Small Caps | Sep 01 2016
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Intellectual property services company Xenith IP outperformed its prospectus in FY16 and brokers suggest growth opportunities abound.
-Increased scale and improvements in IT seen driving fee margins higher
-Attractive for yield players in terms of cash generation and low capital intensity
-Strategic merit and greater market share with Watermark acquisition
By Eva Brocklehurst
Intellectual property (IP) services business Xenith IP ((XIP)) outperformed its prospectus in FY16, supported in large part by positive legislative changes in the US and in Australian patent examinations, as well as favourable movements in the Australian dollar against its US counterpart.
The company's margins expanded to 39% from 20% in FY15, driven, Morgans maintains, by an ability to leverage its fixed cost base. A maiden dividend of 7c for the second half was in line with expectations and the company maintains a pay-out ratio of 70-90%. No specific guidance was provided for FY17 but management is driving its Southeast Asian strategy on the back of recent acquisitions.
Improvements in IT platforms and increased scale are driving up professional fee margins, Morgans observes. The company has acquired Watermark which is expected to expand market share to 10% domestically.
The acquisition price was $19.5m and Watermark, which currently has a 4% market share, is expected to contribute $12-13m in earnings (EBITDA) on a full-year basis. The acquisition will be funded by a $9.5m placement to Watermark principals with shares escrowed for two years. An additional $9.5m will be funded by way of a capital raising and existing debt facilities.
Morgans incorporates the acquisition and rolls forward FX estimates, upgrading its recommendation to Add from Hold. The broker assumes Watermark's top line will grow in line with market trends and also assumes Xenith can extract a higher margins over time. The broker remains attracted to the strong cash flow and ability to consolidate the fragmented IP market. The main risks to forecasts include regulatory changes, adverse FX and economic conditions which impact on innovation.
Shaw and Partners observes the move to US dollar pricing for a large number of clients introduces some volatility into the revenue base although a hedging policy is in place. The broker is bearish on the Australian dollar so envisages revenue upside from US dollar pricing in the medium to longer term.
The broker envisages plenty of opportunities to grow via acquisitions as, with only $6.6m in bank debt following the Watermark deal, financial flexibility is high. The broker believes cash generation and low capital intensity make the business attractive to yield players and, moreover, the company can continue to grow both organically and via acquisitions, so it represents an attractive balance of yield and growth.
Shaw and Partners, not one of the eight stockbrokers monitored daily on the FNArena database, retains a Buy rating and $5.00 target. After revenue growth of 19% in FY16 the broker expects a more “normal” 6.5% growth rate in future, comprising 3.6% growth in patent volumes and some nominal price inflation. The long term nature of client relationships and tenure of key staff mean the broker is confident in the sustainability of revenues amid favourable IP dynamics.
The broker expects margins to increase over time but remains uncertain whether they will approach the level of peer IPH Ltd ((IPH)), given the Watermark business is somewhat independent and, thus, not all synergy benefits that normally are associated with a professional services merger will easily be achieved. The broker does envisage scope for margins to move closer to IPH's 45%.
The acquisition of Watermark has strategic merit, Bell Potter contends. There are diversification benefits, operational scalability and increased geographical reach. The company is engaged with additional prospects in both Australia and Asia and successful execution on any transaction will present significant upside in the broker's opinion.
Bell Potter, not one of the eight monitored on the database, has a Buy rating and $4.80 target predicated on the company's blue-chip client base, growth opportunities and attractive industry fundamentals.
Xenith IP owns entities which provide specialist IP services including identification, registration, commercialisation and enforcement of IP rights for a range of clients.
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