SCISYS — Update 28 November 2016

SCISYS is acquiring 100% of ANNOVA Systems, on a debt-free basis, from five of its management for up to €27.83m. This involves an initial €11.35m (£9.7m), of which €10m is financed through a five-year amortising loan via Deutsche Bank bearing interest of 2.9% per annum, and the balance from the group’s existing cash resources. There is also an earnout that is spread over three years; it is capped at €16.48m and linked to the successful delivery of the group’s project with the BBC. Due to the uncertain value of these payments, SCISYS has established a flexible borrowing programme with Lesmoir-Gordon, Boyle & Co, which enables SCISYS to borrow up to £5m in instalments over the period, at an interest rate of 7-8%. Additionally, SCISYS has the option of satisfying up to 24% of the entire purchase consideration in SCISYS ordinary shares. ANNOVA will remain ring-fenced throughout the earnout period. The vendors are also lending ANNOVA £2.5m via a deferred loan, which is repayable in 2019 and bears interest of 5% per annum. The funds from the loan will be used for working capital purposes and will also act as security in the event of any future claims against the vendors.

Based on our EBITDA forecasts, we estimate earnout payments of £0.6m in FY17, £2.8m in FY18 and £3.9 in FY19, for a total of £7.3m. SCISYS estimates that the net present value of the earnouts, which also takes into account contingencies relating to the BBC contract (ie, payments will not be made if specified milestones are not met), is £5.6m. When added to the initial £9.7m, this gives a total deal value of £15.3m.

On our assumptions and FY17 forecasts, SCISYS is paying 1.9x sales and 10.2x EBITDA for ANNOVA. While this looks on the expensive side, we note that ANNOVA has been growing at a healthy pace in recent years and ANNOVA has the ability to generate high margins (albeit with some volatility; see Exhibit 1) given it has its own proprietary software platform. Further, SCISYS provides cross-selling and international growth opportunities. We also note that SCISYS was able to complete this deal without recourse to equity finance because of its strong balance sheet (a net cash position and freehold property ownership) and healthy cash flows. Additionally, SCISYS knows both ANOVA and its end-market well, and in our view these facts considerably de-risk the acquisition.

ANNOVA is a leading supplier of software based editorial solutions for the media sector. Its OpenMedia product is used by broadcast journalists to manage all their workflows – planning, creating content and filing their stories. OpenMedia is a mature product that is in use by more than 50,000 journalists, including with major European broadcasters such as RTL, Deutsche Welle, WDR and Radio France. While ANNOVA will operate independently during the earnout period, it complements SCISYS’s Media & Broadcast (M&B) division, which is a leading supplier of systems for radio production and playout. OpenMedia does not compete with dira!, the core product of M&B. dira! is focused on the radio vertical and used by producers and DJs to put programmes together for broadcasting. The two products complement each other in the radio space and interface in a number of installations, including at German state radio broadcasters NDR, WDR and Deutsche Welle, and they will also interface at the BBC.

ANNOVA traces its roots back to 1989, and in 2008 the company was purchased by its management in an MBO from Dalet Digital Media Systems. Based in Munich, Germany, ANNOVA has smaller offices in Paris to service its significant French customer base and London to service the BBC contract. ANNOVA has c 70 employees, which will lift SCISYS’s headcount to c 520. It operates a traditional enterprise software business model (a perpetual licence sale with an implementation/customisation project and ongoing support and maintenance at c 15% of the licence value). Recurring support and maintenance typically represents 25% of total revenues, while ANNOVA also has significant repeat services revenues from some key accounts. ANNOVA is investigating the option of a hosted software-as-a-service model. ANNOVA generated c €7.5m revenue in FY15 on a German GAAP basis, along with EBITDA of €1.2m, for a 17% EBITDA margin. In FY16, it is expected to generate revenues of c £7.5m and EBITDA of c £1.3m.

In 2015 ANNOVA won a landmark 12-year contract with the BBC, replacing the incumbent ENPS system from Associate Press. We note that SCISYS won its own landmark deal for dira! with the BBC in 2009 and hence it is well known that the BBC looks at best-of-breed solutions from the international marketplace (SCISYS M&B is based in Germany). We understand that the reason that the BBC chose ANNOVA’s OpenMedia platform was because ANNOVA has developed a unique “story centric” architecture, which enables it to take a story dialogue into any medium, whether it be television, radio, internet, mobile, social media or another medium. The BBC deal boosted ANNOVA’s December 2015 order book to €35m, though this is spread out to 2027, and is still expected to exceed €30m at the end of 2016. The order book includes a £4m software licensing payment from the BBC contract, which is due upon the reaching of a milestone, scheduled for 2017. The services element of the contract involves significant customer-funded R&D work, worth up to £8m, as the BBC wanted to ensure that the product would be developed and enhanced. The acquisition doubles the revenues of SCISYS’s media and broadcast operations, taking it up to a similar level to the group’s other two major divisions.

ANNOVA competes with Avid (iNews product) and Associated Press (ENPS product), which are well-established suppliers of newsroom computer systems (NRCS). There are also other suppliers, like Dalet, which offer “all-in-one” solutions with a less sophisticated newsroom module, and Czech Octopus, which is mainly focused on small to medium-scale media businesses. ROSS Media, which is an ANNOVA partner, has started activities in adjacent areas of social media and cloud computing. ANNOVA has a c 90% market share in Germany, a 40% share in France and a strong presence in Belgium. Other customers are scattered around Europe including RedBull Media House (Austria), Czech Radio, TeleM1 (Switzerland) and 1+1 (Ukraine). While ANNOVA has customers in Turkey and Malaysia, it has no meaningful presence outside Europe.

ANNOVA is highly complementary to SCISYS’ Media & Broadcast division as the two businesses target similar customers, but are not competitors, and both have their roots in Germany. Further, SCISYS understands ANNOVA’s business and market very well and the two companies have many
co-located projects. SCISYS management has been looking at ANNOVA for more than a year and sees a strong cultural fit in the organisations. All of ANNOVA’s management team have been with the business for many years – five became shareholders in the 2008 MBO – and clearly the media industry is in their DNA. This will enable SCISYS to significantly broaden its media and broadcast target market while the combined business will give it critical mass to better address the international media broadcast market.

We highlight the following points

We have assumed that the deal completes on 31 December, hence our FY16 forecasts are unchanged, and ANNOVA contributes £7.9m of revenues in FY17, rising by 4% to £8.2m in FY18. We assume that £4m of licence revenues from the BBC contract are recognised in FY17, on the expected passing of a milestone. While there will be additional services along with support and maintenance revenues from FY18, we assume that ANNOVA will generate additional lumpy licence revenue to enable modest growth in FY18. In all, group revenue rises to £53.4m (from £45.5m) in FY17 and to £55.1m in FY18 (from £46.9m).

Adjusted operating profit rises to £4.6m in FY17 (from £3.3m) and to £4.9m in FY18 (from £3.6m). We assume a £0.6m net interest expense in FY17 (£0.2m) and FY18 ( £0.2m) , to reflect the €10m bank loan at 2.9% along with associated facility fees and the €2.5m vendor loan, which pays 5% interest. We have maintained the tax charge; while German tax rates are higher, our tax forecasts have been conservative. Our EPS forecasts rise by 27% in each year to 11.0p in FY17 and to 11.6p in FY18.

The initial purchase price of ANNOVA is €11.35m cash, including €1.35m from SCISYS’s existing cash resources and €10m from a bank loan. We assume the expected acquisition liabilities relating to the earnout are £5.6m, on a discounted and contingency-adjusted basis, and SCISYS pays £0.6m in FY17, £2.8m in FY18 and £3.9m in FY19. We assume transaction costs of £0.3m, of which half is expended in each of FY16 and FY17. We forecast a net debt position of £7.8m (previously £1.9m net cash) as at the end of December 2016, and the assumed acquisition liabilities take the adjusted net debt to £13.5m. The net debt position falls to £6.2m a year later, and adjusted net debt falls to £11.3m after the first year’s earnout payment is made. By the end of FY18, net debt remains at £6.2m on our forecasts, while adjusted net debt falls to £9.1m.

SCISYS has developed a strong niche as an expert player in highly specialised IT markets. As these markets continue to gain in complexity, SCISYS should, in our view, benefit from an improving negotiating position. Several factors should help the group to continue to expand margins, including the re-use of bespoke software platforms, better project management, and a continuing de-emphasis on third-party software and hardware re-sales. Further, the management has built an excellent track record in driving margins higher.

On our forecasts the acquisition of ANNOVA will be significantly earnings enhancing from the first full year of operation and we believe it will create economic value on our assumptions. The stock trades on c 0.87x our FY17e revenue forecast and c 8.2x EBITDA, which is attractive if SCISYS can successfully exploit the M&B division’s strong BBC success story to drive cross-selling opportunities within Europe and extend the product outside Europe.

We highlight the following points on the group’s valuation: