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K3 Business Technology — Update 26 April 2016

K3 Business Technology — Update 26 April 2016

K3 Business Technology

Written by

Katherine Thompson

Director

K3 Business Technology

Scandinavian retail software acquisition

Acquisition

Software & comp services

26 April 2016

Price

349.0p

Market cap

£111m

€1.27:£1

Net debt (£m) at end H116

10.45

Shares in issue*
*Excludes 4.1m shares to be issued on 29 April

31.9m

Free float

78%

Code

KBT

Primary exchange

AIM

Secondary exchange

N/A

Share price performance

%

1m

3m

12m

Abs

0.7

0.4

53.4

Rel (local)

(1.7)

(5.5)

70.4

52-week high/low

373.50p

226.50p

Business description

K3 Business Technology provides Microsoft- and Sage-based ERP solutions and managed services to SMEs in the retail, distribution and manufacturing sectors.

Next event

Trading update

July 2016

Analysts

Katherine Thompson

+44 (0)20 3077 5730

Ian Robertson

+44 (0)20 3681 2523

K3 Business Technology is a research client of Edison Investment Research Limited

K3 is acquiring DdD, a Danish point-of-sale (PoS) solution provider, for up to €10m/£7.9m. The company is raising £12.8m (net) from the issue of 4.1m shares to fund the deal and future product development. The acquisition adds proprietary retail software and should be complementary to K3’s existing retail software solutions. The deal also expands K3’s presence in Northern Europe and offers cross-selling potential.

Year end

Revenue
(£m)

PBT*
(£m)

EPS*
(p)

DPS
(p)

P/E
(x)

Yield
(%)

06/14

72.0

6.6

18.5

1.25

18.9

0.4

06/15

83.4

7.2

19.1

1.50

18.3

0.4

06/16e

87.5

9.4

23.3

1.65

15.0

0.5

06/17e

95.6

11.9

26.2

1.82

13.3

0.5

Note: *PBT and EPS are normalised, excluding amortisation of acquired intangibles, exceptional items and share-based payments.

DdD: Plug-and-play PoS solution provider

K3 has agreed to acquire DdD, a Danish provider of a plug-and-play PoS solution. DdD has an established customer base across Denmark, Sweden, Norway and Germany, with more than 50% recurring revenues. DdD generated revenues of €6.2m, EBITDA of €1.1m (17% margin) and EBIT of €0.9m (14% margin) in CY15. Based on proprietary software, delivered in the cloud and billed on a subscription basis, the business ticks several boxes for K3.

Earnings enhancing deal

K3 is paying up to €10m/£7.9m for the entire company, with €8.9m/£7.0m cash up-front and the remaining €1.1m/£0.9m contingent on performance post-acquisition. K3 is placing 4.1m shares at 330p to raise net funds of £12.8m. Management estimates that the deal will be earnings enhancing in FY17; we factor in revenue uplifts of 1.1% in FY16 and 6.4% in FY17, with a neutral impact on FY16 EPS and a 2.4% uplift to FY17 EPS. The company expects to use the remaining £4.8m of funds raised after paying for DdD for product enhancements and working capital. We would not be surprised to see further acquisitions to accelerate the product road map.

Valuation: Own-IP strategy to drive upside

The stock is trading on a P/E multiple of 15.0x FY16e EPS and 13.3x FY17e EPS compared to small-cap UK software and IT services stocks trading on an average 20x current year and 16.5x next year EPS. K3 continues to invest in developing and supporting its own-IP solutions and building out its partner channel. Combined with a focus on selling hosting services to a larger proportion of customers, the company has the potential to grow the business on a multi-year basis. We believe that the stock could trade up to at least 15x FY17e EPS (393p per share).

Acquisition of DdD

Deal details

K3 has announced that it is buying Retail Support International AS (known as DdD Retail) for maximum consideration of €10m/£7.9m, with an initial cash consideration of €8.9m/£7.0m and deferred consideration of €1.1m/£0.9m contingent on performance post-acquisition. The purchase is on a cash-free/debt-free basis and is scheduled to close on 29 April.

Placing to fund acquisition and product development

The company has placed 4,090,909 shares at 330p per share to raise gross funds of £13.5m, and net funds of £12.8m after fees. The company will use £7.9m of the funds raised for the acquisition, with the remaining £4.9m targeted for product development and working capital. The shares are due to be admitted to AIM on 29 April.

DdD background

DdD was founded in 1989 and is headquartered in Denmark. The company provides a combined PoS hardware/software solution to the fashion retail market. It operates in Denmark, Sweden, Norway and Germany, with 2,700 installations across 1,800 stores for 750 customers. Customers include Esprit, Pilgrim and Saint Tropez.

DdD’s core offering is its plug-and-play “Retail in a Box”. This incorporates the hardware needed in store (PoS PC, 2D scanner, receipt printer, cash drawer) and the browser-based software. The software is delivered in the cloud and charged on a monthly basis. The software can run on any operating system and can be integrated with any ERP system. It can also be used on the customer’s existing hardware (PC, smartphone, tablet).

DdD employs 43 people who will all remain with the business, including senior management.

Exhibit 1: DdD historic financial performance 2013-15

€000s

CY13

CY14

CY15

Revenue

6,370

6,121

6,233

Gross margin

59%

58%

64%

EBITDA

930

739

1,079

EBIT

713

509

868

Net cash from operating activities

808

615

1,159

Capex/development costs

32

105

117

Free cash flow

776

510

1,042

Recurring revenues

46%

52%

56%

EBITDA margin

14.6%

12.1%

17.3%

EBIT margin

11.2%

8.3%

13.9%

Capex/sales

0.5%

1.7%

1.9%

Source: K3 Business Technology Group

Deal rationale

Management recently confirmed that it was focused on growing the own-IP portion of its business, either through internal product development or through acquisition. DdD’s software is proprietary and will therefore contribute to growing the percentage of own-IP software. It should also help accelerate development of K3’s existing retail-focused solutions. As a cloud-delivered, subscription-billed solution, DdD’s business will add to K3’s existing recurring revenue stream. The company sees DdD’s solutions as complementary to its existing Retail business and there is an opportunity to sell them through the K3 channel.

Changes to forecasts

The company expects the deal to be earnings enhancing in FY17. Incorporating DdD into our forecasts from the end of April, we factor in revenues of £1.0m in FY16 and £5.7m in FY17 and operating profit of £0.2m in FY16 and £1.2m in FY17. This enhances our operating margin forecast by 0.6pp in FY17. We estimate that the deal is earnings neutral in FY16 and we increase our normalised EPS forecast by 2.4% in FY17. Our net debt forecast reduces substantially in both years, benefiting from the net proceeds of the capital raise.

Exhibit 2: Changes to forecasts

£m

FY16e

FY17e

Y-o-y growth

Old

New

Change

Old

New

Change

FY16e

FY17e

Retail

41.3

42.3

2.3%

42.7

48.4

13.4%

6.4%

14.5%

Manufacturing & distribution

45.2

45.2

0.0%

47.2

47.2

0.0%

3.5%

4.4%

Revenues

86.54

87.51

1.1%

89.90

95.61

6.4%

4.9%

9.3%

Margin

Retail

5.08

5.25

3.5%

5.21

6.44

23.7%

12.4%

13.3%

Manufacturing & distribution

5.50

5.50

0.0%

6.29

6.29

0.0%

12.2%

13.3%

Head office costs

(0.54)

(0.54)

0.0%

(0.58)

(0.58)

0.0%

Normalised operating profit

10.04

10.22

1.8%

10.92

12.15

11.3%

Operating margin

11.6%

11.7%

0.1%

12.1%

12.7%

0.6%

Normalised PBT

9.24

9.44

2.1%

10.32

11.85

14.9%

Normalised net income

7.56

7.74

2.3%

8.32

9.59

15.2%

Reported EPS (p)

13.7

14.0

1.6%

18.6

20.2

8.3%

Normalised EPS (p)

23.3

23.3

0.0%

25.6

26.2

2.4%

Net debt

10,049

5,765

-42.6%

7,031

905

-87.1%

Source: Edison Investment Research

Exhibit 3: Financial summary

£'000s

2012

2013

2014

2015

2016e

2017e

Year end 30 June

IFRS

IFRS

IFRS

IFRS

IFRS

IFRS

PROFIT & LOSS

Revenue

 

 

67,961

63,513

71,950

83,427

87,506

95,609

Cost of Sales

(28,491)

(30,375)

(32,990)

(40,446)

(40,131)

(43,878)

Gross Profit

39,470

33,138

38,960

42,981

47,375

51,731

EBITDA

 

 

12,942

7,261

9,861

10,975

13,540

15,676

Operating Profit (before am of acq. Intang. and except.)

11,405

5,164

7,328

8,169

10,215

12,151

Amortisation of acquired intangibles

(3,586)

(3,182)

(2,989)

(2,800)

(2,900)

(2,900)

Share-based payments

(72)

(70)

(27)

(18)

(30)

(30)

Other

(395)

(727)

(1,722)

(546)

(900)

0

Operating Profit

7,352

1,185

2,590

4,805

6,385

9,221

Net Interest

(1,309)

(723)

(705)

(926)

(780)

(300)

Profit Before Tax (norm)

 

 

10,096

4,441

6,623

7,243

9,435

11,851

Profit Before Tax (FRS 3)

 

 

6,043

462

1,885

3,879

5,605

8,921

Tax

(319)

780

675

(436)

(1,057)

(1,659)

Profit After Tax (norm)

8,591

4,165

5,874

6,162

7,738

9,592

Profit After Tax (FRS 3)

5,724

1,242

2,560

3,443

4,548

7,262

Average Number of Shares Outstanding (m)

28.2

29.2

31.4

31.6

32.6

36.0

EPS - normalised (p)

 

 

30.4

14.3

18.7

19.5

23.7

26.6

EPS - normalised fully diluted (p)

 

 

29.7

14.1

18.5

19.1

23.3

26.2

EPS - FRS 3 (p)

 

 

20.3

4.3

8.1

10.9

14.0

20.2

Dividend per share (p)

1.00

1.00

1.25

1.50

1.65

1.82

Gross Margin (%)

58.1

52.2

54.1

51.5

54.1

54.1

EBITDA Margin (%)

19.0

11.4

13.7

13.2

15.5

16.4

Operating Margin (before GW and except.) (%)

16.8

8.1

10.2

9.8

11.7

12.7

BALANCE SHEET

Fixed Assets

 

 

68,325

69,398

67,067

67,497

73,872

72,047

Intangible Assets

21,255

21,040

20,040

20,806

27,256

25,606

Tangible Assets

2,722

2,927

2,439

2,316

2,241

2,066

Goodwill

43,540

44,610

43,952

43,541

43,541

43,541

Other

808

821

636

834

834

834

Current Assets

 

 

32,418

25,523

29,535

33,734

39,564

44,147

Stocks

0

0

0

0

0

0

Debtors

30,322

25,251

28,888

31,839

34,283

36,934

Cash

2,096

272

647

1,895

5,281

7,213

Current Liabilities

 

 

(48,043)

(39,272)

(40,278)

(32,886)

(31,758)

(36,018)

Creditors

(8,797)

(5,842)

(7,218)

(7,640)

(8,012)

(8,750)

Other Creditors

(21,468)

(19,379)

(18,799)

(21,803)

(20,303)

(19,153)

Short term borrowings

(17,778)

(14,051)

(14,261)

(3,443)

(3,443)

(8,115)

Long Term Liabilities

 

 

(5,797)

(4,524)

(3,719)

(14,850)

(11,282)

(3,082)

Long term borrowings

0

(32)

(14)

(10,531)

(7,603)

(3)

Other long term liabilities

(5,797)

(4,492)

(3,705)

(4,319)

(3,679)

(3,079)

Net Assets

 

 

46,903

51,125

52,605

53,495

70,397

77,094

CASH FLOW

Operating Cash Flow

 

 

7,284

8,022

5,352

9,600

9,068

12,614

Net Interest

(839)

(820)

(848)

(950)

(780)

(300)

Tax

(1,312)

(1,217)

290

(264)

(1,697)

(2,259)

Capex

(3,160)

(4,613)

(4,487)

(4,564)

(4,700)

(4,600)

Acquisitions/disposals

(7,132)

(1,917)

(129)

(1,998)

(7,900)

0

Financing

5,026

2,677

277

69

12,800

0

Dividends

(214)

(286)

(316)

(397)

(477)

(594)

Net Cash Flow

(347)

1,846

139

1,496

6,314

4,860

Opening net debt/(cash)

 

 

15,486

15,682

13,811

13,628

12,079

5,765

HP finance leases initiated

0

0

0

0

0

0

Other

151

25

44

53

0

0

Closing net debt/(cash)

 

 

15,682

13,811

13,628

12,079

5,765

905

Source: K3 Business Technology Group, Edison Investment Research

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