K2Fly (ASX: K2F) – Revenue Ramp up is Just Getting Started: Starting Coverage With a BUY

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Software and consultancy for asset-intense industries

K2Fly Limited (ASX:K2F) provides SaaS-based software and consultancy services aimed at helping asset-intensive enterprise clients, such as Mining and Utility companies, manage their assets and land tenements more efficiently.

The company generates revenues from three sources; recurring revenues from software licenses for its main product Infoscope, which is a data visualization platform that integrates companies’ spatial and land data with day-to-day operational and financial data. Key customers include FMG, Westgold Resources and APIM.

The “The Keeping Place” solution is co-sponsored by BHP, Rio Tinto and FMG along with two Pilbara based aboriginal corporations and governed by The National Trust. K2F anticipates that Infoscope’s recurring Software- as-a-Service (SaaS) revenues will account for the largest part of thecompany’s revenues in the future.

Currently, K2F’s largest revenue generator is Consultancy & Advisory Services. These are services, such as software development, consultancy, and IT systems deployment on a project basis. Customers include Western Power, Programmed, Public Transport Authority and FMG. There is strong synergy between Infoscope and Consultancy services and many opportunities for cross selling.

Lastly, K2F sells third-party software, such as Fieldreach from Capita, in a revenue sharing model. These channel partnerships also provide K2F with cross sell opportunities for Infoscope and Consultancy services.

SAP integration is a game-changer for K2F

K2F recently completed the integration of Infoscope with S/4 HANA,SAP’s cloud-based Enterprise Resource Planning (ERP) solution. SAP is theworld’s largest provider of ERP software and has more than 700 mining companies on the books, including most of the top-20 largest mining companies globally.

In our view, porting Infoscope to S/4 HANA will prove to be a game- changer for K2F given that the company can now target SAP’s Mining customers through SAP’s commercial channels. This includes SAP’s salesreps and the SAP App Centre from where SAP customers can now purchase Infoscope directly.

Many as-yet untapped opportunities in next few years

In addition to the acquisition of Infoscope, which was transformational for K2F, there are many similar acquisition opportunities on the market.

These are smaller companies with strong revenue potential that would benefit strongly if positioned and supported properly, e.g. through integration with platforms such as S/4 HANA. Given its track record with Infoscope, we believe K2F could acquire, integrate and grow such companies very successfully. K2F’s senior leadership team has substantial experience in suchacquisitions.

Additionally, with its technical skill set, K2F can develop additional products and consultancy services going forward. For instance, as SAP’s S/4 HANA gathers steam among Enterprises,i.e. the move towards Cloud-based ERP systems, K2F would be in an excellent position to leverage its existing HANA expertise to service those companies.

Lastly, K2F has been predominantly focused on Western Australia (WA), given the State’smining dominance. However, there is substantial scope to expand the business Australia-wide, both through existing customers’ operations outside of WA and through new customer wins. Furthermore, we also see ample opportunities for Infoscope outside of Australia, predominantly through the SAP integration.

K2F’s revenue ramp up is just getting started: starting coverage with a BUY

Our financial model reflects the strong revenue ramp up we expect in the next several years,which will predominantly be driven by Infoscope. K2F’s current valuation leaves very substantialupside, in our view, towards our price target of A$ 0.58 per share. Consequently, we start our coverage of K2F with a Buy recommendation.

Asset and land management solutions for enterprise clients

K2Fly Limited (ASX:K2F) provides various software products and consultancy services aimed at helping asset-intensive enterprise clients manage their assets and land tenements more efficiently. For instance, through the company’s Infoscope software solution, clients, such as Mining companies, can more effectively manage the land on which they operate.

Targeting the Mining, Utilities and Infrastructure sectors

K2F predominantly targets companies in the Mining, Utilities and Infrastructure sectors, given their large asset bases and large-scale use of land. The current client base is fairly well-spread across these sectors with at least one large client in each of these sectors, including Western Power, Fortescue Metals Group and ARC Infrastructure.

Oil & Gas and Telecoms are other sectors that K2F is targeting with multiple commercial proposals to companies in these sectors outstanding.

Three revenue generators

K2F generates revenues from three main sources, IP licensing, consultancy services and reselling of 3rd party software products.

1. Licensing of Intellectual Property in a Software-as-a-Service model

K2F’s main software product is Infoscope, which is sold in a SaaS model (Software-as-a- Service). Customers pay a recurring fee per user for unlimited access to the Infoscope platform.

In FY18 K2F’s SaaS revenues accounted for approximately 20% of revenues, versus nearly 80% for one-off consultancy revenues. Given the recurring and predictable nature of SaaS revenues, and the associated higher stock market valuation for SaaS companies compared to pure consultancy companies, one of K2F’s aspirations is to generate approximately 50% of its revenues from recurring SaaS business within three years’ time.

Land management through Infoscope

Infoscope is a data visualization platform which integrates spatial data with day-to-day operational information and companies’ financial data.

Infoscope is typically sold to companies with sizeable physical assets and large-scale use of land, such as mining and utility companies, railroad operators and Telecom companies. Through the online Infoscope platform users can manage a wide range of aspects related to the use and management of land, such as:

  • Ground disturbance permits and rehabilitation commitments with audit trails;
  • Environmental obligations, i.e. approval recording, rehabilitation and reporting;
  • Cultural heritage and native title, including survey management, native title agreements and management of objections and obligations;
  • Tenement Management, including leases and agreements, compliance, financial forecasting;
  • Stakeholder engagement, and
  • Land access, i.e. access agreements, entry notices etc.

Infoscope uses a variety of different data sources, such as council and state department tenement data, shire data, drilling databases, ground disturbance plans, GIS (geographic information system) systems, land information databases as well as specific flora and fauna databases.

Additionally, companies’ own data that is already available in SAP can be integrated with Infoscope. SAP is the most widely used Enterprise Resource Planning (ERP) software suites in the Mining industry.

K2F sells its Infoscope solution on a per seat basis, i.e. between ~A$ 1,000 and A$ 2,500 per seat per year depending on the number of licenses a customer buys. The company currently has around 350 subscribers to the Infoscope platform, a number which we expect will grow rapidly on the back of the recent integration of Infoscope into SAP.

The Keeping Place

In addition to commercial customers, such as Mining and Utility companies that use Infoscope for commercial purposes, K2F is involved in a pilot project called The Keeping Place, which is a map-first Infoscope solution developed to provide a central and secure way to manage digital cultural heritage data for the rightful custodians of that data – the aboriginal people.

The Keeping Place is a Heritage Knowledge Repatriation Project in which BHP Billiton, Fortescue Metals Group and Rio Tinto contribute vast amounts of data, collected over the last 60 years, around archaeological heritage, ethnographies and other types of data related to Aboriginal land. Through The Keeping Place, participating Aboriginal communities will be able to easily access all this historical information and drive socio-economic benefits.

Currently, two Aboriginal communities have joined this initiative as founding members; the Nyiyaparli People and the Yinhawangka People. It is expected that more communities will join The Keeping Place going forward.

Not only will The Keeping Place generate training and employment opportunities, the project will also enable cross-generational knowledge transfer and local access and control over cultural heritage information for Aboriginal people.

As the project’s technology partner, K2F generates approximately A$ 100,000 in annual software revenues from The Keeping Place through Western Australia National Trust, which provides project administration and support. This figure is likely to grow significantly in 2019 and beyond.

2. Consultancy and Advisory Services: critical friends and trusted advisers

Most of K2F’s revenues are currently generated through Consultancy and Advisory Services, i.e. A$ 2M in FY18, or approximately 80% of revenues.

This project-based work can be very diverse in nature and scope, but generally involves K2F consultants and advisors being deployed on a time and materials basis, i.e. hourly or daily rates plus expenses, to assist enterprise clients with technology deployment, development and strategic planning.

In many of these projects, K2F’s role could be described as that of critical friend or trustedadviser to its clients, many of whom are tier 1 enterprises, i.e. multi-billion-dollar companies.

Examples include client-specific development of new Infoscope features and the selection and procurement processes of new enterprise software suites, such as ERP and CRM suites.

3. Reselling 3rd party software

K2F also generates revenues from third-party software providers, albeit revenues are modest compared to the other two business lines. In FY18, the company generated approximately A$ 100k in revenues by reselling third-party software. This third-party software is related to K2F’sown products and services, i.e. it addresses similar customers and is therefore highly complementary in terms of sales efforts.

The largest contributor to K2F’s third-party reseller revenues is Capita’s Fieldreach product. K2Fis primarily targeting prospective customers in the Oil & Gas, Rail and Utility sectors with Capita’ssolution.

Fieldreach is a Mobile Inspection and Workflow Management tool that enables companies to efficiently plan remote workflows, provides on-site access to assets’ inspection andmaintenance history and helps to locate assets, above and below ground.

Financials: EBITDA positive in the current financial year

K2F derives revenues from three sources, i.e. the company’s proprietary Infoscope solution,consultancy and advisory services as well as from sales of third party software.

Infoscope is sold in a SaaS model, which generates monthly recurring subscription revenues for K2F. Infoscope pricing per seat/user depends on the number of licenses customers purchase.

The company has set three pricing tiers with prices ranging from approximately A$ 1,000 to A$ 5,000 per user. The company’s largest Infoscope customer, FMG, currently uses ~250 licenses with pricing per license at the lower end of that range. Smaller companies can take off a minimum of 5 licenses at the higher end of the pricing range.

With the SAP porting completed recently, Infoscope can be sold through SAP. K2F’s net revenue per user will be similar to the revenue per user in a direct sale. In selling Infoscope to its customers, SAP works collaboratively with K2F to provide the best solution.

Consultancy and advisory projects are priced on a per project basis with the main variables being the number of consultants, their hourly rate and the amount of time they work on projects.

Lastly, K2F generates revenues from third-party software it sells to its customers in a revenue sharing agreement with the providers of this software.

Infoscope revenues driven by uptake in licenses sales

Based on K2F’s existing sales efforts and the integration with SAP’s S/4 HANA, we anticipate a strong uptick in growth of Infoscope licenses from FY19 (Figure 10). We expect the monthly Average Revenue Per User (ARPU) to tick up in 2019 as new customers, paying full price, come on board, both through direct sales and through SAP. We expect ARPU to plateau around A$ 150 to A$ 160 per month as the customer mix matures, i.e. we expect a good mix of large, mid-tier and smaller new customers to be won. Based on these projections we anticipate revenues from Infoscope to grow to A$ 5.8M by 2021.

Regarding revenues from Consultancy & Advisory services, going forward we assume K2F will be able to retain existing customers, such as Western Power, Programmed and ARC Infrastructure. At the same time, we expect additional consultancy work can be won through direct sales and on the back of cross sell from Infoscope and third-party software customers. This cross sell has proven effective in the past, i.e. in situations where new software customers also starting using K2F’s consultancy services. We have projected K2F’s consultancy service togrow to A$ 3.4M by 2021.

Lastly, we have projected K2F’s third-party software sales to grow to A$ 1.9M by 2021 on the back of Fieldreach and Kony revenues in particular.

Infoscope is expected to become the main revenue generator for K2F longer term, as our projected revenue breakdown (Figure 11) clearly illustrates.

We have summarized our Profit & Loss projections in Figure 12. In terms of gross margins, we expect the SaaS business to generate gross margins upwards of 80%, while Consultancy Services and third-party software sales are expected generate margins of around 25% and 35% respectively.

We have penciled in a relatively small, final, capital raise of A$ 500k in FY19 before the company reaches cash flow break even, anticipated in FY19. However, a capital raise may not be required should K2F be able to win more customers than currently assumed in our model, especially if the company can generate higher than expected revenues from its high margin SaaS business.

Valuation

We have valued K2F using several methods, including a peer group valuation and the Discounted Cash Flow (DCF) method. We have also looked at a take-over scenario in which K2F is potentially taken out by one of the larger ERP or EAM players.

DCF valuation suggest initial upside to A$ 0.58 per share

On our financial projections for the next six years and using a theoretical WACC of 11.7%, we believe K2F’s shares have upside to A$ 0.58. If and when the company further de- risks, e.g. on the back of additional Enterprise customer wins and further channel partnerships, we could see room to potentially lower our discount assumption towards 10% in due time, leaving further upside towards A$ 0.70 per share.

Peer group is valued substantially higher than K2F

There are no pure play peers for K2F listed on the ASX, i.e. companies that specifically sell EAM software to Enterprise customers in a SaaS-based revenue model. However, there are companies selling various other types of Enterprise software in recurring revenues models listed on the ASX, including Nearmap (ASX:NEA), Skyfii (ASX:SKF), Integrated Research (ASX:IRI) and TechnologyOne (ASX:TNE)

We have summarized the EV/Revenue multiples for these companies in. Given that K2F is still in ramp up mode, i.e. EBITDA is still negative, we have abstained from an EV/EBITDA multiple comparison.

The peer group average EV/Revenue multiple for FY20, which starts in July next year, is 4.2x. By contrast, K2F is currently trading at a multiple of 2.1x for that year. While K2F is obviously smaller than NEA, IRI and TNE, and hence should arguably be valued somewhat lower than these larger peers, we would argue that K2F’s revenue growth rate should offset that lower valuation.

Our average projected revenue growth rate for K2F of 87% in FY19 and FY20 clearly outstrips the average revenue growth for the peer group of 37% across these two years. In our view, thisshould compensate for K2F’s smaller revenue base.

Valuing K2F in line with the peer group average EV/Revenue multiple for FY20 yields a share price of A$ 0.60.

Valuation range of A$ 0.61 – A$ 0.72 per share in a takeover scenario

In a scenario where one of K2F’s larger peers potentially wants to acquire the company, we believe a likely valuation exercise for K2F would involve valuing the three separate revenue lines individually, i.e. monthly recurring SaaS revenues are typically valued substantially higher than Consultancy revenues. Not only are revenues from Consultancy and Advisory services one-off as opposed to the recurring nature of SaaS revenues, they also carry a lower gross margin than SaaS revenues. Reselling third-party SaaS products also carries a lower gross margin than proprietary software, but these revenues are typically recurring in nature. Consequently, valuation multiples for third-party SaaS products sit in between proprietary SaaS revenues and Consultancy revenues.

To value K2F in an M&A scenario we have used the following revenue multiples; 5x for K2F’s SaaS revenues, 1x for the company’s Consultancy revenues and 4x for revenues from third- party software sales. We have applied these multiples to our 2021 projected revenues, i.e. as if the company were to be acquired two years from now.

We have divided the resulting equity value by the number of shares outstanding to derive a potential value of A$ 0.64 per K2F share in a takeover scenario.

However, this value of A$ 0.64 per share does not include any takeover premium. Typically, acquisitions in the Technology sector are done at substantial premiums to the market price. Applying takeover premiums, ranging from 20% to 40%, to K2F’s equity value per share, yields valuations ranging from A$ 0.77 to A$ 0.89 per share.

Discounted these valuations back to today, using the theoretical WACC in our DCF model, provides us with a valuation range in a takeover scenario of A$ 0.61 – A$ 0.72 per K2F share.

Conclusion: Substantial share price upside

In determining our price target for K2F we have only taken our DCF calculation and peer group valuation into account. While we certainly believe K2F could become a potential takeover target at some point, we believe it is too early include that scenario in our current valuation.

Based on our DCF and peer group valuations of A$ 0.58 and A$ 0.60 respectively, we believe A$ 0.58 per share is a good reflection of K2F’s share price potential in the next twelve months.

Conclusion: K2F well-positioned for strong growth

We believe K2F has a solid product portfolio in the Enterprise Asset Management space that solves problems that many asset-rich companies in the Mining, Utility, Infrastructure and Telecom verticals struggle with, i.e. how to effectively manage land assets, integrate this management process with ERP software suites and simultaneously comply with environmental and cultural heritage legislation.

K2F’s current customer base, which includes several leading Mining, Utility and Infrastructure companies such as FMG and Western Power, is testament to the company’s strong productand service offering. We expect the company to be able to strongly expand its revenue base in the next five years, in part driven by the recent integration into SAP’s S/4 HANA. This integration with SAP has given K2F access to the richest global ERP customer base in the Mining sector.

We derived a price target for K2F of A$ 0.58 per share. This represents substantial share price upside from today’s level, which is why we start our research coverage of K2F with BUY recommendation.

Near term share price drivers

  • Announcement of new Infoscope customers through the SAP partnership and the porting to S/4 HANA, i.e. confirmation that this partnership “works”.
  • Expansion of business with existing customers, either additional business in the same vertical or cross-sell between the SaaS and Consultancy businesses, e.g. expansion of Infoscope seats or cross selling consultancy work to Fieldreach and Ellipse customers.
  • Increasing visibility on the transition to a higher percentage of recurring SaaS-based revenues as a percentage of total revenues.

SWOT

Strengths:

  • Infoscope is quite a unique product with little direct competition, other than legacy systems developed by customers and prospects in-house.
  • Infoscope’s integration with SAP S/4HANA has strengthened K2F’s position in asset-intensive industries, providing it access to SAP’s >700 mining ERP clients.
  • Licensing partnerships with global companies such as Capita, ABB, Kony and OBIPartners further expands K2F’s customer base and provides additional revenueopportunities through consulting and software maintenance businesses, as well as through cross-sell.
  • Acquisition integration track record (Infoscope) can be used to acquire additional companies, similar to Infoscope in terms of functionality and market segment.
  • K2F’s in-house technical skill set can be leveraged to develop more functionality, products and services, e.g. servicing Enterprises migrating to SAP S/4 HANA.

Weaknesses:

  • In scaling up Infoscope sales, the lack of a large sales force makes K2F in part commercially dependent on partnership agreements with third-party providers of ERP and EAM solutions, such as SAP and ABB.
  • K2F’s size relative to some of its channel partners, customers and prospects may lead to lack of bargaining power, which could potentially lead to sub-optimal business outcomes for the company.
  • K2F may have to raise additional equity if it wants to accelerate growth and/or if working capital requirements increase, for instance if larger customers extend payment terms unilaterally.

Opportunities:

  • Asset-intensive companies are increasingly transitioning to cloud-based ERP and EAM solutions, thereby creating significant growth potential in the SaaS space for asset management tools.
  • Increasing manufacturing activity, a rising number of start-ups and increasing government expenditure on strengthening IT infrastructures are all expected to boost ERP and EAM solutions in the Asia Pacific market.
  • Combined with AI, predictive analytics etc., increasing integration of IoT with ERP and EAM solutions offers substantial potential for growth.
  • The market K2F is addressing is a global market. Therefore, expansion outside of Western Australia (WA) is a clear opportunity, especially in light of the integration with global ERP player SAP.

Threats:

  • More established and global players such as IFS, Infor, IBM and ABB have extensive product portfolios, a better ability to scale up as per customer requirements and greater capability to bring new IoT-enabled ERP and EAM solutions to the market.
  • A downturn in the Mining industry would likely inhibit K2F’s growth potential in thatvertical.

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Pitt Street Research work is commissioned by the listed companies it covers, and Pitt Street Research has received or will receive payment for the preparation of such work. Please refer to the bottom of the research notes as published on Pitt Street Research’s web site for risks related to the companies being covered, as well our General Advice Warning, disclaimer and full disclosures. Also, please be aware that the investment opinion in this report is current as at the date of publication but that the circumstances of the company may change over time, which may in turn affect our investment opinion.



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