Investors should be thinking about hybrid IT solutions company Converge Technology Solutions (Converge Technology Solutions Stock Quote, Chart, News TSXV:CTS), says Paradigm Capital analyst Kevin Krishnaratne, who in an update to clients on Friday called CTS attractively priced.
Toronto-headquartered Converge reported its third quarter 2019 financial results on November 20, showing revenue of $144.5 million, a 44.4-per-cent increase year-over-year and adjusted EBITDA of $5.8 million, up from $0.2 million a year prior.
Converge is pushing its growth-by-acquisition strategy to consolidate the regional IT Services market. Over the quarter ended September 30, Converge acquired Nordisk Systems, while since then, CTS has acquired Datatrend Technologies, Essex Technology Group and VSS Holdings.
“As small and medium sized enterprises continue their journey towards cloud integration, Converge continues to benefit strongly by guiding these organizations through the transition process,” said CEO Shaun Maine in the quarterly press release.
“We are pleased to announce that we are near completion of our Phase II strategy and we intend to initiate our Phase III strategy beginning in 2020 which is primarily focused on generating additional operating leverage and efficiencies, working towards further increasing our Adjusted EBITDA margin,” said Maine.
Looking at the quarterly numbers, Krishnaratne sees the potential for continued growth in recurring revenue. Revenue from monthly recurring cloud, software and managed services was at 12.5 per cent of annualized gross revenue in the Q3 versus 11.5 per cent in the previous quarter. The analyst said that related revenue generates higher-than-average VAR gross margins which tend to be in the mid-teen range, with CTS posting a gross margin of 24 per cent over the quarter.
Krishnaratne calls CTS’s recent acquisitions attractive and poised to drive opportunities for revenue upside via cross-selling and margin expansion via synergies, rebates and marketing developing funds.
“We believe that CTS is well aligned where IT spending trends are moving, namely its strategy to offer its clients software, hybrid cloud, and Managed Services, which are higher growth and higher margin and help the company standout versus traditional Value Added Resellers (VAR) who focus more on Hardware and compete on price. In our view, CTS’ deep understanding of its clients increasingly complex IT networks that leverage multiple IT vendors and a mix of public and private cloud services should enable it to drive an increasing mix of Managed Services revenue and drive profit upside,” writes Krishnaratne.
On a valuation basis, the analyst thinks that CTS shares are attractively trading below 6.0x his 2020 EBITDA estimate versus recent transaction in the IT Services space at more than 7.0x 2020 EBITDA estimates and versus peers in the space at more than 9.0x.
With the Krsihnaratne has upped his estimates for CTS, calling for fiscal 2019 revenue of $698.4 million (was $673.2 million) and adjusted EBITDA of $31.5 million (was $29.2 million). For fiscal 2020, he is calling for revenue of $996.5 million (was $744.6 million) and adjusted EBITDA of $45.9 million (was $34.8 million).
The analyst is keeping his “Buy” rating while raising his 12-month target from $1.75 to $2.00 per share, which represented a projected return of 66.7 per cent at the time of publication.