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Potential Re-Rating For Aconex?

Australia | Oct 26 2016

Construction management software service, Aconex, has taken time out to explain its revenue model amid concerns in the investment community and a sell off in its shares.

-Clarity on revenue and cash collections should ensure a re-rating in Morgan Stanley's view
-Conject expected to improve as the transition to the Aconex platform progresses
-Deutsche Bank prefers more evidence of moderating costs before applying higher margin assumptions


By Eva Brocklehurst

Construction management software service, Aconex ((ACX)), took time out at the AGM to explain its revenue model, given disquiet in some investor quarters and the sharp decline in the share price since the company's FY16 result. Aconex has actively moved away from up-front invoicing towards quarterly and annual contracts invoiced in advance. The transition explains to brokers why un-geared operating cash flow to earnings ratio has been at the least, underwhelming.

Aconex hosts a global cloud collaboration platform which enables clients to improve the efficiency and productivity as well as the accountability of their various projects. The company set a positive tone at its AGM and added clarity on revenue and cash collections should ensure a re-rating in Morgan Stanley's view.

The stock has been under immense pressure, the broker notes, heading into the annual meeting, but fears were mostly allayed by guidance on both revenue and EBITDA (earnings before interest, tax, depreciation and amortisation) along with a clear explanation of the cash flow status. FY18-19 revenue growth and EBITDA margin guidance was also provided at 20-25% and 17-22% respectively. Once the removal of discounts for up-front payments has washed through, cash collection is expected to realign and track ahead of revenue. Morgan Stanley expects cash flow to fully normalise in FY19.

FY17 guidance for revenue of $172-180m is below the range implied at the FY16 result, Credit Suisse observes, but EBITDA guidance of $22-25m is broadly in line with expectations, and this implies stronger margins. The broker believes the 30% decline in the share price post the FY16 result has been driven by slowing short-term organic growth, largely attributable to recent acquisition, Conject.

The broker expects the performance of Conject will improve into FY18 as the transition to developing, selling and supporting the Aconex platform progresses. This underpins the broker's confidence in the company's forecast for an acceleration in organic revenue growth in FY18 and FY19. Credit Suisse upgrades to Outperform from Neutral. The main risks envisaged are an inability to improve the Conject sales pipeline, further macro challenges and increasing competition.

Management has noted a lack of will amongst clients to make purchasing decisions amid uncertainty in Europe and the Middle East, given the Brexit decision affecting the former and falling oil prices the latter. Morgan Stanley also notes the fear, or perception, of change with the Conject acquisition appears to have had a material impact on Conject's pipeline of new business opportunities.

Aconex believes confidence has largely been restored, with the Aconex product rather than Conject. The broker suspects the market is underestimating the power and certainty of the company's earnings stream.

Deutsche Bank is more cautious. While accepting the move to quarterly and annual contracts and fewer associated discounts is a key reason for the mismatch in earnings and cash, the broker still expected cash flow would have been stronger in the first quarter given the spike in deferred revenue in FY16. The broker also highlights the unusual practice of providing FY18 guidance at this stage, but suspects this is partly in response to the market's apparent frustration at the modest operating leverage delivered by the revenue model.

This is particularly so, the broker believes, in the context of a well-established software business that should be delivering very high incremental margins. Incremental EBITDA margins of 26% in FY16 and 19% in FY17 appear low to Deutsche Bank, especially considering the higher rate of R&D capitalisation. FY18 guidance for incremental margins of 49% appears more consistent with expectations for a scalable software business. Nevertheless, the broker would like evidence of moderating costs before applying higher margin assumptions.

Given typical seasonality favouring the third and fourth quarters, and annual bonus payments paid in the second quarter, Macquarie considers it likely that operating cash flow will remain subdued until at least the third quarter of FY17. While cash flow is a good indication of recent sales conversion, the broker flags the fact that cash can be lumpy as the group cycles away from up-front billing.

Longer term, the broker believes Aconex is positioned to deliver the margin expansion that is typical of software-as-a-service (SaaS) businesses once scale is achieved. The broker awaits further clarification on the headwinds confronting Europe and the Middle East.

The ambiguity that exists while the revenue versus cash flow issue plays out is a good buying opportunity, in Citi's view. The company has significantly increased its investment in R&D on products such as bill collaboration, field inspections, cost management and analytics and the broker notes Australasia, the Americas and Asia have ongoing sales momentum.

The broker envisages three primary growth drivers in the medium term: attractive dynamics as the construction collaboration industry is under penetrated; network penetration as the company expands and converts per-user clients to enterprise agreements; and acquisitions in a highly fragmented industry along with expansion into other sectors.

FNArena's database shows three Buy ratings and three Hold. The consensus target is $7.72, suggesting 29.4% upside to the last share price. This compares with $8.19 ahead of the AGM. Targets range from $6.70 (Macquarie) to $9.30 (Morgan Stanley).

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