We recently reviewed Hansen Technologies (ASX:HSN) after the Company reported its results for the 12 months to 30 June 2020 (FY20). The key focus in our review was the extent to which strong organic growth and margin expansion, which were both evident in FY20, can continue.
About Hansen Technologies
HSN is a global provider of customer care, billing and data management systems. Its clients are across four major industry sectors: telecommunications, energy, water and Pay Television. Billing sales comprises the overwhelming majority of group revenue. The Company offer four products:
i. Licence, Support & Maintenance – Recurring billing application licence, support and maintenance services delivered as part of a total billing system solution.
ii. Services – Provision of various professional/consulting services in relation to customer billing systems and IT outsourced services covering facilities management, systems and operations support, network services and business continuity support.
iii. Hardware and Software Sales – Provision of other third-party hardware and software licences to customers of the Group’s billing system solutions.
iv. Other – Includes reimbursed expenses incurred for servicing the customer contract
Key Fundamental Drivers
Strong History of Integrating Acquisitions
The Company’s most recent acquisition was Sigma Systems (‘Sigma’), a Canadian-based global software provider. It was bought for C$175m (A$166m) in cash in early May 2019. The acquisition of Sigma followed the acquisition of Norwegian peer company Enoro in mid-2017 for $95m.
Aside from both the Sigma and Enoro acquisitions being the largest made by the Company, they are also very important from the viewpoint of gauging the extent to which HSN has been able to improve overall organic growth and margin. This is what the Company calls the “Hansenisation” of acquired businesses. “Hansenisation” refers to the Company’s deployment of proven processes and methodologies and best practices for the acquired businesses in order to ensure a smooth integration and optimise margin.
The successful integration of the Sigma Acquisition was a key factor underpinning the improvement in organic growth in 2H20. In particular:
i. Sigma’s products sit within or adjacent to HSN’s core business of billing and customer management. They are well designed to capture growth opportunities from the rollout of new telecommunications services such as 5G.
ii. HSN has had success on cross-selling exist into HSN’s large utilities customer base.
Importantly, the potential for the Sigma acquisition to improve organic growth rates over the medium term from these two aspects still remains.
New Contracts Support Organic Growth
Flat core organic billing growth in FY19, after stronger growth in prior periods, was an area of concern. However, in 2H20, organic revenue is estimated to have increased by ~6%. This is on the back of new contract wins, which were mostly secured in 1H20.
Organic growth rates are likely to be maintained, given that the Company is gaining momentum in securing new customers.
In FY20, HSN added 20 new customers, with new contracts secured in utilities and communications. Further new contract wins are likely in FY21. This is given that the Company has globally diversified, long-term existing customer relationships that underpin a strong recurring base. To this HSN can add new customers as well as customer upgrades and projects.
Ability to Improve EBITDA Margin Post Completion of Large Acquisitions
One of the drawbacks that Hansen Technologies has experienced in integrating acquired businesses is that the benefits from restructuring has either been slower to flow through, or restructuring is required on a greater scale than initially planned. In turn, this impacts EBITDA margin. This is especially given the timing delay between any costs incurred and revenue contribution. It can also be compounded by the absence of new contracts. As a result, the EBITDA margin over the prior three half-year periods has been below the bottom end of the target range.
However, the successful application of “Hansenisation” to the Sigma acquisition, as well as broad cost reductions, have led to an improvement in the EBITDA margin in 2H20, to 28.3% (from 23.6% in 1H20), which places the EBITDA margin back within the Company’s 25-30% target range.
We expect EBITDA margin out to FY22 to expand further towards the upper end of the Company’s 25-30% target range. This is as further efficiencies flow through and assuming low single-digit revenue growth in the absence of acquisitions. However, as noted above, acquisitions can have an impact on EBITDA margin that can take 1-2 years to recover.
Gearing Level is Manageable
From an elevated debt and gearing position due to the acquisition of Sigma, the Company has since reduced the net debt level and gearing to a manageable level.
The key contributors to the decline in both net debt and gearing was strong free cashflow. This also allows the Company to fund ongoing product development program and pay dividends. The balance sheet currently has some headroom for further borrowing capacity. However, we expect that any sizeable acquisitions would require an equity raising.
In relation to cashflows, it is worth noting that the timing of receivables (weighted towards the 1st half due to northern hemisphere invoicing) typically increases the volatility of HSN’s cashflows.
We view HSN’s fundamentals favourably. The Company did not provide quantitative guidance for FY21. However, the increase in the 2H20 dividend reflects the Company’s confidence about the operating outlook, given the recurring (and defensive) nature of its revenues and strong cash generation capabilities.
When we look at a long-term chart of HSN, we can see that it has spent the last 4 years forming a very large flag. An upside break of this could therefore lead to some significant upside over many months. At the moment it is at the top of this recent range, so it is too early to buy. The buy zones are either at the bottom of the flag, or on the upside break. An upside break (a movement beyond the upper blue line) is the most likely scenario in the short term. A breakout should therefore be bought and that would lead to a decent rally as HSN gets back into a major uptrend.
Michael Gable is managing director of Fairmont Equities.
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