James Faulkner on Publishing Technology: Small cap of the week

Shares in Publishing Technology (PTO) have taken a turn for the worse in recent months. That said, the firm stands on the threshold of a major market opportunity, as it taps into demand from traditional publishers to convert their content into digital formats. Publishing Tech is coming to the end of an elongated investment cycle that has seen it spend well over £15 million upgrading its product portfolio in recent years to accommodate this opportunity. In the coming years, it looks set to reap the rewards of that investment.

Formed in 2007 following the merger of Ingenta, VISTA, and Publishers Communication Group, Publishing Technology describes itself as “the world-leading provider of content solutions that transform business”. It currently works with around 400 clients, including eight of the world’s ten largest publishers. Specialising in content applications, audience development and content delivery, the group uniquely spans online and print solutions, providing the industry’s only end-to-end proposition specifically designed to support the entire content process. It is also well placed geographically with offices in the USA (Cambridge, MA and Somerset, NJ), the UK (Oxford and Bath), Brazil (São Paulo), India (New Delhi) France (Paris) and Australia (Sydney).

The publishing industry is in the middle of a period of major transformation, with digital products and online market places opening up new sales opportunities. Publishers are now able to break out and re-bundle existing content to create new digital products with which they can target specific markets and boost returns from current assets, as well as make use of new sales methods to widen the customer base. Electronic books and journals can be sold in multiple ways through various channels (as physical copy, as pdf download, as text on a computer, as data pushed to a mobile device) and can be sold whole or piecemeal (a chapter, a collection of elements related to a topic, an index or even just a quote, table or photograph).

One of the key attractions of Publishing Tech is that it owns its own software. One of the firm’s developers estimated it would cost a company such as Oracle or SAP c.£60 million to replicate the firm’s software suite (vs a current market cap for PTO of just over £15 million). This represents a major barrier to entry and is also reinforced by decades of industry experience and goodwill, which would be even harder to replicate. For the record, neither Oracle nor SAP has particularly targeted the publishing industry, largely because of its relative complexity. Given that its technology offering is now the leading solution for publishers in the digital world, Publishing Technology could be a natural acquisition target were anyone looking to get a foothold in this rapidly developing sub-sector.

Recent disappointment…

A disappointing trading update in June saw the shares plunge by almost 50%. The firm said it now expects its results for the year ending 31st December 2014 to be below market expectations and broadly in line with the full year results for 2013 (i.e. £0.7 million adjusted pre-tax profits on £16.9 million of sales). Results for the first half to 30th June showed a loss before tax of £0.69 million, down from a profit of £0.42 million in H1 2014, due to recent actions taken by management to rectify implementation problems on some current contracts, resulting in additional product development expense and deferral of revenue which was expected to be recognised in the period.

A strategic review implemented by new CEO Michael Cairns has identified that certain design problems in the engineering of some of the group’s software are leading to inefficient implementations and performance issues which need to be rectified and that the company’s implementation resources are not scalable enough to meet growing demand from contracted and pipeline business. In response, Cairns has added additional resource to enhance and reorganise the implementation group, and committed additional research and development to improve the efficiency of both leading products, advance and pub2web, while also delaying the delivery of software to clients to ensure those deliveries meet acceptable quality standards. In H1 2014, this will result in the deferral of some £0.6 million of revenue and the addition of around £0.4 million of costs, leading to a worse performance than in H1 2013. However, management is confident that a proportion of this delayed revenue will be recaptured later in the year.

In the longer term, a more durable solution to these problems will be necessary. Consequently, the company is considering working with a range of internationally recognised implementation partners to provide the skills needed to implement instances of its products for the large, global customers it is increasingly attracting. Such partnerships will not only widen the group’s market and geographic reach and bolster its sales and marketing efforts, but should also enhance the quality of its earnings and its overall business profile. Such a move would also enable the group to focus its internal resources on engineering and design expertise.

Future hopes…

On a more positive note, Cairns’ review supports the view that Publishing Technology is now poised to capitalise on the significant research and development investment of well over £10 million which has been made in recent years, which has embedded considerable value in its products and services. Moreover, the company’s future revenue is underpinned by some substantial new contract wins, including £4 million of new business in the last few months, and it is said to be benefiting from supportive sector trends, as publishers increasingly seek partners to help them commercialise their content digitally. In addition to these new business wins, the group has signed contract extensions with a number of key existing clients, including Elsevier and BioOne; its Chinese joint venture is trading ahead of management’s expectations; and the firm’s legacy businesses continue to trade well.

We believe Publishing Technology’s problems appear to be of a ‘growing pains’ nature rather than anything fundamentally wrong with the product suite. The company has for some time now been devoting a lot of its resources to developing its next generation product suite, which has cost considerable time and money. Now that it is emerging from this period of investment, it must begin to reallocate resources towards implementation if it is to meet the requirements of some of the larger contract wins it has been seeing of late. However, rather than scale up the cost base to match this new challenge, we believe that, over the long term at least, the use of implementation partners appears to be a sensible move forward.

What’s it worth?

In line with the company’s statement, house broker Westhouse now forecasts £0.7 million adjusted pre-tax profit on £16.9 million of sales for FY14. Although it retained its sales forecast of £19.2 million for FY15, as a result of the additional costs it lowered its profit forecast to £1.3 million (from £2 million). However, for FY16 it left its forecast of £2.4 million profit on £20.8 million of sales intact. On the back of the reduced estimates its target price was lowered to 400p from 560p.

With FY16 forecasts left intact, Publishing Technology trades on a prospective multiple of just 6.3 times two years out.

Given that the company is a market leader in software for the publishing industry and has a major opportunity in the form of the need for publishers to migrate physical assets to the digital arena, we believe these metrics look attractive. Of course, this assumes the company can deliver on these targets, which we see as the main risk going forward. We also note it is early days for the new CEO, who comes with 20 years’ experience in digital publishing. Michael Cairns has consulted with and managed organisations as they have transitioned from traditional print-based media to online delivery. He has also held senior positions with professional information, trade and educational publishers, and helped to define and launch several start-up content-related businesses. This should prove a major strength going forward.