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Enghouse Systems is still too expensive, this portfolio manager says


Even with the sector-wide pullback in tech stocks Canadian software acquirer Enghouse Systems (Enghouse Systems Stock Quote, Charts, News, Analysts, Financials TSX:ENGH) is still not a buy, according to fund manager Darren Sissons, who likes OpenText better.

“Enghouse is effectively the same as Constellation Software and OpenText and Topicus, which was spun out of Constellation Software,” said Sissons, vice-president at Campbell, Lee & Ross, who spoke on BNN Bloomberg on Friday. “What they are is a growth by acquisition software company. The math is fairly simple: you buy 2x adjusted revenue or less, you acquire it, you milk the recurring cost base and if you do this successfully on a low cost basis, the company gets bigger and scales.”

“The Canadian market obviously has embraced this kind of story,” he said.

Markham, Ontario-based Enghouse focuses on enterprise software solutions for the video and communications fields, including telehealth businesses, and the company currently has two business segments in the Interactive Management Group which features the Enghouse Interactive and Enghouse Vidyo platforms and the Asset Management Group which includes Enghouse Networks and Enghouse Transportation & Public Safety. 

The company has both organic and inorganic growth on its mind, with a little short of half a billion dollars in revenue for its latest fiscal year (ended October). Enghouse’s fiscal 2021 revenue of $467 million divided up into $268.6 million from Interactive Management and $198.6 from Asset Management, with the largest contribution comes from its Hosted and Maintenance Services revenue which hit $279.0 million last year. That was actually down from $286.8 million a year earlier and the overall revenue of $467 million was down seven per cent from fiscal 2020.

The pandemic has been good and bad for Enghouse, with its video conferencing software solutions becoming in higher demand within work-from-home environments but video hardware was hit as it was seen as less important during remote work. 

Enghouse’s M&A program was also impacted through COVID, where management has said that as valuations lifted, potential acquisitions often became too expensive for ENGH’s acquisition strategy. Last fiscal year, the company said it completed three acquisitions that met its investment criteria.

“Going forward, we continue to seek earnings-accretive acquisitions to grow our revenue and further expand both our product suite and geographic reach, while maintaining our commitment to profitable growth in accordance with our disciplined business model. We will continue to operate our business consistent with our value-for-money philosophy that we believe provides shareholder value in the long-term,” Enghouse said in its fourth quarter fiscal 2021 press release this past December.

The company’s rising and falling fortunes during COVID look to be well graphed by the stock’s own ups and downs, where ENGH shot up by about 35 per cent over the first two and a half quarters of 2020 before starting a more elongated downward trajectory over the past year and a half. Now, the stock has lost all of its COVID gains and then some, with Enghouse currently trading around $34 per share, which puts it at a negative return of 29 per cent year-to-date and at levels not seen since early 2019. 

But the drop in share price is not enough for Sissons to pull the trigger.

“If you look at the multiples for the names I mentioned they’ve actually obviously grown quite nicely, but the issue I think in a rising interest rate environment becomes how will that affect the pricing of technology companies? Will the technology company from an acquisition point of view be more fertile or less fertile? And ultimately, are we in a transition point?” Sissons said.

“My personal view is Enghouse is actually quite expensive for the amount of deals that they’ve done in terms of the growth they’ve provided,” he said. “If it was a little lower I might take a look at it. But it’s quite a bit smaller and less verticalized than, say, an OpenText, so I’d prefer OpenText in the space.”

“We don’t currently have a position in the space but it has been a successful category for many Canadian investors,” Sissons said.

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