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First off big THANKS to Andrew for taking the time to write these comments - it is extremely useful because he has asked some very sensible and valid questions and made some important points and as a Holder he clearly understands where he has parked some of his dosh. You can follow Andrew on Twitter at @LTGrowthStocks. I recently bought a small Position in EUSP and as time goes on and I understand the business more and more I might add to this Position, Andrew’s thoughts are helpful for me to assess the Business and to build my knowledge.
The Comments were entered in the Box below Part 1 of what is due to be two ‘Buy Rationale’ Blogs on EUSP but with the limitations of these Boxes I thought it would be best if I responded with a separate Blog. The original Blog with Andrew’s comments below it can be seen here, but I have copied his Text and put it in italics and I will respond in normal font below as I see appropriate:
“Disclosure - I currently hold shares in EU Supply and may buy or sell at any time (a very small portfolio position so I might just sell if I get bored or it takes up too much monitoring time). Any mistakes if there are any are unintentional (I don't know this company well).
Interesting that you have a very small position - like me you clearly size to the Market Cap or Perceived Risk or whatever and I think this is a very useful technique that many People could make good use of.
Wheelie - thanks a very detailed discussion and I liked the consideration of all the risk factors. I would just add that with the company is based in Stockholm there are some specific risks related to IT people. Speaking to the CFO, the city has seen an IT boom and good people are in demand. This creates cost pressures and possible retention issues for EUSP.
That is some useful further information - I haven’t re-read my Blog but I think I hinted at IT Skills being in quite short supply - clearly this is a big Risk then. Thanks for the comments on the scribbles I did !!
Spread - I know you highlight this but the spread on the shares is crazy. When I last looked it was 10.5p to 12p. So you lose about 14% just in the buying and selling. For a lot of people I think this would be a deal killer. You can get great price moves from stocks with a spread of say 2%. With EUSP you really have to want to be in for years to make up for the loss on the spread. If something goes wrong it may also effectively be impossible to exit.
Clearly Spread is an issue - there are of course some ways to mitigate this and/or to be happy to pay a larger Spread than usual. First off these kinds of tiny Stocks can make some huge moves over time if they go right, so in a few years down the track if you are sat on a Profit of 200% it will probably never cross your mind that the Spread was very big. However, there are some ways to ‘Get inside the Spread’ and what I find most useful is to use a ‘Limit Order’ with your Broker where you say something to the effect of “I want to buy 2000 Shares of EUSP with a Limit Price of 13p” - you can do this online using their Order Tickets with most Brokers or if you prefer you can phone most Brokers up and tell then what you want over the Phone. This is often useful on many Stocks and you can use Limit Orders for Selling as well (“I will sell 3000 Shares in XYZ Shares if I can get at least 124p for them”). On a small Share like this I doubt you can sell in any size so such Limit Orders are useful but also it might be a case that TopChopping in future is the way to go. I am very much a Long Term Holder and I expect to be in EUSP for years - unless something changes.
Management - I agree that the CEO and CFO appear to be highly credible. CEO is much more credible than the bulk of AIM CEOs.
Interesting you say this - I thought they were pretty decent and I did feel I could trust them.
Competition - Good coverage of this. Something I find that people covering stocks often overlook. I asked the CFO about this but he didn't appear to have a clear idea about the competitive environment if I recall correctly. From what you state above it is less competitive than it was but is still very competitive.
I always try to cover Competition when assessing any Stock but it is arguably the hardest Chunk to write. I note you mention Cloudbuy CBUY further down and I clearly was remiss in not mentioning these - thanks. I think it is quite a Competitive Market but the EUSP guys (with perhaps an over-reliance on the CEO !!) seem to be pretty good at building Customer relationships and getting in on the Sales Cycle very early - this is important.
There are customer "lock ins" but getting customers is the hard part. There don't appear to be network effects, cost advantages, scale advantages or brand/intangible drivers. I.e. the competitive moat doesn't appear to be significant in terms of attracting customers.
One of the reasons I got interested in EUSP first off was because they were winning Business and new Customers - so they must be doing something right. I see your point about “Network Effects” with regard to winning new business but once they are in with a Customer I suspect the Network Effects actually conspire to keep the Customer locked-in - I think it is hard for Customers to leave EUSP as their Suppliers, Staff, etc. are used to the system as well. Put it this way, EUSP would have to screw up bad and not develop their Software well to get Customers to move (or maybe change Commercial Terms in a really negative way like hiking Prices a lot - that is a Risk). In addition, the more Customers EUSP wins, the more Reference Sites they have and this will help a lot. Deals like the one they have with the Norwegian Government under the ‘Doffin’ thing I assume will help them win new Business.
It isn't clear to me whether this is a localised market (EU rules) or a global market. If it is a global market EU Supply is clearly open to competition from the US etc. I think it pays to be cautious when you can't easily determine the competitive backdrop. I am not really clear what EU Supply's market share is or market share trend. This appears to be a fragmented market.
EUSP are only targeting Europe and the UK - so that gives them some focus which is clearly a good idea. There is no doubt it is a Global Marketplace but in reality the EU is very anti-competitive and restrictive for Companies from the US and in my experience of selling IT systems into Europe it was extremely difficult because there was a clear bias towards ‘Home’ based companies. There were many European Countries where we simply wouldn’t bother trying because they only bought from Local Firms. EUSP’s market share is tiny and probably barely even registers and it is definitely a fragmented Market.
Market size - I spoke with the CFO about this and he mentioned a number of about £200m I recall. This may not be correct it is just what I recall him saying. So this isn't a huge market but the scope for EU Supply is significant relative to its current revenue. The CFO didn't appear to be clear what percentage of the market has an electronic system currently and what percentage doesn't. This is significant as it determines the scope for relatively easy growth with greenfield customers.
That number for Market Size does sound too low - I suspect it is something more like £2bn but I am guessing. It is a large Market but there are a lot of players. I see EUSP as having a huge Market to go for. In addition, the EU Mandate for Electronic Procurement only applies to Public Bodies at the moment - once Private Businesses fall into line as well, the Opportunity will be enormous.
EU tendering deadline - I recall, and I could be wrong, that all tendering in the EU will have to be done by an electronic system by the end of this year. This should provide a very good backdrop for EU Supply this year. However, I agree that contract wins seemed to have petered out recently.
The new EU Rule comes in this April - it certainly seems like EUSP have slowed down their Wins lately but having said that they do seem to come in flurries !!
I know you will cover this next time so I hope this post doesn't steal your thunder. However, in my view the key financial attractions are:
1) Profitable before interest and tax in 2017. Expecting to be profitable after interest and tax in 2018 (CEO comment). I state this because it should significantly de-risk the business from an investors perspective. The group also talked of cash receipts due in early 2018. So I think the risk you talked about of cash issues etc should be less pronounced then they have ever been for the group. A further factor reducing risk is the high proportion of recurring revenue at 66% of 2017 revenue.
Ah, thanks for that, now you mention it I do recall the CFO saying this to me about the Cash due in early this year. As you say that helps the tight Cash situation and the Recurring Revenue is a big attraction to me of these kinds of Software Businesses.
2) Valuation - Given the competitive environment it isn't clear what profit margins will eventually settle at. So EUSP may not be as profitable as some software businesses. However, the shares trade at a relatively low ratio to forecast revenue in 2018. The EV value divided by forecast revenue is 1.44X for 2018. Compare this to Cloudcall, for example, which trades on an EV to revenue forecast for 2018 of 4.1X. Cloudcall isn't expected to be profitable for sometime but does have a robust net cash position.
Ha Ha, that’s funny because I now realise you are mentioning Cloudcall CALL not CBUY - doh. I am assuming at this point in time that EUSP will have the benefits of each additional Customer adding to Revenues and Profits with little additional Cost - this is quite normal for Software businesses. We really need more time to flow under the Bridge for a sensible view on Margins etc.
Moving from price to sales to forecast P/E and this comes in at 12.7X in 2019 (Sharescope broker consensus forecast). So if the forecast is met for a year out the shares don't appear to be expensive. I have ignored the forecast P/E for 2018 as the group is expected to achieve only marginal profitability this year.
I will cover Valuation stuff in detail in my next Blog - however, the numbers you have put here look about right to me. Something worth noting with such a tiny company though is that the growth could turn out to be very fast in coming Years - in which case the Forward P/E could look very cheap, very quickly.
Another way to do the valuation is the amount of money invested into their products to date. We can also potentially add in the investment needed to get to where they are today. I haven't assessed these but I think it is likely that the group has spent more than its current market value just on the product. So an acquirer would perhaps look at the intangible value of the business.
An acquirer may also be able to boost the sales of the business if they have a strong sales distribution function. I imagine pu”
That is a very good idea - not sure how we would do it in practice. However, bearing in mind that this Product started off years and years ago in a Company that went Bust it is pretty clear a lot of Dosh has been put into it - as you say, an Acquirer might be happy to pay a lot of ‘Goodwill’ over the top to get hold of EUSP and what is has. It would certainly make sense that an Acquiring Business might have Economies of Scale which could be in the Sales Function as well as across many other aspects of the Business, such as Software Development, Testing and Consultancy etc.
Many thanks for those Comments !!
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