Disclaimer – As at the time of writing this article, I own shares in Adapt IT.
During times when we’re facing economic downturn, it’s not easy to stick to your investing strategy and one starts to doubt their valuations. With that said, I’m going to write down my thoughts and opinions on my valuation of Adapt IT and reflect back on this a couple of years down the line to (hopefully) prove that I haven’t gone insane and that investing in value rich companies is not a thing of the past.
In a nutshell, Adapt IT is a specialised software business, with a large chunk of that being in-house developed software. The biggest advantage of this? Scalability. Once the software is developed and ready for use, the costs to implement said software at a new customer would be relatively small. This also largely mitigates the reliance risk placed on entities such as Microsoft cancelling their license agreement with you (think EOH).
How often do you hear about a company switching IT Systems? From IT to finance to operations, it’s an absolute nightmare. So how often would you expect existing customers to switch from using Adapt IT’s software? Once a contract is tied down, it’s almost guaranteed annuity revenue. Regardless of what economic conditions are, revenue should be fairly constant. Furthermore, their software is highly customisable and thus brings about a niche offering to their clients. As far as I’m aware, there aren’t any other big ICT players in the market who are able to provide this offering.
After considering the above, I’ve started plugging in the figures into my DCF and got to a value R13.26 a share, which seems like a bit of a stretch seeing as the share is currently trading at R5.6….but hear me out. I’ve applied a very conservative growth rate of 6% (CAGR in revenue adjusted to account for the economic recession and the fact that it is a small cap which implies higher risk) and applied a cost of equity of 15%. With a gearing ratio of 29% and the entity being highly cash generative, one could perhaps even argue that my above assumptions are overly prudent? With a PE ratio of 7.45 and interim results showing 4% growth in revenue during a technical recession, I‘m struggling to see the downside here.
So why is the share trading at a 142% discount? Your guess is as good as mine, however, assuming my valuation is correct, my guess is that it boils down to negative market sentiment over small-caps in the current market conditions (and SA Inc. as a whole) and Adapt IT being constantly labelled as ‘another EOH’. Unless something fundamentally changes, I continue to hold shares in Adapt IT.
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