Learning Technologies Group — FY18 trading is ahead of management’s targets

Group revenue grew by 84% to £52.1m, including 36% organic growth and 35% on a constant currency basis. After stripping out the impact of the high-value and lumpy CSL contract, which took most of its costs in FY16 and experienced peak revenues in FY17, underlying organic growth was 20%. Recurring revenues were 39% of the total, or c 42% if NetDimensions was included for the entire period. 46% of revenues were generated outside the UK in FY17, up from 36% in FY16 and 12% in FY15. Adjusted EBIT increased by 102% to £14.0m, implying that H2 operating margins were 32.4% against 19.2% in H1, largely reflecting the fact that the business is H2 weighted, notably in software licence sales, but also reflecting synergies generated from the NetDimensions acquisition. Operating cash flow more than quadrupled to £12.0m, and the group ended the year with £1.0m of net cash. The annual dividend was increased by 43% to 0.30p. Despite the rise, the dividend cover increased from 5.6x to 6.9x, leaving ample room for dividend growth.

LTG introduced a “revenue by nature” analysis with its H1 results, and now splits the business into two reporting units: Platforms and Content & Services. Platforms accounted for £21.6m or 41% of FY17 revenues, up from £8.9m (31%) in FY16 due to the strong organic growth and the acquisition of NetDimensions. The Platforms segment has 93% recurring revenues, reflecting a predominantly rental revenue model. While Content & Services operates on the basis of fixed-price projects, it has a very high level of repeat business due to high customer satisfaction.

This division includes LEO (generic blended e-learning solutions), Preloaded (developer of “games for purpose”) and Eukleia (specialist in governance, risk and compliance, notably financial services). The division generates higher margins than its peer group, due to the strong management focus on projects and ensuring the correct headcount. Further, management gets close to customers so it is comfortable with each customer’s expectations.

LEO now has offices in London, Brighton and Sheffield in the UK, New York and Bloomington, Indiana in the US, and through its Brazilian joint venture, in Rio de Janeiro and Sao Paulo. LEO has specialist sector expertise in automotive, retail and luxury brands, while Eukleia has specialist expertise in governance, and risk and compliance services, particularly in the financial services sector.

Preloaded is at the forefront of the ‘gamification’ of learning content, or more particularly ‘play with purpose’. In 2017 the company received accolades for its virtual reality learning experiences at the Science Museum and the Modigliani exhibition currently running at Tate Modern. In early 2018 it partnered with the BBC and Google to produce the BBC Earth: Life in VR experience to coincide with the launch of Google’s Daydream View headset. VR is at a very early stage in corporate learning, but these projects have created tremendous interest and invoke discussion with corporates. LTG will be targeting this medium to specialist areas when it adds real value and not generically.

During 2016 LEO, in partnership with KPMG, completed the roll-out of a new core curriculum to the entire UK Civil Service (CSL). This involved the development of 15 core curriculum areas ranging from leadership and management to EU practices and including ‘blended’ course design encompassing face-to-face training and e-learning content. The content was designed, built and launched in less than a year as part of a three-year contract to deliver learning to over 400,000 civil servants. LTG benefited from substantial revenues in 2017 as the courses were launched and adopted faster than management’s expectations. As a result of the revenue sharing structure of the partnership and the accelerated revenue generation during the year, the board anticipates that revenues will continue for the first half of 2018 and then drop significantly in the second half of 2018 and 2019, the last year of the current contract.

LEO is one of the world’s leading Moodle platform developers. Moodle is an open-source learning management system (LMS) platform used by organisations throughout the world. An LMS is a software application for the administration, documentation, tracking, reporting and delivery of educational courses or training programmes. LEO helps clients build new Moodle systems and provides ongoing support and service desk assistance to clients around the world, with particular success in the US.

For FY18, the target for LEO is a flat year, ie to replace the significant revenue dip in the CSL contract with new business.

This division includes NetDimensions (which in turn includes a leading enterprise LMS), Rustici (digital learning interoperability solutions) and Gomo (authoring tool for generating own content). The division has very high gross margins, typical of a software business, with the only significant cost of sales in hosting.

NetDimensions was acquired in late March 2017 for c £45.7m in cash (net of cash acquired) and has comfortably achieved the targeted $8m of cost savings. Its core solution is an LMS. NetDimensions specialises in so-called high-consequence industries, where there are stringent requirements for training and certification. Management budgeted for 90% contract renewals, but achieved 95% and there were 5% upsells as well. This success was a major factor in the strong January update and clearly reflects the benefits of being part of a larger group with a strong services offering. NetDimensions won new business with the analytics division of a global credit rating agency, which had been using several LMSs for different tasks. The rating agency selected NetDimensions as its sole LMS, covering all learners as well as the extended enterprise (eg customers and suppliers). During FY17, both Gomo and Watershed applications were integrated into the NetDimensions product offering.

Rustici has traded ahead of expectations, due to unexpectedly high sustained interest in its SCORM solutions. SCORM is a legacy collection of standards and specifications for e-learning that has been in place since 2001. However, the shift to xAPI, which is the new standard, has been slower than anticipated. This is mainly due to inertia in the industry since SCORM is so prevalent. However, the shift from legacy SCORM to xAPI in the e-learning industry is strongly anticipated by management. The belief is that the Learning Record Store functionality that xAPI provides, thereby documenting a learner’s journey, will help drive the transition to xAPI.

Gomo, the in-house developed authoring tool, grew revenues by 67%, albeit from a low base, and retention rates were 90%.

Watershed, which is 27.3% owned by LTG, is a start-up SaaS business that focuses on developing learning analytics. It has been growing strongly, albeit perhaps a little slower than anticipated due to the slower take-up of xAPI, and has been increasing retention rates. Management expects Watershed to turn cash flow positive in FY19.

In FY17, management implemented a “co-ordinated selling” strategy to help drive cross-sales across the business units. The impact of the successful account management strategy, which has resulted in broadening and deepening of client relationships, is reflected in the three charts in Exhibit 2. Notably, average revenue per customer jumped by 39% to £49k.

IFRS 15 will be applied from 1 January 2018. If applied to the FY17 figures, IFRS 15 would reduce both revenues and EBIT by £0.7m. This reflects the treatment for revenues at NetDimensions and Rustici, where some revenues that were previously recognised at the commencement of licence periods will now be recognised over the licence term of typically one to three years

Cash conversion (adjusted operating cash flow on LTG methodology divided by adjusted EBIT) remained high at 95%, having averaged 97% over the last four years, and management guides 80-90%. Operating cash flow quadrupled to £12.0m and free cash flow (after interest, tax and capex) jumped from £0.8m to £9.0m. After acquisition payments of £45.8m, equity raisings of £47.1m and dividend payments of £1.3m, the group swung from £8.5m net debt to £1.0m net cash. There are also outstanding acquisition liabilities that mainly relate to Rustici, of £5.4m that are scheduled to be paid over the next two years. As Rustici has been a highly successful acquisition, management is expecting to pay the maximum earnout for the business.

The company has stated that it has a strong pipeline of strategic acquisition opportunities and the appointment of Goldman Sachs as dual broker indicates that the group is keen to make larger acquisitions. The main objectives are to increase capability (adaptive personalised learning, social learning, content & video creation, performance management tools, talent management and systems & training), sector specialism (pharma/healthcare, energy and aviation) and geographical reach (US, Middle East, Asia Pacific and Europe). LTG is keen to find businesses where it can improve the operating model. The group limits its gearing to 2x EBITDA, which management states leaves it with c £40-50m capacity for acquisitions (after including the acquired EBITDA) before any equity financing.

LTG achieved its initial objectives, set at the time of the IPO in November 2013, more than one year ahead of plan. These objectives were for run rate revenues of £50m and EBITDA margins of 20% by the end of 2018. In October 2017 LTG announced new strategic objectives; to double run rate revenues to £100m and for run rate adjusted EBIT to exceed £25m by the end of 2020.

LTG has said it had a strong start to 2018 and is trading ahead of management’s expectations. Management reports that on a like-for-like basis, the order book is substantially ahead of the prior year, “bolstered by the increased proportion of multi-year licence sales and strong sales performance in Q4 2017”. FY18 is expected to benefit from a record order book, increased sales resulting from the group’s blended learning capability and sustained strong margins.

Management anticipates a tax rate of 17-18% over the next two years.

We have increased our FY18 revenues by 5% to £59.3m (which translates to organic growth of c 11%), while our FY19 revenues rise by 10% to £65.2m, for 10% organic growth. Our forecasts are before the application of IFRS 15, which the company plans to introduce with its H1 results (ie from 1 January 2018). Adjusted EBIT rises by 8% to £16.3m in FY18 and 8% to £18.3m in FY19, while EPS rises by 8% to 2.18p and by 7% to 2.47p. We forecast the group to end FY18 with net cash of £7.4m, rising to £15.4m a year later. We have assumed a tax rate of 17% in FY18, rising to 18% in FY20.

The stock trades on c 38x in FY18e falling to 34x in FY19e and to 30x in FY20e. Alternatively, the shares trade on 7.4x FY19e revenues and 24x EBITDA. While the valuation looks punchy, the investment case is supported by strong industry dynamics with the corporate e-learning industry growing at 10%+.

On our base case DCF scenario, when applying our forecasts and a 7% 10-year organic CAGR, along with 30% operating margins and a 9% WACC, we calculate a valuation of 52p, or 44p on a 10% WACC. However, we note that the group generated 35% organic growth in FY17, or 20% after stripping out a lumpy contract, and the outlook remains strong. Hence we believe our base case is very conservative and that sustainable15-20% organic growth has a good chance of playing out. When incorporating 15-20% organic growth rates over 10 years and 30% operating margins from FY19, our model suggests a valuation of 94p-136p when applying WACCs of 9%. The valuation calculation is highly sensitive to the WACC – the range would fall to 80p-114p if we increase the WACC by 1% to 10%. On our calculations, the current share price discounts an 11.7% WACC, based on 20% growth rates and 30% margins, or 9.4% based on 15% growth rates and 30% margins.

We also note that further value could be created through applying management’s strategically disciplined approach to acquisitions and exploiting cross-sales.