Time for technology
PUBLISHED : 24 Jun 2010 06:34:00 | Tony Featherstone
Relatively speaking, the software and services sector has more small and mid-cap opportunities than many industries at this point in the economic cycle. Some software companies offer better earnings visibility because of recurring annual licence sales – important in a shaky market. Other technology service companies are a play on more business investment later this year or next.
Several of the sector’s best-performing companies have been covered in this column, among them fast-growing automatic teller machine company Customers and financial data company IRESS Market Technology.
The table lists the sector’s top 25 companies by market capitalisation. Their median return on equity (27 per cent) shows the power of software companies with high-margin, recurring annual sales or long contracts. In all, the sector has 70 listed companies. Almost half are valued at less than $15 million, making them too small and speculative for most investors.
The sector’s diversity is challenging. The largest company, Computershare, is bigger than the other 69 combined. The second-largest, Carsales.com, is oddly classified, given it is effectively a media company, and the third-largest is IRESS.
Those wanting purer software and services exposure must dig deeper. Break the sector into three groups: software companies with recurring product sales; technology service companies with large clients; and industry plays. The first group has immediate appeal as more profit downgrades for small industrial companies filter through. Market expectations for aggregate small industrial company earnings in 2010-11 are still too aggressive.
Companies such as accounting software provider Reckon offer more defensive, recurring sales. Reckon has almost doubled from its 52-week low of $1.07 and is on a forecast price-earnings ratio of 15.2 times 2010-11 earnings, analyst estimates show. After such a strong rally, prospective investors may wait for share-price weakness before buying Reckon.
More opportunities exist in service companies, which should benefit as organisations increase technology investments in the next two years. The pick of the lot, SMS Management & Technology, looks well placed to capitalise on strengthening demand for technology services. A strong recruitment program this year could give SMS an edge over rivals affected by skills shortages.
Northern Territory systems integrator CSG is well liked by leading small-cap fund managers, such as Pengana. CSG this month announced $22 million in new business, including a seven-year contract with the Victorian Department of Treasury and Finance. CSG said it closed $100 million worth of “annuity revenue” contracts in the past quarter in the Northern Territory, NSW and Victoria. After rising sharply in the past 18 months, CSG is on a PE ratio of 14, which falls to about 9 in 2010-11 on some broker forecasts – reasonable given CSG’s growth prospects.
DWS Advanced Business Solutions is also interesting. DWS soared from a 52-week low of 70¢ to a 52-week high of $1.85 before easing to $1.18. With a vision to become Australia’s largest listed IT services provider, the aggressive small-cap has made four acquisitions since its 2006 listing. Performance has been strong, with earnings-per-share rising from 5.48¢ in first-half 2009 to 7¢ in first-half 2010, and the fully franked interim dividend gaining 1.5¢ to 5¢. A forecast 2010-11 PE of 7.5, averaged from two broker estimates, is interesting.
Also, small-cap Technology One is well supported by fund managers, and eServGlobal recently announced the proposed sale of its telco billing business to Oracle for up to $113 million – slightly less than the company’s current valuation. This looks like a good deal for eServGlobal, which will concentrate on other parts of its business.
Top 25 listed software and service companies
| Company | Market cap $m | Return on equity* % |
| Computershare | 6,346 | 32 |
| Carsales.com | 1,128 | NA** |
| IRESS Market Technology | 1,093 | 35 |
| CSG | 455 | 27 |
| Customers | 395 | 4 |
| SMS Management & Technology | 368 | 31 |
| Reckon | 273 | 34 |
| Redflex Holdings | 263 | 16 |
| Technology One | 237 | 28 |
| ASG Group | 205 | 18 |
| Oakton | 199 | 23 |
| Melbourne IT | 176 | 19 |
| DWS Advanced Business Solutions | 156 | 31 |
| UXC | 135 | 9 |
| RP Data | 130 | 18 |
| eServGlobal | 128 | –7 |
| Data#3 | 124 | 42 |
| Hansen Technologies | 90 | 18 |
| Infomedia | 86 | 30 |
| GBST Holdings | 66 | 5 |
| Integrated Research | 66 | 29 |
| itX Group | 50 | 38 |
| Bravura Solutions | 48 | 12 |
| Adacel Technologies | 39 | 37 |
| Objective Corporation | 39 | 28 |
| Median | 27 |
BRW
Tony Featherstone
Contributor
Tony Featherstone is a former managing editor of BRW, Shares, Personal Investor, Asset and CFO magazines. He writes a weekly column for the Australian Financial Review and BRW magazine, specialising in small listed companies, initial public offers (IPOs), entrepreneurship and innovation. Tony also writes a weekly blog on entrepreneurship for The Age, and lectures in entrepreneurship and innovation at Swinburne University.
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