James Faulkner on WatsHot in the small cap world: iomart, Bango and blur group

iomart

iomart (IOM), a past favourite of mine, served up its full year results on Wednesday. This showed a solid performance, as the market has come to expect from the cloud computing specialist, with a 29% jump in revenues to £55.6 million and a 43% rise in EBITDA to £23.6 million.

For the uninitiated, iomart is something of a ‘picks ‘n’ shovels’ play on the continued growth of the internet and in data volumes, which are set to increase exponentially in the coming years. By physically owning and managing its own network infrastructure, including six data centre locations across the UK, iomart differentiates itself through its high quality service offering. The group also offers a unique 100% uptime guarantee, with all hosting services being engineered to ensure no single point of failure.

This competitive advantage is in the process of being augmented by the company’s investment in deploying its own fibre ring around the UK, with resilient connections to all of its datacentres. Not only does this add another layer of competitive advantage to its vertically integrated cloud strategy, it also protects its future variable pricing around connectivity with the capability to scale quickly and cost effectively.

The question for investors is whether or not iomart will be able to sustain its very high margins – i.e. higher even than most software companies in the tech sector – in an industry that looks likely to become ‘commoditised’ in the future. The business is highly cash generative, with operating cashflow closely mirroring EBITDA, and has begun to leverage the balance sheet through acquisitions, which could potentially squeeze out a few more earnings upgrades in the future.

Trading on a FY15 earnings multiple of 18.6 times, there is a degree of quality already reflected in the price. However, iomart still has significant spare capacity of perhaps as much as 50%, meaning there is still room for significant operational gearing, which could provide some upside surprises to earnings. With the share price in consolidation mode, this could be one to watch for the next leg upwards.

Bango

Mobile payments specialist Bango (BGO) is one of those ubiquitous companies that has promised much but has yet to deliver tangible results. The shares soared in 2012 and 2013 after it won milestone contracts with the likes of Google, Amazon and Facebook. However, since then, progress has been slow, and Bango has yet to prove it can successfully monetise its platform, and the market is losing interest. As such I believe that this could be worth closer attention.

Disappointment has primarily been driven by the slow rate of integration of MNOs (mobile network operators) and the firm’s appstore customers into the Bango payments system. This has been a somewhat tedious process and has probably been limited by the resources available to Bango at any one time. However, progress is being made, with a recent AGM statement pointing out that 137 MNO integrations have been completed to date and over 50 additional MNO integrations are in the pipeline, with more than 30 of these already underway.

The real test for Bango will be the development of end user spending, which is growing albeit from a low base. Gross margins are low at 2-5%, but Bango operates a business model with fixed operating costs. Therefore, as end user spend increases and platform fees rise, Bango should eventually move into profit – and operational gearing should take care of the rest. The potential is certainly there. If evidence begins to emerge that Bango is beginning to build scale, the shares could take off again.

On the other hand, if user spend proves stubbornly low, the current valuation of c.£50 million could still look toppy. The situation is worth monitoring until it becomes obvious which way the wind is blowing.

blur Group

Sticking with the scalability theme, crowdsourcer blur Group (BLUR) is one such company that has gone from paladin to pariah in a matter of months.

Crowdsourcing is a process that involves outsourcing tasks to a distributed group of people. This process can occur both online and offline, and it has the potential to transform the way corporates buy business services. It is different from ordinary outsourcing since it is a task or problem that is outsourced to an undefined public rather than a specific body (e.g. paid employees of a company). The implications for business and productivity in general are potentially huge.

Consider that Facebook manages 1 billion+ users with just a few thousand staff. Facebook’s scope in terms of its information output is huge, but it is its users – not its employees – that generate the information. Facebook might seem like a pretty frivolous example of how this kind of technology can have an impact on people’s lives, but many industry commentators believe we are only starting to unlock the true potential of the internet.

With a focus on cost effectiveness, blur aims to transform the way businesses buy services, in particular giving smaller sized suppliers the ability to compete on a level playing field with larger competitors. As management outline in the firm’s Admission Document: “As Amazon and eBay have fundamentally changed the way in which consumers buy day-to-day products, blur Group is seeking to fundamentally alter the way businesses buy core services.” Revolutionary stuff indeed. As we know from eBay and Amazon, the concept may be easily replicable, but building scale is all about gaining a reputation and establishing a brand.

blur’s cites three main elements to its business model:

1. building and maintaining a large crowd of pre-vetted, high quality experts to deliver defined services, utilising advanced social networking platforms and techniques whilst curating the service provider population to ensure its quality, ongoing engagement and delivery (‘Expertsourcing’);

3. efficient targeting to bring business customers directly to the relevant Exchange via digital and social marketing channels, internet sales and a growing corporate sales team.

The key task for blur then is building scale in order to reach critical mass, at which point there should be an inflexion point where profits let rip. So what has gone wrong?

Over the past two months, the company has scaled back revenue guidance from the $10 million level to $4.8 million, due to certain growing pains. (Note that this refers to gross revenues – i.e. the value of projects to be undertaken by third parties – rather than net – i.e. those revenues representing fees charged by blur (c.20% of the gross level).)

As project sizes have increased, so has the corresponding complexity and duration, prompting the company to adopt a more ‘conservative’ revenue recognitions policy. As for what this actually entails, I’m not sure, but it seems to be the classic case of over-promising and under-delivering, which really is a cardinal sin when it comes to a loss-making growth stock on such a punchy valuation.

But all is not lost. blur has raised c. £13 million by way of a (heavily discounted) placing and open offer, which is intended to fund its growth plans and see it through to profitability. The irony is that blur has been putting in some pretty solid growth in terms of project metrics. Bookings in the year to December 2013 grew 825% to $22.2 million, while 1,031 projects were submitted in Q1 2014 (versus 359 in Q1 2013) with a total value of $73.7 million and an average project value 19 times larger compared to Q1 2013.

Broker N+1 Singer expects the company to reach breakeven (on an adjusted EBITDA basis) from Q1 2016. blur has its work cut out if it is to win back the confidence of investors, but should it prove itself up to the task the potential is there, with the market cap now a mere £26 million. Again, this is one to put on the watchlist.