Description

Summary

  - On October 26, 5G Networks (5GN) sold its hosting business and 2/3 of its domains business for a net gain of over $100M.

  - After full debt repayment and transaction costs, 5GN was left with $84M cash vs a $75M current market cap, or -$9M TEV. TEV adjusts to -$5M if options near or at the exercise price are exercised.

  - Post-sale, the remaining company will generate an estimated $5M net income while retaining 1/3 of the domains business worth an estimated $21M.

  - 5GN plans to use its cash to acquire other businesses.  It also announced a share buy back up to 10% of shares outstanding and a $0.02 div worth 8.9% of the current share price.

  - Given low expectations and a matching valuation, the stock should rerate if 5GN comes reasonably close to its earnings target and doesn't squander its cash.

In the remainder of this report, I’ll briefly cover company history, address why enterprise value is negative and how the company can change perceptions and rerate.  Finally, I’ll discuss valuation.

Company history

5GN is a digital services company which aims to acquire and improve other digital companies.  In October 2020 at the height of COVID fears, 5GN initiated a merger with WebCentral, a struggling domain name and hosting company.  The merged company kept the WebCentral name, while 5GN had 52% of voting rights. From October - November 2020, the company fired its previous CEO for poor performance.  It replaced the CEO / Managing Director, Chairman / Director, CFO and one other director.  The domain name and hosting divisions improved quickly in the past three years.  In October 2023, the company sold most of its original WebCentral business.

Why is enterprise value negative?

EV is negative, likely because investors doubt that 5GN can successfully execute its strategy.  In the sale announcement, 5GN stated that it will use cash to acquire other digital service companies, buy back shares and issue dividends.  There may also be uncertainty about the value of its remaining 1/3 stake in the domains business, and whether the remaining company can actually generate $5M in net income.

On January 10, 5GN announced a $0.02 dividend worth 8.9% of the current market cap.  On December 8, it announced plans to buy as much as 10% of shares outstanding.  5GN can gain credibility by buying shares soon, given its low valuation.

How will the remaining 1/3 stake in domains business fare?

It’s unclear how 5GN values its remaining 1/3 stake in the domains business at $21M, but the company that acquired the hosting and 2/3 of the domains business, Oakley Capital, has a good track record of improving and selling its acquisitions.  The table below shows hosting companies that Oakley Capital acquired.  Non-hosting acquisitions have also performed well.

What to expect from 5GN’s remaining businesses

Remaining businesses after the sale generated $47M revenue in FY2023 (ends on June 30, 2023).  5GN sold off its domains business and 78% of its cloud business.  Assuming the same margin for the remaining cloud, revenue split and gross margin by division are: managed services (rev split 26%, GM 30%), network & device (19%, 66%), hardware & software (17%, 17%),  data centres (16%, 56%), cloud (15%, 69%), digital marketing (7%, 38%).  Total gross margin for the remaining businesses was 45% while revenue from FY22 to FY23 was unchanged.

EBITDA margin was -12% based on the sold businesses' multiple and the full company’s pre-sale EBITDA.  The company didn't break out other margins, but pre-sale FY23 net income margin was -20% while OCF / receipts from customers was +7.6%.  Given lack of detail, it's unclear exactly what changes the remaining businesses need to make to reach $5M net income, but some improvements over the next year are clear:

"The Domains Business will also continue to source cloud services and managed support services from Webcentral under a services agreement valued at $12M over 5 years, with a minimum of $4M in the first year."

Cloud services has 69% gross margin, managed support has 30%.  Conversion from gross profit to net income for the service contract from the Domains Business should be high given minimal additional costs.  Assuming a 30% net profit margin, support services increases net profit by $1.2M ($4M * 30%).

Pro-forma net cash after the sale is $84M.  Both U.S. Treasury bills and the Australia equivalent have traded at over 4% yield since the sale of WebCentral, so I estimate a $3.4M gain from interest.

Combining interest, the services agreement and net operating losses, net income increases $4.6M without accounting for improvements from no debt repayment or interest costs on $29M borrowings that were repaid.  $5M net income is feasible if the rest of 5GN can break even.

What to expect from future acquisitions

In order to estimate how future acquisitions might fare, I'll look at previous 5GN acquisitions and sales history after the leadership change in October-November of 2020.

- In November 2020, 5GN sold its interest in Netalliance Pty Limited (“Netalliance”).  Purchase details are lacking, but Netalliance first appeared in the FY14 annual report.  It was most likely sold at a loss since a new regulation enforced five months after the sale would end Netalliance's primary business practice.  Selling at a loss was reasonable given the circumstances.

- In 2021, 5GN started buying shares in Cirrus Networks Holdings Limited, a Managed Service and IT solutions provider.  5GN made an unsolicited offer for Cirrus at a 14% premium, but Cirrus shareholders rejected the offer  By August 2022, 5GN did not raise its offer, saying that Cirrus wasn't worth more than the initial bid.  5GN sold its holding in Cirrus at approximately breakeven.

- In March 2021, 5GN purchased a bare metal cloud provider, Intergrid Group Pty. Ltd. for $2.9M at 3.9x EBITDA.

- In July 2021, 5GN finalized its merger with WebCentral through an all share transaction where 5GN shareholders owned 52% of the merged company.  As mentioned previously, 5GN gained $100M gain upon sale in October 2023.

- In December 2022 5GN acquired New Domain Services, a domain email and webhosting services business for $5M at 4.2x normalized EBITDA.

While the record is shorter than ideal, smaller businesses were acquired at reasonable valuations and the WebCentral sale was profitable.

Effect of Options

Not including options, 5GN has a -$9M enterprise value.  61% of options have exercise prices between $0.11-0.26.  Remaining options have a $0.45 exercise price, or 100% above the current share price.  If all options with exercise prices at $0.26 and below are exercised, EV= -$5M and share count increases 12%.  If $0.45 options are also exercised, TEV= -$11M and share count increases 19%.  Regardless of what options are exercised, the stock is still has a negative enterprise value.

Valuation

Base case

I’ll assume a negative base case.  An 8.9% dividend was already announced, but assume minimal buybacks and 5GN makes poor acquisitions, so cash balance shrinks or is discounted by 33% to $60M.  Also assume that net profit is only breakeven.  FY23 revenue was $47M, so I value the remaining businesses at $20M.  Oakley Capital underperforms, so the remaining 1/3 of Domains drops from $21M to $15M.  Exercising all options with a strike price of $0.25 and under, SotP gives $0.255 / sh or a 13% gain.

Bull case

5GN uses cash effectively for dividends, buybacks and good acquisitions, so cash is fully-valued.  The remaining businesses with FY23 $47M revenue generates $5M net income, so I'll assign a conservative 6x P/E multiple for $30M.  Oakley Capital also improves WebCentral and 5GN’s remaining 1/3 of Domains is worth $21M.  Share price rises, so shareholders exercise all options with strike prices of $0.26 and under.  SotP estimates ~$0.375 / sh or 67% above current value.

5GN is an Australian nanocap with a history of wide price swings, especially during recessions, so a large drop in share price is possible, regardless of any SotP estimate.  However, given its negative enterprise value and acceptable acquisition record, it's more likely to rerate up.

Notes

Given the uncertainty in this stock, it's a small part of my portfolio, so I marked that I don't hold a material investment in the issuer's securities.  Also, credit is due to multiple investors, including VIC's puppyeh, who posted good summaries of 5GN on various social media and websites on the day the WebCentral sale was announced.  Hopefully, people interested in 5GN find the additonal details that I've added on to the thesis useful.

Catalyst

5GN meets its earnings target and uses its cash effectively.