Australia | Aug 30 2019
A period of investment is masking an encouraging growth trajectory at Appen, as demand for machine-learning applications escalates.
-Increase in speech & image data sales gathering momentum
-Figure Eight disruption greater than expected
-Main competitive advantage in long-standing relationships
By Eva Brocklehurst
Appen ((APX)), a global provider of language technology and services, has an encouraging growth trajectory as it capitalises on advances in the use of artificial intelligence.
The company should double 2018 revenue by 2023, UBS asserts, highlighting the fact the world is at an inflection point in artificial intelligence, fast approaching mass adoption. The broker also expects the company can achieve 20% operating earnings margins by 2023.
UBS ascertains machine learning applications are likely to continue requiring human training data sets for at least the next ten years. The company has modified 2019 guidance for operating earnings (EBITDA), expecting it will trend to the upper end of the $85-90m range.
Citi suspects this range could prove conservative, anticipating some further FX benefit and strong broad-based growth in speech & image data and Relevance, which provides annotated data used in search technology. The increase in speech & image data sales is evidence that demand for these services is gathering momentum, the broker adds.
The market may have overlooked the implied growth outlook for the Relevance business, UBS suggests. On a like-for-like basis that business is expected to deliver around 80% growth in operating earnings, which implies the end-market dynamics are strong. Bell Potter calculates that, of the 60% growth in Appen's sales revenue in the half year, 53% was organic and the remainder from the Figure Eight acquisition.
Appen has made a downgrade to 2019 expectations for Figure Eight, acquired early in 2019. Figure Eight allows the transformation of text, image, audio and video data into customised training data for a wide range of uses.
Given this business was only acquired recently, UBS acknowledges the downgrade requires close scrutiny. The business, naturally, requires some integration of software platforms and the migration of customers, which carries risk and may not always be smooth or timely.
Credit Suisse agrees, suspecting prudent cost management will feature more on the path to breaking even for Figure Eight than was previously anticipated. Management has retained its profit outlook as per guidance at the time of acquisition and synergies in 2019 are guided to be 25-35% of the pro forma financials.
Credit Suisse takes a more conservative estimate for synergies, partly because of concerns about the company's ability to hold costs down. Citi acknowledges a loss of momentum at Figure Eight in the June quarter but does not believe this is material to the growth trajectory.
The company appears to be undertaking a period of elevated R&D and this is masking a strong performance, UBS points out. At the time of acquisition Appen expected Figure Eight returns to grow 40-50% but the disruption has been greater than expected and, combined with a shift in customer focus and earn-out, has resulted in lower renewals and sales in the second quarter.
Nevertheless, UBS continues to envisage upside opportunity from Figure Eight while continued artificial intelligence requirements are a major tailwind, particularly in government business, where Figure Eight has worked previously.
The broker upgrades to Buy from Neutral, believing the valuation remains attractive relative to peers. Bell Potter, not one of the seven stockbrokers monitored daily on the FNArena database, also upgrades to Buy from Hold, with a target of $27.50.
The main competitive advantage is in long-standing relationships with many of the company's customers, the broker asserts. The majority of revenue is from repeat business from customers that regularly update and upgrade products.
Credit Suisse is also upbeat when it comes to demand in the industry. Direct competitors to Appen are limited although, longer term, competition is likely to increase. Customers are highly concentrated, with the top five delivering 89% of 2018 revenue. Credit Suisse remains alert for any deterioration in the industry structure and considers the valuation full.
The main risk Citi is mindful of, as Appen adds scale with LeapForce (a website for independent contractors) and Figure Eight, stems from customers pushing harder to participate in the economies of scale. The FNArena database has two Buy and one Hold (Credit Suisse) rating. The consensus target is $29, signalling 13.7% upside to the last share price.
See also, Appen Highlights Lift In Order Book on June 4, 2019.
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