EQS Group — Whistleblowing set to kick in strongly in H2

EQS provides products and services that meet a market need for reliable, secure, trustworthy automation in compliance and investor relations (IR) – regulatory technology, or regtech for short. It has invested in building a cloud-based platform, COCKPIT, for both the Compliance and IR areas of the business, from which it derives software-as-a-service (SaaS) revenues. COCKPIT provides its clients with a dashboard from which to access the subscribed elements to manage their own workflows. It has 5,688 SaaS customers (as at end Q223), with 89% of revenues earned on a recurring basis and a churn of 4.8% (down from 6.2% in H122). The more complex the corporate regulation framework, the greater the opportunity. The current roll-out of the whistleblowing regulations across Europe widens the target market and new opportunities in ESG monitoring and reporting should support the next wave of growth. Management has a clear goal. Its aim is for EQS to be the leading European cloud provider for global corporate compliance and IR solutions by 2027.

We continue to look at EQS’s equity valuation in the context of global peers, but meaningful conclusions will be easier to draw once the earnings start to come through more strongly. For now, the most useful of these metrics is EV/revenue and here, parity of rating with global financial software peers for FY24 would suggest a price of €34.45.

We have also run a discounted cash flow (DCF) exercise, using a WACC of 9%, a terminal growth rate of 2% and management’s own medium-term growth projections – set to the outer end of its targeted date range. This returns a value of €36.18, up from €35.17 when calculated at the time of our May report and which was then based on slightly lower financial forecasts.

The first half results show strong progress in the Compliance segment as interest in whistleblowing systems translates into orders. We expect the pace should pick up in H2 now that the German law has finally come into effect. Despite the long lead time, many of the companies and organisations that need to comply remain unprepared in our view. Management guidance for the year is for revenue growth of 15–20%, delivering EBITDA in a range of €9–11m. We have lifted our forecasts from the bottom of this range to the middle, given the improving visibility. Medium-term targets are for revenues to increase to €130m by FY26 or FY27, delivering an EBITDA margin of 30%, up from the 7% achieved in FY22 and our current year forecast of 14%.

The speed of pipeline conversion will be key to whether full year numbers come in towards the bottom or top end of the guided range. Meeting management’s medium-term ambitions will depend on converting the newly won customers to buyers of a broader range of cloud-based products delivered vis the EQS COCKPIT. Regulatory changes have been a key stimulus to the development of the business and new opportunities may arise, particularly when it comes to monitoring and reporting on ESG metrics. Maintaining an immaculate record on data security is essential to retain EQS’s reputation for integrity, which is crucial for winning and retaining business.

EQS’s business is split into two segments, Compliance and IR, with the stated intention to build a third leg in Sustainability Reporting. Compliance covers products that are required to fulfil a regulatory obligation, while IR includes products designed to facilitate digital investor and corporate communications. The introduction of the sustainability reporting provision is also in response to forthcoming EU regulation, which will require companies to report various ESG metrics in specific formats. EQS is one of the largest global providers of digital solutions, designed to automate and simplify processes for individuals working on the technical administrative aspects of running a corporate concern, enabling them to free up their time to deal with matters that require more than simple information processing. By ensuring that the cloud-based product suites provided are constantly updated for the latest regulatory compliance changes and delivered via intuitive interfaces, EQS should continue to add value for its users. Originally centred on investor relations (which in Germany and some other markets includes functions covered in other jurisdictions by the company secretary or equivalent), the group’s products and services have been expanded across the related areas of compliance, which now accounts for the larger part of revenue, as shown below.

Management has set out clearly that its business is built on the concept of trust. Customers must be able to have absolute confidence in the efficacy and integrity of the products and services on offer. By choosing to work on and with EQS’s platforms, those customers should be able to demonstrate to their own client base that they also take integrity and transparency seriously.

EQS Group was founded in 2000 in Munich, initially building a strong market position in its home markets of Germany, Switzerland and Austria before starting to expand its presence in overseas territories. EQS looks to position itself as a partner with its client companies, working alongside them to solve issues and reduce inefficiencies, rather than simply as a supplier whose interest may not extend beyond the initial sales timeframe, with a growing emphasis on providing SaaS. The shift away from paper-based information to digital channels of communication between corporate entities and their various stakeholders has been a key driver of growth, accelerated by the pandemic. The honed business model is focused on building subscription and annually recurring incomes as a proportion of the whole, increasing the quality of the earnings. In H123, recurring revenues represented 89% of total revenues.

In addition to its headquarters in Berlin, Germany, EQS also has technology centres in Kochi (India) and Belgrade (Serbia), giving it access to a wide pool of programming and technical talent.

EQS has been built through a combination of organic growth and acquisitions, using a combination of cash, debt and equity to fund both aspects. Having invested in building its cloud-based platform to facilitate delivery of the business’s offering in both the investor relations and compliance segments, management identified the emerging opportunity in digital whistleblowing. This is adjacent to the compliance capability, with the impetus coming from the EU Directive 2019/1937, which stipulated the provision of such a whistleblowing channel to guarantee secure and effective reactions to notifications.

The opportunity here was and is of significant scale and the imposition of a deadline meant a relatively tight timescale to address the opportunity. Across the EU, EQS estimated that around 50k companies and organisations would fall within the scope of the directive, of which around half would select a digital solution. The conversion potential was identified as shown below and this remains the scenario envisaged by management.

To achieve this, EQS needed to scale up its digital whistleblowing offering, and fast. This was addressed through the acquisition of Got Ethics in November 2020 (initial purchase price €10m), followed by the purchase of Business Keeper in June 2021, the largest acquisition to date, with a transaction price of €95m. This made the combined group the clear market leader in Europe, adding over 300 customers and around 100 employees. Customers were predominantly large corporations, including 16 DAX-listed companies. Business Keeper generated annual recurring licence revenues of approximately €10m and was previously EQS’s strongest competitor in Germany.

EQS does not have this market to itself. In its own domestic market, management estimates that there may be 60–70 other firms offering whistleblowing solutions, with many at considerably lower price points. Some of these firms will be small start-ups, others might, for example, be law firms offering it as a service to clients. There are five or six more substantial players in the German market, but EQS is the largest.

The competitive landscape differs markedly by country, and this has provided a useful barrier to entry for some of the larger US-based consultancy firms that are used to being able to roll out a unified offering. The ability to manage the demands of meeting the legislation through a secure and proven system with an intuitive interface is self-evidently a competitive advantage. EQS has also put in place a broad and credible partner network to introduce new business, alongside its own sales resource.

To provide a genuine scalable proposition, EQS adopted cloud-based provision for both its products and its services, investing significantly over the period from FY15–18. This pattern of management identifying the opportunity and then investing in order to be able to address it with efficient and appropriate solutions, albeit at a sacrifice to short- to medium-term margins, was repeated with digital whistleblowing.

EQS’s Compliance segment provides tools for companies to fulfil their regulatory obligations. These products include:

These are increasingly being offered as part of the Compliance COCKPIT, with an intuitive client interface, as illustrated in Exhibit 4.

The group also provides various cloud services, including regulatory filing in XML and XBRL formats and legal entity identifier issuance. These are separately reported as they are not necessarily conducted via the COCKPIT. For the last three to four years, the company has been working hard to migrate its customers for individual products or services across to the EQS Compliance COCKPIT, a process that is substantially complete.

The typical customer journey is illustrated below, with the timing of each phase varying with the scale and complexity of the project. The process of upselling is greatly simplified if that customer is using the COCKPIT and it is already integrated into their daily workflow.

The first stimulus to EQS’s ESG service (to be delivered via the EQS Risk Manager on the Compliance COCKPIT) has been the implementation of the German Supply Chain Due Diligence Act, which has the stated goal of ensuring the fulfilment of human rights and environmental due diligence obligations in the supply chain of companies. This will apply for companies with between 1k and 3k employees from January 2024, with sales of the ESG-oriented Risk Manager service set to commence during H223.

Monitoring and reporting of the supply chain is clearly suitable for similar handling to other reporting requirements catered for within the Compliance COCKPIT and management hopes that this will be rolled out in time across the rest of the EU and beyond. In the longer term, it is likely that other elements of sustainability monitoring and reporting will be able to be incorporated.

Similar to that in the Compliance segment, the IR COCKPIT offers a number of different products that can be contracted individually or in combination. These include:

Beyond the products offered on the COCKPIT, EQS has further cloud-based service offerings in:

As of H123, 35% of IR revenues were under SaaS contracts, up from 32% in H122.

EQS provides products and services that facilitate the good governance of other corporate entities and, according to management, corporate integrity is at the heart of its operating culture. It has published its second and more detailed ESG report 2022. This outlines management commitments in respect of

The group’s approach to these factors is described on pages 32–33 of the report, alongside the goal of achieving climate-neutral production by 2025. The report includes the intention that management remuneration will include a long-term component linked to ESG goals.

EQS has a very experienced leadership team that has worked together for many years. The group’s CEO is Achim Weick, who began his career at Commerzbank. Subsequently, he co-founded investor relations manager CMC Capital Markets Consulting. Achim is the originator, founder and second largest shareholder of EQS and has been on the board since its foundation. COO Christian Pfleger joined EQS in 2001, initially as a client relationship manager, moving to project management from 2003. In 2007, he took over responsibility for products and services. André Silverio Marques was appointed to the main board as CFO in July 2018, having been finance director since 2015. He previously ran the group’s Russian businesses and, before that, oversaw the IR, business development and corporate finance activities. The other key member of the management team is Marcus Sultzer, who joined the group in 2007 and oversaw business development in Russia and the CIS from 2009 and Asia-Pacific from 2013. As well as being international managing director, in charge of operations in Asia, Russia, Switzerland and UAE, he is the group’s chief revenue officer. Fuller biographies of management are given on page 16.

The key sensitivity currently is the success or otherwise of the conversion of the sales pipeline for the whistleblowing offering and subsequent conversion into broader client status, as illustrated in Exhibit 3. Delays to the roll-out of the whistleblowing legislation across the EU have had a short-term negative impact on revenues, pushing out the timeline for the medium-term plan from FY25 to FY26/27, as disclosed at the time of the Q123 results announcement.

The recovery from the most severe effects of COVID-19 has seen slower sales conversion cycles, but the group has been able to retain some of the inadvertent benefits, such as virtual meeting hosting within the IR offering.

There are various other factors that will influence EQS’s financial performance, each of which may vary considerably across the operating territories. These include:

The group is now moving steadily towards delivering a net profit (which we anticipate in FY24), so earnings-derived conventional peer-based valuations are set to become more useful in the future. For now, we supplement this with a DCF-based approach.

Peer context

As profitability starts to fall within the modelling horizon, we can start to consider multiples beyond EV/revenue, including EV/EBITDA and P/E. We look at both the small cohort of quoted financial software companies and a broader global set of application software peers (excluding the smallest groups capitalised below $50m).

There continues to be a wide range of multiples for the financial software peer group. For FY1, EQS is trading at 3.9x sales versus the median for the peer group of 4.5x, a discount of 14%. With EQS’s forecast faster sales growth, as implied by management’s medium-term plan, this discount opens out for FY2 to 25%. Against the application software peers, EQS sits at a small premium on the current year, moving to a small discount for FY2. Looking at the earnings multiples, EQS is still at an understandable premium for the current year on EV/EBITDA, but moves to a discount of 23% for FY2. Application software stocks are currently trading at valuations above those for the financial software peers for FY3, with EQS trading at a discount to both groups FY3 (based on very tentative numbers).

For illustrative purposes, closing the discount to the other financial software peers on FY2 EV/revenue would imply a share price of €34.45, 22% above the current price.

DCF also points to value above the current price

Management has outlined its views on the medium-term revenue growth outlook, with Compliance growing at a CAGR of 20–25% from FY22 through to FY26/27e (which we read as FY27 for conservatism’s sake) and IR growing at a more modest 5–10%. From the current mix (and assuming no further M&A), this equates to group revenue growth of 16%. On the basis of this forecast, management anticipates EBITDA margins exceeding 30% by the end of the forecast period.

In view of the global interest rate environment, we are using a WACC of 9% (unchanged) to calculate the DCF. If we apply the assumptions above to the DCF and assume that margins are sustainable at that level and that growth tails off by 200bp per year beyond FY27 simply through scale, then at a WACC of 9% and a terminal growth rate of 2%, the implied value per share is €36.18. In May, we derived a figure of €35.17. Obviously, there is an element of execution risk here, with the bulk of the value accruing beyond our explicit forecast period (to FY24).

Following publication of the interim results, we have made some adjustments to our forecasts to reflect that the first benefits from the German whistleblowing legislation ‘going live’ should now be seen in H223, with some consequent improvement in visibility. Management guidance for FY23 is unchanged, targeting revenue growth of 15–20% and EBITDA in a range of €9–11m, so in effect we have moved our estimates from the bottom of the guided range to the middle.

As would be expected, the main impetus for revenue growth was from the group’s Compliance segment, with both products and services showing good progress. There was a particular impetus in the period from the introduction in January 2023 of mandatory reporting in a standardised electronic format for companies whose shares are traded on a regulated EU market, known as ESEF. This type of filing, alongside XML reporting and the issuing of Legal Entity Identifiers, is a low-ticket item so far as EQS is concerned (and not all are delivered via the COCKPIT) but allows for more meaningful corporate relationships to be developed over time.

More important for the longer-term prospects is the build in whistleblowing customers within the Compliance cloud-services reporting line. Here, 675 new customers were acquired in H123 (H122: 350), either directly or via the established partner network. Notable new customers are set out on page 11 of the H123 financial report.

Progress was more subdued in the IR segment, partly a reflection of the termination of business in Russia, which previously fell into the cloud-services reporting line.

With the close control of costs (personnel costs were 6% above prior year, other expenses up 3%), EBITDA rose from €1.14m to €3.21m in H123 and the loss at the EBIT level narrowed from €2.9m to €0.8m.

Putting this into a broader context, the exhibits below show clearly how momentum has been growing in the Compliance segment. The delays to the full implementation of the whistleblowing regulation have extended the original timescale for reaching the medium-term growth targets and this was revised earlier in the year.

Guidance on medium-term CAGRs for the two reporting segments is now expressed out to FY26/27, whereas it was previously explicitly for FY25. In our modelling as used for our DCF above, we have taken a conservative approach and assumed that these targets will be hit in FY27. On this timescale, management is targeting revenues of €130m, split 78% Compliance, 22% IR. This would generate an EBITDA of €39m (ie a margin of 30%).

On this basis, we regard these targets as eminently achievable, with a 30% margin reasonable for a platform business of this type.

It is worth noting when looking at the longer-term revenue and margin record, above, that there have been two phases where the group’s EBITDA margin has decreased. As explained previously, the first of these reflects the period when margin was sacrificed to fund the investment in building out the COCKPIT platform that equipped the group to scale its offering.

The more recent dip reflects the investment to position the group to take best advantage of the time-limited opportunity within the whistleblowing arena to build market share. This involved comparatively heavy investment in sales and marketing and the building out of a partner network to broaden the reach. The unexpected delays to the passage of the regulation into fully implemented legislation meant that this additional overhead was carried for longer than originally anticipated.

The cost base is now more normalised and appropriate for the scale of the business and its immediate opportunity, albeit at some modest cost to margin from the commission due to introducing partners. It is clear, though, that the operational leverage is already starting to show through in the financial results and in prospects for the second half of the year.

Rather than look at the group’s cash flow in discrete reporting periods, it is more meaningful to show how cash has flowed in and out of the business over time. By aggregating the figures across FY17–22, we can see that the operating cash flow has broadly covered the capex spend on developing the infrastructure. The major obvious elements are the acquisition spend and the equity financing raised to part-fund those purchases.

The largest acquisition was that of Business Keeper in June 2021 for €95m, of which €80m was paid in FY21 with the balance due in FY22 and which gave the group the scale and market credibility within the whistleblowing space.

During FY21, the group raised €43.9m in three capital raises, in February, July and December. These were for €13.6m at €38.00 per share, €22.4m at €38.00 and €7.7m at €41.00.

During Q122, the group carried out a further fund-raise of €45m gross, in part to facilitate the requirements of a new prospective cornerstone investor, Gerlin NV’s Teslin fund. To satisfy this, the deal was structured to be underwritten by other key investors, which only subscribed to the extent that, with a rump placing, they would end up where they wanted to be, thereby avoiding dilution. So, although visually a take up of 9.7% looked poor, this did not represent the underlying degree of support from existing shareholders. Gerlin took 42% of the issue and now has a 6.0% holding in the enlarged equity.

The other advantage of the transaction was that it did not require the major input of investment bankers, saving €2–3m on the deal.

The initial purchase price for Business Keeper was part-funded by an acquisition loan of €50m from Commerzbank. Half of this was repaid with the proceeds of the subscription fund-raising in Q122 (at €33.0/share), as described above. In November 2022, this was refinanced over a period of five years, and extended by a further €5m, with Deutsche Bank and Kreissparkasse Biberach added to the banking consortium. Interest is at Euribor plus a margin, which varies with leverage and achievement of sustainability objectives. Repayments are in equal instalments starting mid-2023.

Net debt at end-H123 had reduced to €25.20m (end-FY22: €28.43m, end Q123: €25.99m), including lease liabilities; excluding these, net debt was €22.23m, down from €22.58m at end Q123. Our forecast for the year-end is for €27.3m (including lease debt, and down from our previous estimate of €28.7m) and this may prove to be conservative. This is equivalent to 2.7x FY23e EBITDA, falling to 1.3x for FY24e.

The business’s capital requirements are minimal, although ongoing investment in products and services is always needed to maintain market relevance.