EQS Group — Compliance with growth story

EQS operates in three interrelated segments: corporate communications and PR; investor relations; and governance, risk and compliance. Initially a provider of products and services, it is transitioning to be a technology partner to the corporate sector, providing tools that enable relevant individuals within companies and organisations to meet their regulatory and compliance obligations and handle investor relations efficiently. Rooted in meeting the needs of the investor relations and company secretariat functions, EQS is bringing together its various offerings on a single cloud-based platform, allowing it to expand and scale. The digital governance, risk and compliance market is developing rapidly, with the group anticipating double-digit market growth in this segment. There are no major incumbents in Germany or Europe.

Management identifies three key growth drivers; regulation; digitisation; and geographic expansion. Corporate legislation and regulation can be seen as a barrier to business, a necessary annoyance or an opportunity to instil best practice. The regulatory environment is increasingly complex, with onerous repercussions, both financial and reputational, from getting it wrong. The growing emphasis on building capital markets that benefit all stakeholders and not simply shareholders broadens the potential sphere of governance activity. EQS’s tools are designed to make compliance with regulation as painless as possible. Offering digital workflow solutions fits well with established trends. Geographic expansion is focused on being in the right place to serve client needs. The group has a very strong presence in German-speaking territories and in Russia, growing business in the UK and US, interests in Asia and has more recently launched in France. EQS has grown historically through a combination of organic growth and acquisition.

In its earlier development phase, EQS focused on the digitisation of corporate communications. Its more recent efforts are focused on expanding its offering in the governance, risk and compliance field. To take advantage of the time-limited opportunity, it has pursued a major project to build a scalable cloud-based platform, first announced in September 2017. The extent and cost of the project grew through 2018 and earning guidance for that year was reduced, with FY18 the peak investment year. Returns on the investment programme have been slower to come through than initially hoped with fewer IPOs and as elements of the project were delayed, with sales behind budget. Spending plans for FY19 and FY20 were lowered with the Q319 results. FY20 should show improving ROI, with the potential coming through more strongly in FY21.

On revised FY19 guidance, we lowered our estimates and now expect FY19 EBITDA of €2.6m (from €3.1m). A reverse DCF, using a WACC of 8% and terminal growth rate of 2% beyond 2025 suggests the current share price is discounting a CAGR for revenue from FY21–25 (ie beyond our current forecast period) of 18% and an EBITDA margin building steadily to 20% throughout this period. The revenue growth rate is at the lower end of management’s expectations, while the EBITDA margin of 20% is significantly below the 30% expected by FY25. If we were to assume revenue growth of 20% (the higher end of management’s target) and that the EBITDA margin steadily increases to that 30% by FY25, the DCF value would increase to c €113.

EQS is one of the largest global providers of digital solutions for investor relations, corporate communications and compliance functions. These are products designed to automate and simplify processes for those individuals working on the technical administrative aspects of running a corporate concern, enabling them to meet all regulatory requirements and freeing up their time to deal with matters that require more than simple information processing. By ensuring the product suites provided are constantly updated for the latest regulatory compliance changes and are delivered via intuitive interfaces, EQS should continue to add value for its users. Originally centred on investor relations (which in Germany and some other markets includes functions covered in other jurisdictions by the company secretary or equivalent), the group’s products and services have been expanded across the related areas of governance, risk and compliance. The definition of investor relations (IR) includes financial and corporate communications, particularly in the form of news feeds, websites, webcasts and media. The compliance part of the group provides the technical (cloud-based) infrastructure for corporate clients to fulfil their legal and regulatory requirements.

The group was founded in 2000 in Munich, initially building a strong market position in its home markets of Germany, Switzerland and Austria before starting to build its presence in overseas territories. EQS looks to position itself as a partner with its client companies, working alongside them to solve issues and reduce inefficiencies, rather than simply as a supplier whose interest may not extend beyond the initial sales timeframe, with a growing emphasis on providing software-as-a-service (SaaS). The shift away from paper-based information to digital channels of communication between corporate entities and their various stakeholders is a key driver for growth. The honed business model is focused on building subscription and annually recurring incomes as a proportion of the whole, increasing the quality of the earnings.

EQS’s solutions and services enable over 21,000 companies worldwide to fulfil complex domestic and international corporate information requirements securely, efficiently and on a timely basis. It has expanded both organically and by acquisition. The acquisition of ARIVA in July 2016 broadened the target markets to include financial institutions, but this concern was sold in July 2019 as it no longer fitted neatly with the corporate strategy. In Q317, EQS acquired a stake in the owner of the fourth-largest US news service, Accesswire, and in December that year bought Swiss-based Integrity Line (€5.0m), a leading provider of cloud-based whistleblowing systems.

For Q319, it employed an average of 364 people, up from 346 in Q318 (pro-forma numbers post the disposal of ARIVA from 1 July 2019). Its headquarters are in Munich, Germany, with further offices in Hamburg and Kiel and in Zurich (Switzerland) and Moscow (Russia). In December 2015, the group purchased Obsidian IR in the UK (price undisclosed), giving it a foothold in that market. In the Far East, the group has operations in Singapore and Hong Kong. More recently, it opened offices in New York and Paris, giving it the global network needed to enable it to offer the solutions sought by some of the largest multinationals. The group’s technical operations are based in Munich, Germany, and Kochi in India. The largest number of employees (between 150 and 200) are involved in web, back-end, platform and software development. There has been a substantial project to upgrade the EQS COCKPIT cloud-based platform through FY17–20, with a total project investment of €8.8m (recently revised down from €9.3m).

The German market accounts for most of group revenue, as shown above. For Q1–Q319, domestic revenues were up by 9% (adjusted for the ARIVA disposal), with international revenues ahead by 19% on a client base of 1,188, up by 21 on the previous quarter. The US is an increasingly important part of the mix, with the Integrity Line offering opening more doors. The downside is that the larger requests for proposal that EQS is being invited to join inevitably require more time and expense to prepare, while having a more extended conversion cycle. The strong reputation that German firms have for technology, data management, security and organisational skills gives EQS an advantage that helps offset its relatively small scale. EQS’s offering is not restricted to any particular sector verticals and clients of note include Bridgestone, Puma and Glencore.

The group reports in two segments: IR and Compliance. The IR segment includes financial and corporate communications products, in particular news, websites, webcasts and media. Compliance encompasses all products that companies require to fulfil legal or regulatory obligations. These include reporting and publishing obligations (Disclosure), filing with the German Federal Gazette (Filing), Insider Manager, Integrity Line and Legal Identity Identifier (LEI) workflows.

Under these definitions, around 80% of group revenues are defined as recurring (84% in Q319, rising to 86% for the larger German customers), being mostly related to cloud subscriptions or licences, such as news distribution, workflow modules, data services, webcasts and/or webhosting. The balance is accounted for by projects or set-up fees such for products, websites, platforms, reports and/or media.

EQS INSIDER MANAGER has now been rolled out to 14 countries and had over 650 clients at the end of September 2019. Integrity Line has already been sold into more than 200 clients. However, sales have been slower to build than hoped as it is primarily sold to larger organisations, which have more cumbersome procurement procedures. Work is ongoing on a similar but simplified solution for selling into SMEs.

These elements are combined within a dashboard that enables the client to assimilate and manage the various compliance aspects within one system, whereas they would previously have needed to be monitoring multiple applications. Within EQS’s framework through to FY25, Policy Manager and Integrity Line are projected to have the strongest growth trajectories, along with Insider Manager.

While growth in the individual elements within management’s projections are relatively modest (4% for IR tools, 9% for media), the real advantage for the client is in time and efficiency, holding all these aspects together in the cloud and managing via a dashboard.

The key short-term drivers in the governance and compliance arena are the last two regulations in Exhibit 4 below. EQS first introduced its whistleblowing system module in H217 as part of the broader Integrity Line service area. Recent modules fall mostly into the areas of CRM and policy management, along with a multimedia learning platform and quiz generator used for continuing professional development and compliance requirements.

While the broader corporate communications and PR market is estimated by The Holmes Report at over $15bn globally, the investor relations market is considerably smaller at approximately $1bn (source: IR Society). The former is estimated to be growing at around a 7% CAGR, while the IR market is likely to be growing at a more modest rate. The emerging governance, risk and compliance market is estimated by Gartner to be worth over $5bn (although with all these segments, the definitions can be hard to pin down accurately). Gartner’s assessment is that it is growing at a CAGR of 13.4% and is therefore a particularly attractive area for EQS’s involvement.

The Integrity Line module broadens the potential market for EQS’s products and services within all organisations with over 50 employees.

The group’s CEO is Achim Weick, who began his career at Commerzbank. Subsequently, he was co-founder of investor relations manager CMC Capital Markets Consulting. Achim is the originator, founder and largest shareholder of EQS and has been on the board since its foundation. COO Christian Pfleger joined EQS in 2001, initially as a client relationship manager, moving to project management from 2003. In 2007, he took over responsibility for products and services. André Silverio Marques, who fulfils the finance function, was appointed to the main board as CFO in July 2018, having been finance director since 2015. He previously ran the group’s Russian businesses and, before that, oversaw the IR, business development and corporate finance activities. The other key member of the management team is Marcus Sultzer, who joined the group in 2007 and oversaw business development in Russia and the CIS from 2009 and Asia-Pacific from 2013. As well as being international managing director, in charge of operations in Asia, Russia, Switzerland and UAE, he is the group’s chief revenue officer. Fuller biographies of management are given on page 12.

There are various factors that will influence EQS’s financial performance, each of which may vary considerably across the operating territories. The three key elements of the growth strategy – digitisation, regulation and internationalisation – are themselves all important sensitivities for the future financial performance of the group and are covered in the list of identified factors below:

The current restraints on profitability stemming from the investment programme make conventional peer-based valuation less useful, so we supplement this with a DCF-based approach.

As the internal investment is affecting profitability for FY19–20, the most reliable of the traditional multiple is that of EV/revenue (although we also show EV/EBITDA and P/E below). There is a wide range of multiples for the peer group. For FY1, EQS is trading at 3.1x sales versus the average for the entire peer group pf 11.3x. Excluding MarketAxess, which is trading at a high premium to the rest of the peers, the average sales multiple for the peer group is 9.0x and is still clearly substantially ahead of the rating accorded to EQS.

As noted elsewhere in this report, estimated sales growth for FY19 has been below earlier expectations, which has boosted this multiple. If the level of sales growth indicated by management is realised, then the discrepancy between EQS and the larger peer group would become even more marked.

For illustrative purposes, closing the discount on FY2 EV/revenue (excluding MarketAxess) would imply a share price of €200. Obviously, the comparative scale and early stage of business development warrant a considerable discount. A 50% discount would imply a share price of €95.

Management has outlined its views on the medium-term revenue growth outlook, with Compliance growing at a CAGR of 20–25% through to FY25 and IR growing at a more modest 10–15%. From the current mix (and assuming no further M&A), this equates to group revenue growth in a range of 16–21%.

A reverse DCF, using a WACC of 8% and terminal growth rate of 2% beyond 2025, suggests the current share price is discounting a CAGR for revenue from FY21–25 (ie beyond our current forecast period) of 18% and an EBITDA margin building steadily to 20% throughout this period. The revenue growth rate is at the lower end of management’s expectations, while the EBITDA margin of 20% is significantly below the 30% expected by FY25. If we were to assume revenue growth of 20% (the higher end of management’s target) and that the EBITDA margin steadily increases to that 30% by FY25, the DCF value would increase to c €113. Assuming a more modest 16% CAGR and increase in EBITDA margin to 25% derives a value of €74.2, around 20% above the current share price.

Our figures are all presented including IFRS 16. This is a relatively substantial adjustment for EQS, as set out in our note in May 2019, reducing operating expenses by about €1.8m annualised (nine months operating expenses were down €1.4m, depreciation was up a similar amount and financial expenses edged up €0.1m). The group’s 92% shareholding in ARIVA was sold in June 2019 and our forecasts were adjusted to strip out its contribution.

Management previously described FY18 as the group’s transition year and FY19 as the year of growth from the new COCKPIT. With this growth slower to materialise than had been envisaged, with a dull market backdrop (few IPOs, languid economies) and delays to the launch of some modules while they were optimised, management adjusted guidance for the FY19 full year with the Q3 numbers in November. The key specific elements cited were:

FY19 now looks to be more of a second year of transition. No guidance is given for subsequent years, beyond the ambitions outlined through to FY25e for both revenue and EBITDA. These imply a CAGR of 20–25% for the Compliance segment and of 10–15% revenue growth for Investor Relations, with EBITDA margins of ‘at least 30%’ in FY25. Revenue growth should be faster in the earlier part of this time frame, with the margin enhancement skewed later.

We have therefore lowered our forecasts to reflect the revised guidance for FY19, with consequent reductions in FY20 as it moves off a lower base than previously anticipated.

Our assumptions are based on management’s guidance for FY19 and for FY20 are underpinned by the build-up in annually recurring revenues (ARR). Market growth within the IR business is estimated at a CAGR of 2.6% through to FY25 (source: The Holmes Report), with IR Magazine putting the CAGR for the corporate communications and PR segment at 7% over the same period. Governance, risk and compliance is clearly the fastest-growing market segment, with Gartner estimating a CAGR of 13.4%.

The internal targets (shown below) are in excess of market growth, partly as a function of growing from a small base and partly by EQS’s offering being an integrated, cloud-based solution designed from scratch rather than a piecemeal solution adapted to purpose.

We show the recent quarterly progression below, with the implied Q419 figures.

The contribution of ARR to the whole is steadily increasing, improving the quality of earnings. At the end of September 2019, around €2.2m of newly acquired ARR was on the books – a figure that had risen to €2.8m by mid-November (compared to a target for the full year of €4.0m, now revised to €3.2–3.6m). ARR would typically form 80% of revenues across the COCKPIT (plus webhosting and webcast), with onboarding revenues forming the balance (set-up plus media)

Costs, however, have been well controlled, with the level in Q319 roughly equivalent to that at Q218. In Q319, pro-forma revenue (stripping out ARIVA) was up by 15% year-on-year, while (pro-forma) total expenses grew just 1%.

With the maturing of the main COCKPIT project, EQS has been able to shift the balance away from freelance resource and to reallocate internal staff more efficiently. The cost of freelancers is included in the accounts under ‘purchased services’ and these have been reducing from Q219. Improvements and upgrades to the platform will continue but can be done at a less frenetic pace. With a more stable workforce, staff efficiency and productivity should also improve.

The group’s cashflow has been dominated by the spend on the cloud programme, including the COCKPIT project, which now tails off as shown below. We are modelling a group maintenance capex level of €1.5m in future years to ensure the offering remains pertinent to client needs.

M&A has also been a regular feature, bringing in new spheres of operation and broadening the geographic reach. The main element of the M&A line in FY19 will have been the proceeds from the disposal of the ARIVA stake, which led to an extraordinary gain of €2.3m (€2.2m adjusted for interest).

The growth in the proportion of ARR obviously has a beneficial impact on earnings visibility and on EQS’s working capital profile. The overall working capital position for FY19 is distorted by the ARIVA disposal, but our modelling assumes the net change over the year will have been around neutral. For FY20, we are forecasting a small working capital absorption of €0.2m. Free cash flow of €1.0m in FY19 improves to €2.2m in FY20 under our modelled scenario.

At end September, EQS had net debt of €13.0m, a figure swollen by the inclusion of the leases under IFRS 16. Stripping these out, the figure would have been €5.6m, against an equity base of €26.9m. Our model indicates a small further increase in net debt across Q4 to end the year at €15.4m, before starting to decrease through FY20. We model €14.0m of net debt by the year-end.

The group has guaranteed working capital lines of €3.0m (€1.4m drawn at end Q319). Structured debt is in the form of five-year fixed interest-bearing loans. The weighted average interest charge on these was 1.41% at the time of the last full accounts in FY18.