GB Group — Update 5 December 2016

The interim results were in line with the trading update on 20 October, which rebased revenue expectations for the year following a slower than initially expected take-up of the GOV.UK Verify platform, as well as a more modest organic growth rate than was previously forecast.

H1 revenues increased by 16% to £37.5m with a strong performance from IDscan, acquired in June, and like-for-like organic revenue growth of 11.4% (excluding the impact of GOV.UK Verify). Divisionally, Identity Proofing (IDP) reported growth of 24% to £19.2m and Identity Solutions (IDS) 8%.

The gross profit margin at 77% continues to benefit from mix effects with the DecTech fraud management services (100% margin) continuing to grow strongly and the consolidation of the higher gross margin biometrics business, IDscan, acquired in June this year.

EBITA of £5.2m (+15%) was slightly ahead of the guidance set of “at least £5m”. The higher gross margin and an earlier break-even from Loqate (acquired in April 2015) meant that despite the £2.4m increase in investment in the period into new product development, investment into the acquisitions and the realignment of the sales team along global product lines, the operating margin of 13.9% was broadly flat year-on-year (14.0% H116).

This largely converted into an adjusted pre-tax profit of £5.0m, or £1.6m inclusive of amortisation of acquired intangibles, share-based payments and acquisition-related exceptional items.

The impact of a greater share of revenues from Asia, especially China where payment days are generally much higher, and the impact of the take-on receivables at IDscan meant that the EBITDA to cash conversion, while strong at 77%, was lower than historic rates (90-100%). Additional procedures are being introduced in newer territories and at IDscan to speed up collection.

After the £36m IDscan acquisition, £1m final earnout payment for DecTech, £24m equity placing and the £2.8m dividend, the group moved into a net debt positon of £4m, although this is expected to return to a net cash position by the year end (all else being equal).

We make no changes to our estimates, which are summarised in Exhibit 1 and presented in full at the back of this report.

Management expects second-half growth to accelerate further with organic growth expected to be in the range of 12-14%, as well as anticipating a strong performance from IDscan, which leaves it on track to deliver consensus revenue forecasts of £89m in 2017. There are compelling reasons to expect growth to pick up further in the second half of the year and we make no changes to forecasts:

GOV.UK Verify – a slower start, but platform’s potential remains

The GOV.UK Verify service is a project the government hopes will help it save £1.7bn in administration costs by enabling users to be verified remotely for a host of services such as self-assessment tax submissions, driving licence applications, pensions and allowances, etc. This service will ultimately replace the current government gateway, which will be decommissioned in March 2018. The UK government has a budget of £450m over four years for three Government Digital Service (GDS) projects including Verify. GBG offers the service directly via its own brand CitizenSafe, and the Royal Mail has also chosen GBG to be the ID partner on its service, meaning GBG is powering two of the eight authorised service providers on offer.

The service launched during April 2016. However, usage has been slower than predicted by the government, with only 20-25% completion rates (vs 70%) in a commercial environment. This slower take up is being attributed to the fact that until the pre-existing gateway is decommissioned, there is little incentive for users to complete registration. Volumes are a quarter of the level expected by GBG and, while it is capturing a good market share, revenues are behind plan. Management has prudently decided that until it sees a stronger uptake it will not recognise revenues from CitizenSafe. We see this as a timing issue rather than a fundamental one and expect take up rates to increase. The investment that the group has made into its service, which adheres to the very high bar set by GDS in terms of security and identity verification, also puts it in a strong position to adapt the platform to other central government services or to governments in other markets (eg Australia or Canada). Ahead of the decommissioning of the pre-existing gateway, the next trigger point to assess take up will be the self-assessment deadline in January.

In light of the weaker than expected trading statement on 20 October, and ahead of the transition to the new CEO Chris Clark in April, a period of share price consolidation was expected. However, the shares have been marked down 25% since then and now trade on a current year (March 2017) P/E of 28x, decreasing to 25x next year, in line with the wider peer group average (27x and 23x, respectively, for a blend of identity and cyber security peers), despite higher revenue growth forecasts (Exhibit 2). Although they lack a short-term catalyst, we believe the shares, which in the past have tended to trade at a premium to peers, are attractive at the current level. Investors should consider the following factors:

Structural growth market: following a string of high-profile identity data breaches over the last three years, companies are devoting more resource to stay ahead of potential fraud, supporting a strong market dynamic for identity data services.

Wide portfolio of services: GBG now operates across the four key areas in identity verification: attributed (eg name and address, passport details, payment details, etc), behavioural (interests, likes, usage patterns), digital (device IDs, IP address, social IDs and cookies) and biometric (fingerprints, retina, voice and DNA). This makes GBG the only proprietary provider of both document and biometric identity data intelligence capabilities that we are aware of.

Global presence: 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 products with KYC and AML standards reached in 53 (40 in H116) markets and fraud solutions in 47 markets. 31% 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 (acquired in April 2014), 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 (June 2016) was also in line with this strategy and IDscan reports an enlarged pipeline since it has been integrated into the group. Acquisition multiples to date have been consistently below GBG’s own rating and all deals have been earnings accretive by year two.

Double-digit organic growth: acquisitions of this nature, with cross-promotional possibilities to an international audience, serve to stimulate organic growth across the group and, with a stronger H2 expected, FY17 should now be the fourth consecutive year of double-digit organic growth at GBG. Although the GOV.UK Verify platform has had a slower than anticipated start, we believe this is a timing rather than fundamental issue and this platform has the potential to become a material revenue generator in time for GBG. As all the investment in the development has been expensed, it should also become a high-margin revenue stream.

Strong balance sheet: the market for data and capability remains fairly fragmented internationally and, with a strong balance sheet (we forecast FY17 year-end net cash of £2.0m), 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. 31% of H117 sales were generated overseas and a 10% depreciation of sterling would add approximately 1% to pre-tax profit.

Transition to new CEO: on 13 October, GBG announced the appointment of Chris Clark as CEO, replacing Richard Law, who announced his planned retirement in April 2017. Clark will join from Experian (a customer, supplier and competitor of GBG’s) where he was MD of the UK, Ireland and EMEA division, before which he worked for 20 years at BT running various international technology-based businesses. He will join on 1 April 2017 and Law will remain at GBG to ensure a smooth handover.