The stock is down plenty so far this year but investors can expect a rebound from Converge Technology Solutions (Converge Technology Solutions Stock Quote, Charts, News, Analysts, Financials TSX:CTS), according to Echelon Capital Markets analyst Rob Goff, who reviewed the company’s latest acquisition in a client report on Friday. Goff reiterated a “Speculative Buy” rating on Converge and $12.00 target price, which at press time represented a projected one-year return of 100 per cent.
Toronto-headquartered IT solutions provider Converge announced on Thursday an agreement to acquire UK-based Information and Communications Technology (ICT) company Stone Group, for $59.6 million.
“2022 has been a monumental year of growth for Converge in the European market,” said Shaun Maine, CEO of Converge, in a press release. “Along with our recent acquisitions in Germany, we are excited to leverage the knowledge and skills of Stone Group and its teams to continue enhancing our capabilities and offerings to our clients in the United Kingdom and European Union.”
Goff said Stone Group has $1.1-1.2 billion of run-rate revenues for the year-to-date, exceeding its annual $1.0 billion target. About 70 per cent of Stone’s revenues are in public sector education in the UK with the rest in government and commercial areas like emergency services. Goff said while Stone’s recurring revenues are relatively modest, its customer relationships are highly re-occurring.
“We see opportunity where Stone could provide a foundation to grow managed service revenues in the UK, where currently we put managed services at less than five per cent of Stone revenues,” Goff wrote. “In the long run we are looking to see efficiencies on the operating level, with immediate focus on sales integration and potential cross-sell,” he wrote.
Goff has put Converge’s cash balance after the deal is around $98.0 million, with the $59.6 million to be drawn against CTS’ $600.0 million credit facility, which was recently expanded from $300 million.
“Stone represents CTS’ platform for UK expansion. It is also reflective of CTS’s move to build sector specialization as it gains scale and reach,” Goff wrote. “Furthermore, the deal is consistent with CTS’ stated objective of financing acquisitions through internally available funds.”
The acquisition represents Converge’s 35th buy since October 2017 by the company and its affiliates including names like Corus Group, REDNET GmbH and Vicom Infinity. Earlier this month, Converge acquired Newcomp Analytics, with big data analytics business in Canada, the US and the Caribbean.
Focusing on Converge’s free cash flow (FCF), Goff said it’s accelerating, hitting about $190 million or $0.88 per share in 2023, according to the analyst. Goff said those funds will help support the company’s continuing copy/paste/repeat M&A activity while at the same time providing valuation support and giving the company the ability to expand on its share buyback program or even introduce a dividend.
At the same time, Goff thinks Converge will now be working on integrating recent acquisitions.
“Over the next few quarters, we see CTS focusing on internal integration, driving managed services, and allowing margins and organic profit growth to strengthen beyond the 8.5 per cent reported for Q222 (Q122 7.2 per cent),” he wrote.
“We have seen before where the acquisition of lower-margin partners negatively impacts margins and masks underlying organic profit growth. While tuck- in acquisitions are likely to occur, the stated focus over the near term is clearly internal,” Goff said.
Goff has updated his forecast after the deal, calling for full 2022 revenue of $2.565 billion (previously $2.496 billion) and 2023 revenue of $3.338 billion (previously $3.145 billion). On earnings, he is now forecasting 2022’s adjusted EBITDA at $170 million (previously $176 million) and 2023’s adjusted EBITDA at $226 million (previously $216 million). The analyst has CTS’ FCF going from $29 million or $0.13 per share in 2021 to $144 million or $0.55 per share in 2022 and to $194 million or $0.88 per share in 2023.
On valuation, Goff is estimating Converge’s EV/Revenue at 1.5x for 2021, 0.6x for 2022 and 0.4x for 2023 and its EV/EBITDA at 14.5x for 2021, 8.3x for 2022 and 5.4x for 2023.
On a comps basis, Goff said CTS’ 8.3x and 7.6x(proforma) EV/EBITDA for 2022 and 2023, respectively, compared to its US IT Solutions Provider peers at averages of 8.7x and 8.4x, respectively, and to its Canadian peers at 10.3x and 15.7x and European peers at 10.0x and 8.6x, respectively.
Goff noted that Converge’s share price is now down 45 per cent year-to-date compared to Canadian peer SoftChoice which is down just four per cent. Other names like Bechtle and Cancom are down 42 per cent and 57 per cent, respectively.