Enghouse Systems Ltd T.ENGH

RBC 2

[retiredcf]

Their upside scenario target is now $53.00. GLTA

December 13, 2024

Outperform

TSX: ENGH; CAD 27.92

Price Target CAD 40.00 ↓ 43.00

Enghouse Systems Limited
More complicated than usual

Our view: Enghouse provides few/no forward-looking comments, which tends to increase quarterly volatility if there are surprises against expectations. Q4 missed RBC/consensus due to normalization in revenue at Lifesize. However, FCF was better than expected, Lifesize is tracking to a high IRR, and management sees an attractive M&A environment. Maintain Outperform, given valuation at trough levels (8.2x EBITDA) and M&A are likely to ramp going forward. Our price target moves from $43.00 to $40.00.

Key points:

• Q4 below RBC/consensus. Q4 revenue of $126MM (2% Y/Y) was below RBC/consensus of $133MM. Adj. EBITDA of $36MM (-6% Y/Y) was also below RBC/consensus of $39MM. IFRS EPS was $0.41 compared to RBC/ consensus of $0.44/$0.37.

• Organic growth is more complicated than usual this quarter. We estimate that headline constant currency (CC) organic growth was -9% Q4, below the -3% in our model and down from -2% Q3. Adjusted for $4.4MM revenue normalization at Lifesize, CC organic growth would have been -5%. Given Lifesize (which is now in our organic assumptions), we are reducing our FY25 organic growth estimate to -8% from -3%.

• License to SaaS transition. Enghouse is also undergoing a license to SaaS transition. Excluding the drop in IMG license (-$3.1MM Y/Y), Q4 organic growth would have been -3%, in line with Enghouse's historical average. Moreover, management sees IMG SaaS up "double-digits" and maintenance renewal rates in line with its historical 90% average. Given Lifesize and the SaaS transition, we assume Enghouse's organic growth stabilizes at -3% in FY26.

• FCF and acquisition IRR are the most important metrics. Q4 FCF rose 11% Y/Y to $31MM, above RBC of $26MM. TTM FCF is up 14% Y/Y. Management disclosed Lifesize is tracking to a cash-on-cash payback of 2 years, ahead of its target for 5-6 years. We estimate Lifesize would likely generate >32% IRR, even under conservative assumptions (FCF drops to zero in 5 years). Lifesize is an example of Enghouse's M&A strategy; even though Lifesize is now a drag on organic growth, it represents a high IRR investment.

• M&A is a potential catalyst. Management sees a large number of acquisition opportunities. With cash at record highs ($275MM Q4) and our outlook for Enghouse to generate $122MM NTM FCF, we believe M&A is a potential catalyst. We estimate every $100MM deployed on acquisitions is 17% accretive to annual adj. EPS.

• Maintain Outperform. Enghouse is trading 63% below peers and 44% below its 10-year average. Enghouse has a strong track record of allocating capital at high rates. We believe risk-reward on the shares is attractive given Enghouse’s discounted valuation and our outlook for M&A to ramp over the next 12-18 months. We are rolling forward the basis of our price target from CY25e to CY26e; our revised $40.00 price target is based on 12x CY26e EV/EBITDA, down from 13x CY25e EV/ EBITDA, given the increased quarterly volatility of the shares.