Does a 20 per cent slide in the IRESS (ASX:IRE) share price make it a takeover target?
IRESS is a supplier of technology solutions for clients in the financial markets, wealth management, and mortgage sectors. They have operations in Australia, NZ, UK, Asia, Canada, and South Africa.
For the retail stockbroking and private wealth management industries, IRE’s unique selling proposition is that it offers a complete service. It meets a significantly large portion of a client’s core system needs on a simple platform. The majority of the Company’s licence fees comes from wealth management (mostly financial planning) firms where revenues are only marginally moved by changes in equity market conditions.
IRE provides the XPLAN financial services software system for the financial planning and wealth management industries in ANZ, the UK, South Africa and Canada.
Is there evidence of operating leverage?
A key focus in the analysis of IRE’s fundamentals is the extent of revenue growth in light of higher cost investment being undertaken by the Company. This was evident in November 2017, when the Company downgraded its FY17 earnings growth guidance. This was done on the basis that operating leverage was not evident. That is, the higher cost investment undertaken earlier in FY17 had not led to as much revenue growth as IRE expected. This was due to delays around client decisions.
Our analysis of The Profit & Loss Statement for the six months to 30 June 2018 (IRE has a 31 December balance date) led us to conclude that meaningful operating leverage is yet to flow through. In particular, while cost growth in three key functions, Products & Technology, Operations and Corporate (which comprise less than 60% of the overall operating costs) have been controlled, there is still further work to do in terms of reducing costs in other areas of the business. This is required in order to potentially mitigate a re-occurrence of one-off increases in client implementation costs.
Increase in net debt has stretched the balance sheet
The net debt balance increased to $189.7m as at 30 June 2018, up from $165.8m as at 31 December 2017, with gearing increasing to 1.4x (on a net debt to EBITDA basis). The gearing level is unlikely to come down in FY19. This is because the Company’s investment in cloud infrastructure is expected to have a cash impact in FY19.
Further, the headroom under the recently-refinanced debt facility remains limited. This means that further acquisitions are likely to stretch the balance sheet further (if debt-funded), or they require another equity raising. To this end, it is worth noting that the most recent major acquisition (Financial Synergy) was fully funded by a $115m equity raising at $11.35 per share.
We remain cautious on IRE given that revenue growth and operating leverage in the key UK Wealth Management business needs to increase further. Especially from the viewpoint that growth is needed from stronger areas of the business in order to offset ongoing weakness in other areas of the business. Most notably, the contribution from the APAC Financial Markets segment, which showed negative revenue and earnings growth in 1H18 due to continued sell-side pressures.
Having said that, one potential source of upside is that IRE is considered an attractive takeover target, given that the Company is a small player on the global stage. Most of its competitors are significantly larger in terms of revenues, earnings and market capitalisation. Another factor making IRE a potentially attractive takeover target is that it continues to re-invest in product – its fully-integrated offering has multiple operating modules that are complex and therefore need constant updating to meet changing client and regulatory requirements.
From April to August this year, IRE had a fantastic run from under $10 to over $14. Unfortunately it has come back just as quickly and has struggled to bounce with any conviction. There doesn’t seem to be any strong support yet so we are likely to see IRE retest the recent lows near $9.50. That would make the pricing levels much more attractive from the point of view of a trader or other investor.
Michael Gable is managing director of Fairmont Equities.
Sign up to our newsletter. It comes out every week and its free!
Would you like us to call you when we have a great idea? Check out our services.
Disclaimer: The information in this article is general advice only. Read our full disclaimer HERE.
Like this article? Share it now on Facebook and Twitter!