Governments Provide Appen With Growth Potential

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Language technology provider Appen is supported by large customers increasing their use of its products, and a government opportunity is highlighted in the 2019 results.

-Figure Eight reveals big uplift in recurring revenue
-Government interactions likely to provide a new leg of growth
-Significant amount earmarked for investment in sales & marketing
 

By Eva Brocklehurst

Brokers welcomed the quality of the 2019 result from language technology provider Appen ((APX)) and breathed a collective sigh of relief that there is expected to be negligible impact (so far) from coronavirus. Growth in 2019 was underpinned by the increasing use by existing customers of the company's products, as revenue from the five largest grew 46%.

The Figure Eight business has rebounded and established its base, with a big uplift in recurring revenue, and Canaccord Genuity observes the path to profitability has now shortened.

While growth in Relevance was at the slowest pace for some time, this is attributed to difficult comparables. The company has pointed to a multi-year agreement with one of its largest Relevance customers at flat pricing for five years.

While pricing pressures from major customers have been a key risk, UBS considers this development a material incremental positive, and supportive of a stronger market position for the business.

The broker also notes US government interactions are tracking ahead of expectations and the company is likely to be one of the few specialist annotation providers with access, providing a material catalyst to the upside. UBS asserts the company's scale and speed to market has solidified its position and potential for future growth in government and automotive sectors is significant.

Canaccord Genuity anticipates government work will provide a new leg of growth for Appen and it is well-positioned to engage, having established in the secure data space some time ago.

Citi agrees this is a significant opportunity, given the security clearance for Figure Eight and the company's secure data annotation capability. A meaningful presence is also being established in China, although Canaccord Genuity notes Appen avoided the temptation to lower expectations by citing a coronavirus impact.

Investment

While guidance for FY20 operating earnings (EBITDA) of $125-130m is slightly below consensus expectations, Canaccord Genuity assesses, on further inspection, there is a significant amount earmarked for investment in sales and marketing.

Citi suspects this detail provided fodder for the bears but discounts that view, expecting the investment will result in stronger medium-term growth, as the company diversifies its customer base and reduces client concentration.

Moreover, group operating earnings margins are expected to improve and reflect the increased scale. The broker expects Appen will have the option to both continue investing in its platform and pursue bolt-on technology acquisitions because of the strong free cash flow.

Canaccord Genuity also suggests the order book has become a less powerful forecasting tool as customer orders are now spread more evenly. The broker, not one of the seven monitored daily on the FNArena database, finds it unsurprising the underlying growth rate is slowing and remains curious about how the market will value such stocks when stellar growth rates have passed, retaining a Hold rating and $28.80 target.

Bell Potter, also not one of the seven, downgrades estimates for 2020 and 2021 by -11% because of the large increases in amortisation forecasts. This more than offsets the upgrades to revenue and earnings forecasts.

The net result of the broker's review of the numbers is a downgrade to Hold from Buy with a target of $27.50. On the other hand, UBS finds the valuation attractive, with earnings risk is firmly skewed to the upside and reiterates a Buy rating.

Over the longer term, however, Credit Suisse has structural concerns regarding the increase in competition in the industry and profit margins that appear high for what is "in large part a labour hire business".The database has two Buy ratings and one Hold (Credit Suisse). The consensus target is $29.97, suggesting 26.7% upside to the last share price.

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