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By Chris Bainbridge
Thomas Edison made 1,000 failed attempts before successfully inventing the light bulb. Luckily for investors, Gentrack Group Limited (ASX.GTK/NZX.GTK) has been more switched on.
Kiwi software company Gentrack was established in 1989 to take advantage of the deregulation of the New Zealand energy market. By 1999, Gentrack had won four out of five of New Zealand’s ‘gentailers’ (power companies) as customers.
After establishing a strong presence in the New Zealand electricity market, the company expanded into Australia in 1994 and the UK in 2010. Today, Gentrack is a world leader in utility billing software and it develops, implements, and supports software solutions for more than 150 utilities companies and airports.
An unstable start on the stock exchange
Since its inception, Gentrack has undergone a number of ownership changes. In 2007, it was purchased by a consortium of management, directors, and ANZ capital. This was followed by a management buyout in 2012, before Gentrack finally listed on the NZX and ASX in 2014.
Gentrack had a troubled start as a public company, downgrading just six weeks after listing due to delays in contracts with two customers. It was severely punished by the market, and in 2015 new chief executive Ian Black was appointed to lead a turnaround in the business.
Turnaround takes hold
That turnaround is now in full force, with Gentrack beating expectations at its recent first-half result. Revenue was up 26 per cent (versus guidance of 20 per cent) on the previous corresponding period to NZ$23.3 million. And earnings before interest, taxes, depreciation and amortisation (EBITDA) was up 22 per cent to NZ$6.7 million (versus guidance of 20 per cent). The UK market continued to outperform, with revenue increasing 80 per cent on the previous corresponding period; the UK now represents 22 per cent of total revenue.
At the half year, GTK forecast guidance of 20 per cent revenue growth for the full financial year and EBITDA relatively flat at NZ$15 million. On 4 November 2016, GTK again beat expectations, upgrading its previous guidance for the full year stating that revenue would be up 25 per cent to NZD$52.7 million and that EBITDA would be up 16 per cent on the prior corresponding period to NZ$16.7 million. The upgraded result was well ahead of previously reported guidance and was achieved despite currency headwinds in its key export markets of Australia and the UK caused by the strength of the NZ currency. With staff headcount (GTK’s key constraint to growth) also up around 20 per cent year on year, GTK looks set for another strong performance in 2017.
Fragmentation of utility sectors to GTK’s advantage
Gentrack’s strong growth is being driven by deregulation of the electricity and water markets in the UK and Australia. GTK benefits from deregulation because the number of utility companies servicing the market increases significantly. Deregulation also drives an increased need for the complex billing and customer relationship management (CRM) software that Gentrack provides.
Growth from new customers should accelerate over the next three to five years as the water market in England deregulates (from April 2017), and as market share for smaller energy utilities increases. Despite a weaker British pound, the highly sticky nature of Gentrack’s customers and the mission-critical nature of its software means that the business is unlikely to be affected by the noise associated with Brexit.
GTK airport software ascends to new heights
In addition to high demand from electricity and water customers, Gentrack's airport software offering has more than an 85 per cent share in the Australasian airport market (as measured by passenger numbers). The company is now expanding market share of its airport software product internationally, with just under a 20 per cent share in the UK and 7 per cent worldwide.
Like most software companies, Gentrack is capital light, allowing it to scale up quickly without tapping shareholders for more funds. As a result, GTK has built up a war chest of over NZ$12 million cash, has no debt, and has signalled a desire to make an acquisition using debt (up to one times EBITDA). On these assumptions, such a purchase could add up to 20 per cent to EBITDA for the 2017 financial year.
Rosy prospects for GTK investors
In determining a valuation for Gentrack, the closest comparable listed company is Hansen (ASX.HSN). Like Gentrack, Hansen develops, implements, and supports billing software solutions for customers in the gas, electricity, pay TV, and water industries.
GTK is trading at a significant discount to HSN on key metrics, including revenue growth, margins, and valuation. What’s interesting is that HSN is growing by acquiring assets in sunset industries (for example, pay TV). And by acquiring assets, Hansen is capitalising its research and development (which GTK expenses), so the valuation gap is even larger than it appears.
GTK has a large addressable market, strong revenue growth, sticky customers, high margins, and a great balance sheet. With a market cap of around NZ$250 million, a price-earnings ratio of 18x FY17 and trading with a 4 per cent yield, GTK is priced at a discount to comparable listed software companies. Investors will be hoping that if the good-news story continues, and the valuation discount to peers closes up, they should enjoy a strong return over the next 12 months.
CAPITAL LIGHT: Limited amounts of capital are required to fund the business. A characteristic of software companies and start-ups, and the opposite to capital intensive, where a high level of capital is needed, to fund plant, machinery, or equipment for example.
GUIDANCE: This is a forecast given by a company to its shareholders that provides an estimate of upcoming financial results.
PRICE-EARNINGS RATIO: The trading price per share divided by earnings per share. A higher price-earnings ratio indicates expectations of higher future earnings.
STICKY: When a customer chooses to continue to subscribe to or purchase a product or service. In some cases, habit, reliance or investment in that product may make it too hard to discontinue its use.