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Nitro Software Disappoints, Better Times Ahead?

Small Caps | Jul 28 2022

This story features NITRO SOFTWARE LIMITED. For more info SHARE ANALYSIS: NTO

Brokers set lower price targets for Nitro Software on lower growth expectations after a trading update surprised negatively.

-Nitro Software lowers FY22 annual recurring revenue guidance
-Management aims for a lower loss by reducing costs
-Brokers set lower 12-month price targets
-Positive cash flow expected in 12-18 months
-Goldman Sachs points to a reduced capital raising risk

By Mark Woodruff

Brokers have set lower 12-month price targets for Nitro Software ((NTO)) following a disappointing trading update by the global document productivity software company.

Morgan Stanley downgraded its rating to Equal-weight from Overweight on the assumption of lower growth into FY23 and FY24. The broker points to ongoing underperformance by the company versus consensus expectations and reduces its target price to $1.30 from $2.00.

While Shaw and Partners also lowered its rating to Hold from Buy, given the potential for a recovery to take longer, Shaw still sees value over the longer term.

Over that longer term, the company stands to benefit from the secular growth of e-signature adoption as well as broader digital transformation spending, particularly in a world of hybrid work.

Wilsons reminds investors that appeasing both growth and cost "gods" can be difficult. Last November, at the time of the Connective acquisition, the company’s valuation reflected potential to grow revenues strongly with the aim of reaching scale.

The plan now, as outlined in the trading update, is to prioritise cost reduction ahead of growth, which resulted in a -23% fall in share price following the update. The Overweight-rated Wilsons decreases its target price to $1.93 from $2.60.

Management lowered FY22 annual recurring revenue (ARR) guidance to US$57-60m from US$64-68m. This was based upon a combination of sales & marketing headcount reductions, challenges for e-signature cross-sell, and deal slippage due to macroeconomic conditions.

ARR synergies from the Connective acquisition were also reduced to US$1.0m from US$2.5m due to lengthened sales cycles, while revenue guidance was unchanged.

The company intends to reduce costs to achieve FY22 guidance for a reduced earnings (EBITDA) loss of -US$10-US$13m, down from -US$15-US$18m. A US$5m cost-out program for the second half aims to simplify the business and drive the company to cash flow breakeven in the second half of FY23.

Goldman Sachs displays a more understanding attitude and retains its Buy rating. It’s felt the update will rebase market expectations on the company’s growth outlook (lower), given the pull-back in sales & marketing spending, and highlight the path to breakeven (sooner). It’s even felt the new outlook further reduces the requirement for additional funding.

However, the broker acknowledges several quarters of strong ARR performance are necessary to allay concerns over execution challenges.

Overall, Bell Potter assesses the trading update was disappointing and a slowdown in hiring reduces the medium-term growth outlook. More positively, the business model is thought to remain sound and there is a clear path to positive cash flow in 12-18 months’ time.

When this pathway is combined with a strong cash position, the overall outlook is still considered reasonable, and the broker retains its Buy rating.

UBS appears the most positive and sets the highest target price ($2.30, down from $2.50) from among brokers covered in this article. It’s believed near-term macroeconomic challenges are already reflected in the share price and thus the Buy rating is retained.

The outlook

Management of Nitro Software noted sales enablement for e-sign cross-sell has proven more complex than anticipated, which has impacted both PDF and e-sign sales. This marks the third consecutive quarter of sales execution issues, points out Goldman Sachs, though the company has made changes including sales organisation simplification which should assist improved performance.

The company emphasised the pipeline remains strong and should convert in coming quarters, which echoes recent commentary from other enterprise software companies, according to the analysts.

Goldman Sachs notes the company trades at a wide discount to SaaS peers relative to its growth potential and believes investor sentiment is at a low point following the broader technology sell-off and disappointing second quarter trading update.

Potential positive catalysts such as ARR growth momentum, improvement on sales execution and e-signature cross-sell could re-focus market attention on Nitro’s long-term potential, believes the broker.

On the other hand, Morgan Stanley feels the trading update is a material step-down in FY23 ARR growth, a key value driver, and forces a re-examination of the sustainable long-term growth profile.

While UBS feels the decision to lower ARR investment in favour of faster cash flow breakeven is prudent amid a weaker macroeconomic backdrop, further clarification is needed on any potential constraints to a growth recovery as the operating environment improves.

The FNArena database has two broker ratings with one Buy and one Hold (or equivalent) rating, and an average target price of $1.80, which suggests 52.50% upside to the latest share price.

Outside the database, which in this case is made up of UBS and Morgan Stanley, all of Goldman Sachs, Bell Potter and Wilsons have Buy (or equivalent) ratings, while Shaw and Partners is on Hold. The average target price set by these four brokers is $1.95.

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