EQS Group — Update 8 September 2016

EQS is a leading supplier of digital products and services that help corporate clients communicate with their stakeholders, in particular in the elements of financial communications and regulatory disclosure. By offering highly automated tools, often cloud-based, the group helps its clients streamline their investor relations (IR) functions. It also has the creative capabilities to design and build websites and apps and present reports in digital and interactive formats, so offering a one-stop shop. Founded and headquartered in Germany, EQS has spread its activities firstly to Russia, then to Far Eastern markets. More recent acquisitions have extended its reach in Switzerland and given a good foothold in the UK, while a small office has also been established in the US. This gives the group a global network from which it can target larger clients and build its SaaS revenue streams.

EQS is in the invest-buy-build phase of its corporate development plan and, as such, is not yet generating the revenues or the returns that its increasing scale might justify. Comparing multiples directly to established global businesses is therefore inevitably going to show the group at a disadvantage. We have added into the mix the multiples attributed to software companies working within the financial and business support verticals. Using blended historic and forward EV/revenue and EV/EBITDA multiples, EQS is trading at a discount to peers of over 25%. Applying a discount of 15%, which would be more appropriate for the group’s relative development stage, implies a share price nearer €50. Sense-checking this against a reverse DCF implies a WACC of a little over 8% on a terminal growth rate of 3%, which seem to be conservative assumptions.

At face value, the results for H116 show a business with revenues rising but costs growing at a faster rate, with affected cash flow. The broader picture is quite different. This is a group in an expansionary phase, when alignment of overheads and revenue does not always fall concurrently. The effect was exaggerated by timing of regulatory changes, whereby disclosure requirements that had delivered bread-and-butter revenues in the German market were reduced, while the new EU Market Abuse Regulations, which should stimulate strong and profitable growth, were introduced after the period end. Guidance for the full year show management’s expectations of good progress in revenue and pre-tax profits, with a strong rebound in EPS. Our model shows FY17 to be also moving ahead strongly, with dividend growth in both FY16 and FY17.

The Regulatory News and Information segment is a volume-driven business, dependent on the regulatory frameworks and the number of regulatory announcements being generated – itself a function of the number of companies required to issue such information. While there has been some reining in of disclosure rules on quarterly reporting and voting rights, the general impetus is towards greater levels of disclosure. Moves to promote transparency in corporate activity have made the task of communication more onerous, and solutions that offer integrated and efficient dissemination should continue to attract clients. The increasing use of digital over paper-based communications gives potential for companies to develop greater levels of engagement with their stakeholders. Expansion into overseas markets is increasing the inherent risk in the business model but is potentially transformative.

EQS is one of the largest global providers of digital solutions for investor relations and for broader categories of corporate communications. These are products designed to automate and simplify the work processes for IR professionals, enabling them to meet all regulatory requirements and freeing up their time to deal with the messaging of their company’s equity story and strategy rather than on information processing. By ensuring that 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.

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 out 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 and is a trend unlikely to be reversed.

EQS has expanded both organically and by acquisition and now employs around 300 people (including those brought into the group with the consolidation of ARIVA) of whom the largest number 100 are involved in web, back-end, platform and software development. Its headquarters are in Munich, Germany, with further German offices in Hamburg and Kiel and offices in Switzerland (Zurich) and Russia (Moscow). In December 2015, the group purchased Obsidian IR in the UK (price undisclosed), which gave a strong foothold in that market on which to build. In the Far East, the group has operations in Singapore, Hong Kong, China (Shenzhen and Shanghai) and Taiwan (Taipei). It also has an early presence in New York, which gives EQS the network it needs to enable it to offer the global solutions sought by some of the largest multinationals.

The group’s technical operations are based in Munich, Germany and Kochi in India. EQS’s solutions and services enable over 8,000 companies worldwide (up from 7,000 this time last year) to fulfil complex domestic and international corporate information requirements securely, efficiently and on a timely basis. Its most recent expansion, increasing its stake in ARIVA from a 25.44%-owned associate to 50% plus one share, has added capabilities in the production of documents for packaged retail investment and insurance-based products (PRIIPs), further broadening the target markets to encompass the financial institutions. A fuller description of the ARIVA business was given in our recent note on the transaction (Update 20 June 2016).

The group reports in two segments, Regulatory Information and News and Products and Services. It has historically broken the latter down into three constituent parts (Reports and Webcasts, Websites and Platforms and Distribution and Media), as illustrated in Exhibit 1 below. We have added a full year of ARIVA revenues for context, although in FY16 the figures will only be consolidated for H2, as the purchase of the additional shares was completed in June 2016.

Regulatory Information and News: the group’s original core product, DGAP is a mechanism for corporate clients to fulfil their statutory disclosure obligations (broadly equivalent to the RNS service offered by the London Stock Exchange in the UK). It has added products and tools for wider categories of corporate communications. These include developing corporate websites and apps, producing online reports (report and accounts, but also other categories of reports such as those for sustainability or on CSR) and producing, editing and hosting audio and video webcasts. Social media channels are also included, in line with increasing client usage. Most recently, EQS has added modules to cater for new and enhanced regulatory requirements for monitoring Insider information flows. EQS also provides services in financial marketing, collating data and other relevant content, as well as developing financial portals. These elements of the offer have been developed to sit alongside the original core service DGAP, which is the dominant supplier in its home markets, providing news dissemination services to issuers of equity and debt/bonds. This business is eminently scalable, predicated on high volumes of announcements and delivers a good operating margin (26.5% in FY15, 24.1% in FY14), although in the current financial year, this is being supressed by the additional investment costs. Guidance given with the H116 results reiterates that, once the investment phase is through, margins should be returning to their historic levels.

EQS has effectively developed its product suite to align with the work processes of IR managers within corporates, simplifying their tasks. Various information streams can be brought together within one unified dashboard described as the EQS COCKPIT, building on concepts introduced to the group with the acquisition in April 2014 of TodayIR, based in Hong Kong, which added over 400 clients. The EQS COCKPIT can be integrated with the client’s own contact management and can distribute to the relevant information platforms as well as the regulatory authorities.

Within Products and Services, the Reports and Webcasts service offers XML and digital reports that can offer a more flexible approach and enriched content than a traditional paper-based report. The relevant information can be ‘sliced and diced’ into different formats according to client need. The XML format is a particular requirement in the German market for delivery of reports to the Federal Gazette. Both video and audio webcasting is also offered for company meetings and updates. Websites and Apps can be specific IR embedded microsites or the whole of the corporate website and the group has a good (prize-winning) reputation for the quality of its creative input. Websites can include interactive charting tools and stock information, designed to the client requirements. EQS offers services for optimising existing sites for mobile channels but also designs both Apple and Android apps delivering the content optimised for tablets. The purchase of UK-based Obsidian IR added further capabilities that mesh well with existing group products, but, more importantly, gave a good foothold in the sizeable market, opening doors to selling the broader SaaS services.

Operating margins across Products and Services have historically been lower than for Regulatory Information and News (6.0% in FY15, 12.4% in FY14).

When we initiated coverage of EQS a year ago, the growth strategy was predicated on increasing the range of products and services and rolling them out across different territories. These were itemised and (briefly) discussed in our initiation report, September 2015. To a large extent, the core of the growth strategy remains unchanged, but the increase in the scale of the operations has meant that management is able to lift its gaze and look at the more fundamental drivers of the next few years of growth opportunities. These fall into the three factors identified in the heading above (which are also itemised within the Sensitivities analysis below).

Digitisation. As the business of corporate communications has become more complex, with different stakeholders with often very different requirements in terms of style and content, the attractions of digitising and automating as much of the process as possible are becoming ever more apparent. The tools that EQS has built to service this market have been designed to relieve the IR or Communications teams of as many of the routine elements as possible, with the COCKPIT (described above) allowing the client control over what is integrated. Driving the SaaS sales should protect from avoidable client churn and improve the quality of the group’s earnings, as well as delivering a higher margin than one-off sales with a high element of customisation.

Regulation in financial markets changes regularly. There is some deregulation, such as the reduced requirements for publicising changes in voting rights in Germany, but considerably more in the way of tightening and extension of existing regulation, as well as the imposition of new requirements on corporate entities. With the rise of the larger asset managers, cash is increasingly seeking out investment opportunities globally and there is a correlated increase in expectation that investor protection will be in place in some form. The impact of changes in regulation can be a major factor. Well flagged, the reduction in the requirement to issue quarterly notifications in some circumstances following the introduction of the EU Transparency Directive, had a marked impact on EQS in H116, with 46% fewer such announcements in H116 when compared to H115. There was, however, an increase in voluntary communications, which partially offset the decline of news volumes released through the COCKPIT. The second half of the current year will benefit from the introduction of the EU’s Market Abuse Regulations, which came into force in July 2016. This extends the obligations to unlisted securities, opening up a new potential market area for EQS, one where those responsible will have less working knowledge of the day-to-day requirements imposed. Even for experienced IR professionals, the responsibilities are onerous and the risks of not complying with the requirements are heavy both in terms of finance and individual careers. This is helping to drive sales of contracts for INSIDER MANAGER product, growing the group’s SaaS revenues.

Internationalisation. Being the market leader in its home markets, the potential for growth was self-evidently restricted. The steps into other markets, primarily through acquisition, have been taken carefully over the last few years, with the aim of building a global network of business that serve clients within their domestic markets and those larger, and/or global, concerns, that want to have consistency between the markets in which they operate. EQS needs both global capability and local expertise. This requires local offices and local knowledge, which obviously has cost implications. However, by centralising the technical development and support functions, these capabilities can be leveraged across the network.

The group’s CEO is Achim Weick, who began his career at Commerzbank. Subsequently, he was co-founder of the 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 on to project management from 2003. In 2007, he took over responsibility for Products and Services. André Silverio Marques, who fulfils the finance function, previously ran the group’s Russian businesses. Before that, he was in charge of the IR, business development and corporate finance activities. The CEO Asia-Pacific is also a key team member. He is Marcus Sultzer, who joined the group in 2007 and was in charge of business development in Russia and the CIS from 2009. Fuller biographies of management are given on page 12.

The opportunity that EQS has to build its business ultimately depends on the number of listed companies across the global markets in which it operates. This is obviously a function of new listings, offset by de-listings, which have been a feature of the more mature markets. A company going through the IPO process is potentially the most remunerative client for EQS, as it may well be putting in place investor communication for the first time, therefore offering several possible income stream opportunities.

EY issue a regular report, ‘Global IPO Trends’. The latest issue for Q216 shows that IPO activity picked up by 29% in volume and by 120% in total capital raised over Q116. A total of 246 IPOs raised US$ 29.6bn in aggregate. Despite this improvement, the total for the first half of the year fell well short of that for H115, with volumes down 38% and the total raised down by 61%. More than half of the IPOs in H116 were in the Asia Pacific region, highlighting the perspicacity of EQS’s investment in this region, particularly given the lesser dominance of the major US competitors.

The scale of de-listings generally reflects the health of local economies, but mostly the relative pricing of equity versus debt funding. Looking through the statistics compiled each month by the World Federation of Exchanges, the retrenchment has been most marked in the most mature markets; notably the NYSE, London Stock Exchange and Deutsche Börse. The pace slowed on the Deutsche Borse when the legal requirements surrounding de-listings were tightened in H215, as is clear from the table above.

There are a number of factors that will influence EQS’s financial performance, each of which may vary considerably across the operating territories. The three key element 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:

Events, such as 2015’s turbulence in Chinese markets (which led to a temporary suspension of new listings), may lead to further intervention to promote more professionalism in the market and a higher degree of institutional ownership, particularly from non-domestic investors. This could be helpful for EQS as local providers are less likely to have the relevant expertise to guide corporate clients.

Beyond these external factors, the group has internally generated sensitivities, which fall into the broad categories of system risk, personnel risk, geographic risk and acquisition risk.

As previously, we have appraised EQS’s valuation against peers then looked at the resulting data for a sense check against a DCF under various WACC and terminal growth rate scenarios.

We have looked at the valuation of EQS in comparison to three peer categories: global technology software companies in business services (principally US based); business-to-business media companies, principally based in Europe; and financial publishing companies (Thomson Reuters, Envestnet, Morningstar and Dun and Bradstreet, with the addition of FactSet).

The market valuations of technology software and financial publishing companies are broadly similar (following underperformance of the first of the relevant tech stocks, which last year traded at a considerable premium). Both are valued by the market at greater multiples than those for the B2B media stocks, which are dominated by the large exhibition companies.

All three groups, though, are trading at higher valuations than EQS, although its business model has elements common to all of them, particularly in communications and delivery mechanisms.

Obviously, EQS is less well known than the companies we are comparing it to, particularly outside its original home markets of Germany, Austria and Switzerland, with a shorter record of delivering against objectives. With less liquidity in its shares, applying a meaningful valuation discount is sensible and we view 15% as a reasonable assumption. Using the software companies as comparators would suggest that the price could move up towards €51 as the group builds a record of delivering returns on the ongoing expansion investments. The current share price puts the valuation roughly on a par with the more mature B2B business models, while against the financial publishing companies €53 is the equivalent valuation. The average of these three sectors is €49.

The numbers generated in the above comparison fall comfortably within the range implied by our reverse DCF analysis, below. The longer-term growth rates are assumed from 2019 onwards. With sales growth momentum picking up following the investment programme, it is reasonable to look at the higher rates shown in this excerpt table. At a 3% terminal revenue growth rate, the WACC being implied by the prices given by the peer comparisons above is in the region of 8.0%. As the group has a low historic Beta (0.53 per Bloomberg) this looks to be a conservative valuation.

Our forecasts were revised on the increase in the ARIVA stake (see our note of June 16). The publication of the H116 results has not required us to make any further changes. ARIVA is built into the H216 numbers, then for a full year in FY17e.

Due to the PRIIP business, we have allocated ARIVA into the Regulatory Information and News segment, although there is clearly an argument for adding it to Products and Services. Clarification will come with the Q316 figures, when we will change the breakdown if necessary.

The changes in regulatory requirements regarding voting rights disclosures had a significant impact on the volumes of announcements processed and made in H116. However, the financial impact within the table above is masked by the consolidation of the Tensid AG acquisition, which is included for H116 and which generated €504k of revenues in the period. Stripping this out shows first half revenues broadly flat H116 on H115. The increase in operating expenses, shown clearly in Exhibit 6, reflects the investment being made in both product and overhead. Further modules were developed and added in to the COCKPIT suite, including the INSIDER MANAGER, which is set to benefit strongly from the introduction of the Market Abuse Regulations from H216, with a full year in FY17.

With the Products and Services segment, growth had been very strong – obviously off lower comparatives – in the first half of 2015, slowing in H215 as media planning revenues tailed off. Moving into FY16, the order situation improved, with good growth in Asian revenues and the first contributions from the Obsidian purchase. These aspects have more than helped to offset the detrimental impact of reduced regulatory requirements on submitting reports. As with the other segment, the costs of expansion have weighed heavily on short-term margins, although the lift in the top line is already starting to leverage the return.

Putting the segments together and looking forward, Exhibit 7 clearly shows that there is revenue momentum across the business, with the inclusion of ARIVA for a full year in FY17e propelling the RI&N segment to revenue parity with Products and Services. If, however, the Q316 numbers when published show ARIVA within Products and Services, the latter will represent c 70% of group revenues. Our forecasts are unaltered from those published in June and remain consistent with company guidance for FY16e, which is for revenues within a range of €23.0m-23.9m and for non-IFRS EBIT of €3.4-3.6m.

Costs of expansion are obviously affecting the margin, but are a necessary part of moving towards the goal of establishing a credible global supplier of digital IR and communications solutions to the corporate sector. In the absence of further step changes of scale, the implication is that margins should start to rebuild from a base in FY17e, with no structural reason why they should not revert to the 20-25% level over the medium term, particularly if the proportion of SaaS sales within the revenue profile continues to build as management envisages.

With the process of news dissemination highly automated, the Regulatory Information and News element of the business is particularly cash generative. Operating cash conversion for the five years from 2013 through our forecast modelling horizon to 2017 comes out at 106%. This has enabled the group to fund the acquisitions of TodayIR in April 2014, Obsidian IR (December 2015) and the increased holding in ARIVA, as well as investing in building its business in the Far East and opening its first office in New York. The ARIVA price was undisclosed beyond that EQS has paid less than it did for its original 25% stake (acquired in 2007). 25% of the purchase price was funded from its own resources, with the rest through an acquisition loan by Commerzbank Munich. Despite the net costs of this loan (we assumed an additional €20k interest), the deal should enhance EPS and we raised our FY17e forecast by 12% on the acquisition in June.

The current heavier investment phase is curtailing debt reduction for now, but should help drive the businesses top lines and achievable operating margins.

Our forecast equity dividend for FY16e is 2.1x covered by normalised earnings, cover improving from 1.5x in FY15, the year that is expected to have seen the nadir for the EPS.

The bulk of the balance sheet is made up of intangible assets, as would be expected in a business of this type. At the half year, total assets amounted to €31.4m, of which €21.0m were intangible, the majority of which is goodwill. Financial liabilities at 30 June 2016 totalled €7.8m on coupons varying between 1.00% and 1.85%, with tranches of €1.5m falling due in each of 2018, 2019 and 2020, which should all be comfortably covered by cashflow. Net debt at the half year was €5.9m and our modelled forecast for the year end stands at €7.1m, starting to fall back in FY17e as the returns from the investment start to pay back. This peak level of debt represents 1.8x EBITDA for FY16e, with year-end forecast gearing standing at 39%.