TXT e-solutions — Well-funded to ride out the crisis

TXT e-solutions is an Italy-headquartered software and services company. Having sold TXT Retail, its retail software business, in 2017, TXT now operates solely through the business that was known as TXT Next. TXT is a software solutions and services business focused on the aerospace & aviation and fintech segments, with three-quarters of revenues generated in Italy. The group plans to drive growth through a combination of organic growth and targeted acquisitions, using some of the proceeds from the recent disposal of TXT Retail.

TXT reported revenues in line with our forecast, with growth of 48% y-o-y (24% organic). Gross margin was 0.8pp higher than forecast and increased 1.9pp over the year. This dropped through to the EBITDA level, with the normalised EBITDA margin expanding to 11.9% from 10.3% a year ago. Normalised EBIT increased 90% y-o-y and the margin expanded by 1.9pp to 8.8%. This resulted in normalised diluted EPS 7% ahead of our forecast. We have revised our FY20 forecasts to reflect delays to new business and lower demand for services and assume a rebound in demand in FY21.

On an EV/sales and EV/EBITDA basis, TXT trades at a large discount to its peer group, with EBIT margins forecast to be below the peer group. With €41m net cash, TXT is trading on inflated P/E multiples. Until the remainder of the cash is put to use on value-accretive acquisitions, we would expect the stock to trade at a premium to peers on a P/E basis. The share price has declined so much (39% since its peak in January) that a reverse DCF requires very conservative assumptions to match the current share price. In our view, this appears unduly pessimistic.

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. Until 2017, the company operated through two divisions: TXT Retail (52% of FY16 revenues) and TXT Next (48% of FY16 revenues). In October 2017, the company sold TXT Retail for €85m to APTOS, a US retail software company. The remaining business provides services and software solutions focused on the aerospace and aviation (A&A), and fintech segments, primarily in Italy. Deploying some of the proceeds of the disposal, TXT acquired several banking and finance businesses in 2018 and 2019. The group has more than 650 employees across 11 locations (Italy, Germany, the US, France, Netherlands, Switzerland and the UK).

TXT provides specialised software solutions and services through two divisions: A&A, and Fintech. Exhibit 2 below shows how three-quarters of group revenues are generated in Italy, with remaining sales generated elsewhere in Europe and, to a lesser extent, the US. In 2019, TXT generated 88% of revenues from services and 12% from software licences and maintenance (FY18: services 87%, software 13%).

TXT has shown robust organic revenue growth over recent years (CAGR 17.9% FY15–FY19) boosted by the acquisition of PACE in FY16, Cheleo and TXT Risk in 2018 and Assioma in 2019. EBITDA margins have expanded over this period from 10.8% in FY15 to 11.9% in FY19.

TXT’s strategy is to grow through a mixture of organic growth and acquisitions in the aerospace and aviation and banking and finance markets.

The group offers specialist software solutions across a number of niche verticals. Its services offering comprises product specialists as well as consultants working in four key areas of competence: embedded real-time software, cloud/web, AR/VR and blockchain. To grow the business, the group aims to apply the four competence areas to existing vertical markets as well as potential new markets. It is also seeking to develop or acquire new specialist software solutions, either within existing verticals or possibly in related new verticals.

In terms of funds available for M&A, at the end of FY19, the company had a net cash position of €41m and 1.2 million treasury shares. It also has access to debt facilities worth c €40m.

At the beginning of 2018, E-business Consulting, the largest shareholder in TXT with a stake of 25.6%, sold its entire holding to Laserline SpA. Laserline is a private company majority-owned by entrepreneur Enrico Magni. Mr Magni was subsequently appointed to the TXT board as group CEO. In May 2019, Daniele Misani was appointed to head up the A&A division. Mr Misani has worked at TXT for more than 20 years. In July 2019, Eugenio Forcinito took on the role of CFO; he has worked in the TXT finance team for more than 17 years.

This business was founded more than 30 years ago and makes up the largest proportion of TXT, generating revenues of €38.7m in FY19 (65% of TXT revenues; +25% y-o-y) and EBITDA of €5.1m (13.0% margin).

The division provides a mix of software and specialised engineering services, providing support to customers’ R&D, engineering and manufacturing operations. In FY19 revenues were generated from OEMs and first-tier suppliers (c 75%), airlines (c 10%) and automotive & industrial customers (c 15%). The business was originally staffed out of Italy but 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, Switzerland and the US. In FY19, the business generated 60% of revenues from Italy, 24% from other EMEA countries and 16% from the US and elsewhere.

TXT already had a significant aerospace-focused business, providing IT, consulting and R&D services to mainly Italy-based business such as Leonardo. The acquisition of PACE in 2016 added specialist aerospace software as well as a larger international customer base. Customers included more than 50 companies covering aircraft and engine manufacturing, airlines, civil and defence operators, and maintenance, repair and overhaul (MRO). Until the acquisition, the A&A business had predominantly generated revenues from services; PACE added higher-margin software revenues, which over time should drive higher recurring revenues.

The division is now sub-divided into a specialist software business (15% of FY19 divisional revenue) and a services business (85% of FY19 divisional revenue), each with its own revenue and EBITDA goals.

PACE continues to trade under its own brand, and the original founding members are still managers of the business. TXT has a put/call option for the remaining 21% stake in PACE owned by the three founders exercisable from 1 January 2020 to 31 December 2021.

The A&A division now has a customer base of more than 70 companies. Although much of the work is project based and therefore not recurring, TXT has a very loyal customer base that provides repeat work. Project work, which makes up c 55% of divisional revenues, is roughly three-quarters from turnkey service engagements, with the remainder contracted on a time and materials basis. Exhibit 5 shows key customers and highlights the international nature of the customer base.

TXT provides software and services all the way from initial aircraft design through to product configuration, training and operation. Exhibit 6 shows the fully packaged software offered by PACE.

Exhibit 7 shows the range of software and services available for different types of customers within A&A. We note that TXT also serves the automotive and industrial sectors with the services shown below within the digital manufacturing business area; these end markets only made up c 15% of A&A FY19 revenues.

TXT has developed Pacelab WEAVR as a platform to create, maintain and deploy training programmes that use AR (augmented reality), VR (virtual reality) or MR (mixed reality). Digitising materials in order to use them in AR/VR/MR can be costly; the platform was developed to make this process simpler.

Over the course of FY18 and FY19, TXT has also focused on developing collaborative elements in its Pacelab FPO solution. Previously, the product was used on a standalone basis within a plane. By adding the ability to collaborate, the software can now be used in connected aircraft, sending data back to a central control room, which helps with post-flight analysis and can be used in pre-flight planning.

With the increasing focus on environmental issues, TXT is keen to highlight that its Pacelab FPO software can help customers to reduce aircraft fuel consumption. For example, it has been shown to reduce fuel consumption in regional aircraft by 4%, the Airbus 230 family by 1.9% and long-range aircraft by 1%.

One obvious source of organic growth for TXT is to increase its share of wallet with the existing customer base, selling to multiple divisions within each customer. The business is also targeting new international customers. In terms of its product range, the company has started offering managed services; this should increase the level of recurring business. It is also looking to extend the capabilities and range of its software assets. In addition to achieving this through internal R&D, the company is looking to acquire niche software providers and is selectively targeting highly specialised mid-sized companies.

The Fintech business, which has been in operation for more than 15 years, has recently expanded from purely a services business to offering specialist fintech software, via a number of acquisitions. The division generated revenue of €20.4m in FY19 (+132% y-o-y, +21% organic) and EBITDA of €2.0m (9.6% margin). Fintech targets the top 50 Italian banking institutions; customers include Banca IFIS, Banco BPM, Banca Mediolanum, BP Sondrio, Ergo Assicurazioni, Credito Valtellinese, ING Bank, Intesa SanPaolo, Monte dei Paschi di Siena, Nexi, SIA, UBISS, UniCredit, Widiba and Zenith Service. The division has more than 300 employees.

Fintech offers the following products and services:

This business provides software testing, verification and validation services to banks and insurance companies in Italy. Exhibit 8 shows the services offered across the software quality assurance lifecycle. Functional testing of software accounts for the majority of the division’s services. Testing services are performed both onsite and offsite, using the company’s Test Factory methodology.

In May 2019, TXT acquired Assioma, an Italian software testing business, for c €6m plus a further potential €2.4m in earn-outs. In 2018, the Assioma group generated revenues of €9.4m, EBITDA of €1.3m (13.9% margin) and net income of €0.9m.

Drivers of demand for software quality services include increasingly strict regulation, emerging fintech software and services and the rapidly evolving IT landscape. The company estimates that the market for quality assurance and testing services in the Italian banking sector is worth at least €100m per year.

Also included within this division are payments services. Assioma owns 51% of Assiopay, a payments software business. Assiopay provides software to manage meal vouchers (‘Ticket Restaurant’ in Italy) and loyalty cards.

In July 2018, TXT acquired 51% of Cheleo, an Italian developer of lifecycle management software for financing,1 and acquired the remaining 49% in January 2019. In total, Cheleo cost €10m (€6m in cash and €4m from the issue of 354,202 shares). Cheleo was majority owned by Laserline, the business owned by Enrico Magni, TXT’s CEO and largest shareholder.

Cheleo’s portfolio includes software to manage the entire process (initial application, credit management and collection, disposal of loan books) for leasing, mortgages, personal loans, salary-based loans, factoring and non-performing loans. Customers are Italian specialist financial companies. Cheleo reported 2017 revenues of €2.8m and EBITDA of €0.95m (34% margin). We estimate that revenues in 2019 were similar.

Although Cheleo continues to operate on a standalone basis within the Fintech division, the division is focused on cross-selling opportunities across the combined Italian client base. The two founders, Bruno Roma and Flavio Minari, remain on the Cheleo board and will be entitled to a future cash payment based on the 2019 performance of Cheleo.

In November, TXT made a small acquisition to add risk-assessment software to its Fintech offering. It acquired 51% of T3M Innovation (now TXT Risk Solutions) for €0.3m and has a put/call option in place to buy the remaining 49% at a price based on the performance of TXT Risk Solutions in FY20.

TXT Risk Solutions has developed risk assessment solutions based on predictive, probabilistic models using machine learning and AI techniques. Its cloud-based FARADAY platform is used by customers to carry out checks on potential clients to prevent involvement with money laundering (Faraday AML), corruption (Faraday AC) and terrorist financing (Faraday AT).

The business recently signed up Monte dei Paschi di Siena to use the Faraday platform.

The division intends to take advantage of its large financial institution customer base to cross-sell. It will also consider additional acquisitions.

TXT 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 has worked closely with the majority of its customer base for many years, creating a strong partnership and demonstrating its specialist expertise.

The aerospace and aviation markets are characterised by global groups with large investment budgets; many groups have multiple subsidiaries that could each use TXT’s software engineering services. The rapid pace of innovation combined with increasing regulation drives growth in R&D. In its 2022 strategic plan, Altran estimates that the global engineering and R&D services market was worth c €155bn in 2017 and is forecast to grow at a CAGR of 9% to 2022. Within that, it forecasts growth in Europe of 4–6% pa and growth in the Americas of 8–10% pa.

On the services side, TXT’s competition is from customers’ in-house R&D and IT departments, as well as outsourced engineering services providers and system integrators. The A&A business sees competition from large European engineering services businesses such as Akka Technologies, Altran, Alten and Assystem in France (all listed on Euronext), ESG Group in Germany (private) as well as smaller local providers such as Critical Software (private, based in Portugal), Teoresi (private, based in Italy) and Philotech (private, based in Germany). Both the A&A and Fintech businesses compete with the large offshore BPO providers such as HCL, Tech Mahindra and TATA Consultancy Services, although TXT’s specialist knowledge and on-shore capabilities are often preferred for mission-critical work that requires not only technical expertise, but also in-depth industry knowledge and proximity to customers. The Fintech business also competes with specialist outsourced testing providers such as SQS (recently acquired by Assystem Technologies).

On the software side, PACE operates in the market for aircraft design and engineering processes, typically served by the large PLM2 software vendors such as Dassault, PTC and Siemens. PACE offers niche solutions to address specific, critical tasks that complement and integrate with PLM software solutions. Cheleo’s software is very specific to the Italian market. TXT Risk Solution’s Faraday software competes with BAE’s NetReveal and Cedacri’s GIANOS, which are rules based, whereas Faraday uses predictive models and machine learning.

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

TXT reported revenues in line with our forecast, with growth of 48% y-o-y, of which 24% was organic. Gross margin was 0.8pp higher than forecast and increased 1.9pp over the year. This dropped through to the EBITDA level, with the EBITDA margin expanding to 11.9% from 10.3% a year ago. Normalised EBIT increased 90% y-o-y and the margin expanded by 1.9pp to 8.8%. This resulted in normalised diluted EPS 7% ahead of our forecast. Reported EBIT includes a €0.7m charge for restructuring. The company reported an exceptional charge at the financial level of €3.4m for the revised valuation of two contingent consideration provisions: a charge of €4.1m for PACE and a credit of €0.7m for Cheleo. Net financial income also includes an upward revaluation of the cash held in multi-segment insurance funds of €2.2m, compared to a charge of €1.0m in FY18. The reported tax rate at 81% appears high as the €3.4m charge was not allowable for tax purposes.

The company announced it would not be proposing a dividend for FY19 to preserve cash to deal with coronavirus-related issues (see p12 for further detail). It would consider an extraordinary dividend later in the year depending on how the business performs.

At the end of FY19, the company had a net cash position of €41.4m. Net cash reduced from the end FY18 as a result of the dividend (€5.8m), Assioma acquisitions (€6m), net increase in contingent liabilities (see below) and a new lease taken out for offices in Berlin.

Contingent liabilities for acquisitions are included within short-term debt (PACE €5.9m, Cheleo €0.8m) and long-term debt (TXT Risk €1.6m). TXT has fully consolidated the three acquisitions, with the value of the minority interests treated as debt.

The A&A division grew revenues 24% y-o-y, all organic. It signed licences with major OEMs and airlines in North America in Q4, much of which should be recognised as revenue in FY20 and FY21. The Fintech division grew 132% y-o-y, of which 21% was organic. The division acquired Assioma in April 2019, which contributed revenues of €9.7m, and benefited from a full 12 months of TXT Risk and Cheleo (both acquired in FY18).

As an Italy-headquartered company, a large proportion of the workforce moved to working remotely some weeks ago; the remainder of locations are now also doing so. In the Fintech division, software quality testing services can be provided remotely. Activities in both divisions are deemed by the Italian government to be essential services (falling under the categories of transport and finance), so staff are not part of the general nationwide lockdown.

In the A&A division, the company has not yet seen any reduction in demand from customers but is aware that new business is likely to be harder to sign with aviation customers, given the drastic cuts to airline travel. The company has a strong licence backlog entering FY20 as it has previously signed term and subscription licences that will allow revenue to be recognised over FY20 and FY21. Its aviation relationships are with the larger airlines that have more resources to weather this difficult period. We note that airlines made up c 6% of group revenues in FY19, with the majority of A&A business providing services to OEMs to help with the design of avionics for future aircraft, including pre-design and configuration work.

While trading in the first two months of the year was in line with expectations (both revenue and margins), management estimates the crisis could reduce Q120 profitability. We have revised our forecasts to reflect potential disruption from efforts to contain coronavirus extending into H220. The £2.6m cut to our FY20 revenue forecast and a reduction in gross margin based on mix results in a £2.1m reduction in gross profit. Assuming no cut to our opex forecasts at this point, as we believe the company would want to be prepared for a resumption in demand once containment efforts are reduced, this results in a 52% reduction in normalised EBIT and a 53% reduction in normalised diluted EPS.

We note that while we have factored in 6.4% revenue growth for FY20 (down from 10.6%), this includes a full 12 months of revenue from Assioma (consolidated from 1 April 2019), which accounts for two-thirds of the growth.

Our peer group includes European IT services and engineering services companies as well as software providers with a similar customer base. On an EV/sales and EV/EBITDA basis, TXT trades at a large discount to its peer group, with EBIT margins forecast to be below the peer group. With €41m net cash, TXT is trading on inflated P/E multiples. Until the remainder of the cash is put to use on value-accretive acquisitions, we would expect the stock to trade at a premium to peers on a P/E basis.

The share price has declined so much that a reverse DCF requires very conservative assumptions to match the current share price. In fact, we can get to the current share price by assuming that from FY21, revenue only grows at 1% per annum, the EBITDA margin is 10% in perpetuity, and long-term growth is 1%. In our view, this is unduly pessimistic.