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Appen: The Future Is Artificial

Small Caps | Dec 01 2017

Appen’s game-changing acquisition leaves the company firmly positioned to ride the new wave of artificial intelligence applications.

– AI industry at inflection point
– Leapforce acquisition materially increases scale
– Significant earnings accretion forecast

 

By Greg Peel

Appen ((APX)) is a global leader in the delivery of high-quality, human annotated data sets for machine learning. The company has two divisions – Content Relevance, offering data search for social media, and Language Resources, providing speech data. Appen offers services in over 130 countries and 180 languages and its customers include leading global tech companies, automakers and governments.

Suffice to say, Appen is a pioneer in the field of artificial intelligence, and UBS believes AI is now at an inflection point due to technological advancements in that which enables AI, such as semiconductors and algorithms.

Up until yesterday, one of Appen’s major competitors was US-based private company Leapforce, founded in 2008 by an ex-Google employee. But not anymore. Appen has now acquired Leapforce for a cash/scrip mix, and the metrics have left brokers somewhat astonished.

Appen has paid 5.9x Leapforce earnings, when prior to the acquisition Appen was trading at 20x. Canaccord Genuity believes the discount reflects both a typical discount when buying an unlisted company (as opposed to listed, which usually requires a control premium) and the fact Leapforce sees the tie-up as its most attractive growth option.

Appen estimates earnings accretion of at least 35%.

Scale

Although Leapforce is smaller, the acquisition will provide Appen with a significant increase in scale, analysts note, with a combined “crowd”, to use industry parlance, in excess of one million workers. Leapforce will also alleviate Appen’s customer concentration (top five customers represented 88% of revenue in the first half 2017).

Appen will materially increase the volume of work it currently does, but also what it can do going forward, Citi suggests. Cost synergies will be extracted from the merger but have not yet been quantified. Appen believes Leapforce’s direct data feeds will increase customer “stickiness”.

UBS sees new opportunities for the businesses arising from autonomous vehicles, finance and medicine.

Leapforce’s revenues and earnings have grown at a compound annual rate of 27% and 30% respectively over the last four years, Canaccord notes, compared to 42% and 35% for Appen. But Leapforce’s profit margins are notably higher at 23% to 17% in 2017. Citi expects some margin pressure ahead, as customers point to the merged business’ increased scale.

But margin pressure does not take away from the significance of the acquisition. This is apparent as Canaccord (Buy) lifts its share price target to $8.10 from $4.90.

Citi (Buy) is sticking with a $5.88 target which was close to the traded price when the analysts wrote their note, but at the time of writing Appen is trading at $7.70. UBS has today initiated coverage of Appen with a Buy rating and a target of $9.80.

Appen will fund the acquisition with a combination of cash at hand, a new debt facility and a $30m capital raising.

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