Small Caps | Feb 24 2016
-Pure play exposure to the cloud
-Negative cash flow timing resolved
-Key relationship with Microsoft
By Eva Brocklehurst
Rhipe ((RHP)) is ripe for growth. The cloud-based software distributor is gaining traction with licensing momentum on the domestic scene very strong. Stripping out investment costs and non-cash items in the first half, the core business recorded a 17% increase in earnings to $3.3m.
Licensing revenue growth was 38% and this is the key metric in the midst of the company's growth phase, Ord Minnett contends, as scale is needed for distribution in order to build long-term profitability. Revenue growth is expected to be 40% in FY16, with licensing gross margins of 14-16%. This implies, the broker suggests, a stronger performance from leasing in the second half.
Softer margins and the timing of cash flow detracted from the first half results but Ord Minnett is not put off. The stock offers a pure play, capital-light leverage to cloud computing. It has key vendor relationships with Microsoft and a strategic partner network which should enable it to take market share. A Buy rating is maintained for the stock and the target lowered to $1.75 from $1.95.
Solutions revenue was flat and did not contribute to first half earnings. This is non-core business and therefore the result is not considered material, although Ord Minnett does reduce earnings estimates as a result. The broker expects Solutions to break even going forward.
Gross operating cash flow was a negative $5m, affected by a new system which affected debtor collections. Ord Minnett understands that a large part of the drain has been reversed and the cash balance is now stronger than it was in December.
Negative cash flow points to a timing issue that has since been resolved so Morgans is also not concerned. The rest of the trends are tracking in line with expectations. The broker notes the company is displaying resilience in the face of increasing competition and believes the company is on track for profit in FY16.
Morgans considers Rhipe a compelling way for Australian investors to tail Microsoft and other multi-national cloud vendor strategies as they gain an increasing foothold in the Asia Pacific region.
The Australasian business accounts for 69% of revenue and while this segment has been exposed to increased licensing competition the company’s value proposition continues to resonate with customers, the broker observes. South East Asia reported growth of 38% and, whilst this is positive, Morgans believes there is significantly higher growth potential ahead.
The broker is also reassured that while Microsoft added new partners to the Australasian distribution agreements last year, the revenue trajectory remains impressive. This supports the view that the addressable market is growing fast enough for new distributors not to put pressure on existing distributors.
This is the main risk. The company's relationship with Microsoft is across various levels and, with Microsoft continuing to issue Rhipe with new product and geographical licences, Morgans views the partnership more as an opportunity than under threat.
Other risks to the downside include slower realisation of profitability. If it takes longer than expected to reach self-funding for growth the company's cash position may erode. Upside risk relates to faster customer take up. On this subject Morgans is reassured by demand for Microsoft's Public Cloud, which has been strong, and Azure, which was recently launched.
The broker does note that high price/earnings ratio stocks have come under selling pressure recently as investors review their willingness to pay higher multiples for higher growth. As Rhipe is not currently profitable this can exacerbate its share price movements, Morgans contends.
Ultimately, Morgans believes large-scale legacy distributors will look to acquire key licences and critical mass and this could be a risk and a reward for Rhipe, as by that stage it should have more revenue and profit and be an attractive means for a legacy vendor to enter new markets. Morgans has an Add rating and $1.89 target.
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.
