Technology One Offers Strong Earnings Growth

This story features TECHNOLOGY ONE LIMITED. For more info SHARE ANALYSIS: TNE

-Capital management expected
-Resilient customer base
-Strong cloud expansion
-UK taking time to develop
 

By Eva Brocklehurst

Technology One ((TNE)) is an IT company which continues to find favour with brokers, reliably shoring up earnings with substantial contract wins despite the subdued economic environment.

Profit growth of 16% in FY13 was slightly ahead of guidance. BA-Merrill Lynch, having downgraded to Neutral at the half year, has returned to a Buy rating. This is because the broker is confident that Technology One can deliver double digit earnings growth upon strong licence sales and margin improvement. Robust cash generation paves the way for potential capital returns and the cloud opportunity could develop into a material driver of earnings, not only in terms of minimising costs but also in providing a stronger relationship with the customer. Merrills has also now moved to value the company in line with global software and cloud providers.

Moelis likes the positive earnings profile an the likelihood of capital management initiatives from FY15 in order to utilise the strength of the balance sheet. The company has previously said it would consider capital management once it had the ability to frank dividends. Moelis expects this will be the case from FY15. UBS thinks a special dividend in FY15 is the likely way that Technology One will go as it considers capital management options. State government IT and migration to the cloud are seen as the main thrust of the company's growth plans.The broker thinks conversion of the existing client base to the cloud could reach 50% in five years. Technology One has eight clients on the cloud with the ability to convert existing customers and acquire new ones.

Following the dismantling of the Western Australian share service centre, Technology One has successfully bid for a number of tenders over the past 12 months, winning contracts from larger operators Oracle and SAP. UBS observes that ongoing cost pressures and IT service project failures could lead to a similar outsourcing trend in Queensland, Victoria and NSW. The integration of WA state agencies into Technology One's arena via financial and supply-chain management also presents the opportunity for further cross selling.

Macquarie expects scale benefits from the transition to the cloud as research and development delivers margin expansion. The broker notes the company now operates its own corporate head office in the cloud, in order to demonstrate the advantages. Hardware/software will be hosted in the cloud utilising Amazon's data centres. Management expect cost savings of $1.5m in FY13/14 from the transition and Macquarie envisages this having a positive impact on revenue too. The broker expects over a five year period, cloud contracts will typically generate twice the revenue contribution when compared to the traditional product offering on the client's premises.

One blip in the report was the weakness in project services, which involves non-company custom software that has suffered as a result of the weak economic climate. Macquarie does not expect a significant rebound in this segment, as management maintains a focus on value-added services around the Ci and Ci2 products. Sales are in good shape elsewhere and, in terms of contracts, Macquarie notes the government customer base tends to be resilient. UBS expects FY13 is the cyclical trough for Technology One. From here, growth should accelerate and the broker is expecting 18-20% in FY14-15. There was no specific guidance provided for FY14 and UBS expects more details at the AGM.

Merrills also notes that there was a larger than usual unbilled component in the results. This relates to the way contracts have been agreed but, at the year-end, not yet been invoiced. Licence sales made at the end of a period is a reminder of how lumpy the software revenue can be. Nevertheless, it's not a significant issue for the broker, just something that needs to be watched.

Moelis retains a Buy rating and $2.50 target. The broker, as at the half year, remains concerned about the challenges in the UK operation as Technology One tries to make its mark against large incumbents such as SAP and Oracle. Management has stated it remains committed to growing the business in the UK, although brokers note that a further strategic review is being undertaken. Macquarie expect more information in the first half and suspects that initiatives such as targeting vertical markets and potential partnering with a third party are going to take some time to evolve.

Technology One has three Buy ratings on the FNArena database. No Hold and no Sell. The consensus target is $2.46, suggesting 3.8% upside to the last share price. The dividend yield on FY14 forecasts earnings is 2.8% and jumps to 4.1% on FY15 forecasts.
 

Find out why FNArena subscribers like the service so much: "Your Feedback (Thank You)" – Warning this story contains unashamedly positive feedback on the service provided.

Click to view our Glossary of Financial Terms