4iG — M&A set to launch 4iG into orbit

H121 revenues were driven by a combination of organic growth and M&A. 4iG reported H121 net revenues of HUF32.1bn, 59% growth y-o-y (H120: HUF20.2bn). Gross profit rose by 65% y-o-y to HUF10.2bn (H120: HUF6.2bn) with EBITDA rising 30% y-o-y to HUF1.8bn (H120: HUF1.4bn), as H121 EBITDA margins fell to 5.5% from 6.7% in H120. Employee costs rose substantially in the period, both from a year-on-year doubling of headcount (H121: 1,256 employees, H120: 644) and rising wages in a tight domestic employment market. Net income fell 36% y-o-y to HUF0.5bn (H120: HUF0.8bn), with EPS falling by 38% to HUF5.3 (H120: HUF8.5). H121 net debt rose to HUF11.8bn, from net cash of HUF2.7bn for FY20 (H120: HUF0.0bn). The major cash outflows have been to fund working capital (trade creditors increased to HUF10.7bn in H121, from HUF4.6bn in H120) as the business has grown, together with HUF11.5bn (H120: HUF0.5bn) spent on M&A, funded by 4iG’s maiden HUF15.45bn bond issue.

H1 revenues are typically c 40% of annual revenues, with H121 revenues c 39% (H120: 35% of FY20) of our FY21 revenue estimate of HUF82.7bn. The FY21 forward order book reached HUF42.7bn on 27 August 2021 (H120: HUF20.8bn). As an indicator, total revenues, including H121 and the identified forward order book, adds up to HUF74.8bn, 90% of our FY21 revenue estimate, with the expectation of additional orders to be received during the remaining four months of the year. With significant acquisitions also expected to be completed in H221 (notably Antenna Hungaria, DIGI Group and Spacecom), we have few concerns the FY21 revenue target will be met. However, we are yet to be in a position to reflect these acquisitions in our forecasts.

With the acquisition of Poli Computer and HDT, employee headcount increased to 1,256, a third higher than 31 March 2021 (Q121: 944), bringing in specialist expertise and greater capacity.

The breakdown of revenue by segment has shifted somewhat from H120, with acquisitions driving an increase in higher margin software development revenues (+9pp y-o-y), largely at the expense of hardware and software reselling revenues (together, -12pp y-o-y) which were partly constrained by global supply chain challenges. 4iG has also been awarded a number of large, multi-year development projects, providing revenue visibility over multiple years. At 17%, recurring revenues continue to increase slowly as a proportion of total revenues, from 16% as at H120 and 14% as at FY20.

Public sector clients continue to represent the majority of 4iG’s business (H121: 68%), with large corporates 19% of the total and SMEs 13%. In terms of sectors, public administration, together with IT and telcos remain the largest two sectors, representing 56% of total revenues in H121, up from 41% for H120. Consulting, science and legal was the only other sector with double-digit revenue share (12%).

Management is aiming for 4iG to become the number one IT systems integrator in Hungary by the end of FY22, and a significant regional player across the CEE and the Balkans. This strategy accelerates 4iG’s move away from a lower-margin software and hardware reselling business model towards the higher margins and longer-term contracts available in telecoms services (although we would note the fall in H121EBITDA margins to 5.5%, although we expect these to strengthen in H221). Where a skillset does not exist internally, management expects to hire or acquire expertise, with acquisitions also used to broaden the company’s geographical footprint, sector expertise and track record.

4iG’s CarpathiaSat JV (August 2020) with its strategic partner, Antenna Hungária, laid the groundwork for 4iG’s ambitions in space, further consolidated by its H121 minority investment in Rotors & Cams. 4iG’s Q121 majority investment in HDT represented the next step in 4iG’s strategic relationship with Antenna Hungária (which retains a 25% minority holding in HDT), diversifying 4iG’s presence in the telecoms and infrastructure sector and offering better revenue visibility through longer-term contracts and higher EBITDA margins than IT services. When it completes, DIGI Group will complement HDT, strengthening the group’s position as a leading Hungarian telecoms services provider.

4iG’s M&A strategy remains aligned with its growth strategy, with management expecting continued robust organic growth (4% growth forecast in Hungarian IT market 2020–25) to be complemented by acquisitions in the coming years. Management also remains open to considering strategic partnerships and JVs, including long-term cooperation with European or other international groups with complementary resources.

In H121, 4iG announced five acquisitions, four of which have completed (DIGI Group is expected to complete in H221): Poli Computer and SpaceNET in IT services, Rotors & Cams in space and defence and HDT in telecoms services, adding a further HUF7bn to FY21 revenues and HUF1.8bn to EBITDA. We have already discussed these acquisitions in our note Executing at pace on its five-year plan. Additionally, the acquisition of Invitech was announced and completed in September 2021 (summarised below).

Following the four transactions completed in H121 and Invitech, that completed in Q321, 4iG has a further five announced deals that have yet to complete. Consideration, acquisition multiples and sources of funding have not been disclosed for these acquisitions, however, on a pro-forma basis, the acquisitions of DIGI Group and Spacecom alone look set to generate run-rate EBITDA of HUF88bn (c US$300m), unlocking substantial debt funding capacity for the enlarged group.

With the Hungarian market still highly fragmented, management continues to review M&A opportunities. Although we do not anticipate any further major deals to be announced before the completion of DIGI Group, thereafter we expect 4iG to follow an opportunistic regional expansion strategy, building on client contracts to land and expand in nearby or adjacent markets.

Scope Ratings gave 4iG a BB-/Stable issuer rating ahead of its acquisition of HDT and the issue of the group’s initial 10-year bond as part of the Central Bank of Hungary’s growth bond programme. 4iG issued the HUF15.45bn (c €43m) bond on 29 March 2021, with a 10-year maturity and offering a 2.9% coupon. Subsequently, on 25 June 2021, Scope Ratings placed 4iG's BB- issuer rating under review for a developing outcome, pending completion of the Spacecom and DIGI Group transactions. Most recently, on 24 September 2021, Scope Ratings changed 4iG’s BB- issuer rating to under review for a possible downgrade, reflecting heightened execution and integration risk given 4iG’s large and numerous potential acquisitions as well as its limited exposure to telecom services.

4iG reported net debt of HUF11.8bn at 30 June 2021 (net cash of HUF2.7bn at 31 December 2020), reflecting its HUF15.45bn (c €43m) 10-year bond, less cash spent on its H121 acquisitions and increases in working capital. Given a lightly geared balance sheet, together with contributions from DIGI Group and Spacecom that look set to generate run-rate EBITDA of HUF88bn (c US$300m), we would expect management to fund the acquisitions with a substantial increase in debt as well as equity.

Our estimates do not take account of the significant M&A expected to complete in Q421. Until we have better clarity on the terms and impact of the outstanding acquisitions, we are not in a position to revise our estimates as 4iG has yet to provide any details of the structure or consideration for the announced deals. However, given 4iG’s lightly geared balance sheet with the significant additional debt capacity from the enlarged group, we would not be surprised if 4iG went back to the bond markets to part-fund its acquisitions with a further bond issue.