Plugging into growth

The WA-based IT services group Empired is on a clear growth path.

Empired (EPD) is a WA-based IT services company that is entering a high growth phase, positioning to benefit from a transitioning IT industry.

Since 2012 two key acquisitions and a strengthened management team have increased the capabilities and ability to win larger ($50 million) long-term contracts.

The company was established in 1999, and listed on the ASX in October 2007. Revenue has grown from $4.9 million when listed to our forecast of $75 million in FY14.

Despite only having a market capitalisation of $55 million, the management team has ambitions of becoming a leading Australian IT services company. Our earnings forecasts to 2015 are underpinned by an increasing amount of contracted revenue.

In simple terms EPD offers a range of services complemented by hardware and software products. This includes planning, building and running corporate or government entities’ ICT requirements. The focus is on supplying IT business solutions, rather than just technical labour.

In more technical terms the company completes enterprise and managed services for IT infrastructure, application and consulting. The acquisitions of Conducive and OBS last year have enhanced the Applications division’s capabilities, with revenue up 86% in that division for the recent first-half result.

With the goal of being ahead of the game in the new IT world, a class-leading cloud computing service has been rolled out – “FlexScale”. The recent multi-year multi-million-dollar cloud-related contract with Barrick Gold vindicated management’s strategic move into this area last year.

Across the group, approximately 40% of revenues are from producing energy and resources companies, with the next-largest exposure being the state governments at 27%.

Management

Russell Baskerville is managing director and has more than 10 years’ experience with the group. He was a founding member of Tusk Technologies P/L, which was acquired by EPD in March 2002. He was also the founder and managing director of Procom Solutions, a company established to provide technical service and support to merchant banking facilities on behalf of the larger banks in Australia.

The management team gained a major boost with the appointment of Rob McCready as chief operating officer in October 2011. He brought with him 25 years’ industry experience, and a prior similar role at ASX listed ASG Group (ASZ) – a competing IT services company. With approximately 700 staff reporting to him he played an important part in tripling the revenues at ASZ to $155 million, and producing $28 million EBITDA in the 2011 financial year. McCready also held senior positions at global computing companies CSC and Unisys.

In addition to McCready, in early 2012 a number of high-profile industry executives were announced in what EPD called an energy and resources “dream team”. These included Brett Gresele (GM of Managed Services), Mike Luyckx (BDM of Strategic Services), and Don Beer (BDM of Energy and Resources). All three of these additions had impressive backgrounds that included prior positions with ASG Group (ASZ), CSG Ltd (CSV), CSC and Unisys.

Non-executive chairman Mel Ashton has a long history as a chartered accountant, and is currently the chairman of three other ASX listed companies. He is also a director and vice president of the Fremantle Football club.

With the well-rounded and experienced management team together since early 2012, there have been a number of excellent strategic decisions that leave the company well positioned to achieve its ambition of becoming a leading Australian IT services company.

Business cycle

The number one driver in the IT services sector is business confidence. As a result, it is no surprise that the industry has had a few difficult years with a lack of spending from both corporate and government entities. Business confidence aside, there is underlying demand from the need to replace old systems.

Through the development of innovative technology solutions there is increasing opportunity for service offerings to drive operational efficiency and improve productivity. EPD focuses on providing highly customised solutions with quantified deliverables and benefits to the business. This provides a differentiator when bidding against some of the larger more traditional IT services companies who have previously just focused on supplying technical labour.

First-half results for ASX listed IT services companies were weak across the board, with most CEOs hoping rather than confidently stating the trough in earnings had passed. Interestingly EPD actually had a very productive first half – winning $96 million worth of five-year contracts (Rio Tinto and Main Roads). The weakness in EPD’s result was more related to acquisition costs and start-up costs for the new contracts. The company is set for a much stronger second half and that is not assuming any further contract wins.

Catalysts

Empired is bidding on $115 million of contestable revenue in the next six months spread between nine companies - $50 million in Infrastructure, and $65 million in Applications.

Among those bids management has submitted a tender for a major contract with Main Roads – a WA Government run entity. It is due to be awarded this month, and is in addition to the existing five-year $46 million Main Roads contract that was announced in October last year. The existing contract is to operate and maintain the core IT infrastructure, whereas the new contract is to supply application services.

The contract amount is likely to be $40-50 million and would give a major $10 million per annum boost to our forecasts. The current provider, believed to be SMS, makes for tough competition as it is one of the largest IT services companies in Australia, and also is bidding for the contract.

Two of the other large tenders are applications support for a large resources company (existing customer) and a management system for the Department of Corrective Services.

In FY15 there will be a full-year impact from the OBS acquisition versus an effective 60% impact in FY14. Our FY15 forecast, similar to the second half of this year, is not assuming any further contract wins.

Earnings forecasts

We have based our earnings forecasts on the following key drivers: billable staff, utilisation rates, charge-out rates, gross margins and fixed costs. As the company’s grows revenue there will be continued margin growth for two reasons. One will be the benefits of increased scale and earnings per employee, and the other the larger growth rate within the higher margin Applications division. The target gross margin for Applications is 35-50%, whereas Infrastructure is 30-35%.

There are currently approximately 430 staff, with 220 billable staff in Applications, and 140 billable staff in Infrastructure. For FY14 I have assumed 80% utilisation and a charge out rate of $135 per hour and $115 per hour for Applications and Infrastructure divisions respectively.

The balance sheet is strong with only $5 million net debt, and operating cash flow conversion is also high at around 85%.

We have a BUY recommendation and $0.85 discounted cash flow valuation (assuming a weighted average cost of capital of 12.4%).

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