Empired's winning combination

Since the first-half result Empired (EPD) has announced five contract wins including two last week.

The contracts are annuity based and mostly spread over five years. Many of the wins have been a direct result of recent acquisitions, and the IT services company is confident of further wins in the near future.

The five contracts have a combined value of $57 million plus an undisclosed amount for Toyota. This suggests a high strike rate of wins given management stated at the first half that there was $100m of contract tenders to be decided by June 30. In the past the company has achieved a contract win rate of about 20 per cent, but in recent times it has been well above this.

The company's differentiator is that rather than providing technical labour, it instead focuses on business solutions and leverages its high quality team of systems and software engineers.

With a market cap of $90m ($0.80) the Empired share price is up 50 per cent over the last 12 months, and a few hundred per cent over the past couple of years. Managing director Russell Baskerville could be forgiven for sitting back and enjoying his achievements. Instead he is turning the small Western Australian niche business into a national IT force thanks to three quality East Coast acquisitions and a hunger to develop high quality new age IT services. 

Thanks to a strong partnership with Microsoft and a team of around 800 he is focused on creating a larger scale business that will leverage new services to its growing client base. 

The three East Coast acquisitions of OBS, eSavvy and Intergen have all been integrated under the one Empired brand. Now with more size and not just focused on Western Australia, the company is capable of bigger deals with a wider range of customers.

The company's partnership with Microsoft is critical, but it is now winning more than just the applications rollouts. There is a focus on managed services and leveraging its new cloud based capabilities.

Its three new IP products include “Flexscale” which is an infrastructure as a service (IaaS) platform, “Cohesion” which is a software as a service (SaaS) document and records management solution, and cloud-based “Formplicity”. All of this services are working towards an annuity based revenue model with a more diverse spread of customers.

Recent contract wins

Undisclosed oil and gas (18/6/15)

The company announced a $10m contract with a global oil and gas company to provide infrastructure managed services and professional services. It is for three years commencing April 2015.

Empired has provided a range of services to the company in the past but this contract offers an opportunity to further extend the relationship between the companies.

Importantly the contract was strongly contested through a rigorous procurement process where Empired was selected to replace a major global IT Services provider.

InterOil (16/6/15)

Empired will provide $15m worth of application and infrastructure managed services for five years (3 years with two 1 year options). It includes a fixed monthly managed services fee plus a conservative estimated level of project work.

Empired will complete the work out of Singapore providing a low cost entry into Asia. Management are confident it can leverage the work with InterOil to win additional contracts in the region.

Rio Tinto (28/5/15)

The company originally won a $50m contract with Rio Tinto that was announced in September 2013. This was for the design, delivery and implementation of a new mining system upgrade.

Encouragingly, Empired has now won the maintenance contract for that system. The contract is worth $20m (three years plus two one year options), and is a strong endorsement of management's ability to serve and maintain a high profile client.

Toyota (24/3/15)

Empired has secured a contract with Toyota to provide managed services across the Microsoft critical platforms.

This contract was won through OBS, and transforms the engagement with Toyota from a niche project based arrangement to a broader annuity based contracted services arrangement at an increased value.

This contract validates management's strategy to leverage a broader range of services into a newly acquired client base.

New Zealand government contract (2/3/15)

Empired announced a $NZ12m contract in March with the New Zealand government to provide them with its Cohesion service.

Cohesion was developed by Intergen, which Empired acquired in October last year. The solution provides electronic documents and record management as a service, predominately on the Microsoft SharePoint platform.

The NZ contract over a six year term has a relatively small impact on group earnings. But of more interest is the large potential for more work.

The contract is the third New Zealand government Cohesion contract to be awarded to Empired (Intergen) since been appointed as one of three potential suppliers of the service to the New Zealand government.

A five year grace period has been given in New Zealand to convert to the electronic documents service. Although Empired has been appointed as one of three potential suppliers we understand they have been winning more than their fair share of contracts.

We estimate this is a $400m market opportunity and more New Zealand contracts are likely.

Management are also exploring opportunities to service the Australian government and corporate and commercial sectors for this same Cohesion service. Empired is the largest Microsoft SharePoint developer in Australia and is therefore well placed to leverage its service into the Australian market.

Earnings

Although the contract momentum above is very positive not much of it will drop into FY15. The first half result was messy due to short term working capital impacts, the integration of acquisitions, and an expensed $1.3m transaction cost that resulted in a reduction in the purchase price of Intergen.

As it is due to one-off factors, we expect this weak first half cash flow result to be offset by a strong second half cash flow result.

For the full-year result we are forecasting revenue slightly above the guidance range of $110-120m, and we forecast a slight increase on the first half underlying earnings before interest, tax, depreciation and amortisation (EBITDA) margin of 9 per cent.

FY16 revenue guidance was $145-165m, and with recent announcements management are looking good to challenge the upper limit of this guidance.

The risk with Empired is that for now they still have a high percentage of earnings exposed to a few major contracts. Clearly there is a shift occurring that will in future provide greater recurring revenues and a much more diversified customer exposure.

The other major uncertainty is related to the integration of acquisitions and if there is any related margin drag. In the first half FY15 result there was $10m of Intergen revenues with a zero EBITDA impact. For the second half there is $30m of Intergen revenue forecast.

Management guidance has suggested no major cost savings in the second half, but a potentially large positive impact for FY16. There are $3m of cost savings targeted for next year that should produce an EBITDA margin of approximately 12 per cent.

We also expect further smaller bolt-on acquisitions are likely.

Valuation

Given the business transformation that is occurring with Empired we don't believe a discounted cash flow (DCF) valuation is appropriate at this stage. With much of next year's work already contracted, and strong prospects for future growth, we currently view an FY16 price-earnings (PE) multiple of 12 times as a fair valuation. This gives a share price of $1.05. With a current share price of $0.80, we have a “buy” recommendation for Empired.

We see the full-year result in August as a strong share price catalyst, given it will most likely display that the first half cash-flow issues were a one-off factor. Further the successful integration of the three major acquisitions should be evident, and management is likely to guide towards continued strong contract momentum.

To see Empired's forecasts and financial summary, click here.