More upside available to Converge Technology Solutions, Paradigm says

Canadian tech consolidator Converge Technology Solutions (Converge Technology Solutions Stock Quote, Charts, News, Analysts, Financials TSX:CTS) is off to a good start in the new year, according to Paradigm Capital analyst Daniel Rosenberg, who reviewed the company’s latest acquisition in a Tuesday research note to clients. Rosenberg reiterated his “Buy” rating and $13.50 target price for Converge, which at press time represented a projected one-year return of 34.7 per cent.

Hybrid IT solutions provider Converge announced on Monday the acquisition of PDS Holding Company, a Delaware-based company with subsidiaries including Paragon Development Systems, which offers digital transformations solutions for clients in three markets: healthcare, the public sector and corporate. The deal comes with a purchase price of US$52 million paid in cash.

“We’re pleased to announce the addition of Paragon Development Systems, with its expertise in digital transformation, to Converge’s portfolio of companies,” said Shaun Maine, CEO of Converge, in a Monday press release. “PDS’ knowledge and proficiency in the healthcare space will enhance Converge’s ability to deliver enterprise solutions and managed services to our clients in this sector across North America. Additionally, PDS’s presence in the central region will give us more scale across Wisconsin, Illinois and Minnesota to help us continue to meet the requirements of our clients in these areas.”

Commenting on the acquisition, the 26th in Converge’s history and the second-largest, Rosenberg said PDS generated about $239 million in revenue and $11.4 million in adjusted EBITDA in the last 12 months which reflects a purchase multiple of about 0.3x revenue and 5.8x EBITDA, which is in line with CTS’ past acquisitions.

“PDS has a deep presence in the healthcare space that will enable Converge to deliver enterprise solutions and managed services to clients in the sector. In addition, Converge can up-sell PDS solutions to its clients across North America,” Rosenberg wrote.

“The outlook for 2022 is strong with strength in cloud spending, digital transformation and cybersecurity driving organic growth complemented by the company’s M&A strategy. We are increasing our forecast to account for the acquisition,” he said.

By the numbers, Rosenberg is now calling for CTS to hit 2022 revenue of $2,370.8 million (previously $2,300.7 million) and adjusted EBITDA of $191.3 million (previously $189.3 million). Those top and bottom numbers are above the consensus estimates at $2,226.7 million and $171.4 million, respectively.

“Converge is rapidly growing by consolidating regional IT service providers to create a national service offerings in North America and Europe. CTS’s strategy is aligned with IT spending trends in cloud and COVID-19 has been a catalyst for further investment in the area,” Rosenberg said. 

“CTS has strong strategic partnerships with cloud technology leaders, including VMware, Red Hat, Microsoft Azure, Amazon Web Services and Google, which highlight its capabilities in serving complex IT networks. These relationships support high-margin managed service revenue. In addition to strong organic growth, the company is executing a disciplined M&A model. With eyes set on international expansion, CTS offers investors a strong growth profile, proven execution, and an attractive valuation,” he wrote.

On comps, Rosenberg has Converge at 2022 EV/Revenue and EV/EBITDA of 0.8x and 9.4x, respectively, versus its peer group average at 1.9x and 12.6x, respectively.

Converge has come a long way over the past year and a half, with the stock moving from about $1.50 per share in July of 2020 to the $11-$12 range over the past six months. For 2021, CTS delivered a return of 119 per cent.

But Rosenberg sees more upside on the horizon.

“We believe a large opportunity to expand and cross-sell should drive continued share price appreciation over the long term. Industry tailwinds support organic growth and a well-capitalized balance sheet and proven M&A model point to a substantial growth opportunity,” Rosenberg said.

“We use a 14.0x multiple on our 2022 EBITDA estimate. Peers trade at 12.6x CY22e EBITDA while Converge is at 9.4x. Our target multiple accounts for the large M&A opportunity for Converge and attractive growth profile. We see a compelling entry point into the name and reiterate our Buy recommendation and $13.50 target,” he said.

Converge last reported its financials in mid-November where the company’s third quarter featured revenue up 93 per cent year-over-year to $367.3 million and adjusted EBITDA up 29 per cent to $18.9 million. Cashflow came in at a record $48.1 million, up 86 per cent from $25.9 million a year earlier. 

Over the quarter, CTS closed on the acquisitions of REDNET AG, Vicom Infinity and Infinity Systems and closed on a $259-million equity financing at $10.55 per share. Since the quarter’s end, Converge completed the buy of business analytics company LPA Software Solutions and closed on a $35-million non-brokered private placement to the company’s new SaaS-based cybersecurity business Portage CyberTech.