Head of Equity Strategy
Danish IT growth star Netcompany has just filed for its IPO on the Copenhagen Stock Exchange with a mid-range market valuation of around €1 billion. The company has been an unique growth story as the first Danish company in 20 years to break the 1,000 Danish employees mark from scratch.
With its recent string of acquisitions, the company is also gearing up for international expansion.
The offer period will commence on May 23 and will close no later than June 6 at 11:00 CET (the closing date can be moved forward if demand is high). In its IPO prospectus, the company and its joint global coordinators and joint bookrunners expect the first day of trading on June 7. Netcompany is offering 20,000,000 shares from existing shareholders in the DKK 135-165 price range (update: price has been fixed at DKK 155) with an additional over-allotment option to the joint global coordinators. As a result, the company will not receive any proceeds from the IPO, but given that Netcompany does not invest heavily in physical assets and has easy access to lease financing, additional equity financing is not necessary.
The total number of shares outstanding post the IPO is 50,000,000. If the joint global coordinators exercise their over-allotment option, the free-floating shares will be 23,000,000. leading to an attractive free float of 46% which is a good starting point for liquidity.
Growth business with international ambitions
Netcompany is a pure-play IT services company delivering critical IT infrastructure solutions to the public and private sectors. In the public sector, the company offers end-to-end services (development, maintenance, and operations) for projects such as tax collection from citizens. In the private sector, the company offers end-to-end services to primarily mid- and large-sized businesses spanning CRM and ERM systems. The IPO prospectus has a long segment on the business where the company obviously sells itself as a scalable business model and delivers a long list of buzzwords that some investors would like to see.
At the end of the day, though, Netcompany is a classic IT services company. It might have better processes and a good track record, but it is not a scalable business in the truest sense of the word. A scalable business is a business that can grow its revenue without meaningfully growing its operating expenses.
The term we would use for Netcompany is 'flexible,' as the company is people-intensive and can easily adapt its costs to adverse developments on revenue.
The organic growth and EBITDA margin say that Netcompany is a well-run company that is taking market share in a large market. With the recent acquisitions of Mesan and Hunter Macdonald, the firm is also gearing up for international expansion. This expansion is not without risks, however, as each country's public sector is unique and their private sectors likely feature stiff competition. We do not believe that it will be easy for Netcompany to replicate its Danish success in other countries. It can be done, but it will take longer than expected and the firm's good reputation in Denmark is not portable to the UK and Norway.
For new investors in Netcompany, it will be critical to observe organic growth.
Valuation and peer analysis
Based on our projections for revenue growth and EBITDA margin in FY2018, we expect Netcompany to deliver FY2018 revenue of DKK 1,768 million and EBITDA of DKK 454.3m. The company has DKK 154.2m in cash and total interest-bearing debt of DKK 1,301.1m. Assuming a mid-price of DKK 150, the market value post-IPO is DKK 7.5bn.
Adding all the capitalisation components together, the enterprise value is DKK 8.65bn.
These numbers lead to a FY2018E EV/EBITDA ratio of 19.0, which is around 85% above global equities (MSCI World Index).
Netcompany mentions two publicly listed companies as competitors: DXC Technology and CGI Group. These IT companies dwarf Netcompany on revenue by a factor of 39-122x but Netcompany is a better growth story with an average organic growth rate of 25% over the past three years whereas DXC and CGI have experienced negative to low growth rates.
In terms of profitability, Netcompany shines again with an average EBITDA margin in the past three years of 25.7% compared to DXC (10.4%) and CGI (18.3%). With a high EBITDA margin, the expectation would be to see a high return on invested capital (ROIC). But Netcompany sports only a 8.3% ROIC compare to DXC (7.2%) and CGI (12.8%).
Before we get negative on Netcompany, however, it is worth understanding the accounting of ROIC.
ROIC is calculated as the net operating profit after taxes (NOPAT) divided by the total invested capital (IC). We calculate Netcompany’s NOPAT at DKK 236.9m in the past 12 months and the IC at DKK 2,851m. The majority of the company's IC comes from large increases in capital (equity and debt), mainly as a function of its combining Netcompany A/S and NC TopCo A/S as of February 1, 2016 (creating a large goodwill post) but also due to its acquisitions of Mesan (entry strategy to the Norwegian IT market) and UK-based Hunter Macdonald.
In order to get a more fair estimate of ROIC, one could make an adjustment to capitalise the goodwill from the 2016 merger over time which would lower the IC on an adjusted basis.
Netcompany's EV/EBITDA multiple for FY2018 is significantly above the two peers. In our view, though, this seems to reflect both the company's growth potential and a better-operating business with a higher EBITDA margin.