James Faulkner on AdEPT Telecom: Dialing up the profits

Telecommunications services business AdEPT Telecom (ADT) is a cash cow that is managing its business well and stepping up returns to shareholders. Although it operates in the declining fixed line telecoms market, it is managing that decline well and managing to offset it through growth in data, mobile and broadband, as well as through some rather clever bolt-on acquisitions, which have become something of a management specialty.

Earlier this week, AdEPT released a an excellent set of full-year results for the year to 31st March 2014. Although revenue fell by 0.8% to £20.9 million, this was down to a drop in traditional fixed line revenue (-£1.1 million) partially offset by the growth in data and broadband (+£0.7 million to £3.3 million). Notably, data, mobile, inbound and other services now represents 24.7% of total revenue, with call revenue now down to 27%. Adjusted EBITDA increased by 8.3% to £4 million – the eleventh consecutive year of EBITDA growth – and margins increased 160 basis points to 19.4%.

Earnings per share climbed 18% to 14.99p, which was slightly ahead of forecasts due to a lower tax charge. As usual, profits were well backed by cashflow – with free cash flow, after interest, of £2.6 million during the period. This led to a further net debt reduction of £0.3 million year-on-year to £3 million. The declaration of a final dividend of 1.5p resulted in a 100% increase in the full year payment to 3p.

Two blue…

The standout development during the period was the firm’s 18th acquisition, that of Bluebell Telecom in August (and, post-period end, Bluecherry Telecom). Both have been fully integrated into the group, bringing with them additional revenue and margin but no additional operating costs. The focus on delivering fixed monthly revenue streams helps to reduce revenue volatility, with the proportion of revenue which is derived from fixed monthly values having increased to 63.3% of total revenue from 59.8% in 2013.

Meanwhile, the firm achieved solid progress in the public sector with a number of contract wins, including several County Councils. AdEPT was awarded approved supplier status to the Crown Commercial Service (CCS) in addition to the existing framework agreements with ESPO and Ja.net. At the year end, the public sector represented 11.9% of group revenue, up from 4.5% in FY13.

AdEPT continues to provide voice and data services to its customers by offering “best of breed” products from all major UK networks. Continued deployment of 21CN data connectivity products has led to data and broadband revenues increasing by 27% during the period under review. As the demand for faster data connectivity speeds continues, AdEPT has seen further customer orders for 10Gb Optical Spectrum Services (OSA) and is currently underway with the launch of 40Gb and 100Gb Optical Spectrum Services (OSEA).

Strategy…

The strategy remains much the same going forward. The business remains focused on on organic sales growth through the firm’s approved supplier status on the various telecom frameworks, whilst maintaining profitability and cash flow generation, which will be used to reduce net borrowings and/or fund suitable earnings-enhancing acquisitions if identified. As the company explains, its smaller in-fill acquisitions are simply an alternative to sales and marketing spend, and the fact that the Bluecherry acquisition was completed for between 4.5-6.2 times EBITDA highlights the attractions of such a policy. The board is confident that the continued strong cash generation will support a progressive dividend policy.

AdEPT continues to exhibit robust levels of cash generation, which is helping the company to pay down debt, while at the same time carry out bolt-on acquisitions and pay a decent dividend to shareholders. AdEPT’s revenue per employee of £444k leads the sector and could rise even further given the intention to make further bolt-on acquisitions in the fragmented reseller market. The firm’s proven ability to deliver tangible cost savings to customers remains a major growth opportunity.

Valuation…

Broker Northland forecasts adjusted pre-tax profits of £3.9 million on revenues of £22.2 million for the year to March 2015, giving adjusted earnings of 13.1p per share. For FY16, it has pencilled in respective figures of £3.9 million, £22.5 million and 13.1p. The broker also expects a dividend payment of 4p in FY15, rising to 5p in FY16. On these forecasts the shares trade on a current multiple of 9.4 times, with a prospective yield of 3.3%. We admire the focus on increasing the dividend, which could have much further to run considering that dividend cover is currently high at 5 times earnings.

In light of the continuing strong performance and the prospects for further acquisitive growth, we would argue that the shares remain undervalued. There are obvious risks associated with growth through acquisitions, but we believe that AdEPT has thus far lived up to its name in that respect. The industry remains highly fragmented, which should ensure AdEPT has many acquisition targets in the future. On the flipside, we wouldn’t rule out AdEPT becoming a target itself, with Alternative Networks, among others, as a potential suitor. Risks include falling margins in the firm’s fixed line business and the market being highly competitive.