When we upgraded Reckon to Speculative Buy last August, we felt the sum of its three businesses was greater than the whole. It seems management agrees with us, and today it has announced plans to spin off its Document Management division to existing shareholders. As 85% of the division's revenue comes from overseas, primarily the United Kingdom and United States, the new company (Newco) will be listed on the AIM market of the London Stock Exchange rather than the ASX.
Document Management business to be spun off
Shareholders will also be able to invest further in Newco
Boosts earnings and cash flow of remaining businesses
As we explained in Reckon: Result 2016, the company’s Document Management business is its fastest-growing division. However, due to the expenditure required to market and integrate its SmartVault and Virtual Cabinet products – and develop a cloud-based version of these products – the division currently produces little free cash.
So while Reckon will lose its fastest-growing business, spinning off the Document Management division will increase the earnings and cash flow of Reckon's remaining Practice Management and Business divisions – at least in the near term – and the company will able to direct the cash flows from these businesses to other uses, such as further developing existing products, making acquisitions, reducing debt or returning it to shareholders.
For its part, Newco will be able to access the additional capital it needs via the public markets. To help it along, Reckon shareholders will also have the opportunity to invest further in Newco as part of the restructure.
Freed from its association with Reckon's slower-growing businesses, we wouldn’t be surprised to see NewCo valued at high multiples of revenues given it’s a fast-growing, subscription-based business with a large addressable market. This is another reason why it is being listed on AIM rather than the ASX.
More attractive to suitors
With its underlying earnings and cash flow now more apparent, investors may also focus more on the strength of Reckon’s Practice Management division and the still-decent cash flows from its Business division.
During its strategic review 18 months ago, the company received a number of offers but management felt they undervalued the company. No doubt prospective purchasers considered the large development expenditure requirements of the various divisions in making their offers, so a reduction in this expenditure may make the remaining Reckon business more attractive to suitors.
In that vein, Reckon’s Business division – which recorded $17m in underlying earnings before interest and tax in 2016 – could be attractive to a competitor. A purchaser would not only gain its existing 39,000 online customers but potentially the 100,000 to 150,000 customers that are estimated to still use its desktop products. These customers could be transferred to any purchaser's products at a lower cost than having to acquire them individually. Any deal would also remove the low-cost competitor in the small business accounting space, thereby potentially improving the profitability of remaining competitors.
While planning is still in its early stages, the potential spin-off suggests our investment case is on track. It also perhaps illustrates one benefit of investing alongside owner-managers.
The company will release more detailed information towards the middle of the 2017 calendar year and we’ll provide a further update then.
The stock is hovering just above our $1.70 Speculative Buy price but, for now, it remains a SPECULATIVE BUY.
Disclosure: The author owns shares in Reckon.