Converge Technology’s pullback is overdone, says Desjardins

Desjardins analyst Kevin Krishnaratne remains confident in Converge Technology Solutions (Converge Technology Solutions Stock Quote, Chart, News, Analysts, Financials TSX:CTS), reiterating his “Buy” rating and target price of $13.75/share in an update to clients on October 7.

Founded in 2016 and headquartered in Toronto, Converge Technology Solutions is a North American IT solutions provider with offerings in advanced analytics, cloud, cybersecurity and managed services to clients across various industries.

Krishnaratne’s latest update comes ahead of the company’s expected third quarter financial results, with the analyst addressing both the stock’s recent pullback and potential issues for the company related to supply chain constraints.

“While the IT services sector is down alongside broader tech weakness, and we acknowledge the potential for near-term headwinds on supply chain constraints, we view CTS’s outsized decline as overdone,” Krishnaratne said.

Krishnaratne portrayed a view held by many manufacturers that there is a backlog in supply for hardware chips which has impacted the near-term revenue outlook. According to companies like CDW, Insight Solutions and Accenture, demand has been driven by customers seeking resiliency in their hardware, as well as Microsoft releasing the new Windows 11 operating system. Krishnaratne said many of Converge’s key vendor partners like Dell, Cisco and HP have also forecasted issues in their supply chains, though IBM has identified three key areas that should help supplement Converge’s tailwinds, namely a focus on its Red Hat cloud strategy, increasing software to represent 65 per cent of its revenue mix compared to its current 45 per cent, and an expectation for infrastructure changes to drive opportunities for the company.

However, Krishnaratne also said many other areas of the business remain well-positioned given software and cloud tailwinds; most recently, the company announced that it had acquired New York-based LPA Software Solutions, a full-service IBM Platinum Partner that provides business analytics solutions and professional services in analytics, data science, artificial intelligence, financial performance management, data governance, data integration, location analytics, and data sets.

“Converge is excited to add LPA Software Solutions to our ever-expanding team and array of solution capabilities,” said Shaun Maine, CEO of Converge in the company’s October 4 press release. “With 20+ years’ experience serving clients in the analytics space, we’re looking forward to folding in LPA’s advanced analytics knowledge and skills to our current offerings and are excited to grow Converge’s business intelligence, data, and AI practices alongside their team. LPA will enable us to continue to scale and grow our advanced analytics practice across North America.”

With potential shifts in the company’s device-heavy businesses like Northern Micro and REDNET, Krishnaratne has made some slight adjustments to push some of his financial projections further into the future, with a more subtle revenue drop to $370.8 million (previously $372.2 million) in play for the third quarter, with a more substantial lowering to $506.4 million (previously $609 million) now projected for the fourth quarter.

Krishnaratne’s EBITDA projections also go down on a similar trajectory, with third quarter EBITDA now projected at $21.8 million compared to the previous $24.4 million estimate, while the fourth quarter is now projected to yield $37.1 million in EBITDA compared to the initial $44.5 million projection.

Through the annual lens, Krishnaratne projects the company’s revenue to now be $1.5 billion in 2021 (previously $1.6 billion), with an increase to $2.2 billion in play for 2022, slightly lower than the previous $2.3 billion estimate, though it’s modelled on eight per cent year-over-year organic growth in Converge’s North American business, which profiles better than Gartner forecasts for IT spending growth at 5.2 per cent.

Krishnaratne’s EBITDA projections also drop from an annual perspective, with a revised estimate of $99.4 million in play for 2021 (previously $109 million), followed by a projected increase to $177 million in 2022, reduced from the initial projection of $191 million.

Despite the drops in the more immediate projections and a belief that the supply chain will be disrupted until at least the middle of 2022, Krishnaratne still believes the company is in a strong position to navigate any future issues.

“We see Converge’s relationship with distributors such as Ingram Micro and its position as a scaled OEM vendor partner as helping it better source products relative to the smaller regional VARs it competes with,” Krishnaratne noted. “Converge saw such benefits during the onset of the pandemic in early 2020.”

Overall, Converge has performed very well through the course of 2021, yielding a return of 80.8 per cent for the year to date. However, the stock’s value has slid by 28.2 per cent since reaching its high point of $12.85/share on September 7. At press time, Krishnaratne’s $13.75 target represented a projected return of 46.9 per cent