Description

Cheap opportunity to invest in a small Italian company in a growth trajectory: due to limited liquidity of the stock and volumes, this is an opportunity mostly for retail investors and/or small portfolios

Digital Value in a nutshell 

Digital Value SpA (“Company” or “DV” while DV with its subsidiaries are the “Group”) is a leading player on the Italian IT market. It originates from the business combination of the former system integrators - Italware Srl (“Italware”) and ITD Solutions SpA (“ITD”), long-term players on the Italian market covering different end users: 

Italware was founded in 1988 in Rome. Led since the beginning by Massimo Rossi, it boasts over 30 years of experience in the IT environment, with a focus on large accounts in the utilities, telecommunications and public administrations.

ITD, established in 1986 by Carlo Brigada, grew thanks to the successful integration of selected businesses acquired in the past. In 2017, Massimo Bramati joined the company with a minority stake bringing in his long-term experience with IBM Italy. 

The combined entity targets large accounts, i.e. firms with more than 500 employees, accounting for more than 50% of the total Italian IT spending and with the highest expected digitalization growth rate.

Over the years, the two combined companies successfully advanced their respective technologies and the role of service provider, integrating it with skills and solutions internally developed and enriching the portfolio of solutions offered in the ERP and business applications. In the future, The Group will assign growing focus to infrastructure services, security, governance of complex IT systems and the Cloud, which is the most attractive segment to exploit. The latest press release claimed the Company reached €365m turnover in 2019 with a 23% increase over the previous year. Return on capital exceeding 40%, FCFF more than 50% EBITDA.

Listing

The Company listed in November 2018 on the Italian Alternative Investment Market- https://www.borsaitaliana.it/azioni/mercati/aim-italia/home/aim-italia.en.htm - (“AIM”) through a €22.5m rights issue (the “Transaction”) at €10 per share, implying a €89m post money capitalization. As a result of the Transaction, the former owners of Italware and ITD became Digital Value’s majority shareholders through the contribution into the newly established Digital Value of their Italware and ITD controlling stakes. Furthermore, with the proceeds of the rights issue, the Company purchased the minority stakes into Italware and ITD (thanks to the Transaction, Italware and ITD shareholders could monetize part of their respective investments into the companies).

Due to illiquidity of the AIM market, in order to qualify and execute the Transaction, it was set with some anchor investors (“Minority Investors”). The IPO took place via a Club Deal, with the Investors taking nearly 13% while the remaining went 20% to the market. 

The controlling shareholder of Digital Value is DV Holding (“Holding” or “Controlling Shareholder”), retaining 66.7% of the shares post recent conversion of warrants by the retail investors. DV Holding’s key shareholders are the previous owners of Italware (Alessandro Rossi with nearly 80% of the Holding’s share capital), ITD (Riccardo Benedini and Carlo Brigada – with the 5.7% each) and Sesa SpA (6%). Sesa is a listed Italian company with nearly €1.0bn market cap, operating in the value-added IT solutions for business and professional segment, focused on SME. It is also a key supplier to Digital Value.

There is a 36-month lock-up period among the DV Holding’s shareholders (up to the end of 2021). Furthermore, DV Holding and the Minority Investors committed not to dispose any of its Digital Value shares for an equivalent period.

The Market

Trying to depict the market, the value of IT services (including hardware, software and cloud solutions) in Italy is close to €20bn with a 2.8% growth rate. Out of the total, the addressable market (large accounts) for DV is nearly €8bn, so DV enjoys a 4% market share within a highly fragmented industry. 

This is a market where the top 5 players (among which large multinational business like Accenture and key leading Italian companies as Reply and Engineering) cumulatively retain more than 50% of the market share while the top 10 players have a 80% share (with DV the tenth). In the described framework, DV is emerging as a dynamic, leading and rapidly growing player.

After years of performance characterized by structural weakness (from 2007 to 2014), the Italian IT market seems to have reversed the trend, with accelerating growth rates (+3.5% in 2019 and 2020).

The management services segment is the most dynamic (expected growth of around 10% in the next two years). The market is characterized by a progressive adoption of the modality “technology as a service” and the switch from hardware and software to Cloud services, at both infrastructure and application levels.

Business Model

Through the Company presentation, it is possible to gather some info on the business model (see this presentation by their adviser to get more details (https://www.cfosim.com/ricerche-equity/digital-value-2/). The Company provides to the customers an integrated offer of customized services and solutions: network infrastructure and data centers, security, network testing and monitoring, workstations management, Help Desk, data management and analysis, ERP systems management, retail applications, information systems on premise support and governance, outsourcing and cloud.

The Company leverages on a customer base of nearly 2,500 accounts distributed among the key end markets: public administration (33% of the business), telecom (35-40%) and finance (13%). Key customers are: TIM (the telecom giant in Italy), Poste (the state-owned mail service company), other large public administrations (Consip, INAIL, Sogei). The first 10 customers represent nearly 70% of annual turnover.

As a system integrator, DV enjoys long-term relationships with the large IT (both hardware and software) vendors (the “Vendor”) and technology distributors who purchase from Vendors and sell to systems integrators, offering solutions together with integrated logistics, financing and pre/post sale services. The technologies purchased from the Vendors and sold to customers by ITD and Italware are covered by guarantees provided by the Vendors themselves.

Solid Management team with real money invested into the Company

The Company management is made up of professionals with proven long-term experience in the relevant sector. In addition to that, the board leverages on the experience and professional background of senior members as:

Massimo Rossi, the CEO and Chairman of the board, is the founder of Italware and its CEO since 1988. He is therefore the key shareholder of DV Holding and DV.

Alessandro Fabbroni, board member, is CEO at SeSa, a large Italian IT group with more than €1bn in revenue. He invested through its company in DV.

Carlo Brigada, founder of ITD in 1986, an Italian reseller of IT components imported from US. In 2012, following the acquisition of a business, ITD transformed itself in a system integrator. Brigada successfully brought the turnover from €13m to €83m in a few years.

Within the board, there are other experienced professional in the field of corporate finance and consultancy.

The departure of one of few key relevant people is one of the potential risks for the Company: that is strongly mitigated by the fact that the Company’s leaders are the key shareholders.

Relevant infos

Last November, Marco Patuano and Paolo Vantellini, joined DV. 

Marco Patuano will act as advisor to the Group for the definition of the strategic plan, contributing to consolidate the relationships network at national and international level. He will also take care of the external growth (M&A transactions). Marco Patuano was CEO at Telecom Italia until 2016. He then was appointed CEO at Edizione Holding srl, the financial holding company of Benetton family.

Paolo Vantellini joined DV with the role of Chief Operating Officer (COO), being in charge of coordinating and optimizing the corporate functions. Paolo Vantellini was President at Sirti and was subsequently Head of the Business Support at Telecom Italia.

Investment case

This is an opportunity to invest in a growing business exhibiting a substantial progression over the past years. In particular, pro-forma financial information based on the aggregate income statement of the two companies show an impressive evolution of turnover from €258m (2017A) to €365m (2019PC): the turnover target achieved one year in advance with respect to the business plan.

As per the 2018 listing transaction on the AIM, as indicated above, it allowed the shareholders of Italware and ITD to monetize part of their success through the disposal of the minority stakes in the respective companies. The post money capitalization of DV was particularly low (just €89m) considering the figures as of the end of 2018 (Sales nearly €300m, EBITDA €24m, EBIT €21.5m, Net Profit nearly €15m and net cash for €31m). Moreover, as a proof of the very cheap listing price, the 2019 was extremely positive and the appointed adviser revised twice upward the target price in the last 12 months (from €16 at the beginning - the Company listed at €10 - to the current €21). My understanding is that the Controlling Shareholder disposed a pure minority stake to the Minority Investors, opting for this transaction instead of a private equity deal, in order to retain full control over the business. Listing the Company on the AIM, for the Minority Investors means extremely limited opportunities to dispose the shares and that was reflected in the tremendously low entry multiple paid by them. Therefore, the listing price was very cheap, the stock (and its owners) benefitted with a 100% surge. My view is that the medium-long tem goal of the Minority Investors and Controlling Shareholders is the Company to use its cash available and expected retained cash flow to develop the business through acquisitions, making it a prominent player in the relevant segment. From that point, the Company might be, alternatively: (i) listed on the primary segment of the Italian Stock Exchange, where the opportunities to liquidate the shares for the Minority Investors will be significantly higher; (ii) sold it to a trade buyer. 

Despite the impressive progress of the stock price since the listing, I believe there is still a significant potential to be exploited considering:

(i) The significant turnover expansion in 2019 (recently the management announced to have reached €365m turnover, more than 20% progression over the previous year), which should drive further growth in the following years thanks to conspicuous retained earnings that can fund the growth with no debt recourse. The Company recently issued another press release indicating a positive turnover trend also in January 2020 (https://www.digitalvalue.it/wp-content/uploads/2020/02/2020-02-17-DV-COS-trendgennaio.pdf) and strengthening the expectations for a persistent advance trend.

(ii) The fact that the entry multiples are still low: at the current market price (€19) an investor pays 5.0x 2020E EBITDA, 5.5x 2020E EBIT and 9.3x the FCFF. These multiples appear cheaper whether considered in the context of a business with a market capitalization of €189m but with €30m in cash, generating more than €20m in FCFO with a return on tangible invested capital that I estimate to be stably in excess of 60% (look at the return on tangible invested capital cause intangibles are purely goodwill arisen from the recent business combination – accounting effect of the consolidation). The projection is based on a 30% payout ratio that frees up more than €13m cash per year for the business (retained earnings) and growing over time.

Below I report a simple valuation exercise (easier to walk through it, instead of discussing long the assumptions and figures in details) where I assumed a reasonable growth trend for the coming years and a 10% required return. My fair value estimate is in the region of €28 versus €19 current market price: the current market price seizes the present value of the business but does not factor the growth that presents a satisfying visibility based on the recent performance of the business. According to the analysis, the ability of the business to generate cash internally thanks to minimum required invested capital, the cash available and the total absence of debt give the investors an adequate protection to downside also in case of macroeconomic adverse development. 

I also want to draw the attention to the fact that the project is based on the assumption of undistributed retained earnings. This cumulative is - at least partially - inconsistent with the moderate growth rate assumed during the explicit period: the projection does not factor any acquisition (which, of course, I cannot predict) or cash distribution to shareholders.

Catalyst

I guess the upcoming FY2019 results presentation might be a short-term catalyst for the stock. Another catalyst might be an acquisition; alternatively, the Company could pay a hefty dividend but I do not see the strategic rationale behind that. The long-term catalyst is the listing on the primary segment of the Italian Stock Exchange that might attract more interest and investors.