TXT e-solutions — Update 15 August 2016

TXT e-solutions is an Italy-headquartered software and services company. TXT operates through two divisions: TXT Retail (53.5% of H116 revenues) and TXT Next (46.5% of H116 revenues). TXT Retail develops, supplies and installs supply chain management software, specialising in fashion, luxury and retail. TXT Next is a software solutions and services business focused on the aerospace and defence, high-tech manufacturing and banking and finance segments. The group plans to drive growth through greater internationalisation (currently more than 50% of revenues are generated outside Italy), cross-selling and product development, and may make bolt-on acquisitions.

TXT reported growth of 6.6% in H116, including a €2m contribution from the PACE acquisition, which was integrated from 1 April. TXT Retail revenues declined in H116 (-5.5% y-o-y), although this masks the pick-up in licensing in Q2, as customers finally closed contracts that had been delayed from Q1. TXT Next saw strong organic growth of 9% in H116, as it continues to develop its international business. The PACE acquisition added a further 16% to growth. Profitability was flat
y-o-y, excluding the €0.3m of acquisition-related expenses. Net cash declined to €0.5m at the end of H116 from €8.3m at the end of FY15, reflecting payment for PACE and the dividend. We forecast net cash will increase to €2.3m by the end of FY16 and €4.2m by end FY17.

On our revised earnings forecasts, TXT trades at an EV/Sales and P/E premium to European IT services companies, but at a discount to specialist SCP software suppliers. Based on the growth and profitability profiles of both groups, we would expect TXT to trade somewhere in the middle of the two groups. With the addition of PACE, the mix of revenues is shifting in favour of higher-margin licence sales, which should drive up multiples over time. We note a forecast dividend yield of c 3%. Triggers for share price appreciation include large licence wins in TXT Retail, evidence of growing North American and Asia Pacific market share and further international wins in TXT Next.

TXT e-solutions was formed in 1989 as a software and solutions vendor and listed on the STAR segment of the Borsa Italiana in 2000. The company operates through two divisions: TXT Retail (53.5% of H116 revenues) and TXT Next (46.5% of H116 revenues). TXT Retail develops, supplies and installs supply chain management software, specialising in fashion, luxury and retail. The business has grown organically and via acquisitions in Germany (2004), the UK (2008) and North America (Maple Lake acquisition in 2012). TXT Next is a software solutions and services business, focused on the aerospace and defence, high-tech manufacturing, and banking and finance segments, primarily in Italy. This business has grown organically, and via the acquisition of PACE in April.

Group strategy is to continue to drive revenue growth in the two businesses via greater internationalisation (in H116 57% of revenues were generated outside Italy), cross-selling and product development. The company continues to consider acquisitions in the TXT Next business. We discuss the individual divisional strategies in more depth later in this report.

TXT is run by a long-established team: the chairman is the original founder of the company and the group CEO, Marco Guida, joined TXT in 1994. Divisional heads have many years’ experience with the company. Key managers in TXT Retail are the divisional CEO, Simone Pozzi (who joined TXT in 2009 after many years in a variety of sales and consulting roles for software companies, with a focus on fashion and retail) and the divisional COO, Andrea Cencini (who joined TXT in 1989 and has performed various roles in the business). TXT Next is headed by Paolo Colombo, who has been with TXT since it was founded and has built the division into its current structure.

TXT Retail develops, sells and installs supply chain planning software. The division has more than 300 employees operating out of 17 sales and delivery offices across Europe (France, Germany, Italy, Spain and the UK), Canada, the US, Hong Kong, Singapore and Australia.

The retail market has a number of characteristics that drive the need for specialised SCP solutions:

TXT’s software solutions are based on its TXT Retail platform, developed to work with Microsoft SQL, Excel and Sharepoint. TXT Retail offers a suite of products across two main functional areas:

TXT Retail has many years’ experience in the retail sector and a product range that has been tailored to the industry’s specific needs. Exhibit 2 shows TXT’s comprehensive solution, although customers can choose to buy modules within it, such as Sales Planning or Merchandise & Assortment Planning. The software is designed to enable users to see the implications of each decision they make on both operational and financial KPIs, with ‘what-if’ analyses possible for a variety of factors such as channel, product, geography and brand. The lifecycle management module is used to bring order to the collection-development process. The software is designed to align all stakeholders, eg merchandisers, designers, buyers, suppliers, product managers and developers, to reduce the time and cost involved in developing a new collection. TXT’s solution operates in a single web environment and is Sharepoint-based, enabling all stakeholders to participate in and/or review the process wherever they are.

TXT’s market focus is consumer packaged goods (CPG) and consumer-facing industrials such as Eckes-Granini, Hotel Chocolat, Lavazza, Liz Earle and Toyota. The company has c 100 customers for this solution.

Exhibit 3 demonstrates the strength of TXT’s customer base in its chosen markets – TXT Retail has more than 350 customers. Customers won year to date include Arcadia Group (UK), Auchan China, Future Group (India), ECG (TXT’s first customer in Belgium), REI – Recreational Equipment Inc (US) and Zalando (Germany). The company has also won licence extensions and follow-on work this year with existing customers including Adidas (Germany), Delta Galil (Israel), Groupe Dynamite (US), Missoni (Italy), Pandora (Denmark), Peek & Cloppenburg (Germany) and Takko (Germany).

The company traditionally targeted tier one customers, ie those with annual revenues of more than €250m, with the sweet spot being those over €500m. In recent years, the company has widened its addressable market to mid-tier retailers and has had success signing up multi-channel and online retailers. Department stores are a newer target market, as are smaller retailers. Other growth areas include:

The company’s technical staff is made up of two teams:

The core R&D team has previously developed and launched TXT On-Cloud, TXT Mobile and mobile PLM and planning modules, and is currently developing in-memory processing capability, social media-related solutions and customer analytics. In-memory processing is already available for some modules and the plan is to make it available for all processes; this should enable faster processing of data, particularly for retailers with a high volume of product lines. Customer analytics aims to take advantage of customer data, such as that gathered from loyalty cards, to improve assortment planning. The team also developed the AgileFit methodology, which provides standardised implementation models for selected verticals. This is designed to be used by the delivery teams to accelerate the implementation process and potentially enhance margins.

Business is generated across the main geographies in which TXT Retail is based, with Italy making up only 11% of FY15 revenues (UK & Nordics 21%, France 21%, Germany 21%, North America 16%, Spain 2% and Asia Pac 8%). The focus of expansion is North America and Asia Pacific.

The acquisition of Maple Lake in 2012 accelerated TXT’s penetration of the North American market, adding a customer base of around 50 retailers.

In 2015, the company created a new Asia Pacific subsidiary and opened offices in Hong Kong and Singapore from where it can service existing international clients with operations in Asia Pacific and also market to local companies. Last year, the company entered into a partnership with ebp consulting, which will provide implementation support for TXT Retail in the region. The Hong Kong office signed a contract for a licence worth more than €1m in H115, to support 40 DFS and Galleria stores in airport hubs and tourist locations worldwide. So far in 2016, the Hong Kong office has won two major contracts in Asia: Future Group in India (operates 18.5m square feet of retail space across more than 250 cities and towns) and Auchan China (230 hypermarkets and 45 shopping centres).

The supply chain management software market was worth $10.1bn in 2015 (source: Gartner) and grew 2.8% y-o-y (11% in constant currency). Gartner expects the market (ex-procurement software) to continue to grow at a CAGR of 9.5% from 2015 to 2020. The top five vendors (SAP, Oracle, JDA Software, Manhattan Associates and Epicor) make up close to 50% of the market. The remainder is made up of a large number of small and medium-sized vendors, including TXT. The market splits into two broad areas: supply chain planning and supply chain execution software. TXT specialises in supply chain planning (SCP) software. Gartner estimates that the SCP software market was worth $3.79bn in 2015 (+3% y-o-y or +11.3% in constant currency).

SAP and Oracle dominate this market and the other major player is JDA Software (owned by RedPrairie). TXT is focused on specific areas of the SCP market: fashion, luxury and retail integrated planning solutions, and sales and operations planning (S&OP) software for the CPG and industrial sectors. Competitors include companies that develop standalone supply chain software that can be integrated with a customer’s existing ERP software, or companies that develop supply chain modules as part of their ERP offering. TXT software is designed to integrate with the main ERP vendors’ software, including SAP and Microsoft. For markets such as retail, often the supply chain functionality within an ERP system is not sufficiently deep to maximise the benefits of the software. For all products, TXT also competes with inertia, ie the customer continues to use their own spreadsheets and other manual processes.

Based on the countries and niche segments in which TXT operates, the company estimates that it has an addressable software licence market of c $300m and a market share of c 15%.

In recent Gartner Magic Quadrant reports, TXT has achieved leader status for merchandise assortment management applications (high level of innovation and ability to execute), challenger status for supply chain planning (high ability to execute) and niche status for S&OP.

TXT Next is the engineering division of TXT, which provides specialised software solutions and services to four end-markets: aerospace & defence, automotive, high tech and banking & finance. The first three sectors are served through the Aerospace & High Tech Manufacturing (A&HT) division (c 75% of TXT Next FY15 revenues) with the Banking & Finance (B&F) division generating the remaining revenues. In April, TXT Next acquired PACE, a German aerospace software business, which should increase the proportion of A&HT revenues.

Until relatively recently, the business was mainly staffed out of Italy. Partly through a “follow-my-customer” strategy and partly as a concerted effort to expand internationally (organically and via the PACE acquisition), the division now has more than 350 consultants based in Italy, Germany, France, the UK, the Netherlands and the US.

The division now has a customer base of more than 70 companies. Although most of the work is project based and therefore not recurring in nature, TXT has a very loyal customer base that provides repeat work. Exhibit 4 shows the key areas supported in each end-market.

TXT Next already had a significant aerospace-focused business, providing IT, consulting and R&D services to mainly Italy-based business such as Finmeccanica (now renamed Leonardo). The addition of PACE brings specialist aerospace software as well as a larger international customer base. Customers include more than 50 companies covering aircraft and engine manufacturing, airlines, civil and defence operators, and maintenance, repair and overhaul (MRO), including Airbus, Air France & KLM Engineering, Boeing, COMAC, Delta Airlines, Embraer, GE Aviation, Lufthansa, Rolls-Royce, Safran Group and Sukhoi. Until the acquisition, TXT Next had predominantly generated revenues from services – PACE adds higher-margin software revenues, which over time should drive higher recurring revenues.

From PACE’s perspective, TXT Next has a large number of qualified consultants who are able to provide services to PACE’s client base. The business will continue to trade under the PACE brand, with the three founders continuing as managing directors.

TXT paid initial cash consideration of €5.6m for 79% of the company. There is also a put/call option for the remaining 21% stake (owned by the three founders) exercisable from 1 January 2020 to 31 December 2021 and contingent consideration payable subject to meeting targets for FY15 and FY16. Total consideration for the business, net of cash acquired, is €6.8m.

The division’s competition is from customers’ in-house R&D and IT departments, as well as from other system integrators. TXT Next has been a beneficiary of the trend to outsource, which gives the customer greater flexibility on cost and better access to specialist skills. Once a customer has outsourced a specialist area of R&D or IT, it is usually very difficult to bring it back in house, as the in-house knowledge and expertise will have diminished. TXT Next has worked closely with the majority of its customer base for many years, creating a strong partnership and demonstrating its specialist expertise.

The division continues to develop new solutions and expertise and is looking to expand the aeronautics business internationally (with the focus on embedded electronics, simulation and training and digital manufacturing) and to grow the automotive and rail businesses. TXT has been making progress with this strategy, recently winning contracts with Pilatus Aircraft (Switzerland), Reiser Simulation & Training (Germany) and Goodrich Control Systems (UK). At the end of June an office was opened in Switzerland to help support international growth. The division will expand internationally where customers demand it and continues to consider further acquisitions.

Our forecasts and TXT’s share price will be sensitive to the following factors:

TXT reported 6.6% y-o-y revenue growth in H116, with 14.2% growth in Q216. The PACE acquisition was integrated from 1 April; excluding the €2m revenues from PACE, revenues for H116 grew 0.2% and for Q216 grew 2.4% y-o-y.

TXT Retail declined 5.5% in H116 and 3.1% in Q216, reflecting the large software sale reported in Q215. We note that some of the delayed contracts from Q1 were closed in Q2, with divisional revenues up 24% q-o-q and licence & maintenance revenues up 41% q-o-q.

TXT Next grew 25.1% in H116 and 42.1% in Q216. Excluding PACE, the division still grew 8.9% in H116 and 9.5% in Q216.

We have excluded €0.3m of acquisition-related costs from operating expenses – normalised EBIT and EBITDA were slightly higher than a year ago and flat in margin terms. Net cash has reduced as a result of the upfront cash payment for PACE and payment of the FY15 dividend.

Management expects to see a positive development in Q3 for both divisions. We have made small changes to the divisional revenue split, which overall have no impact on group revenues but a small impact on gross margins. At the earnings level, we have reduced our dilutive share count forecasts now that there are no share options outstanding. This results in a small increase in normalised EPS in both years.

On our revised earnings forecasts, TXT trades at an EV/Sales and P/E premium to European IT services companies, but at a discount to specialist SCP software suppliers. Based on the growth and profitability profiles of both groups, we would expect TXT to trade somewhere in the middle of the two groups. With the addition of PACE, the mix of revenues is shifting in favour of higher-margin licence sales, which should drive up multiples over time. We note a forecast dividend yield of more than 3%. Triggers for share price appreciation include large licence wins in TXT Retail, evidence of growing North American and Asia Pacific market share and further international wins in TXT Next.

As the business is a combination of software and IT services, we include the valuation multiples for international SCP software companies, as well as European IT services providers.

We have performed a reverse 10-year DCF to calculate what we believe the market is factoring into the current share price. Using a WACC of 9%, long-term growth of 2%, working capital/sales of 1% and capex/sales of 1% (the company does not capitalise development costs), a revenue CAGR of 3.6% for 2018-25 and average EBITDA margins of 11.7% from FY18-25 are required to reach the current share price. Based on forecast market growth for SCP software and IT services, this appears conservative.