Investors, here’s why you should adopt Adapt IT
Software solutions company is a buy
Adapt IT is a software solutions company with an enviable earnings record and looks poised to exhibit further strong and sustainable growth. Turnover has grown by 29% compounded per annum over the past five years; earnings before interest, taxation, depreciation and amortisation (ebitda) by 38%; and headline earnings per share by 17%.
It is well diversified in terms of activities and geographies and its proprietary software can be adapted quickly and at low cost into a variety of new areas and countries. Rather than competing head on with the giants of the software industry such as Microsoft, Oracle and SAP, Adapt IT has instead concentrated on high-margin niche activities that the big players cannot participate in profitably. And although earnings per share were flat in the year to June 2017, the group appears to be back on its high growth trajectory once more.
While players like EOH and BCX, which operate in the services segment of the information technology space, have done well until fairly recently, they are overly dependent on their highly mobile skilled personnel who can walk out of the door at any time, taking their talents with them. Other players such as Pinnacle and Datatec are effectively just wholesalers of other peoples’ products, or, as they are referred to (perhaps rather unkindly) in the industry, “box droppers”. Adapt IT, on the other hand, produces computer code which generates software, and if skilled personnel leave the company there is little or no effect on the business.According to Keith McLachlan of AlphaWealth, whose fund has an investment in Adapt IT, the technology market globally is growing at between 5% and 10% per year. Within that broad category, the lowest growth of around 2% to 3% per year is found in hardware resellers, with services companies growing at around 4% to 5% per year. “Software, on the other hand, is growing at around 15% to 20%”, says McLachlan.
And it’s not just the high sales growth that makes Adapt IT attractive. “There is almost no cost involved in selling,” says McLachlan. “And the billing cycle is such that software licences tend to be paid in cash in advance. This gives a stable, cash generative underpin, with a 90% to 110% cash conversion ratio with respect to earnings.”
In recent times earnings from the educational segment have been hit by an extraneous event in the form of the “fees must fall” campaign. Adapt IT’s ERP software is run at South African universities, thus when budgets were frozen this had a noticeably negative impact on earnings. But with that experience now out of the way, earnings growth is back on track. In the interim six months to December 31 2017, group turnover grew by 46%, ebitda by 29% and headline earnings per share by 22%.
Growth has been both organic and acquisitive and that mix should continue. While the group will consider larger, more transformational deals, it won’t go for scale at the expense of its proven strategy. Increasing gearing for future acquisitions shouldn’t be problematic because the group is so highly cash-generative. Diversification regarding acquisitions has worked well and single-client concentration risk is now only 7% compared with around 90% a few years ago. Penetrating the public sector is firmly on Adapt IT’s agenda, as is the objective of improving its BBBEE rating from the current level 3 back to level 2. According to CEO Sbu Shabalala, “We believe we can gain new public sector business on merit as the political situation evolves.”
While the bulk of operations is in South Africa, there is ample scope to grow offshore. Commercial director Tiffany Dunsdon is based in Australia, where the group’s LGR subsidiary has operated profitably for many years. According to McLachlan, “Adapt IT is the kind of business that can potentially internationalise quite successfully.”
On a current PE ratio of around 16 times, it is not expensive.
– Chris Gilmour is an investment analyst