Converge Technology Solutions has more upside, Eight Capital says

Converge Technology Solutions (Converge Technology Solutions Stock Quote, Chart, News, Analysts, Financials TSX:CTS) has been on an amazing run over the past month and a half, not to mention the whole of 2020 when the stock returned 255 per cent. But there’s likely more upside to come, according to Eight Capital analyst Suthan Sukumar, who reviewed Converge’s latest move in a report to clients on Friday. Sukumar says Converge’s newly bulked-up coffers have the company primed for European expansion.

Hybrid IT provider Converge Technology Solutions has been consolidating a fragmented North American IT solutions and services market, having completed 19 acquisitions since its inception in November 2016. Converge’s businesses provide clients with a mix of hardware, software and recurring cloud services, delivering analytics, cloud and cybersecurity offerings.

The company announced on June 3 the closing of a previously announced bought deal financing round offering 23 million shares at $7.50 per share for gross proceeds of $172.5 million including over-allotment. Converge says it plans to use the funds for acquisitions, working capital and other general corporate purposes.

Converge has hit a number of milestones of late, including achieving titanium partner status with Intel Corp and diamond partner status with Palo Alto Networks, both representing the highest levels of partner status with the respective companies. Converge also completed in April the acquisition of Silicon Valley-based IT solution provider Dasher Technologies which had gross revenue and EBITDA of $220 million and $12.6 million, respectively, over the trailing 12 months.

For Converge, which graduate to the TSX senior board in February, the company reported first quarter 2021 earnings in early May, showing revenue growth of 28 per cent year-over-year to $310.2 million and adjusted EBITDA of $18.8 million compared to $11.0 million a year earlier. The Q1 also saw Converge acquire multi-cloud infrastructure provider Vicom Computer Services, analytics consulting company CarpeDatum and IT infrastructure and security solutions and services company Accudata Systems.

“Converge has attained yet another historic Q1 earnings and I am pleased to witness our 2020 momentum carry us successfully into the new year, despite the challenges we continue to face around the globe,” said CEO Shaun Maine in a May 11 press release.

On Converge’s latest financing, Sukumar said after the cash outlay for Dasher the company should have a pro-forma cash balance of around $230 million, with a further $190 revolver with about $50 million undrawn for further capacity if needed for a larger acquisition.

“We believe the raise provides the company with greater firepower for M&A to establish a beachhead in the European market, while accelerating key growth initiatives that include scaling their managed services business, a key driver for continued margin expansion,” Sukumar wrote.

“From an organic growth perspective, we see CTS well positioned for continued sales and new logo momentum, with growing pent-up demand as project activity ramps with market re-openings and greater channel activity, as key partners like IBM shift more focus into the channel in H2, driving an expanded outlook for up/cross-sell of higher- margin software, cloud, and managed services,” he said.

Sukumar said while he expects Converge to deliver strong execution in upcoming quarters, the European M&A should be a key catalyst (over quarters two and three), with some details on the broader European expansion and managed services growth likely coming in the company’s AGM on June 23, itself a potential catalyst for the stock.

On CTS’ potential first European acquisition, Sukumar said the company last confirmed NDAs signed with four targets after having evaluated over 60 potential targets, with management expecting to close on its first transaction later in Q2 or early in Q3.

“European M&A will be incremental to the four to six deals targeted this year in North America and will be generally larger than CTS’ typical $75-200-million revenue profile. CTS expects to pay similar 5-7x EBITDA multiples for North American deals, although we expect valuations could be slightly higher given the greater scale and quality of assets being acquired in the European market,” Sukumar wrote.

By the numbers, Sukumar thinks CTS will generate revenue in 2021 and 2022 of $1,482.2 million and $1,681.2 million, respectively, and adjusted EBITDA in 2021 and 2022 of $104.2 million and $146.1 million, respectively.

With the update, Sukumar has reasserted his “Buy” rating and $11.00 target, which at press time represented a projected 12-month return of 36 per cent. The analyst estimated CTS to be currently trading at 10.1x 2022 adjusted EBITDA, which he sees as a discount to regional VAR and IT solution providers and global SI firms trading at 11.6x and 12.6x, respectively.

“Our target implies 14.0x (up from 13.3x) F22E adj. EBITDA, given stronger growth rates and upside from M&A, with room to expand with continued margin expansion given a growing mix of higher-margin software/IP, cloud and managed service offerings,” Sukumar wrote.

Year-to-date, Converge’s share price is up 68 per cent.