GB Group — Update 1 July 2016

IDscan provides software that reads and extracts biometric information from documents (eg facial recognition, finger prints) to validate the authenticity of this information automatically. The company was founded in 2003 and currently has 77 employees across its offices in London, Lithuania, Turkey and South Africa. The two founders have committed to remaining for 18 months post completion.

IDscan’s Optical Character Recognition (OCR) technology enables image and video capture (interactive photographs to ensure faces are ‘live’) and conversion into editable and searchable data, which can then be authenticated by being matched to its database. This process takes approximately five seconds to complete. The technology enables self-certification by users, removing the need for passwords (processing occurs on the phone, no personal data need to be transported).

Biometric capture and validation is an increasingly important component in many compliance or security checks. IDscan’s main markets are in customer registration, Know Your Customer (KYC) and fraud prevention; it has a number of high profile clients (Credit Suisse, Santander, Tesco and Scotland Yard, among others).

In its year to July 2015, IDscan’s revenues increased by 134% to £7.6m, gross margins were stable at c 80% and it reported EBITA (GBG basis) of £3.2m.

Expanded product offering: the use of biometrics for ID validation is a rapidly evolving industry. By adding biometric data identity capture and verification software, GBG is strengthening its positon in the ID registration, AML and fraud detection markets.

Proprietary software: reduces GBG’s reliance on third-party software. Following this deal, GBG will become the only proprietary technology provider (rather than provided by partnership) of document, biometric and global identity data validation and identity verification solutions.

Cross-sell opportunities: with little overlap in the customer base, it opens up additional cross-selling opportunities across 13 geographies. The platform is scalable and GBG plans to step up investment in additional sales staff (currently only the CEO is focused on outbound sales) to accelerate the group’s already strong growth.

IP: buying a company with biometric software capabilities and experience provides GBG with IP in an emerging sector.

GBG will pay £37m in cash, plus up to £8m contingent on IDscan’s revenue and EBITDA targets over a 12- to 18-month period. To finance the acquisition, it has issued £25m of new equity (9.1m shares at a price of 275p), put in place a new £12m facility (Libor plus 1.5% interest rate) and will draw on its own cash reserves; GBG has strong cash conversion and had net cash of £8.7m on its balance sheet at 31 March 2016.

For the year to July 2015, IDscan reported revenues of £7.6m (+134% y-o-y), gross margin of 80% and £3.2m of EBITA (adjusted to be consistent with GBG’s policy of expensing the majority of R&D expenses). The business is in the process of transitioning from a perpetual licence model to a repeatable licence model, which would make revenues more predictable but has affected growth over the last year. Of the existing contract base, approximately £3.2m of revenues are on the new repeatable model.

As the transition to repeat licences completes and supported by a stronger direct sales effort, as well as cross-promotional opportunities across GBG’s global footprint and client base, we expect a strong growth profile from IDscan to resume. We estimate that IDscan will contribute sales of £5.1m to GBG in the year to March 2017 (nine months’ contribution), rising to £10.1m in FY18 and £12.6m in FY19. We assume operating margins remain at approximately 30% given the accompanying investment. In addition, there are likely to be some small software savings as GBG will no longer need to license the use of this software (although we have not explicitly forecast this).

Management expects the deal to be earnings accretive within 12 months. We upgrade our GB Group forecast to include the proposed acquisition. Thus we increase our EBITA forecasts by 10% and 17% in FY17 and FY18 and our EPS forecasts by 4% and 8% respectively. We present a summary of our forecast changes below, with full forecasts at the back of this report.

On a post-deal P/E of 29.5x FY17e, falling to 25.0x in FY18e, while still at a premium (c 25%) to peers (all of which are lower growth), GBG’s rating is the lowest is has been for a year.

While the shares are already recognising good prospects, based on the group’s current momentum, management’s track record in creating value from acquisitions and the group’s own strategic value in a consolidating market, we believe this premium value is justified. Investors should also consider the following:

Strong position in a growing market: following a string of high-profile identity data breaches over the last three years, companies are devoting more resource to staying ahead of potential fraud, supporting a strong market backdrop for identity data services. GBG is one of the largest providers of identity data intelligence in the industry and one of the few truly global data identity intelligence companies. It has three global offers and can verify c 4.3 billion consumers globally, with KYC and AML standards reached in 40 markets; 26% of GBG’s revenues are from outside the UK.

Good acquisition track record: GBG has made nine acquisitions over the last five years, adding capabilities, data sets and client reach, as well as driving revenue and cost synergies; DecTech, for instance, has seen growth accelerate from 5-10% to 20-30% since acquisition, and has facilitated the launch of new products internationally (eg the fraud bureaus). The acquisition of IDscan is in line with this strategy. Although management does not disclose its valuation criteria, acquisition multiples to date are consistently below its own rating and all deals have been earnings accretive by year two. GBG’s proposed acquisition multiple for ID scan is 14.7x FY18e, assuming 100% of the earnout is paid.

Accelerating organic growth: acquisitions of this nature, with cross-promotional possibilities, serve to stimulate organic growth across the group: In FY16, organic growth continued to accelerate (16% in FY16 vs 15% in FY15, 10% in FY14) and, at the time of its results, management indicated that momentum and prospects remain strong. Deferred revenues at the year-end of £13.8m represent c 16% of our FY17 revenue forecast. Furthermore, two notable new projects – the GOV.UK Verify platform and retailer fraud bureaus – have launched recently and should contribute to revenues incrementally as the services scale during FY17.

Strong balance sheet: the market for data and capability remains fairly fragmented internationally and, with a strong balance sheet (post this acquisition and fund-raising, we forecast FY17 year-end net cash of £2.1m), high EBITDA to operating cash conversion and a £50m revolving credit facility in place (incorporating a £20m accordion option), we expect GBG to continue to be on the lookout for opportunities to add data and capability that can be deployed globally.

Brexit view: GBG should be fairly resilient to the impact of Brexit. Approximately 70% of revenues can be considered recurring, providing good revenue visibility during times of economic uncertainty. We consider growth to be more structural than cyclical and GBG is executing well on its strategy to gain share in this growing market through its own organic initiatives, in parallel with an active acquisition pipeline. 26% of FY15 sales were generated overseas and a 10% depreciation of sterling would add approximately 1% to pre-tax profit.

CEO Richard Law: plans to remain at GBG for as long as necessary to ensure a smooth transition to the incoming CEO.