Converge Technology still has more upside, says Laurentian Bank

Nick Agostino of Laurentian Bank Securities has increased optimism about Converge Technology Solutions (Converge Technology Solutions Stock Quote, Chart, News, Analysts, Financials TSX:CTS), reiterating his “Buy” rating while raising his target price to $13.25/share from $11.75/share in his latest update to clients on Thursday.

Converge Technology Solutions is a North American IT solution provider focused on delivering industry-leading solutions and services. Converge offers advanced analytics, cloud, cybersecurity and managed services to clients across various industries.

Agostino’s update comes after Converge completed the acquisition of a 75 per cent stake in Germany-based Internet telephony service provider (ITSP) REDNET AG for 96 million euros, plus an adjustment of 75 per cent working capital. The deal was financed by a recent bought deal for gross proceeds of $172.5 million. The deal allows for CTS to acquire the remaining 25 per cent of REDNET after three years and to receive its pro-rata share of REDNET’s earnings starting Jan 1, 2021.

REDNET represents Converge’s 23rd acquisition to date, and its first entry into Europe.

“We are excited to announce Converge’s acquisition of REDNET AG,” said Shaun Maine, CEO of Converge, in the company’s August 5 press release. “The addition of REDNET is significant, as it marks Converge’s official expansion into Europe and will greatly increase our ability to serve clients globally. From infrastructure, to service, to operations and logistics, REDNET’s strong capabilities and offerings in the public sector will both enhance Converge’s current services and strengthen our global footprint.”

Founded in 2004 with just under ten employees, REDNET specializes in serving education, healthcare and government/public sectors, providing detailed advice, economic planning, smooth logistics, and fast service to their clients, with a particular emphasis on bringing value through comprehensive, high-quality services and extensive know-how in handling large rollouts.

Agostino views the acquisition as being highly accretive, as the purchase price represents an approximate 8x multiple on the expected 2021 EBITDA of 16 million euros, and an approximate 5x multiple of the expected 2022 EBITDA of 24 million euros, with Agostino also noting Converge paid a premium to secure quality management in the name of establishing self-sufficient operations and infrastructure in Europe, with REDNET CEO Barbara Weitzel expected to be in charge of Converge’s future operations in Germany.

“CTS ultimately acquired a highly lucrative asset in REDNET, with its long term value proposition deemed an ideal fit and helping stave off competition from other players,” Agostino wrote in his report. “We believe a total of 31 bids were also received from private equity players. REDNET will serve as a platform acquisition for CTS in Germany.”

With Converge expected to announce its second quarter financial results on August 11, Agostino has made some revisions to his overall estimates, though he has a more conservative outlook in the present, projecting revenues of $328.2 million (44 per cent year-over-year growth) for the Q2 and an EBITDA of $22.1 million, good for a 6.7 per cent margin.

Overall, Agostino’s projections for Converge have increased, as he has raised his revenue expectations for 2021 from $1.52 billion to $1.69 billion, which would mark a 77.6 per cent year-over-year change from 2020’s reported $948.8 million in revenues. Agostino then has Converge crossing the $2 billion revenue threshold in 2022, moving from the initial $1.79 billion projection to now an estimated $2.27 billion, which would be approximately 34.5 per cent higher year-over-year than the 2021 projections.

Agostino projects the EBITDA to take a similar annual spike, with the 2021 projection moving from $105.8 million to $113.3 million, with the projected margin percentage dropping  from seven per cent to 6.7 per cent. Agostino sees the 2022 expected EBITDA jumping from his original $160.9 million estimate to $182.5 million, representing a margin of 8.1 per cent.

Agostino has projected the company to have $108.1 million in free cash flow in 2021 and $107.5 million in 2022.

Meanwhile, Agostino believes investors can expect a slightly improved return on their share, as the adjusted diluted earnings-per-share numbers now come in at a projected $0.27/share for 2021 (up from $0.25/share), before spiking to a projected $0.52/share in 2022, up from the initial $0.46/share estimate.

On Converge’s second quarter, Agostino wrote, “We expect a host of organic opportunities to continue to spur growth, including the continuing rebound in IT spending, an active managed services pipeline (with CTS targeting a 2021 exit run-rate of $100 million; currently at ~$65 million), strong relationship with vendors as IBM (which reported strong Q2 results led by strong hybrid cloud adoption; 6.1 per cent YoY increase in software revenues, Red Hat sales up 20 per cent YoY) and increasing customer wallet share with a focus on managed services (59 customers in Q1 represented >$1M in transaction value), including the company’s partnership with Lucira Health.”

“In addition, we model ~$90.1 million in M&A contributions – including a full quarter of revenues from the Workgroup, CarpeDatum, Vivvo, Vicom and Accudata deals, alongside proportional revenues from Dasher (Apr. 1/21) and minimal contribution from the ExactlyIT (Jun. 23/21) acquisition. That said, we recognize our Q2 revenue figure is conservative in light of an expected pickup in business with IBM in H2 and onboarding delays with i-Series hosting contracts,” he said.

Going forward, Agostino believes Converge’s European acquisition strategy will continue to play out.

“With its first European deal now wrapped up, we expect the company to only accelerate its M&A pace in the continent as it narrows down its list of European targets, with follow-on transactions possibly in order either before 2021 year-end or heading into 2022,” Agostino wrote.

At press time, Agostino’s $13.25 target represented a projected one-year return of 19.9 per cent.