Stock Picks | Vianet - Going With The Flow?

18th Jun by illiswilgig

3 comments 168 reads

Time for a new thread on Vianet (LON:VNET)

Mainly because I was away for the recent prelims 11th June - and it takes me a while to ponder things. my insight can take weeks to emerge - and the result commentary I placed on the SCVR will soon disappear.

I’m a full-time investor with a small portfolio exclusively in UK listed small cap companies. I look for cheap entries into long term growth opportunities. I much prefer companies where there is a transformation underway and the investment is self-funded – the existing business can help to obscure the prospects of new businesses and products getting me a cheaper entry. There is also a higher than usual risk that the transformation does not succeed, but the existing business can limit the downside in comparison with blue sky, no revenue, capital devouring companies?

There have been a few of these opportuniites coming to light post-pandemic (with MS International (LON:MSI) Goodwin (LON:GDWN) in my own portfolio) where after years in the underperforming wilderness the companies are beginning to perform strongly thanks to long term investments in products, operations and people often in new and growing markets. A strong narrative but the light well hidden under the bushel of the existing often declining business, which allows me a cheap entry to what is often still seen as a value rather than growth company, though almost inevitably too early. I don't tend to distinguish between value and growth so strongly just as a wide range of relative characteristics.

Is Vianet (LON:VNET) another such successful transformation? I was too early, again, There are now promising signs of success, though as usual only hindsight will deliver the answer? So why am I invested when the commentary, particularly in this place, is so downbeat?

Vianet (LON:VNET) describes itself as ‘Tranforming business performance’ through ‘alerts, actionable data, remote asset management, insight and contactless payment – delivering increased profits in the hospitality, vending, unattended retail and machine management sectors.

https://vianetplc.com/

Some remember the company as Brulines when it listed on AIM in 2006 – the primary product being draught beer flow-monitoring in pubs. A business that has seemed in terminal decline in recent years as the rate of pubs closing has increased.
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illiswilgig

18th Jun

My commentary from the June 11th SCVR on the FY24 Prelims

illiswilgig Joined 2010 307 posts Yesterday 9:09 am

Vianet (LON:VNET) Prelims – Been out of digital reach in a meadow in Somerset (entirely by choice). Now catching up – and to be honest it takes me quite a while to ponder. So late to the party again! Not that there seems to have been much celebrating for Vianet (LON:VNET) recently?

The view in this place seems very downbeat? On that basis I’d see an amber rating as quite an achievement? Never mind, as a contrarian I’m entirely used to it. Indeed I’m continually searching for growth companies hiding in plain sight – and for that to happen there has to be a downbeat narrative?

I shan’t be arguing with Pauls excellent short summary. It sets out the history very well. I’m not so sure it sets out the future though, and there we are all entitled to our opinions, as none of us know what the future holds.

There are a few things in the results and the past year that point to there being quite a turnaround underway?

Revenue: £15.2m is still £1.1m below the FY20 (year to march pre-pandemic) £16.3

Profit: barely off the ground at £0.8m compared with £2.43m in FY20

So far, so nothing special, however

Gross margin: is high and at 69% in FY24 is 1% above FY20 at 68%

Operating cashflow (pre wc) at £3.929m is also above FY20 £3.722m

Higher gross margin and higher operating cashflow on lower revenue can be an indicator of a more profitable company with operating leverage will occur as revenues rise. If they do!

Recurring Revenue: 85% in FY24 is below both FY23 88% and FY20 92%

Is there a reason for this? I think so – the non-recurring sales relate to the installation of new connections to sites and machines after which they become recurring revenue. Provided that absolute recurring revenue is still rising – which it did marginally to £12.94m in FY24 – then the reduction in % recurring revenue indicates an increase in new connections feeding growth in FY25.

As well as increasing connections the profit per site and device grew in FY24 as customers make more use of the connections - particularly for contactless payment services.

The elephant in the room is the capitalisation of R&D costs. With FY24 amortisation at £2.164m it’s highly significant. Close to wiping out the statutory profit. The obvious concern is that the capitalised costs may be operational rather than capital costs. A way of propping up apparent performance at EBITDA level. The question does not arise if development costs are expensed as they arise. Though its not clear to me why this is a concern in this case and VNET may not have much choice in the matter. My understanding is that significant tax rebates and reliefs are available but only for R&D that is eligible. And only if capitalised. In FY24 HMRC paid a rebate of >900k and the company claimed R&D tax relief of >800k. The high level of rebates and reliefs indicate that HMRC is satisfied that the R&D is real and eligible – though thats not an indicator of future success unfortunately.

Recent products and trials underway include:

Hardware module with uploadable modular software (outsourced manufacture)
Software as a Service platform migrated to the cloud (resulting in VNET becoming a software and service company)
Customer portal for real time analytics, management and data insight (insight allows sector wide access to data on what customers are drinking/buying on a near real time basis)
Contactless payment services
Mobile payment services (in trial)
Forecourt services (two large contracts rolling out with automated car wash providers)
Beverage stock management module (including automated ERP integration – in trial in UK, in operation in US)

Management has stated that R&D spend has peaked – FY24 capitalisation of development is £1.24m significantly below the FY24 amortisation charge. Management indicates a likely eventual reduction to £1.5m (though to be frank with the recent acquisition of the inventory management platform - I see more development is likely in the short term)

Debt reduction: Despite development spend, cost of changing finance facility, costs of BMI acquisition and integrating the US teams, limited share buy-backs and paying a dividend there was enough cash to pay down net debt by around 50% or £1.78m (partly due to the HMRC rebated cash).

Valuation and FY25 outlook:

I agree that the shares are not cheap at 115p. They were a lot cheaper when I last bought, but arguably now they are backed by improving numbers there is less downside risk? The prelims are vague (as ever) on FY25 numbers, forecasts are for 13% increase in revenue to £17.1m and profit rising by 230% to 6.2p which puts the shares on 18.5x current year profits.

Not expensive if you view it as a software and service company with strong growth – but very expensive if you regard it as a cashcow in decline with the new products unlikely to generate real growth. Only the future will determine which it turns out to be?

Worth noting that the FY24 in-line results were softly upgraded by brokers Cavendish after the April24 update. Historically management have been too quick to promise growth and then underdelivered. Though in recent years they are hardly alone! Nevertheless we may have entered a soft-upgrade cycle in which management remains upbeat whilst brokers quietly raise forecasts on new contract announcement or after the interims?

According to management (on the recent IMC presentation) there is enough growth within existing customers (land and expand) to satisfy the FY25 forecasts – without new large contracts. The company aims to demonstrate that the Vianet platform recovers the cost of installation for customers within 3 – 6 months – through reducing wastage, stock leakage, increasing quality, improved service levels and stock availability across estates - and thereafter customers save more by adding further sites or machines to the system. Which means that large new contracts, specifically the forecourt car-wash rollout, and the US BMI platform are not included in current forecasts.

Management. Management is a big issue for me. I have to agree that I find it hard to warm to the longtime executive chairman/CEO (and largest shareholder) and the CFO. On the other hand I don’t have to like them but competence at managing their team with integrity is important. They appear to be straight talking – but not smooth or friendly. Maybe its a County Durham thing? They do appear to have recently put in place a complete senior management team (see https://vianetplc.com/about/ ), a good step in preparation for significant growth. In the past I have fallen for too many smooth-talking CEO’s – so I’m cautious and sceptical, don’t see any red flags and willing to give them a little rope.

Management Sharedealing: I like founder and owner managed businesses as long term investments. In addition to longterm buying by James Dickson (17.9%) the largest shareholder, Stella Panu, recently appointed NED with extensive tech experience, bought 310k shares at a cost of £216k over 18 months.

My opinion? After the recent strong shareprice performance I’m somewhat surprised to find Vianet (LON:VNET) is my second largest holding. The shareprice is up with current events – but at the moment I have no intention of selling. It seems to me that the company now has the right products in the right sectors with considerable market opportunities. Will they capture the growth? On current performance I think it’s very likely that they will meet forecasts for FY25 – but it’s the potential upside that I am after - more rapid expansion - now that the company is operating as an increasing SaaS business. In which case the current price will start to look cheap in 1 to 2 years. Nothing is guaranteed, but I do prefer a growth opportunity hiding in plain-sight, profitable, cashflow generative with operational leverage to those that have to come back to the market for more funds?

Analyst notes: Both Cavendish (house broker) and Capital Access have new notes out and freely available on Research Tree. The Cavendish note is particular thorough on the products, opportunities and new senior management team. Well worth a read if you are interested, or already invested.

Cheers

Mark

Vianet - Going with the flow?

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Illiswilgig

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