Tech stocks on the ASX have run hard during the last few years. Yet we have found one that is still cheap and has more upside to come.
After a challenging period over the last 12 months, underlined by management changes, leadership uncertainty, unexpected profit downgrades and cashflow concerns, Integrated Research (ASX:IRI) appears to have turned a corner.
We looked at the stock 5 weeks ago in The Dynamic Investor. Since then it has gone up 15% but we believe it has further to run. (If you also want to be the first to know of our best ideas, then GO HERE to access an 8-week free trial of The Dynamic Investor).
In this note, we look into the factors that have improved the Company’s fundamentals more recently. We also assess the attraction of IRI as an IT-based investment at a time when the trading multiples for ASX-listed peers remain elevated. Finally, we have a look at the chart for IRI to determine the nearest support and resistance levels.
About Integrated Research
The Company is a leading global provider of performance management software for business-critical computing environments. The Company’s core product, Prognosis, is an integrated suite of products that provides availability and performance management, diagnostics and insight across four revenue lines. They are: Unified Communications, Payments and IT Infrastructure and Consulting Services. Prognosis is supported by multiple platforms, vendors and applications. It is used by many of the world’s largest organisations. These include major stock exchanges, banks and telecommunication companies. IRI has +1,200 enterprise customers and +125 Fortune 500 customers.
The Company generates most of its revenue through licence and maintenance fees. Combined these represent >85% total revenue. The maintenance fees (~25% of total revenue) are by nature highly recurring but the licence fees are also highly recurring. This is because the licences are typically sold on a fixed term and the Company has a very high renewal rate (>95%).
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Why We Like the Fundamentals
1. Transition to Cloud is a Significant Opportunity
The Company has expanded its products into hosted services with the migration of IT environments into the cloud. While the Company is about 12-18 months away from completing the platform that will deliver its products via the cloud, at present, the majority of IRI’s customers have yet to switch to the cloud and so are not yet demanding such a platform. Accordingly, cloud-based Service as a Software (SaaS) fees still represent <1% of the overall revenue base (as the on-premise service is still needed). This is one of the reasons why the stock is not trading on P/E multiples of other ASX-listed technology companies – for example ASX:TNE is +40x.
Interestingly, the new CEO John Ruthven commenced his role this month and his most recent role was Operating Officer – Global Sales at TechnologyOne. It is a Company that is more advanced with the transition of the revenue base from on-premise licenses to SaaS, so we would expect IRI’s transition to the cloud to accelerate over the next couple of years under the new CEO.
2. New Appointments Provide Greater Management Stability
A spate of senior management departures last year, including the Chairman/founder, the CEO and Head of Americas division, made IRI a high-risk investment, in our opinion. More recently, the Company appointed a well-regarded CEO (as referred to above). In 1H19, IRI made a number of new leadership appointments, including Product Management, Development and a Chief Commercial Officer. Also, we expect the new management team will re-establish a sales presence in the US, which is the Company’s key geographic market.
3. Cashflow Concerns are Abating
The Company is susceptible to operating cashflow weakness as a result of the timing of sales (particularly if these occur late in the period), as well as the impact from the recent transition in licence payments from perpetual to upfront annual payments. The latter had resulted in relatively poor cashflow over the last few years. This in turn has impacted cash levels on the balance sheet.
In order to help improve cashflow and support both the balance sheet and the payment of dividends, the Company has undertaken some debt factoring. Debt factoring appears to be working, as evidence by a solid improvement in operating cashflow, which in turn supported an increase in the interim dividend payment (3.5 cents per share in 1H19 compared to 3.0 cents per share in 1H18).
4. Significant Revenue Growth Opportunity Remains
The rollout of the Federal Risk and Authorization Management Program (FedRAMP) program, which began in January 2017, provides significant future revenue opportunities for IRI. However, the rollout has been slower than expected. As such, the expected revenue contribution (the Company previously indicating that it expects to generate US$2.1m per month from the rollout) has been pushed out further. There is also revenue growth potential from the inclusion of Prognosis in Cisco’s Global Price List in 2017 as well as Cisco’s elite SolutionsPlus program in 2H18.
Fundamental View of Integrated Research
The shares have recently re-rated and are currently trading on a 1-year forward P/E multiple of ~23x. This is considered reasonable in the context of consensus estimates for mid-double-digit EPS growth over FY19 to FY21 and also in comparison to other ASX-listed peers. The latter discount underpins the potential upside for IRI should the transition to cloud accelerate. However, it also reflects a couple of risk factors, namely the former Chairman (who holds 39.7% of IRI) selling further shares and the difficulty in predicting the revenue trends for the Infrastructure division (which accounts for ~20% of overall revenue).
Charting View of Integrated Research
In May this year, IRI broke the neckline of an inverse head and shoulders. Measuring the upside based on the head and shoulders pattern will give us an upside target near $4, which is the old high. During the last few weeks, the stock has consolidated sideways. This bullish sign is telling us that IRI is getting ready to make that final move higher. Nearest support is back at $3.
Michael Gable is managing director of Fairmont Equities.
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