Cirrus Networks

Cirrus Networks Holdings Ltd

About the Company

Cirrus  (CNW) is a mid-tier IT services company with a presence in WA , VIC, and ACT. It focuses on servicing government agencies and corporates with between 200 to 2000 employees, and operates in three segments, each with different quality characteristics:

1. Enterprise Products – Resale of hardware and software. This revenue is low margin and competitive with a lumpy revenue profile.
2. Professional Services – IP Consulting, architecture, integration, and support services.  This has stronger margins and is less commoditised.
3. Managed Services – Cloud & DC, niche managed services, outsourcing, and XaaS, Maintenance/Asset Management. This is the highest margin and highest quality revenue as it is recurring in nature.

With a focus on ACT and WA, it is not surprising to see large exposure to government and resources spend.

History

Since listing in 2014, the company has achieved organic and acquisitive revenue growth but had failed to achieve profitability in line with revenue growth. A turnaround plan was instigated back in October 2021 when the board rebuffed a takeover offer from Web Central, changed its CEO, started a $4m cost reduction plan focussed on eliminating middle-management  to get the company to profitability, and set a strategy to drive the focus away from the competitive Enterprise Product segment into Managed and Professional Services.

The Turnaround

In early February, Cirrus (CNW) released its 1H23 results declaring the turnaround was complete, reporting strong revenue and profit growth for the half. As we can see below, CNW has certainly met its financial objectives for profitability. During the period it has also won some key managed service contracts that have contributed to the turnaround, while others will contribute to earnings growth in future periods. Margins have improved, the quality of revenues is improving, and the business now has a coherent strategy and is executing strongly on its goals. It is unusual for a turnaround to be completed so quickly and with so little disruption to the business. Credit must be given to CEO Chris McLaughlin for execution.

Our Investment

After following the business for a number of years, we took a position in CNW in August 2022 as part of the Web Central selldown at 3.2c. At that time, the turnaround was well advanced as CNW had reported a strong 2H22.  Encouragingly,  there had also been strong director buying throughout the year.  We increased our exposure after the 1H23 result as the investment thesis de-risked, but felt this was not yet reflected in CNW’s pricing as we discuss below.

Current and Future Earnings Stream

CNW’s reported EBIT over the last 12 months was $3.1m. It starts 2023 in a strong position. Two new managed services contracts currently being onboarded should add $1.4m to FY24 as they are rolled out during 2023, providing a proforma EBIT of $4.5m without any organic growth factored in. In addition, CNW enters 2023 with a record backlog of $16.2m in product sales yet to be invoiced, equating to ~$1m of EBIT, which together with the momentum in the services segments suggests a strong second-half outlook. The pipeline for new managed services contracts is encouraging, and if CNW can continue to secure two new medium-sized contracts each year, that should add around $1m in incremental recurring EBIT annually, supporting a strong ongoing earnings growth profile.

The company currently has $9.4m in cash and no debt, however, CNW is expected to have a strong second half of cash generation, driven by government purchasing cycles, and is likely to finish FY23 with close to $13m cash. With a market capitalisation  of $32.5m(@3.5c) and its current cash of $9.4m, CNW has an EV=$23.1m. Consensus EBIT for FY23 is $3.8m resulting in an EV/EBIT = 6.1X.

As a reference point, this compares to closest peers Data3 (DTL) and  Attuara (ATA) which are trading on  FY23 EV/EBIT=19X and 9.6X  respectively providing reasonable upside as CNW achieves market acceptance.

Acquisitions

We would expect the excess cash to be deployed into an acquisition for a new territory or complementary services E.g. cyber security. This could add $1.5m+ EBIT without any debt. Therefore, we could exit FY24 with a run-rate EBIT of $6m. Assuming a full tax rate, this would equate to a NPAT of $4.2m. At a share price of 3.5c the market capitalisation  is $32.5m implying a PE=7.7X.

Takeover Potential

The ASX has had a lot of takeover activity in the IT services space and it appears to be accelerating with rollup plays like Atturra especially active recently. Shown below is a summary recent transactions. We see CNW as an attractive target as they grow into a substantial managed service business with a government-accredited NOC (Network Operations Centre).

Summary

CNW ticks a number of boxes for us: strong management, a strong balance sheet, a growing earnings profile, and strong cash generation. Its growth is supported by strong IT market and industry tailwinds, as corporates and government drive digital transformation agendas. It remains very much under the radar and unloved, and, as a result, trades on very attractive earnings multiples and at a significant discount to its larger peers. This attractive valuation and growth outlook means there are multiple ways to win from current pricing: 1) a multiple re-rate closer to its peers 2) additional managed services contract wins increasing the quality and the level of CNW’s earnings 3) an accretive internally funded acquisition improving the range and/or reach of CNW’s services and 4) attractive takeover candidate. We like the potential from here.