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Technology One Surprises In The Cloud

Australia | May 24 2017

This story features TECHNOLOGY ONE LIMITED. For more info SHARE ANALYSIS: TNE

Technology One surprised brokers in its first half result, posting a maiden profit in cloud business and weakness in its more established consulting business.

-Typically volatile first half with sales heavily weighted to the second half
-Considerable leverage to be realised once new products contribute to the bottom line
-Strong dividend outlook and potential for special dividends

 

By Eva Brocklehurst

Technology One ((TNE)) surprised brokers in its first half result, posting a maiden profit in cloud business and a loss in its more established consulting business.

Morgans observes the company typically has volatile first half results so was pleased to witness guidance of 10-15% profit growth for the full year. The company has consistently stated first half results are not indicative of the full year. The FY17 sales pipeline is heavily weighted to the second half.

In the half year, total consulting fees were $32.9m and flat, initial licence fees were up 30% to $24.1m, while cloud service fees of $8.2m were up 90%. First half operating cash flow was up 177% and cash conversion was 57%. The dividend was up 10% at 2.6c, 75% franked, reflecting a pay-out ratio of 101%. The company has highlighted a potential special dividend at the end of the year.

A large skew to the second half was well flagged by the company and UBS expects an improved pipeline of business should bear this out. The broker believes a strong track record of growth in earnings per share warrants a premium valuation for the stock, although much of this is factored into the share price at current levels.

Cloud

Brokers welcome the maiden profit in the cloud, six months ahead of forecasts. The company has added 41 new cloud customers, which takes the total to 199, and upgraded its guidance for the cloud. The aim of the cloud platform is to move the business away from perpetual licences towards an annuity business (software-as-a-service).

In FY16 the cloud business lost -$2.2m and this has now swung around, with the company guiding to a $2.5m profit in FY17. Management is targeting around $32m in annual contract value from the cloud in 2017, building to $43m by FY22.

Macquarie observes there is considerable leverage to be realised once new products contribute to the bottom line, along with cloud momentum and market scale in the UK. The broker accepts there are risks with the migration to cloud services but believes a premium valuation is warranted, as the company has an opportunity to increase higher-value solution sales to clients.

Consulting

Consulting revenue was disappointing. Macquarie notes costs growth of 15% was ahead of revenue growth, although affected by a -$1.6m customer conference charge and associated lost revenue for the Evolve conference. The Brisbane City Council dispute has cost the company -$2m of consulting profit in the half-year and the contract is expected to be terminated in the near term. Management remains confident of its legal position and ability to recover damages.

The broker notes the UK business continues to be a drag but improvements are gathering momentum and management believes it has potential to reach $100m in revenue by 2022. Morgans points out that the UK booked a maiden profit last year after 10 years of losses but this reversed in the first half and the company lost -$800,000. The full year outlook for the UK appears positive and the broker accepts the first half issues may have just been related to timing. The company has guided to a $500,000 profit in FY17.

Consulting business missed Bell Potter's estimates, having forecast a profit. The offset to this was the unexpected profit in the cloud business. The broker forecasts growth in pre-tax profit of 16% in FY17 and higher growth of 19% and 20% in FY18 and FY19 respectively.

The broker now includes special dividends in its distribution forecasts, in addition to the final dividend in each forecast period. Bell Potter, not one of the eight stockbrokers monitored daily on the FNArena database, has a Hold rating and $5.75 target.

Morgans asserts Technology One is a high quality business with an impressive track record but the share price is overly optimistic on the medium-term outlook. Given the market is supporting high-quality growth stocks the broker envisages little change to the share price premium at this point. Morgans sets its target price at a 15% premium to valuation, down from 25%, to reflect market optimism.

The main risk in a stock with a strong position relates to market sentiment, Morgans contends, which can unravel quickly. The question remains if the market is willing to pay a substantially higher multiple. The stock trades on a price/earnings ratio of 39x, which appears excessive to the broker relative to growth in earnings per share.

The database shows one Buy rating (Macquarie) and two Hold. The consensus target is $5.92, suggesting 2.4% upside to the last share price.
 

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