New acquisition looks good on Converge Technology, says Laurentian

Nick Agostino of Laurentian Bank Securities likes the new pickup by Converge Technology Solutions (Converge Technology Solutions Stock Quote, Chart, News, Analysts, Financials TSX:CTS), reiterating his “Buy” rating and maintaining a target price of $12.50/share for a projected return of 26.5 per cent in an update to clients on Monday.

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 a number of industries.

Agostino’s latest update comes after Converge announced its acquisition of PDS Holding Company and its subsidiaries including Paragon Development Systems, Inc. (PDS), a Wisconsin-based organization focused on digital transformation.

“With 30+ years of experience, PDS has driven customer success with its focus on Enterprise Solutions, Digital Workplace Platforms and Managed Services,” Agostino said. “The company’s host of solutions range from cloud and security, to servers and infrastructure, to virtualized work environments and remote work.”

Converge acquired PDS from Mason Wells, a private equity firm headquartered in Milwaukee. All told, Converge paid US$52 million for PDS along with positive net working capital paid out at closing, making it Converge’s 26th acquisition since October 2017.

PDS serves three market verticals in healthcare, public sector, and corporate, advising and assisting with unique IT needs in upgrading and modernizing core infrastructure to boost innovation and digital transformations. The company has established strategic relationships with best-in-class industry partners including Aruba (Hewlett Packard Enterprise), Cisco, HP, Microsoft, VMWare, Samsung and Lenovo, with security partners such as Fortinet, FireEye and Arctic Wolf strengthening its cybersecurity practice.

With $239 million in revenue and $11.4 million in adjusted EBITDA in the last three months, the deal reflects an approximate 5.8x adjusted EBITDA multiple, although Agostino notes that the multiple is reflective of a greater proportion of recurring, higher-margin managed services revenue, despite being slightly above the historical 4-5x range.

“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 the company’s January 10 press release. “PDS’s 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.”

The acquisition has prompted Agostino to revise some of his financial projections for the company, primarily on account of trailing sales and EBITDA performance and maintaining eight per cent organic growth. While the 2021 revenue projection remains at $1.5 billion for a 58.2 per cent year-over-year increase, he has increased his 2022 revenue projection from $2.18 billion to $2.41 billion, representing a year-over-year jump of 61 per cent. 2023 also sees a slight increase, with Agostino upping his estimate from $2.37 billion to $2.62 billion, a year-over-year increase of 8.6 per cent.

From an adjusted EBITDA perspective, Agostino maintains a projection of $85.5 million for a 5.7 per cent margin, though the 2022 projection increases to $164.1 million for a reduced margin of 6.8 per cent (previously $152.5 million and seven per cent margin), while the 2023 projection is now set at $230.3 million and a margin of 8.8 per cent (previously $212.7 million and a nine per cent margin).

Agostino’s gross margin projections have also gone up, though the margin percentages remain the same. 2021’s projection remains at $345 million for a 23 per cent margin, while the 2022 projection is up to $602.4 million (previously $543.4 million) while maintaining a 24.9 per cent margin, and the 2023 projection is now set at $706.3 million (previously $637.3 million) for a 26.9 per cent margin.

The acquisition also helps bring Converge’s valuations into better focus, according to Agostino, as he projects the multiple to go up from the reported 18.9x in 2020 to a projected 20.7x in 2021, then dropping to a projected 12.3x in 2022. Meanwhile, with adjusted EPS projections of $0.12/share in 2021 and $0.40/share in 2022, Agostino projects the P/E multiple will increase from the reported 39.5x in 2020 to a projected 80.6x in 2021, then falling to a projected 24.7x in 2022.

“We believe the acquisition offers a host of advantages, including enhancing CTS’s Managed Services offering, noting the company was aiming to reach $100 million in managed services revenue by 2021-end; adding to CTS’s healthcare presence (high growth area), which currently stands at about 20 per cent of overall sales; and increasing the company’s presence in the central region, with scale across Wisconsin, Illinois and Minnesota,” Agostino said.

Converge’s stock price climbed significantly in the last year, producing a 79.9 per cent return and hitting a 52-week high of $12.85/share on September 7.