Growth back in focus

Blancco reported FY18 results that were marginally ahead of our forecasts, which had recently been updated to reflect the July trading update. The company achieved modest revenue growth of 2.1% (5% in constant currency) for the year, with a 1.4% decline in H118 and 4.4% growth in H218. As a result of the cost-cutting implemented during the year, adjusted operating profit increased 4.1% y-o-y, resulting in a margin of 12.1%, slightly higher than a year ago. The main difference between actual and forecast normalised net income was a lower than expected normalised tax rate of 3.4% compared to our 22.7% forecast.

Net debt at year-end stood at £2.7m. The company made several exceptional payments during FY18: £1.4m in restructuring costs, £1.2m in contingent consideration and £1.9m in tax.

Exhibit 2 shows the progress of revenues by type over the last four half-year periods. We note that the company is unlikely to report in this format in the future, as it is now selling products on the basis of type of customer rather than type of erasure. In some cases, customers will take both erasure and diagnostics solutions and it is difficult to split out the revenues. H218 group invoiced sales rebounded, after a decline in H118.

We note that after a weak half-year for end-of-life in H118, revenues recovered in H218, resulting in a small decline for the year. Mobile erasure saw growth for the full year, with significant contract wins in each region. Active erasure saw minimal growth over the year. Diagnostics revenues were flat year-on-year – the wind-down of some pre-acquisition Xcaliber contracts was offset by a large one-off contract in Asia Pacific.

As the company was going through a period of review and restructuring to put it on a stronger financial footing during H118 and went through a transition of the management team through FY18, the focus was not on driving new sales but on supporting the existing client base. Management now believes it has the right company structure and financial controls in place, and has decided that it will focus on the three key markets of Mobile, Enterprise/Data Centres and ITAD. Through FY19 it will work to reinvigorate the sales process and to target R&D on the first two markets.

The mobile market has several sources of demand for erasure and diagnostics software. Phones are sold through retail locations, such as carrier-owned stores, and customers will often return phones to those locations for repair or will trade them in to upgrade to a new handset. Second-hand phones are available for sale from a variety of specialist companies such as Redeem or Flip4New. In both cases, second-hand phones will need to be wiped before they can be sold.

For faulty phones, diagnostic software is vital to ascertain why a phone is not working and how it can be fixed. Blancco’s diagnostic software is used by a large US carrier. Between February and November 2017, this customer used the software to test 1.3m so-called faulty mobile devices, of which only 0.6m were confirmed to have a fault. This meant that 0.7m devices did not need to be sent off for further investigation and repair, saving c $80 per device, or $56m in total.

There are multiple types of companies involved in the mobile market: carriers, retailers, buyback/trade-in companies, phone repair companies and third-party logistics and warehouse operators. The company sees a number of smaller and similar-sized competitors, but none with a fully comprehensive erasure/diagnostics solution. The company is keen to focus its R&D to develop solutions that address the whole mobile asset lifecycle.

The business has signed a renewed contract with a major US mobile carrier, worth more than $10m for the period up to March 2021. The contract covers 6,000 retail stores and renews the existing diagnostics contract as well as providing a combined diagnostics/erasure product to process second-hand phones. Blancco also signed a new contract worth $1m for in-store diagnostics for a major South Korean mobile carrier. With 13m subscribers and 1,100 retail stores, we believe this to be LG.

Demand for erasure within the enterprise tends to be driven by the requirement to manage the data lifecycle within a business. In some cases, this will involve active erasure, ie erasure of specific files within a live environment, and in others, end-of-life erasure as PCs or servers are retired from use, sent off for repair or repurposed to be used elsewhere in the business. Blancco is focusing first on the data centre market, which has a regular cycle of asset investment.

Blancco has low penetration of this market, mainly due to lack of awareness by customers. One avenue to explore is working with OEMs such as Dell and HP to integrate Blancco’s software with their products. R&D is focused on developing a robust API architecture to enable this, as well as developing analytics tools.

Active erasure has seen limited take-up to date, often because before companies can erase data in a live environment, they need to know where exactly that data is stored within the company’s infrastructure (for example, multiple back-ups could exist). Blancco is considering working with data discovery software companies to provide a complete solution to find and erase critical data.

Blancco renewed a contract with a major multinational technology company to use the Data Centre Erasure solution to decommission servers in 20 of its data centres. The company expanded its relationship with a large multinational cloud-based software application provider to deploy the Data Centre Erasure solution in six new data centres opened in FY18. Blancco also signed a contract with a global major retailer to use the Drive Eraser solution on returned electronic purchases in locations across EMEA.

Blancco has a well-established position as the leading supplier of erasure software to the ITAD companies; the company aims to maintain this position. It is a more mature market and as Blancco has such a strong market position, it is likely to be a slower growth business line. As such, it is not the main focus for R&D but should benefit from efforts to develop product enhancements for the other two markets.

Blancco renewed a contract with a major multinational ITAD company, which has more than 1,000 enterprise customers, for its Drive Eraser solution for an additional multi-year term.

The company has historically generated the vast majority of revenues via direct sales. It has a number of resellers but to date this has not generated a large contribution to revenues. During H218, it signed new distribution agreements with Arrow Electronics and Ingram Micro. It also launched its Erasure as a Service offering through its new Managed Service Provider Partner programme, leading to deals with 14 global and regional partners including Fujitsu and Techchef.

The company recently hired a new head of business development, Anders Klemmer, to focus on building partnerships with manufacturers, software companies and system integrators in the enterprise and mobile markets.

Invoiced sales for the first two months of FY19 are ahead of the prior year period. Management expects to meet market expectations for revenue growth in FY19. It has, however, decided to increase investment in R&D, and expects this to have an impact on adjusted operating profit in FY19, but that this investment should help accelerate revenue growth and margins in FY20.

The debt facility was extended by 12 months to October 2020. At year-end the company had drawn down £8.9m of the £12.4m facility. At the end of FY18, there was a total of £2.2m in contingent consideration recorded on the balance sheet. We estimate that this equates to c £1.4m owing from the Tabernus acquisition and £1.0m owing from the Xcaliber acquisition. We forecast a pay-out of £2.4m in FY19 (reflects discount unwind), but we note that the company highlighted the possibility of settling the Tabernus consideration in equity rather than cash.

Despite gaining 46% since the July trading update, Blancco is trading at a discount to all peer groups on an EV/sales and EV/EBITDA basis. On a P/E basis, it is trading broadly in line with UK peers and at a discount to US peers. Its forecast revenue growth and EBITDA profitability are towards the lower end of its peers. Evidence that the focus on the three key markets is accelerating revenue growth should provide support to the share price.