TD Are Back Converge Technology Solutions
(CTS-T) C$5.19
Q4/F23: Monitoring Some Growth/Margin Headwinds
Event
Converge reported its Q4/F23 results. Click here for our initial take.
Impact: SLIGHTLY POSITIVE
F2024 guidance implies a rebound in margins (finally). LTM Adjusted EBITDA
margins have been flattish in recent quarters, following a two-year period of declining
margins. However, management's guidance implies a notable rebound in margins
commencing mid-year, with the midpoint of F2024 guidance implying Adjusted
EBITDA margins of ~25.6%, up from 24.2% in F2023 and slightly below the 25.9%
in F2022. The projected y/y margin improvement is primarily expected to come from
cost optimization/control initiatives (e.g., travel and entertainment, insurance, leases,
headcount — although Converge is targeting a >10% increase in selling capacity
this year). The ERP migration is expected to provide some margin benefit starting in
H2/F24, with a more meaningful impact in the years ahead.
Germany is a drag... On the call, management highlighted strong organic growth
in North America (16% y/y) and the U.K. (>20% y/y) in Q4/F23, but indicated that
Germany declined ~32% y/y, driven by lower public sector (education) end-user
device sales and a decline in government spending. Converge has implemented
structural changes to the business, including installing new leadership, that it
believes should drive stronger performances going forward. An expected pickup in
device demand in H2/C24 could provide an additional tailwind, but we note that
Germany's economic growth outlook remains near the bottom of the Euro Region/
EU and below the U.S./Canada, according to TD Economics.
...and Portage too (in more ways than one). Portage's Q4/F23 revenue was
flat y/y and down 9.5% q/q to $4.4mm, while Adjusted EBITDA was ($1.3mm), its
largest quarterly Adjusted EBITDA loss to-date, as Portage was a >100bps drag to
Converge's F2023 Adjusted EBITDA margins. To help fund its operations, Converge
extended Portage a $25mm inter-company loan with a 5% interest rate (below the
7%+ Converge is paying on its credit facility; $2mm in accrued interest at December
31, 2023). We believe a potential monetization looks unlikely until stronger market
conditions (and better financial performance) prevail.
TD Investment Conclusion
We are increasing our target price to C$6.00 (from C$4.25), based on 6.5x (up
from 6.0x previously) our F2025 (F2024 previously) Adjusted EBITDA estimate.