Echelon Capital Markets analyst Rob Goff says Hybrid IT solutions company Converge Technology Solutions (Converge Technology Solutions Stock Quote, Chart, News TSXV:CTS) is still significantly undervalued despite share price gains this year of 24 per cent.
In an update to clients on Sunday, Goff kept his “Speculative Buy” rating and $3.30 price target for Converge, one of the analyst’s Top Picks for the fourth quarter.
Vancouver-based Converge, which engages in combining accelerators and foundational infrastructure solutions to deliver best-of-breed solutions and services to customers, announced last Friday that it has secured a $140-million revolving credit facility with a syndicate of banks led by CIBC. The company expects the refinancing arrangement to generate interest cost savings of about $8 million.
“This move strengthens our cash flow from operations and significantly increases our financial flexibility,” said Shaun Maine, CEO, in a press release. “We have materially strengthened our balance sheet throughout 2020 and this new credit facility is a reflection of our improved financial position. The cost savings will allow us to continue to make acquisitions and further investments in our analytics, cloud, cybersecurity, and managed services offerings.”
Goff said the move should positively impact CTS’s fully diluted EPS by $0.03 per share and that the interest savings are consistent with the top end of management’s previously targeted range for refinancing savings of $6 to $8 million annually.
Goff said Converge is benefitting from the ongoing digital transformation, one which Microsoft CEO Satya Nadella earlier this year said was being accelerated by the COVID-19 pandemic, effectively putting two years’ worth of growth into just two months of this year’s third quarter. Goff said positively-revised secular growth expectations for technology adoption have driven shares for the likes of Microsoft, Amazon, IBM, Cisco and Dell to average gains of 12 per cent over the last three months, while private equity interest in IT Services has peaked over the last 12 months with further recognition of the potential for organic and acquisition growth in the currently fragmented market.
“We see the impressive outperformance of the marquee technology leaders and the interests of private equity as positive reflections of market growth along with a move to higher-value/margin services as digital implementations take on great complexity,” Goff wrote.
We remain notable above the consensus 2021 EBITDA where our gap can likely be attributed to higher acquisition activity. However, we see the lower consensus leaving room for outperformance organically and through acquisitions that could in turn support EBITDA exceeding our forecast depending on the timing and size of acquisitions.
Goff said that Converge’s track record of successfully completing 13 accretive acquisitions since October 2017, “speaks to the existing market opportunities and management’s capabilities.”
“We see many companies with profiles like its latest acquisition, Unique Digital (Oct.1/20), where they are challenged to properly service client demands for cloud services and where they lack the scale to realize full vendor savings. We believe the Company stands to build further shareholder value given the positive momentum of cross-selling its product suite for organic growth while key vendor relationships bring efficiencies, referrals, and acquisition candidates. We are bullish towards the Company’s ability to maintain its acquisition and organic growth momentum,” Goff wrote.
After finishing 2019 up 154 per cent, CTS looks headed to repeat the strong results in 2020, with its share price currently up 111 per cent. At press time, Goff’s $3.30 target represented a projected 12-month return of 15.0 per cent.
On a comparative basis, Goff thinks CTS stacks up well, with its shares currently valued at 8.9x and 5.6x 2020/21 EV/EBITDA estimates versus the company’s US IT Solution Provider peers averaging 11.7x and 10.9x, respectively, Canadian peers at 11.9x and 13.9x, respectively, and European peers at 14.8x and 13.7x, respectively. The analyst’s $3.30 target reflects 10.0x and 6.3x multiples, respectively.
Ahead of Converge’s third quarter financials coming after market close on Monday, the company last reported in August where its second quarter 2020 results saw revenue increase by 44 per cent year-over-year to $227.8 million and adjusted EBITDA grow by 112 per cent to $11.7 million.
For the Q3, Goff is expecting revenue of $216.8 million and EBITDA of $10.7 million, while for the 2020 year, the analyst is calling for revenue of $1,021.1 billion and adjusted EBITDA of $54.9 million, followed by 2021 revenue of $1,426.2 billion and adjusted EBITDA of $87.1 million.
“Our baseline organic growth forecasts (we use 7.0 per cent) reflect the underlying growth of CTS’s product and services suite in a highly fragmented IT Services market where client migration to larger, more comprehensive IT Services companies is reflected in the sector’s consolidation,” Goff wrote.
“We see the Company’s $2-billion revenue target as achievable within the next five years where growth, if roughly evenly split across double-digit organic growth and acquisitions, would see Converge making roughly $200M in acquisitions. The Company’s revenue ambitions are balanced with profitability and free cash flow discipline as seen by recent moves to realize annualized efficiencies representing $20 million-plus or two per cent of revenues in the context of 2020/2021 EBITDA at $54.9 million/$87.1 million,” he said.
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