THE DARK CLOUDS MAY DISPERSE AT IOMART - 28/10/21

Nobody across the investment field has any wish to catch a falling knife and in tandem with that, attempting to second guess or call the bottom with a particular stock is a futile exercise. In the case of cloud computing company iomart, recent news and subsequent falls in its share price arguably implies a big red flag, suggesting that it is perhaps one to best avoid.

Indeed, iomart’s shares have retraced sharply from a twelve month high of £3.52p to a current £1.44p, after the company delivered a poor set of full year results for the year to March 2021.

To make matters worse, since then, there has been a less than sparkling trading update which has resulted in broker downgrades and thus, resulted in the shares heading further southwards to the current subdued levels. Whilst the above perhaps paints a less than rosy picture, I’m inclined to take a contrarian stance and a much closer look at the business with a view to an entry, as it remains a profitable and highly cash generative operation, which arguably shouldn’t be written off yet. Not least, as the notion that IOM is now ex-growth, could well be premature.

Just when the selling and ongoing slide of the shares is halted though is indeed a difficult call, but halt it should, as the shares are looking increasingly oversold and attractive for a medium-term turnaround of the more recent decline in profits. As part of my delving here, I have been able to speak with both the CEO and CFO for some further insight into what has been happening and when investors can perhaps look forward to a return to more positive news.

As background, the business itself was co-founded by two former Scottish Telecom executives, in Angus MacSween and Bill Dobbie back in 1998, before coming to the market two years later.

Under MacSween’s tenure the business grew strongly on the back of a buy-build model assisted by organic growth, which saw the shares performing strongly over the years.

MacSween however stepped down from the role of CEO in September of last year which saw Reece Donovan moving into the hot seat and which thus far has given him and investors something of an uncomfortable ride.

Despite the ongoing pandemic hastening the transformation to the digitally connected world and the much talked about hybrid workplace, iomart - amongst others in the space - has unfortunately seen increased churn. It has also seen reduced revenue in some areas, that has perhaps understandably resulted in questions being asked as to whether it is on a declining road.

The CEO acknowledged that things have been difficult, but is keen to stress that on stepping into the role part of his remit was to take a good look at the business and its future direction.

Donovan says that they ran a firm eye across the operations via way of a strategic review, really focusing on what they are good at with an aim of gaining traction in those areas.

This sees a refreshed strategy and progress towards a concentrated shift to a hybrid cloud offering including increasing traction across areas related to the public cloud, along with gaining a foothold within cyber security.

The aim, adds the CEO is to drive revenue to £200m in the next five years, which will be achieved through a combination of organic and acquisition driven growth.

The company already enjoys a broad spread of customers totalling some 80k, which whilst predominantly concentrated in the UK also brings with it exposure to other territories further afield, where there is a small operation in the US.

Within its cloud hosting and managed services operations, Donovan says that the focus has predominantly been on the smaller to medium sized enterprises, although around ten-per cent of the base equates to larger sized customers where importantly there is no reliance on one or two majors.

Typically, within its operations, IOM will provide its services to businesses that don’t have much in the way of an IT team or prefer to outsource it and Donavan says that relationships are long term with their offering proving sticky and providing strong levels of recurring revenue which currently runs at 93%.

As a result of the former, the company enjoys excellent cash generation and visibility that provides for a strong degree of comfort from an investment perspective.

Typically, contracts will run for three years, although some extend as long as five with fixed monthly invoices in place providing solid and predictable cash flow.

With the focus now on a hybrid cloud offering, IOM should be in a decent spot to return to growth, not least as it is well placed to leverage that with some fourteen of its wholly owned Data Centre’s, where it is able to utilise those in conjunction with connected facilities around the world enabling it to handle the needs and requirements of its customers’ cloud services. The shift to a hybrid model is said to provide businesses with much more flexibility enabling direct interaction between private and a public cloud and IOM, with its around the clock back up services and offerings appears to be in an ideal spot to thrive in such a space.

Although the dominance of the likes of Microsoft can be seen as a danger to a business like this given the area it operates, the CEO highlights the personal service and unrivalled back up offered by his company as proving positive in both retaining existing and winning new business.

He also points out that owning their own Data Centre assets provides them with a strong base on which to operate, with no reliance on a third party, which enables them to provide and deliver the ongoing services businesses require. Looking ahead, Donovan says that with their existing and geographically well spread UK Data assets they won’t be looking to buy more, rather, the emphasis will be on building on their capabilities.

In terms of further acquisitions, he adds that the ideal spot will be around the £10m mark, which would see the company using their own capital to achieve this, where he stresses that he is very keen to secure such an addition by the end of the financial year.

In its recent Trading Update, announced at the beginning of the month, the company stated that a shortfall in its VAR revenue due in part to sales disruptions had played a negative part in the group performance and there was a £2m reduction hit in non-recurring revenue.

On a brighter note, total recurring revenue increased from a previous 90% to 93% and the business as a whole continued to demonstrate that key element of strong cash generation.

Where IOM does appear to have slipped in the last few years is on its organic growth performance which has been hovering around the one or two per-cent levels, although different aspects, deliver a differing number.

CFO Scott Cunningham says that its an area that they have clearly looked at and the emphasis now is to get that up to the six or seven per-cent level across the group, which would in turn equate to an improved financial performance. He adds, that rather than chasing big revenue numbers the focus from a financial perspective will be one of having a sensible ambition, which takes in the organic growth target, along with high single digit revenue growth with good profitability and good cash flow, which in turn makes for a positive combination going forward.

Despite the shares retracing in recent months, some notable long term Institutional holders such as Octopus have held firm and added, whilst the CEO recently purchased 8k shares and the CFO’s wife bought 7k.

Perhaps not a major sign, but welcome nevertheless where the shares are looking decent value on current forecasts, which should allay wider worries prior to a return to growth over the medium term.

This sees Broker Peel Hunt looking for current full year revenue of £104m rising to £107m next year with EBITDA of £38m for both periods. Adjusted pre-tax profit is pencilled in at £16.9m and £17m with EPS of 12.6p providing for a PER of 11, which looks potentially attractive for an entry point.

Additionally, there is expectation of a total 7.1p per share dividend from Peel Hunt, which in itself should provide for some floor on the recent weakness and is an added attraction going forward, particularly if growth comes through as envisaged.

By contrast, FinnCap is suggesting a reduction in that dividend payment to 5.9p for the year in progress, which obviously sees a lower yield on offer, but although there is obviously a marked difference in the two forecasts, it provides for some added attraction. Aside the dividend forecast, the Brokers appear to concur on the other key aspects and both take the view that the shares are undervalued, each having target prices of over the £3.00p.

Such targets, should of course be treated with a degree of caution and look way out of kilter with current market sentiment, but nonetheless shine a light on the current lowly rating.

Indeed, such situations often attract larger predators and given the valuation of IOM at present, it would come as no surprise if someone didn't run an eye over the business.

More should become clear when the Interim results are announced in December, but until then, the shares look worthy of closer scrutiny, if not an opening interest for me at these levels.