Description

At 2021e 8.5x P/FCF or 7.9 EV/EBITDA, I believe Umanis is trading at a compelling valuation for a company that over the last 16 years has always been FCF positive and grown revenues per share at a 12% CAGR. I believe Umanis is an easy double in three years, maybe a triple if it continues executing on its M&A strategy, while offering a low risk due to is sticky base of customers which generate recurring revenues.

Umanis was created in 1990 and is today one of the largest Digital Services Companies in France. It implements IT solutions, namely in the areas of Big Data and Artificial Intelligence. The IT services sector in France has been growing historically at ca 3%, while Umanis has managed to grow organically a bit more than that (ca 5%). Additionally, Umanis is a roll up story: The IT consulting sector in France is highly fragmented. Umanis finds lots of opportunities to buy companies from founders who want to retire. Often, those companies are not managed efficiently and Umanis can optimize their cost structure. In the past, Umanis has been able to acquire companies at 0.60-0.85x EV/sales.

I like Umanis because it ticks all the boxes on my investment checklist:

• Highly sticky and recurring revenue: Since 2005, revenue has only decreased in three years (2009: -7.5%, 2010: -1.4% and 2020: -2.0%), which shows that a very high percentage of revenues are recurring. The company has been FCF positive in all years.

• Barriers of entry: French companies want French speaking consultants, which minimizes foreign competition. Within France, they are a low-cost provider (young staff), whereas the incumbents have a much older and expensive staff. Laying-off employees is extremely expensive in France due to strong labor unions and a very protective labor legislation, which hinders restructuring efforts by incumbents.

• Revenue growth: Revenue has grown at a 12% CAGR from EUR 38M in 2005 to EUR 214M in 2020, through a combination of organic growth and acquisitions.  Umanis benefits from secular growth trends in the IT consulting sector and has been able to outperform the average industry growth by offering lower prices than incumbents

• EBITDA margins expansion: EBITDA has grown at 33% CAGR over the same period due to an expansion of gross margins as the company grew the scale of its operations and streamlined acquisitions (more on that later).

• Excellent capital allocation: The company issued shares when the share price was high and opportunistically bought them back when the price was low. As a result, there is the same number of shares outstanding today as 15 years ago. Further, they have collected more by issuing shares than what they have spent on repurchasing shares over these 15 years.

• Very high insider ownership and moderate executive compensation.

• Compelling valuation: 8.42 P/FCF on my 2021e figures, which consider the acquisition of Adolphus in Q1 2020 (EUR 20 mm in run-rate sales for 2021) and the guidance provided by the company.

• A catalyst to realize value.

Why is Umanis cheap?

Firstly, in general in West and Southern Europe and specially in France, small caps are cheap

Until 2016, Umanis had historically traded at ca. 0.5x EV/sales with operating margins about 5%. In 2017, Umanis was able to improve operating margins up to 10%. This happened as the company gained scale and contracts signed during the financial crisis rolled over on better terms. Net income increased over proportionally from EUR 12mm to EUR 20mm and the share price tripled to 1.8x EV/sales or EUR 15 per share. However, soon thereafter salaries for engineers in France started to increase rapidly, reflecting a tightening labor market. As Umanis cannot increase prices immediately, margins decreased again, net profit returned to EUR 12mm per year and the share price fell to EUR 4 per share.

Where are we now?

EBITDA margins had a strong recovery in H2 2019 as IT companies were able to reflect higher labor costs in their prices (H1 2019 7.6%, FY 2019 10.1%). In H1 2020 EBITDA contracted slightly to 9.2%, with a good Q1 and a not so good Q2 following the COVID outbreak. However, the company ended FY 2020 with EBITDA margins of 11.2%. In my model, I have assumed that EBITDA margins will remain constant for the following years for the sake of conservatism. However, I think it is likely that Umanis has optimized its cost structure during Covid (salaries and leases).

On March 11, Umanis acquired Alphonse. Alphonse had revenues of EUR 20mm in 2020 and, according to the company, a profitability in line with that of Umanis.  Revenues from Alphonse have not yet hit the P/L for an entire reporting period. However, the company did incur significant debt to prepare for acquisitions and the interest expense has been hitting the PL over the last reporting periods. The next fillings will show the additional contribution from Alphonse. Further, either the company finds an acqusition target or it will reimburse the loan, thus reducing interest expense.

How much is Umanis worth?

As shown on the table below, Umanis trades at 7.9 EV/EBITDA, 0.8x EV/sales and 8.4 P/FCF on my 2021e numbers.

I work with three scenarios:

• Bear case: EUR 10-12 / share: the company does not re-rate and does not manage to grow inorganically. Absent M&A opportunities it buys stock back (Umanis is already buying stock every day in the open market. At current prices, this yields 11% return). In case they cannot deploy all cash flow into buy backs, they will pay debt down, which reduces interest expense and puts pressure on EV/sales and EV/EBITDA metrics (this is what I have considered in my model). If the stock simply pays down debt and the multiple stays at 8.4 P/FCF this will yield a ca 4% annualized return till 2023, plus any accretion from buy backs. I believe the current valuation (8.4x FCF) and the buy back scheme provides a floor to the current valuation.

• Base case: EUR 18 / share: as normalization of EBITDA margins becomes visible, the company re-rates to a multiple more consistent with its recurring revenue stream and the excellent capital allocation skills of its management. I believe a 15x P/FCF multiple is not a stretch in today’s market. This yields a more interesting 26% annualized return till 2023.

• Bull case: EUR 25-35 / share: the company executes on its M&A strategy, as it has consistently and successfully done for 15 years. Management has publicly stated they aim at revenues of EUR 400mm in 2024. If that happens, and the stock re-rates accordingly to 20x we are looking at annualized returns in the neighborhood of 60%.

Umanis is not alone in trading at such low valuations. In fact, the whole Southern European IT sector trades very cheap (and in a couple of cases controlling shareholders have attempted to take the companies private). However, when compared to a selective group of peers, I believe it offers margins and growth rates above the average for a valuation below the average.

*Takeover bid by controlling shareholders

Catalyst

Contribution from Alphonse becomes visible in the P&L.

Recovery of EBITDA margins becomes visible in the P&L.

M&A and/or buybacks