(10,795)

(9,367)

Average Number of Shares Outstanding (m)

33.3

37.8

41.3

41.2

EPS

 

 

(46.9)

(19.4)

(18.4)

(15.0)

EPS - normalised fully diluted (c)

 

 

(46.9)

(18.6)

(18.1)

(14.6)

EPS - (IFRS) (c)

 

 

(27.9)

(35.8)

(26.2)

(22.7)

Dividend per share (c)

0.0

0.0

0.0

0.0

Gross Margin (%)

88.1

90.0

89.2

89.1

EBITDA Margin (%)

N/A

N/A

N/A

N/A

Operating Margin (before GW and except.) (%)

N/A

N/A

N/A

N/A

BALANCE SHEET

Fixed Assets

 

 

6,469

8,526

8,356

8,359

Intangible Assets

5,977

7,081

6,826

6,744

Tangible Assets

492

556

641

726

Investments

0

889

889

889

Current Assets

 

 

13,703

33,365

27,207

29,192

Stocks

0

0

0

1

Debtors

6,145

5,969

6,721

8,164

Cash

7,558

27,396

20,486

21,026

Other

0

0

0

1

Current Liabilities

 

 

(9,409)

(14,052)

(13,113)

(15,953)

Creditors & Deferred Income

(9,320)

(13,068)

(13,113)

(15,953)

Short term borrowings

(89)

(984)

0

0

Long Term Liabilities

 

 

(6,980)

(10,372)

(1,400)

(1,800)

Long term borrowings

(294)

(3,310)

0

0

Deferred Income

(6,686)

(7,062)

(1,400)

(1,800)

Net Assets

 

 

3,783

17,467

21,051

19,797

CASH FLOW

Operating Cash Flow

 

 

(2,944)

656

4,336

8,017

Net Interest

(161)

(257)

(315)

(315)

Tax

690

1,364

408

354

Capex (inc capitalised R&D)

(5,923)

(7,056)

(7,044)

(7,516)

Acquisitions/disposals

0

0

0

0

Financing (net)

13,523

21,188

0

0

Dividends

0

0

0

0

Net Cash Flow

5,186

15,895

(2,616)

539

Opening net debt/(cash)

 

 

(2,555)

(7,175)

(23,102)

(20,486)

HP finance leases initiated

(383)

0

0

0

Other

(175)

32

0

0

Closing net debt/(cash)

 

 

(7,175)

(23,102)

(20,486)

(21,026)

Source: Company data, Edison Investment Research

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Level 12, Office 1205

95 Pitt Street, Sydney

NSW 2000, Australia

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Frankfurt +49 (0)69 78 8076 960

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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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