Description

FD Technologies

FD Technologies (FDP LN) is a £300mm market cap software and services company based in the UK. It was written up a couple years ago, but we believe it is worth a revisit and refresher with share prices hitting new lows and potential value-enhancing structure changes being actively considered by the company to finally unlock the SOTP value.

Business Overview

FDP has three segments with different growth and margin profiles that are essentially operated as three separate companies:

KX: fast-growth time-series database provider (~26% of revenue). FD bought 35% stake it didn’t own in 2018 for £48mm, implying a £137mm valuation. Solution was originally used for the finance industry where the software allowed traders and quants to ingest, manage, and store huge volumes of data. This enabled high-speed time-series analytics. Use cases have expanded to other industries and will expand further with the rapid industry growth of AI and data science.

This is the crown jewel of the business with fast growth and a superior financial profile. FY24 (2/28/24) ARR is growing >35%, with >110% net retention, the business has ~78% gross margins, and expanding EBITDA margins. Current ARR is £69mm and is expected to hit £88mm by end of FY24. Growth could likely be accelerated with incremental spending in sales & marketing – current CAC / annualized contract value is 1.5-2x. This division made a successful transition from perpetual license to SaaS with ~90% of revenue now recurring SaaS and an immaterial amount of perpetual license revenue.

Notably, KX now has partnerships with the large cloud service providers – Microsoft, Google, and AWS – which will support the availability of products to more potential customers. The agreements have increased the deal pipeline 4x and shortened sales cycles. KX reports low-teens EBITDA margins but there is a portion of R&D that is capitalized – expected to be breakeven within the next two years with steady-state cash EBITDA margins of 20-25%. In FY21, before management ramped up investment in the business unit, KX had a 15% cash EBITDA margin.

First Derivative (FD): this is a legacy capital markets consultancy business (~63% of revenue). Primarily a services consulting business that provides expertise on digital transformation to financial services and capital markets firms across a variety of functions. Consulting projects tend to focus on mission critical priorities for financial services firms, i.e., regulatory compliance and risk management. Business competes with other consultancies like Accenture, Capgemini, PWC, and KPMG, but differentiates itself on its capital markets specific subject matter expertise.

Financial profile of the business is stable but far less attractive than KX. Should grow high single digits to 15% per annum with ~30% gross margins and 10-15% cash EBITDA margins.

MRP: tech-enabled services business offering analytics for demand generation (~11% of revenue). Solution is an account-based marketing platform that combines human insights with analytics to improve lead generation for sales teams. The demand generation platform tracks billions of intent signals to help MRP customers identify and prioritize their customers. But this segment is most subject to macro softness – recent results have been negatively impacted by customers, particularly in the tech sector, pausing or reducing demand generation spending amid macro uncertainty.

MRP has created volatility in the FDP’s financial results. In 2022, the business had 11% growth, 44% gross margins and 14% EBITDA margins. However, with the softer demand environment in FY23, revenue declined 19%, gross margin declined to 41% and EBITDA margin declined to 3%. In 1H24 (ended August), revenue was down more than 30% and EBITDA was slightly negative.

What is the path forward?

In 2021, the board put in place a new group structure to report and organize the business along the three aforementioned segments. However, this failed to create value with share recently hitting new lows – despite highlighting the potential upside of KX, the legacy business have still been a drag on consolidated results and the consolidated financial metrics are unimpressive. Together, the segments offer only single digit growth, mid-20’s gross margin, and low-teens EBITDA margin. Weak MRP performance has obscured better results in the KX and FD business units. MRP has declined from ~20% of revenue in FY22 to ~11% in 1H24, creating a significant drag to growth at the consolidated level – a 33% revenue decline for MRP in 1H24 drove revenue growth negative for FDP.

Each of the business units is a distinct company with their own strategy, revenue mix (software vs. services), profitability profile, and capital requirements. With this backdrop, FDP initiated a more formal review of the group structure and expects to reach a resolution by May 2024, when FDP reports FY24 results. We believe that a separation of the entire structure makes the most sense, but at the very least, the company should separate or monetize KX because its value isn't being rewarded in the current structure.

What is it worth?

KX: this is the most valuable piece of the business and the AI craze has increased interest in vector and time-series databases. Public comps MongoDB and Elastic trade at 17x and 8.5x this year’s revenue, respectively. Private company Pinecone raised $100mm Series B at a $750mm valuation with less than $20mm of revenue. We believe 5x FY24E ARR of £88mm is a reasonable valuation for the business. This puts value for the segment at £440mm. Assuming £40mm of additional capital required to fund KX until cash breakeven, value to FDP would be £400mm

First Derivative: we believe the business is worth ~10x EBITDA. The lowest public IT services / consulting comps (Capgemini and Cognizant) trade ~11x EBITDA. On £20mm of EBITDA, this is worth £200mm

MRP: to be conservative, we are assuming no value.

At these valuations, shares would be worth £21/share, or nearly 100% gross upside from current levels with a potential catalyst coming in early 2024.

Catalyst

Company has announced a review of its current group structure - plans to reach a conclusion no later than May 2024, when FY24 results are reported.