From a recent high of $10.60 following the release of its full-year results, the share price for Appen (ASX:APX) has retreated. However in the last week it has resumed its uptrend. Given the strength of the last few days, it is worth a quick review of Appen. And should we ask, is there further upside?
A side note: We recently researched Appen following the release of results for the 12 months to 31 December 2017 (FY17). From our report on 27 March, the stock has already returned about 5%. If you want to get in first with our paid subscribers, click here to sign up to a free 8-week trial.
Overview of Appen (ASX:APX)
Appen is a global leader in the development of high-quality, human annotated datasets for machine learning and artificial intelligence. The Company has extensive experience in collecting and enriching a wide variety of data types including speech, text, image and video. Following the recent acquisition of Leapforce in December 2017, Appen now maintains an on-demand global crowd workforce of over one million people. This crowd allows Appen to execute project for clients in over 180 different languages.
The Company’s customers include eight out of the 10 top global technology companies. While the names are not disclosed, the type of technology companies that would demand Appen’s services include search engine providers, e-commerce facilitators & social media companies and speech recognition system developers.
Appen has two operating divisions: Content Relevance and Language Resources. Content Relevance provides smart data to increase online discovery and search relevance of global search engines and e-commerce and social media platforms. Language Resources provides training data for speech-recognition technologies in devices such as mobile phones, computer games and TV consoles.
Why is the Leapforce Acquisition Significant?
The acquisition of Leapforce has created a third revenue stream, as it will act as a separate business unit going forward. However, Leapforce is essentially a Content Relevance business. The acquisition of Leapforce is significant as it:
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i. Consolidates the market and reduces the number of key providers in search relevance from three to two and transforms Appen into the leading player in search and social media relevance evaluation.
ii. Adds further scale to Appen’s current offering, increases the volume of work and diversifies the revenue base.
iii. The existing Content Relevance business can adopt the platform of Leapforce to generate efficiency improvements and thus expand margin.
Scope for Further Acquisitions
Traditionally, Appen has grown through organic growth and maintained little to no debt. From a net cash position of $20.0m as at 30 June 2017 (and negligible debt), the balance sheet swung to a net debt balance of $43.9m as at 31 December 2017, which equates to a gearing level that remains moderate enough to fund further acquisitions via debt. In addition, the Company generates strong free cashflow which enables the payment of a dividend.
Is Appen Attractive at Current Levels?
With the shares now trading on a demanding 1-year forward P/E multiple of over 30x, this needs to be put in perspective with the EPS growth outlook of the next three years (FY18: +100%, FY19: +30% and FY20: +20%). Also the likelihood that earnings growth could exceed market expectations. This is on the basis that there are a couple of factors underpinning the potential for EBITDA margin expansion. These factors have not yet been fully factored in by the market. These include further cost reductions through consolidating the Appen and Leapforce platforms over the medium-term (which have yet to be quantified) as well as better-than-expected performance of the Leapforce business under APX’s ownership.
The Appen Chart
In our report at the end of March, we commented that “It looks as though the easing back of the last few weeks is over and we should expect APX to resume the uptrend.”
Price action in the last few days has seen the short-term downtrend from late February get broken and therefore confirm the resumption of this longer term uptrend. We now expect Appen to trade to new highs.
Michael Gable is managing director of Fairmont Equities.
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